Roast Ltd is an independent coffee house chain that was established in the UK in 2008. It has become a well-established part of the popular café culture that has developed alongside the emergence of the digital age, with workers taking their mobile devices to their local café to benefit from wifi, a caffeine boost and possibly something to eat, as an alternative location to their desk. To face off competition, Roast Ltd has built its brand strength on the fact that it is independent. Paola King, the chair of the company since their inception, and formidable driving force behind their success to date, cites their USP as follows: “We offer an alternative to the big brands: we are all about employing local people, and giving something back to the high street; our coffee shops are not cookie-cutter duplications of each other, they all have a certain character depending on their location, and that’s important to us in this increasingly globalised and corporate world. This is a family business, proud of its Italian heritage and inspiration: my parents were from Rome, and we use only the best Italian technology in our coffee machines and follow Italian brewing processes to ensure that every cup of Roast coffee is on a par with what you’d get in a top Italian caffè.” It may be smaller in size than its big brand competitors, but that hasn’t limited Roast’s ambitions, as it is currently in the middle of a two-phase expansion strategy: • Phase one – which commenced at the start of 2017 was the opening of a chain of coffee shops in Romania. This has been slow to get going: the launch was initially anticipated for midway through 2017, but ultimately sales only started in January 2018. • Phase two – In 2019 Roast Ltd is seeking to use its strong supplier contacts in Italy to acquire a share in a coffee machine manufacturer for which it needs to secure finance of a further £400m. 7 Exhibit 1: Extracts from Roast Ltd’s Financial Statement for 2018 Roast Ltd Statement of Profit or Loss for the year ended 31/12/18 2018 2017 £’000 £’000 Revenue 2,534 2,022 Cost of Sales (1,990) (1,505) Gross Profit 544 517 Other operating income 60 0 Operating Expenses: (477) (466) Operating Profit/(Loss) 127 51 Finance costs (26) (6) Profit/(Loss) before Tax 101 45 Income Tax expense (20) (9) Profit/(Loss) for the period 81 36 Note 1 – Extract of supporting notes for the Statement of Profit or Loss 2018 2017 Operating Expenses £’000 £’000 Employee expenses 227.7 269.9 Directors remuneration 35.1 51.8 Bad Debt charges 7.9 5.3 Utility costs 22.8 26.2 Legal and Professional fees 3.6 28.7 Depreciation charges 31.7 20.9 Store maintenance 72.2 27.6 Distribution costs 29.2 8.9 Marketing & Advertising costs 46.8 26.7 477.0 466.0 8 Roast Ltd Statement of Financial Position as at the end of 31/12/18 2018 2017 ASSETS £’000 £’000 Non-current Assets Property, Plant and Equipment 996 670 Current Assets Inventories 299 120 Trade and other receivables 148 93 Cash and cash equivalents 0 134 447 347 Total Assets 1,443 1,017 EQUITY AND LIABILITIES Equity Share Capital 200 200 Retained Earnings 660 579 Total Equity 860 779 Non-current Liabilities Long-term borrowings 275 100 275 100 Current Liabilities Trade payables 235 138 Bank overdraft 73 0 308 138 Total Liabilities 583 238 Total Equity and Liabilities 1,443 1,017 Note 2 – Extract of supporting notes for the Statement of Financial Position Retained earnings column only Retained Earnings 2018 2017 £’m £’m Opening balance 579 573 Profit for the year 81 36 Dividend paid 0 (30) Closing balance 660 579 9 Roast Ltd Statement of Cash Flows for the year ended 31/12/18 2018 Cashflows from operating activities £’000 £’000 Operating Profit 127 Adjustments for: Depreciation 32 159 (Increase)/Decrease in inventories (179) (Increase)/Decrease in trade and other receivables (55) Increase/(Decrease) in trade payables 97 Cash generated from operations 22 Interest paid (26) Income tax paid (20) Dividend paid 0 Net cashflow from operating activities (24) Cashflows from investing activities Purchase of Property, Plant and Equipment (358) Net cashflow from investing activities (358) Cashflows from financing activities Proceeds from long-term borrowings 175 Net cashflow from financing activities 175 Net increase/(decrease) in cash and cash equivalents (207) Cash and cash equivalents at the start of year 134 Cash and cash equivalents at the end of year (73) 10 Exhibit 2: Notes from a meeting between the Loan Officer at Finance Bank and Roast Ltd’s Chief Financial Officer, Dan Shaw Purpose of meeting: to begin to consider whether Finance Bank is willing to finance Roast Ltd’s second