SECOND ILLUSTRATIVE SCRIPT AND EXAMINERS’ COMMENTS The commentary below follows the order and numbering of the script, with reference to the topics in the marking key It should be read in conjunction with the review of the First Illustrative Script and full Examiners’ Report for this session Examiners’ comments – overview This script failed the exam The candidate has produced a fair executive summary (over 50% of competent grades) and a reasonable answer to Requirement but has gained fewer than 50% of competent grades for Requirements and As illustrated more clearly below, at Requirement there is no proper analysis on Wychdean; while at Requirement there are weaknesses throughout There are some astute points scattered across the script, especially on operational aspects of multi-sourcing: if this quality had been more consistently evident, the candidate might have achieved a pass The script is written throughout in bullet points – a technique the Examiners not recommend as it can result (as in this case) in a lack of fluency The technique here is further impaired by a stilted English style and the irritating habit of highlighting each recommendation with the phrase “I would recommend ” (Some other language shortcomings in the original have in fact been corrected to make the script more useful for review purposes.) Although fairly average in length (in fact, not much shorter than the First Illustrative Script), the report is too general in its coverage and especially its shortage of numbers at Requirement Terms of reference and executive summary The script begins (on a cover page) with a very brief overview, followed by terms of reference, including an inappropriate disclaimer and limitation of scope The executive summary begins with an introduction, followed by a section for each of the three main requirements The introduction is short, disjointed and random (for example, no reference to the Requirement issues), and the logic is not helped by the double use of “however” The first part provides good coverage of each heading under Requirement 1, though it could have included more figures and made reference to the forecasts, not just 2009 comparatives Despite its rather fatalistic opening (“Mangold will expire soon”), the analysis of the Longmore and Mangold proposals is good, including not only the headline NPV numbers but also the sensitivity percentage It goes on to refer to “non financial factors”; but, in common with the later main section on Requirement 2, there is little attempt to challenge the optimism embodied in Longmore’s plans The section on multi-sourcing is the longest in the executive summary, consistent with the main body of the report The key elements (benefits / risks, operational and ethical aspects) are all covered, though the recommendations are somewhat muddled (“ carry out due dilligence [on Tryphik] before accepting their work” and “ Tryphik and Jugson are both used and we look into allegations about their work”), while the final lines ( “See if we can find this You Tube film” and “Ethical aspects should be made clear to both Tryphik and Jugson”) not add a great deal of value for the reader Analysis of Kreem’s financial performance [Requirement 1] As noted earlier, this is a weak section Although superficially it deals with many of the main elements of the requirements (comparison with both prior-year actuals and forecasts; revenue / costs / EBITDA / working capital; Wychdean), the coverage is not deep enough and in particular © The Institute of Chartered Accountants in England and Wales 2010 Page of 13 the grades for AJ are poor Better grades could have been earned by expanding some of the analysis The related appendix (see below) is brief, with the result that the candidate does not have enough figures to include in the report The candidate begins by apparently summarising his/her previous analysis of the AI (commentary on 2008 / 2009) (S)he goes on to compare 2010 with 2009, starting with the comment “these comparisons are better as based on actual results but the 2010 accounts are only draft unaudited” It is not clear what point is being made here, unless the candidate is gratuitously perpetuating the theory (peddled by many failing Case Study candidates) that management accounts cannot be relied upon The following point, referring to Kreem’s reliance on a limited product range and on one sector, is well made but then not developed The quality of the next set of bullets is poor, with very few numbers and no real attempt to explain the impact of Wychdean – the (brief) comparison is done only on a like-for-like basis, rather than starting with an analysis of the unadjusted figures and then adjusting them The only good analysis of Wychdean is the bullet referring to it becoming Kreem’s second biggest customer – though this too is flawed as it is already the second biggest customer, even from only six months of activity Like the First Illustrative Script, this candidate mistakenly treats discounts as a cost rather than as a deduction from revenue (S)he also notes that the figures for discounts in 2010 have