Case study illustrative script 1 november 2012 ICAEW

This candidate achieved a clear majority of the competent grades in the Executive Summary, a good majority of competent grades in both Requirement 1 financial analysis and Requirement 2

FIRST ILLUSTRATIVE SCRIPT AND EXAMINERS’ COMMENTS

In the commentary below extracts from the scripts are shown in quotation marks and italics; spelling, grammar, sentence construction and punctuation from the original script have been retained The commentary follows the order and numbering of the script with references to the topics in the marking key It should be read in conjunction with the review of the Second Illustrative Script and also the full Examiners’ Report for this session

Examiners’ comments – overview

This script achieved a pass in the 1st quartile It is around average length (but as always this depends

on the actual handwriting), addresses all the key issues and contains some strong sections In terms

of professional skills this candidate achieved competent grades across the script as follows – Clearly Competent (CC) and Sufficiently Competent (SC) – in 6 out of 8 grade boxes for Assimilating and

Using Information; in 9 out of 12 for Structuring Problems and Solutions; 6 out of 12 for Applying Judgement and 6 out of 8 for Conclusions and Recommendations

The original 27-page length of the manuscript version was broken down as follows

 Cover and contents – 1 page

 Terms of reference and executive summary – 6 pages

 Report (main body) – 17 pages

 Appendices/workings – 3 pages

The 17 pages of the main body of the report address the key issues and together with the appropriate appendices demonstrate sensible planning and a proper balance in answering the main requirements This candidate achieved a clear majority of the competent grades in the Executive Summary, a good majority of competent grades in both Requirement 1 (financial analysis) and Requirement 2

(assessment of Banbury rental proposal) and a majority of competent grades in Requirement 3

(evaluation of new business opportunities) and for Appendices and Overall

Terms of reference and executive summary

This report starts with a terms of reference section, which acts as a contents summary The

remainder of the executive summary (ES) is well structured with clear headings to sections and covers all three areas of the report adequately – there is evidence of some good planning in compiling this summary, and no suggestion of time pressure

The three main pages of the ES are split fairly evenly between the three topics The summary of the financial analysis of the FS management accounts contains some of the appropriate numerical

analysis covering most of the key areas which need to be considered, but concentrates mainly on percentages and percentage changes However, it was weaker on the analysis of Translation and Interpreting (T&I) and the review of the Myanmarpic2012 (MP) issue was not covered In the section dealing with the Banbury rental proposal the ES contains some appropriate figures from the

calculations and identifies some recruitment issues as well as querying the assumptions and

providing conclusions and recommendations on the way forward Similarly in the evaluation of new business opportunities the candidate presents a short summary of the benefits and risks of this

opportunity and brings in some of the ethical issues – the weakness in the script was in looking at this issue from too broad a perspective

The executive summary covered all areas and was sufficiently competent in the use of numbers and

in the quality of discussion provided It was competent on judgement, conclusions and

recommendations

To score better grades on this section, the candidate could have (i) used absolute numbers and provided a more comprehensive coverage of the T&I and MP analysis; and (ii) adopted a more tightly

focussed approach with better judgement and conclusions on the analysis of the new opportunities

FS financial analysis / Myanmarpic2012 [Requirement 1]

The financial statement analysis in this section is accompanied by Appendix 1 (see detailed

commentary below) This appendix supports the comparative analysis of revenues, gross profit and the revenue streams, in both percentage and absolute terms – it is a good piece of work from which the report can be written The appendix is less thorough on the details concerning the T&I analysis and the MP information

The review starts with an appropriate analysis of overall revenue comparing 2012 against 2011 and discusses the strength of FS revenue diversification The analysis then moves on to discuss the three primary revenue streams, again in both absolute and percentage terms This analysis is set

appropriately in the broader business context The candidate provides relevant commentary on the

numerical work: “The worst performing revenue stream is English language, which had a substantial

decline of 6.5% to £2,314 in 2012 compared to £2,475 in 2011 … The decline is as a result of the UKBA visa restrictions, deterring students from coming to the UK However FS has successfully maintained the accreditation status, and managed to benefit from increased foreign students from other colleges who had lost their status” An important missing detail is the scale of the numbers