phase of expansion into Italy. Dan Shaw talked through the company’s latest financial statements set out in Exhibit 1. The following points were noted: • 2018 has been a good year for the company, with the increase in revenue indicating that phase one of the expansion strategy has been successful, despite the delay to the initial launch that was originally planned for 2017. • The split of Roast Ltd’s revenue by country is set out below Country Revenue 2018 Revenue 2017 £’000 £’000 UK 2,184 2,022 Romania 350 0 Total Revenue 2,534 2,022 • Roast Ltd always prided itself on high quality ingredients, but the increasingly public scrutiny of supply chains combined with trends for organic and fair-trade coffee beans have led Roast Ltd to experience a small increase in their product costs, which they have not been able to pass on to consumers. • The expansion into Romania required new investment in the properties and equipment of a chain of coffee houses based there. All legal costs relating to this were completed in 2017. • Early in 2017, a supplier called Caffè Tostato was accused of stealing and copying a number of Roast Ltd’s brand designs. This resulted in a lengthy court case during 2017 and lots of media interest. In January 2018 this case was decided in favour of Roast Ltd. Caffè Tostato was ordered to pay them £25 million in legal costs and £45 million in damages. • Roast Ltd has been focused on cutting costs across the business and the following was noted: o The general reduction in the global price of oil in 2017 meant that Roast Ltd was paying less for their power and heat. o Roast Ltd outsourced various business support areas, which included payroll, human resources, finance and customer support teams to an external service provider. o This outsourcing resulted in 13 of Roast Ltd’s employees (out of a business support workforce of 20) being transferred to the external service provider. 11 o The outsourcing exercise did not impact on the company’s production workforce, only the support functions. o This outsourcing exercise also resulted in a review of the company’s board structure and various changes occurring in 2018, which included: § Roast Ltd’s previous Marketing and Human Resources director resigned his post due to ill-health. Rather than replacing him, Roast Ltd’s chair Paola King has decided to combine the role with her role as chief executive for no additional salary. § In an attempt to make the company leaner and more focussed on generating shareholder wealth, it was decided not to re-elect or replace its Non-Executive Director, effectively removing this role from the board’s structure. • Roast Ltd’s customer base is almost entirely individual consumers, but it does also have a branded coffee bar in the offices of a handful of companies. Normal payment terms for the business customers are 30 days from receipt of goods (when the sales invoice is provided). However, in 2018, one of Roast Ltd’s main business customers suffered cash flow difficulties and negotiated an increase in the payment period from 30 to 90 days.  12 Exhibit 3: Investment Appraisal – Romania expansion figures drawn up in 2016 for 2017 onwards Investment – New Product Lines Initial Investment £500m Management Forecast Year 1 Year 2 Year 3 Year 4 Year 5 £’m £’m £’m £’m £’m Revenue 300 560 740 900 1,120 Variable costs (240) (448) (592) (720) (896) Contribution 60 112 148 180 224 Notes: Year 1 = 2017 Contribution represents the cash inflows Payback Period Time Cash flow Cumulative Cash Flow £’m £’m 0 (500) (500) 1 60 (440) 2 112 (328) 3 148 (180) 4 180 0 5 224 224 Assuming that the cash flows occur evenly, payback period will be 4 years Accounting Rate Of Return ARR = Average annual profit from investment x 100  Average investment Roast Ltd has a target ARR of 10% Year Cashflow Notes: £’m Ave. Annual Profit = (724 -500)/5 years = £44.8m 1 60 Ave. asset value = 500 / 2 = 250 2 112 ARR = (44.8/250) x 100 = 18% 3 148 4 180 5 224 724 13 Net Present Value Time Cash flow Discount Present Factor Value £’m 5% £’m 0 (500) 1.000 (500) 1 60 0.952 57 2 112 0.907 102 3 148 0.864 128 4 180 0.823 148 5 224 0.784 176 NPV 110 Note: The cost of capital is 5% End of case study 2.2. Assessment Submission Structure Executive summary Part 1: Industry Review Part 2: Business Performance Analysis 2.1 Statement of Profit or Loss 2.2 Statement of Financial Position 2.3 Statement of Cash Flows Part 3: Investment Appraisal and Sources of Finance 3.1 Investment Appraisal • Management Forecast • Investment appraisal Techniques • Payback Period • Accounting Rate of Return • Net Present Value 3.2 Sources of Finance