not been given without appreciating that they can be derived from other numbers in the June 2010 management accounts Coverage of costs, working capital and EBITDA is far too sketchy, as though the candidate is too lazy to work through the impact of the numbers and/or incapable of articulating them clearly On working capital, though including relevant calculations in Appendix 1, the candidate has not reproduced any of them in the body of the report, merely noting that “the impact of Wychdean means that more trade is being carried out and so the end of year stock, payable, receivable figures will be higher” In the comparison with forecasts, the candidate correctly begins by noting that they were prepared in May 2009 and that they exclude Wychdean, and by questioning the simplistic underlying 5% growth assumption However, that is as good as it gets: the remainder of the section consists of some very general comments about the forecasts (no figures here even though there are in the Appendix) and some additional observations – including figures – about working capital However, the figures are incorrect (the candidate has added the ‘days’ for payables to those for receivables and inventory rather than deducting them) and the section is totally out of position (there was no balance sheet information in the forecasts – a source of frustration for the candidate, as indicated in the footnote to Appendix 1) In the final section, the candidate has achieved his/her best grades for Requirement by concluding on Kreem’s performance both overall and by reference to Wychdean, as well as including a pertinent recommendation about forecasting However, other recommendations, such as “maintain relationships with all existing customers ” and “investigate further why costs have increased so much”, are too naive or vague to earn much credit Evaluation of proposals [Requirement 2] This section is poor throughout (calculations, evaluation of options and recommendations), with only limited professional scepticism displayed It begins with an unconnected and badly written series of points relating to Kreem’s customer base; Longmore’s non-replacement policy; and the respective financial records of the two customers Only then does it summarise the NPV outcomes for Longmore and Mangold, followed by some attempt at drawing out the benefits of each customer While the points individually are mostly sensible and relevant, they could have earned higher grades by being presented as a more structured discussion © The Institute of Chartered Accountants in England and Wales 2010 Page of 13 The script next assesses the risks of each proposal, where candidates were expected to demonstrate their professional scepticism, especially in relation to Longmore’s assumptions However, this candidate has barely touched on it at all, with comments being limited to “Kreem has no concrete evidence that Longmore venues, room and occupancy rates would increase as stated” and “Actual sales and costs associated with either contract may vary and so the NPV would not be a fair reflection” There are two comments here about discounts on Longmore – picking up the fact that the candidate has used a 12% trade discount when calculating the Longmore revenue – even though the proposal letter clearly refers to a contract price However, some of the other points in this section (eg being locked into a contract with Mangold, balance between financial and environmental) are well made The section headed “Sensitivity analysis and assumptions” appropriately starts with the outcome of the candidate’s sensitivity calculations, followed by some brief related comments (albeit again erroneously assuming that discounts are available for Longmore) It may be that the candidate has misinterpreted Exhibit 15 as requiring a commentary on the assumptions for the sensitivity analysis only and not the initial NPV calculations The candidate has achieved competent grades for conclusions, recognising that the financial decision is marginal and sensitive to small price changes, as well as reiterating earlier views on Mangold’s finances and Longmore’s environmental practices, and eventually concluding that Longmore is the better option For recommendations, the candidate makes a vague reference to “due dilligence” [sic]; see the First Illustrative Script for a more considered approach to this Discussion of diversification of packaging supplies [Requirement 3] This part of the report was the longest and the best, with good coverage of all key elements (benefits / risks, operational and ethical aspects) It starts with an excellent analysis of the current Jugson situation It then goes on to set out the benefits and risks of multi-sourcing, though some obvious points that with good exam preparation could have been included (eg issues of competition) have been overlooked Although there are separate sections for the operational and ethical aspects, much of the former section (the first five bullets) also deals with the latter, effectively resulting in two disjointed sections on ethics rather than a cohesive single one On the