£2,314k

The figures for the analysis of gross profit are only provided in percentage terms, which means that there is no yardstick to guide the reader However, the commentary is relevant and shows an

awareness of comparative contributions within and between revenue streams: “The gross profit of English language has increased slightly to 48.7% in 2012 compared to 46.5% in 2011 This is

because of the decreasing overseas students (semester long-lower margin courses) towards more corporate businesses (Intensive courses – higher margin)”

The analysis of the impact of T&I services on movements in cash and accounts receivable, together with (MP) analysis, is adequate but not strong

The candidate’s conclusions are consistent with the analysis but are not developed in sufficient depth The recommendation that “FS should consider withholding payments to MP suppliers until start receiving money for contract” implies somehow offloading the responsibility for poor credit control to

the translators, which is neither commercial nor appropriate (especially in this instance as FS has

already paid its translators in full)

To score better grades on Requirement 1, the candidate could have:

 Provided some clear absolute numbers for the changes in gross profit overall and by revenue stream

 Considered the impact on ELT of the previous decision to terminate the Banbury rental

 Discussed in more detail the cash analysis of T&I activity

 Provided better conclusions and relevant recommendations in the report

Assessment of Banbury rental proposal [Requirement 2]

The financial data analysis in this section is accompanied by Appendix 2, which contains correct calculations, as far as they go, but it is a short and poorly labelled numerical starting point from which

to comment on the proposal

The candidate starts this topic by summarising the potential effect of the new proposal but refers to the contribution as being “profit” With that proviso the calculations for the two years are correct “For

the new rental proposal, in the year ended 30 September 2013, this would produce a profit of

£23,040 For the financial year to 30 September 2014 this would produce a profit of £49,560.”

(Having correctly calculated the different “contributions” it is a pity that later in this section the

candidate states that cash flows for the two years would be identical.)

The script has comments on a number of the assumptions, with reasons: “The calculation assumes that monitoring costs are 10% of direct costs, however this may need to be increased to ensure FS maintain their UKBA accreditation status” but it is not a complete review of all the factors which are

contained in the calculations and which might vary

The consideration of other factors includes some pertinent points: “FS also need to consider the impact on secondary revenue streams The exam fees and sales of material are also likely to rise as

a consequence of increased courses” But there is also evidence of scattered thinking in this section

in that the candidate includes what are essentially recommendations in this part of the report:

“Semester long courses are the lower margin courses, FS needs to consider growing intensive

English courses which are higher margin by promoting these.” There is little evidence of professional

scepticism concerning the current level of ELT oversubscription or the validity of the ‘review of

demand’ referred to by Edwin Sanguine

The conclusions reached by the candidate are in line with the previous writing in this section of the report and are sufficiently competent and state the way that FS should proceed The

recommendations do follow on from the report but are not sufficiently comprehensive and because of

some gaps in the evaluation of assumptions (such as 1 January 2013 start date) the

recommendations do not cover sufficient ground

To score better grades on Requirement 2, the candidate could have:

 Provided a more comprehensive questioning of the assumptions surrounding the calculations in this section of the report

 Used more thorough professional scepticism over the ELT information

 Provided more comprehensive recommendations

Evaluation of new business opportunities [Requirement 3]

This candidate does not start with a consideration of the information provided but instead starts this section of the report with an evaluation of risks associated with operating a new business needing Brazilian-Portuguese translators – and their scarcity The risks identified are not focussed on the specific details provided by the opportunities associated with the FS clients, potential and current, seeking to expand into Brazil but are much broader, longer-term issues: “Any expenses incurred in Brazil will also have to be met by FS FS needs to investigate further the viability of any translation work in Brazil … There are also increased forex risks, as FS will not be paid in sterling” Although

these may be issues in the future there has been no consideration by this candidate of the type of work which is available from the contacts identified in the EP and what risks might be attached to that work

The section on benefits also concentrates on the longer term and bigger issues: “Translation work in

Brazil is a huge opportunity both with the 2016 Olympics and the FIFA world cup in 2014” This

statement is true, but it is some way off by comparison with the relatively immediate needs of the three companies who have already contacted FS – which the candidate does not assess, or even mention There is some analysis of the opportunities against the three revenue streams and the script does identify some ethical / professional scepticism issues but they are incomplete

