Cash flow Clue-doh! The Mystery is Revealed…
Over 1,500 colleagues have now downloaded our cash-flow murder mystery activity - Cash Flow Clue-doh! And we’re getting an increasing number of enquiries asking what the solution is!
So why did Peston Plastics get put into receivership? The answer (as with all questions in Business Studies) is...it depends!
However, the clues are in the evidence (which students gain access to by getting questions on cash flow management correct).
Exhibit 1 (Balance Sheet):
- Clear deterioration in the financial position between 2007 and 2008
- An increase in stocks and trade debtors is not matched by the higher trade creditors = a worsening of the working capital position
- A substantial cash outflow and increase in bank borrowings
- A reduction in shareholder funds: caused by a combination of losses in 2008 and a possible dividend payment too?
Exhibit 2 (Profit and Loss Account)
- Sustained falls in revenues (2006, 2007 & 2008) contribute to a £20m fall in operating profit between 2006 and 2008
- Cuts in operating costs not enough to offset a sharp decline in gross profit margin
- Significant increases in bank interest payable, reflecting higher levels of bank borrowings and overdraft
Exhibit 3 (Cash flow forecast)
- Substantial cash outflow on fixed assets in Jan-April 2008
Exhibit 4 (Memo from Ray Bodger)
- Net cash outflow for 2008 of over £30m
- Suggestion that the bank is unhappy
- Bank overdraft limit has been reached (key)
- Need for “continued support” of the bank
- Impending bank loan repayment of £1.5m
- Deterioration in cash flow from major customers
- Seasonal cash flow problem coming up - buying production raw materials
- Suggestion in the last line that the bank is not aware of the dire financial position
Exhibit 5 (Ratio Analysis)
- Confirmation of the calculations that students might do on the P&L and Balance Sheet
- Gross profit margin is a major concern
- Significant deterioration in liquidity ratios
Exhibit 6 (Press Cuttings)
- The cause of the £30m investment in fixed assets is revealed - a major factor extension (increase in capacity)
- Hint at main cause of falling gross profit margin: rising raw material and energy prices
- Does this business really need extra capacity when sales are falling - surely the expansion cannot be justified on cash flow grounds alone?
- More evidence of the problem of late payment by Peston Plastics’s customers
Exhibit 7 (Competitor Profiles)
- On almost every comparative measure, Peston performs worse than its major competitors - which hints at poor management and/or poor products
- Peston doesnt have the market share or scale to be able to exploit cost advantages
So what is the answer?
Students are asked to identify “the three most likely causes of the cash flow problems” that sent Peston into receivership, identifying these from a list of 10 (A to J)
The evidence seems to suggest that the following were most important:
- Low profits (A): the fundamental issue for cash flow at Peston is its low and declining profitability. In nearly every case of business failure, the root cause of failure is usually losses or poor profits.
- Over-investment in fixed assets (H): a seemingly reckless expansion in capacity with the new factory extension at a time when sales and margins were in decline. This might have been the straw that broke the camel’s back
- Management of trade debtors (B): a major liquidity problem for Peston, which is referred to several times in the clues.
A good case can be made for several other potential causes. For example, cause J (Credit Crunch) - the banks may simply have decided to pull the bank overdraft facility once they became aware of the perilous financial position; quite likely given their heightened sensitivity to banking risk as a result of the credit crunch and recession.
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