operational issues, the candidate makes some sound observations that reveal a better understanding of the supply chain than of other parts of Kreem’s business Indeed, the entire series of bullets from “Also, by outsourcing abroad ” to “Tryphik must be aware ” (including a reference to intellectual property, similar to the First Illustrative Script) is by some way the most impressive section of the whole report In the section headed “Conclusions & Recommendations”, the candidate does not full justice to the foregoing paragraphs The first two comments are not conclusions at all and should have been made earlier The candidate could also have extended earlier points on Tryphik’s overseas location into some suggestions about forex accounting or compliance with French regulations The recommendations on ethical issues are too vague (“investigate further allegations made about both”) as is the advice to “due dilligence” on Tryphik (cf Longmore at Requirement 2) Overall paper This script is poorly written, with an overuse of bullet points, numerous spelling errors (eg “no” for “know”, “dilligence” several times, “there” for “their”), unclear punctuation (eg some odd uses of the exclamation mark) and some incomplete sentences which often make it hard to see what the candidate is trying to say Appendices The candidate has included three appendices, one for Requirement and two for Requirement © The Institute of Chartered Accountants in England and Wales 2010 Page of 13 Appendix is too short, comprising only some broad calculations, without developing the headline numbers into more detailed analysis of revenue by customer or division, with no data on sales volumes and no breakdown of the two main cost captions into their constituents In Appendix 2, the candidate has set out the calculations for both customers, but there are some errors and leaps of logic here For Mangold, there is no reference to occupancy rates and it is not apparent where the figure 3,510 comes from – the resulting revenue is too high Similarly for Longmore, the figures 2,625 and 6,375 are not explained, and in addition the candidate has unnecessarily applied a trade discount to Longmore Appendix presents the candidate’s sensitivity analysis The approach is confused and does not lead to a meaningful conclusion ie an amount by which the price for either customer must change for the two contracts to be equal in value © The Institute of Chartered Accountants in England and Wales 2010 Page of 13 ILLUSTRATIVE SCRIPT Draft Report To: From: Date: Subject: Kreem Board Robin Tyler 28 July 2010 Kreem results and business planning The following report covers the future business planning Taking into account a potential new HCC customer, Longmore, and our issues with our existing packaging arrangements This report is for the internal use of the board only It contains sensitive and confidential information It rd should not be passed onto a party and I accept no liability in such a case © The Institute of Chartered Accountants in England and Wales 2010 Page of 13 Executive Summary Kreem is currently going through the recession However the Toiletries industry seems to be able to withstand this as it is a necessary product However consumers may trade down in these bad times Kreem needs to maintain its ethical stance on animal testing and its commitment to the environment Company performance to 30 June 2010 • The company has seen good performance during the year: EBITDA has increased by 711k (9.4%) and revenue by 862k (2.8%) • This is mainly due to the Wychdean contract coupled with our price increase • Costs also seem to increased on last year mainly due to bringing Wychdean into our company There is also the advertising campaigns on back of world cup • Kreem however needs to address its working capital as this seems to have increased too much • I would recommend that Kreem maintains relationships with existing customers and looks to add to this in the future NPV of Mangold and Longmore proposals • Mangold will expire soon and Longmore have made us a proposal • Their proposal gives a NPV of £5.9m, that is £400k more than the NPV of renewing Mangold • However the sales price is very sensitive in these proposals and any slight change would change NPVs further Price sensitivity is 4% (see appendix 2) • Therefore we need to consider non financial factors such as our existing relationship with Mangold versus Longmore outlook on wastage and the environment • Longmore seems to have greater prospects in the future and better plans if we can rely on their figures • We should investigate their figures further and if happy go with the Longmore contract Potential multisourcing • Kreem has used Jugson for years and solely relied on their services building a strong flexible relationship • However, multisourcing with Tryphik would be an option Based overseas this would help with our expansion strategy and gain more brand awareness • Jugson has been seen to be misrepresenting the capabilities since we have had them as a supplier • The risks of going overseas are increased costs, and great miles to be covered by