The candidate provides some clear conclusions and some appropriate recommendations: “FS would need to carefully recruit freelancers … use translators with correct qualifications, thorough checking of references, qualifications etc”

To score better grades on Requirement 3, the candidate could have:

 Provided a more comprehensive analysis of the benefits and risks of this new business

opportunity in relation to the three businesses that have already contacted FS

 Provided a more detailed analysis of the opportunities by considering which revenue streams might be positively affected

 Explained more carefully the ethical / professional concerns relating to each step of the

development of this business opportunity

Appendices

Appendix 1

This relates to the financial statement analysis (Requirement 1) and provides a series of well laid out columnar analyses of the summarised FS income statement extracts for 2012 compared with 2011 The analysis of movements between the years is made in both absolute and percentage terms The detail provides a clear calculated analysis of primary revenue streams In the analysis of the T&I receivables and cash, good use has been made of the accounts receivable schedule but the T&I cash analysis starts by using information from the overall statement of cash flows rather than the detailed quarterly cash analysis This candidate has also analysed the secondary revenue streams which was not part of the requirement and which has clearly taken time to do Overall this is an adequate,

relevant working document which provides a basis for the analysis provided in the body of the report

Appendix 2

This short appendix relates to the Banbury rental proposal (Requirement 2) The numerical

calculations of the contribution are correct but this piece of work is not clearly labelled and if it were to

be presented to an audience which did not know the facts then it would simply provoke a lot of

requests for explanation of the numbers being used The candidate does not extend the contribution calculation to cover breakeven or margin of safety – nor is the cash flow aspect of this proposal identified This appendix is not really adequate for its audience

Overall paper

This was a well-structured answer which followed a logical format in answering the detailed

requirements There were some lapses in style and grammar but overall the language used was appropriate The report was appropriately balanced between the three sections and it was mostly written for the target audience, with good financial explanations where needed in the body of the report and no unnecessary facts provided to the board about their business The competent grades gained under ‘overall paper’ reflected the result for the script as a whole

ILLUSTRATIVE SCRIPT 1

Subject: Financial Review

Of Fluent Speech Limited

Terms of Reference

The purpose of this report is to provide a review of Fluent Speech Limited management accounts to year end 30 September 2012

To provide an assessment of the new rental proposal with Banbury Building and Properties Limited

To provide an evaluation of the business opportunities arising from the market developments

associated with Brazil

It has been prepared for Fluent Speech Limited Board, and should not be distributed to any other parties without prior written consent No liability can be accepted in the event of such distribution The report is based solely on information provided by Art Manor and no attempt has been made to corroborate or independently verify any of this information

Executive Summary

Review of management accounts

Overall revenue has increased by 20.7% due to the opportunities of the 2012 Olympics

Revenue of English language has fallen by 6.5%, which isn’t as much of a decline as anticipated, as

FS has managed to keep accreditation status and benefited from attracting students from colleges who had lost accreditation

Revenue of translation and interpreting increased significantly by 85%, this is due to the Olympic opportunities and MP contract

Revenue of foreign language increased substantially by 17% due to the growth of the UK motor industry

Gross profit margin is 36.6% in 2012 compared to 43% in 2011, due to the change in course mix from English language to translation and translation margins falling

Gross profit margins for translation fell significantly, at 23.7% in 2012 compared to 47.8% in 2011, due to the MP contract, with lower margins of 25%, compared to expected 40%

Gross profit margins for English language increased to 48.7% due to trend towards intensive courses which are higher margin

Gross profit margins for foreign language increased to 49.6% due to trend towards Days per week courses, which are higher margin

FS was non-cash generated for the first time in recent history, net cash outflow of –343

This is because of the significant trade receivables of translation services

FS are causing their own strain on cash by continuing to make prompt payments to suppliers, such as

MP contract freelance, but then not getting the money in

The trend toward translation services who pay in arrears from English language students who pay in advance has also caused significant cash strain

Conclusion

Impressive revenue growth despite the economic recession

English language revenue didn’t decline as much as anticipated

Recommendations

FS need to focus on better credit control and getting cash in quicker to improve cash position

FS need to review their payment policy and consider delaying payments to suppliers until they receive cash from customers to improve cash position

Assessment of new rental proposal

The new rental proposal generates profits in year end Sept 13 of £23,040 and profits in year end Sept