our products • Also we would be able to get a better service by multisourcing • The likelihood of our supply chain would be reduced as well • Tryphik will be a good fit for Kreem and I would recommend that we carry out due dilligence work with them before accepting their work • I would recommend Tryphik and Jugson are both used and we look into allegations about their work See if we can find this You Tube film • Ethical aspects should be made clear to both Tryphik and Jugson © The Institute of Chartered Accountants in England and Wales 2010 Page of 13 Company’s performance for year to 30 June 2010 Kreem has previously recorded strong growth in revenue and profits in the years 2008 to 2009 Kreem was able to stay through profitable in the rise of recession as toiletries are seen as a necessary product But Kreem must be wary of consumers down trading to more basic products Please see appendix to see the changes in revenue, costs (cost of sales / other costs), EBITDA and working capital for the years 30 June 2010 and 30 June 2009 These also show comparisons with 30 June 2010 forecasts Wychdean results have been taken out of the results so as like for like comparisons can be made June 2010 Actuals v June 2009 Actuals • Firstly I would like to state these comparisons are better as based on actual results but the 2010 accounts are only draft unaudited • Kreems revenue is only based on products, which is a worry and its main revenue streams come from the retail sector • Revenue has increased by 86k (2.8%) and EBITDA by 711k (9.4%) (see Appendix 1) • However costs seem to have increased more than revenue and this must mean that either less discounts are now being given – this information is not given or greater margins are being produced • These figures also exclude Wychdean results so as like for like comparisons can be made • Working capital figures have all increased substantially These figures include Wychdean’s results • The impact of Wychdean means that more trade is being carried out and so the end of year stock, payable, receivable figures will be higher • Including Wychdean results Kreem has increased profitability again in 2010 and also increased cash This is probably as a result of its strong brand name that it still maintains an increase • Wychdean will be the main reason for this If we pro rata their revenue: 5,835 x = £11,670k, they nd become our biggest customers This is a healthy position for Kreem having not only one main customer • Reason behind cost increased, again obviously due to Wychdean but our advertising costs would have increased on the back of the world cup • Looking forward this is a healthy position for Kreem to be in June 2010 Actuals v June 2010 forecasts • The forecasts were only prepared in May 2009 with a basic growth assumption of 5% These forecasts ignore anything that has happened to date • Overall the comparisons ignore the Wychdean contract • Kreem board should consider preparing forecasts on ongoing basis • Due to the above the comparison between the figures are as follows (see appendix 1) • Kreems working capital is increasing it appears too much Working capital cycle is gone from 232 days to 236 days © The Institute of Chartered Accountants in England and Wales 2010 Page of 13 • Kreem is still in breach of its 60 day SLA terms with its suppliers As Kreem has only one supplier this needs to be addressed quickly • Kreem has overstated all forecast figures due to the simplistic 5% growth model • However by including the Wychdean contract all forecast figures would increase considerably and would have been even considerably higher than the actuals • Kreem should be more prudent in their approach to forecasts Conclusions & Recommendations The appendices only show like for like performance However the improvement in Kreem performance is mainly due to the Wychdean contract I would recommend that our 2011 forecasts are updated for Wychdean Also the EBITDA increase will be down to Wychdean Like for like increases on Revenue and EBITDA will down to bi annual price increases and potentially below margins I would recommend that we look to obtain a greater customer base, we have seen the impact Wychdean has had I would recommend that we still should however maintain relationships with all existing customers and not focus too much on new customers I would recommend that we investigate further why costs have increased so much I would recommend Kreem look to increase their products NPV of Mangold / Longmore Contracts & Risks • Please refer to Appendix for calculations • Currently Kreems HCC segment only has a limited number of customers: Mangold being one of them The recession does affect this segment as these are luxury services However the Kreem brand is strong enough to still be in demand • Longmore will make a 20% allowance each year for unused product whereas Mangold disposes of unused wastage • Kreem will be happy that Longmore appear to look out for the environment • Longmore has made PAT of £9.2m up by 7% of Dec 08, whereas Mangold PBT is 12% down • Longmore will be bigger than Mangold in 2013 and is looking overseas • The Longmore has a greater NPV (£5.9m) than Mangold (£5.4m) and based on shareholder wealth Longmore would be preferred choice • Longmore seems to compliment our brand and is after ‘Top quality products to add to its overall impression’ • Longmore also offers sales via supplier websites which will increase brand awareness • But we have a long standing relationship with Mangold © The Institute of Chartered Accountants in England and Wales 2010 Page of 13 Risks • Mangold has struggled in the recession and has seen a reduction in profits Kreem would not want to be locked into another year contract with a Hotel that has poor performance • Longmore is looking on going into Europe in 2014, this may mean that would not take us seriously, or we would not be a main focus • Longmore prices are set at £1 which would be set for whole contract, however this is negotiable • We not no what discount Longmore would be after and we assume that Mangold would stay constant • Kreem needs to weigh up any financial aspects against the environmental issues which are so close to our heart • Kreem has no concrete evidence that Longmore venues, room and occupancy rates would increase as stated • Actual sales and costs associated with either contract may vary and so the NPV would not be a fair reflection • Would discounts be negotiable with both hotels during the contract period Sensitivity analysis and assumptions • It would only take Mangold prices to increase by 4% over the contract or Longmores to fall by 4% and the NPV would be the same • Also Longmore prices are negotiable! • £400k change in prices is only small over the years in comparison to the NPVs • Also Longmore discount rates have been assumed to be the same as Mangold They could actually differ • So looking at this we can not safely make our decision on the numbers Conclusions and Recommendations • Longmore has an NPV of £400k more than Mangold However this is only marginal when put into context Also any price changes would affect NPVs dramatically • Both contracts have their benefits and risks (see risks) We have an existing relationship with Mangold yet there prices profits are poor • Longmore seems to fit in with our environmental policy and also has the greatest NPV I would recommend that we further investigate Longmore contract to see if we can increase prices and to see what discounts they can offer I would recommend that we some form of due dilligence over their increase number of rates and rooms upto 2013 I would recommend that we see if we can sell unbundled products, further reducing waste with the contracts I would recommend we go with Longmore © The Institute of Chartered Accountants in England and Wales 2010 Page of 13 Diversifying packaging to Tryphik in 2011 • Kreem has had a longstanding relationship with Jugson which has been flexible due to the one on one relationship • However recently Jugson’s work has not met our standards Incorrect labelling and also almost ran out of packaging • Jugson appears not to take our custom as seriously as others and is concentrating on the cosmetics clients • Jugson is our only supplier of packaging, but has many customers with us just being one of them This gives them greater power over us Benefits and risks of multisourcing • By having one supplier Kreem is able to build up a flexible business relationship • Kreem will also build up good strong relationships which will hopefully have a positive affect into the future • Kreem is open to supplier interruption and also this could affect the brand of Kreem • In the case of Jugson where products could have been sent out with incorrect labelling this would affect customer goodwill • Multisourcing would not achieve strong flexible relationships • Kreem will exhibit more power with more than supplier and also Kreem will not make more informed decisions • Kreem is using one supplier for packaging (which is one of its key core competencies) any disruptive work will have an impact on the rest of the supply chain • Kreem may come to used to substandard work and let it flow through the supply chain to market • Whereas when multisourcing Kreem has the ability to stop this Operational issues of transferring • The public may view the transfer of services outside the UK as the same way they viewed Ellis Ltd • Kreem must be wary of the ethical stance of Tryphik A newspaper article states that they are no stranger to controversy • Tryphik are accused of supplying Merjoram who have carried out animal testing which can be seen on YouTube! • Kreem must investigate these allegations and previous allegations made to Tryphik We should be sceptical about the reliance of the newspaper article and follow up the YouTube film • Kreem must consider if any outsourcing abroad will result in the loss of jobs at home • Also by outsourcing abroad we must be conscious that is not being done to reduce costs but for a better all round service from our suppliers • We need to consider how Tryphik would fit into our supply chain Would it be able to integrate its services smoothly Also does it have any existing