14 of £49,560

This has been based on numerous assumptions such as that there is no inflation in tutor costs and course fees

That the courses are run with 6 students per semester long course, however they could run at under capacity if UKBA restrictions increase

The calculation assumes maintaining the 10% monitoring costs as direct costs, this may need to be increased if FS want to maintain the UKBA accreditation

Other factors to consider are the impacts of the rental on secondary revenue streams, particularly lucrative streams

Another factor to consider is the uncertainty of the student numbers in the next year, the number could increase or decrease and this will affect demand for the semester long courses

Recommendations & conclusions

FS should rent another premise to meet the demand, but consider alternative premises locations

FS should attempt to renegotiate the contract terms to get lower rent, and payments quarterly instead

of annually to improve strain on cash

Evaluation of potential business opportunities in Brazil

The main benefits are the increased opportunities due to the Olympics 2016 and FIFA 2014 The additional follow on options

This would significantly increase translation revenue, but also foreign and English revenue

Brazil is part of the BRIC economies and has significant growth opportunities BRIC economies account for 20% of world economic output The main risks are the practical problems with translation

in Brazil, and the forex risks and reputational risks There is also the risk of not having the appropriate Brazilian-Portuguese speakers

The ethical considerations are the use of inappropriate tutors/translators to do the

Brazilian-Portuguese work and the employment laws in Brazil The use of commissions in Brazil could also cause ethical problems

Conclusions & Recommendations

FS should take up the opportunity of work in Brazil

FS should use the freelancer database to find appropriate freelancers, and check qualifications

thoroughly

FS should talk with the British trade of Commerce to understand how to trade overseas and seek advice from UK Department BIS

FS should consider methods to hedge the forex risk

Review of the management accounts to 30 September 2012

Revenue

Total revenue increased by 20.7% to £10,503 in 2012, from £8,705 in 2011 This is because of the substantial increase in translation and interpreting revenue and foreign language revenue, which have overly compensated for the fall in English language revenue This indicates that FS has a good

diversification of revenue streams

Translation and interpreting was the best performing revenue stream, which had a dramatic growth of 85% to £3,339 in 2012, compared to £1,803 in 2011 This is because of the additional work generated

by the 2012 Olympics and also the additional work from the MP contract

Olympic revenue is one off so growth may not be sustainable However use of contracts from the Olympics would give future opportunity for additional work However this may be impacted by the error in the Arabic security poster, and the dispute over quality of a translation document with MP which would have a negative impact on FS’s reputation

Foreign language has grown significantly by 17% to £2,029 This is because of the growth in the motor industry In the year to date the UK car market is up 4.3% (Jan-Sept 12) (source – BBC)

There has been significant investment in the UK car industry Including, the government scrappage scheme in 2009, and the £500m BMW investment in July 2011 for next 3 years However, potential withdrawal of the motor industry investment would adversely affect this revenue stream

The worst performing revenue stream is English language, which had a substantial decline of 6.5% to

£2,314 in 2012 compared to £2,475 in 2011 However the decline is not as much as anticipated The decline is as a result of the UKBA visa restrictions, deterring students from coming to the UK

However FS has successfully maintained the accreditation status, and managed to benefit from increased foreign students from other colleges who had lost their status

Both secondary revenue streams have improved slightly in 2011, an increase of 6% in sales of

learning material, and an increase of 3.3% in exam fees The sales of the secondary revenue streams are dependent on the success of the primary streams

Gross profit

Gross profit has increased slightly by 2% due to the increased revenue However the gross profit margin is 36.6% in 2012 compared to 43% in 2011

This is because of the change in revenue mix from English language to translation and interpreting Translation and interpreting represented 32% of revenue in 2012, compared to 21% of revenue in

2011

The gross profit margin for translation and interpreting has fallen significantly to 23.7% in 2012

compared to 42.8% in 2011 This is because of the MP contract, where profit margins are 25%, for translation services, compared to expected margins of 40% The falling margins reflect price

competitors, fees lowered for translation services in order to stay competitive

The gross profit margin of foreign language is 49.6% in 2012 compared to 48.8% in 2011 This is because of a change in course mix, towards higher margin courses, such as Days per week course The gross profit of English language has increased slightly to 48.7% in 2012 compared to 46.5% in

2011 This is because of the decreasing overseas students (semester long-lower margin courses) towards more corporate businesses (Intensive courses – higher margin)

Impact of translation and interpretation cash and accounts receivable

Fluent Speech is not cash generative for the first time in recent history

The cash flow shows a net cash outflow of –343, resulting mainly from the trend away from English language courses which pay in advance upfront towards translation services which pay in arrears The main drive for the negative cash outflow are the high trade receivable balances Trade receivable days in total are 103 days in 2012 compared to 67 days in 2011

Translation and interpreting receivables are a significant portion of trade receivables

The trade receivable days are 253 days in 2012 compared to 202 days in 2011 This is primarily because the receivables are made up of Government bodies, such as the NHS who are under

budgetary pressure, and also the result of the MP contract

The MP contract has been slow paying, from the MP contract there is £680k of invoiced amounts outstanding that represents 36% of the year end receivable balance

However FS has continued to pay the translators for their services, this has caused significant cash strain, as FS aren’t getting the money in but also still paying suppliers

To the year end September 2012, translations represented a total cash net outflow of 540, cash inflow 1,957 less cash outflow 2,497 There are also concerns about the recoverability of the balance, as FS

is in dispute with MP about a translation document, and due to Government spending cuts

Conclusions

FS has had impressive revenue growth of 20.6% in 2012, due to revenue from the Olympics

Gross profit has decreased by 2% due to the course mix towards translation and interpreting and the translation margin declining

FS has not been cash generated this year, however FS still has a positive cash position of £592k in

2012

The receivables are concerningly high for an industry that is supposed to have low working capital commitments

Recommendations

FS needs to improve their credit control system, employ an in-house credit controller, to get money in quickly

FS could consider withholding payments to MP suppliers until start receiving money for contract Trade debtors need to be reviewed for recoverability

FS needs to provide higher margin courses in order to grow profit margin next year

Assessment of the new rental proposal

For the new rental proposal, in the year ended 30 September 2013, this would produce a profit of

£23,040 For the financial year to 30 September 2014 this would produce a profit of £49,560

In calculating these figures it has been assumed that in the year end 30 Sept 13 there will be able to

be 2 semester long courses run in January and April There would be rent prepaid of £30k

In calculating the figures for year end 30 Sept 14 it has been assumed all 3 courses will be able to run

in Jan, April and October

The additional contribution earned per program is £56,250

It has been assumed that there will be 6 students per semester long course However classes may not be running at full capacity, further UKBA restrictions could worsen student numbers

There has been no inflation in tutors wages and course fees

The calculation assumes that all direct costs are entirely variable, no payment is made for tutor idle time, this may not be the case for employed tutors

The calculation assumes that monitoring costs are 10% of direct costs, however this may need to be increased to ensure FS maintain their UKBA accreditation status

The figures calculated are in terms of profit The rental property will substantially improve the cash flow strains in Q4, as students will be paying in advance for the Q1 semester long course

So in year to Sept 13, you would expect fee income of £169,560 (£56,520) from all 3 courses and cash outflow for the entire rent of £120k paid in January 2013 The cash flow implications would be net £49,560 same as for year end Sept 14

FS also need to consider the cashflow implications for paying the rent of £120k in January 2013, as

FS is currently in a reduced cash position

Other factors

FS have experienced an oversubscription of their semester long courses, due to attracting other students from colleges who have lost their accreditation status, such as London Metropolitan who has lost the accreditation status and had to send away 2,000 students This year 500 colleges lost their accreditation status

However, as the government want to cut net immigration further, to tens of thousands by the end of Parliament, student numbers could decline further and FS could end up with surplus semester long courses

FS also need to consider the impact on secondary revenue streams The exam fees and sales of material are also likely to rise as a consequence of increased courses

Semester long courses are the lower margin courses, FS needs to consider growing intensive English courses which are higher margin by promoting these

There is a general trend towards shorter courses and student number not be as much as anticipated, leaving courses undersubscribed

FS also need to consider the location of the motor industries factories, a location in Banbury is not near the BMW factory in Oxford, so perhaps it is better to rent premises in other locations BMW have made a substantial investment in the UK of £500m in July 11 for next 3 years