relationships with our other suppliers like Klingley • Tryphik offer a fit for Kreem as one of our key strategies was to expand into European markets This will help with our brand awareness © The Institute of Chartered Accountants in England and Wales 2010 Page 10 of 13 • Multisourcing would increase the risk of our control over suppliers Kreem would want to keep quality control over suppliers • Also the use of Tryphik would increase product miles and increase our monitoring and compliance costs • We would also be increasing number of suppliers who have access to our internal and confidential data They may use this information to their advantage in the future • Also there is risk due to the language & cultural barrier which an existing company has commented on • Tryphik regardless of the press article appears to have very satisfied customers They comment on their work ethic and their policy on recycling and training on ecological sustainability • Kreem has the responsibility of ensuring Tryphik conduct themselves in an ethical way which they seem to • Kreem must be made aware that one customer thought they were very expensive This could be a risk especially coupled with the exchange rate risk Ethical Aspects • Jugson has previously not met our standards and in the ‘Toiletries Today’ an article states that they have misrepresented their capabilities for years! • Tryphik also has been in the press about supplying Merjoram a company accused of animal testing • Kreem also have to be careful of the perception of moving abroad for suppliers The loss of UK jobs to find cheaper services Kreem should really advertise their ethical stance and let the public know what they are all about instead of letting public perception build Conclusions & Recommendations • Jugson and Tryphik appear to be total opposites regarding how they promote their policies on the environment and wastage • Jugson appears to have misrepresented all its claims whereas Tryphik offer a quality round the clock service I would recommend that we investigate further allegations made about both I would recommend we request financial information / projections of Tryphik I would recommend we carry out due dilligence work with Tryphik I would recommend we use Tryphik as a supplier on a trial basis first If standard of work look to lock into a long term contract © The Institute of Chartered Accountants in England and Wales 2010 Page 11 of 13 APPENDICES Appendix Kreem performance to 30 June 2010 Like for like Results June 09 Actual £’000 June 10 Actual £’000 June 10 Forecast £’000 % Change % Change of of 10 v 09 10 v forecast Revenue (Adjusted for Wychdean) 30,691 31,553 33,000 + 2.8% -4.4% Cost of Sales 11,316 11,914 12,000 + 5.3% - 0.7% Other Costs 11,777 11,330 12,750 + 3.8% - 11.1% EBITDA 7,598 8,309 8,250 + 9.4% - 0.7% June 09 Actual £’000 June 10 Actual £’000 June 10 Forecast £’000 Stock Days 1,620 52 2,383 58 - + 47% - Receivables Days 5,729 68 7,789 76 - + 36% - Payables Days 3,469 112 4,179 102 - + 20% - 2011 £’000 2012 £’000 2013 £’000 Revenue 3,580 3,861 3,861 Discounts @ 12% 3,150 3,398 3,398 GP = 64% HCC Division (09) DF (@ 9%) 2,016 0.917 2,175 0.842 2,175 0.772 PV 1,848 1,831 1,679 Adjusted for Wychdean Revenue Cost of Sales Other Costs EBITDA 37,388 – 5,835 = 31,553 14,995 – (5,835 – 2,754) = 11,914 Reduced by 20% Changes in Working Capital 10 v 09 10 v f/cast % Change % Change Could with having balance sheet for forecasts Appendix Mangold Contract Sales 2011 2012 2013 : : : 1.02 x 3,510 = 3,580 1.10 x 3,510 = 3,861 1.10 x 3,510 = 3,861 NPV = £5.4m © The Institute of Chartered Accountants in England and Wales 2010 Page 12 of 13 Longmore Contract Revenues → → → 2011 2012 2013 1.00 x 2,625 = 2,625 1.00 x 6,375 – (20% x 2,625) = 3,075 1.00 x 6,375 – (20% x 3,600) = 5,655 2011 £’000 2012 £’000 2013 £’000 Revenue 2,625 3,075 5,655 Discount (assumed 12%) (315) (369) (679) Additional 10% revenue 263 2,573 308 3,014 566 5,542 GP = 64% HCC Division (09) DF (@ 9%) PV 1,647 0.917 1,510 1,929 0.842 1,624 3,547 0.772 2,738 NPV = £5.9m Appendix Price sensitivity Prices would have to change by +£0.4m for Mangold or -£0.4m for Longmore PV of Mangold revenue cash flows: 3,580 x 0.917 = 3,283 3,861 x 0.842 = 3,251 3,861 x 0.772 = 2,980 9,514 Sensitivity is 0.4 = 4.2% 9.5 PV of Longmore revenue cash flows: 2,625 x 0.917 = 2,407 3,075 x 0.842 = 2,589 5,655 x 0.772 = 4,366 9,362 → 0.4 = 4.3% 9.4 © The Institute of Chartered Accountants in England and Wales 2010 Page 13 of 13 ... → 20 11 20 12 2013 1.00 x 2, 625 = 2, 625 1.00 x 6,375 – (20 % x 2, 625 ) = 3,075 1.00 x 6,375 – (20 % x 3,600) = 5,655 20 11 £’000 20 12 £’000 20 13 £’000 Revenue 2, 625 3,075 5,655 Discount (assumed 12% )... 3 ,28 3 3,861 x 0.8 42 = 3 ,25 1 3,861 x 0.7 72 = 2, 980 9,514 Sensitivity is 0.4 = 4 .2% 9.5 PV of Longmore revenue cash flows: 2, 625 x 0.917 = 2, 407 3,075 x 0.8 42 = 2, 589 5,655 x 0.7 72 = 4,366 9,3 62. .. 1, 620 52 2,383 58 - + 47% - Receivables Days 5, 729 68 7,789 76 - + 36% - Payables Days 3,469 1 12 4,179 1 02 - + 20 % - 20 11 £’000 20 12 £’000 20 13 £’000 Revenue 3,580 3,861 3,861 Discounts @ 12%