Task

Financial Analysis and Operational Review for Greenway Builders Ltd: Rebuilding Trust and Informing Strategic Decisions Amidst Internal Disputes

Introduction

I have been engaged as a Management Consultant for Greenway Builders Ltd to review the company's situation and provide recommendations after recent accusations between the directors. Greenway Builders Ltd is a construction company founded in January 2021 by siblings Alice and David Green. The company enjoyed early profits but encountered financial troubles in 2023 with its first loss since inception.

Accusations of asset misappropriation have now sparked tensions between the directors.  

My report aims to thoroughly analyze Greenway's finances, identify any internal control weaknesses, and advise on financing options to support the company's plan to invest £250,000 into a new building materials product line.

The report contains a ratio analysis of the financial statements, a discussion of potential misappropriation risks and internal control improvements needed, an evaluation of internal and external financing options with a justified recommendation, and a preparation and analysis of functional budgets for the next financial quarter.

The intent is to provide the directors with an independent, objective assessment to aid decision-making and rebuild trust in moving the business forward. I utilize financial analysis techniques, apply academic concepts around internal controls and financing options, review the case details, and format the financial data into actionable insights.

My role is to uncover the business' true situation, strengths, and weaknesses in order to advise a prudent path ahead. I aim for my review and recommendations to resolve tensions and align the leadership team.

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Part 1: 

Ratio Analysis: Examining key financial metrics, referred to as "financial ratio analysis," is a vital tool for comprehending financial statements. By calculating ratios based on financial data, one can evaluate an organization's fiscal performance and status regarding revenue earnings, efficiency, cash availability, and ability to meet obligations.

Tracking how these ratios trend over time provides insight into a business's growth trajectory. Additionally, setting benchmark ratio targets empowers managers to define and work toward actionable goals for the company. (Goel, 2015). 

Investors including analysts, lenders, and asset managers have long utilized financial ratios to assess corporate achievement. A company's liquidity ratio, signifying its capacity to pay near-term debts, is especially predictive of growth prospects since improved liquidity points to faster expansion and decreased chance of default. (Megaravalli and Sampagnaro, 2018)

1.    Liquidity Ratios  

The ease of converting an asset into cash, known as liquidity, is a pivotal feature of financial instruments. It enables financial markets to function (Ahmed et al., 2020). A liquidity ratio quantifies an asset's ability to transform into money.

Therefore, assets must have interconnectedness such that one can evaluate the portion of asset value readily available as cash versus the portion needing conversion (e.g. stocks, claims). (Breur et al., 2012).  

Current Ratio:  The current ratio weighs a company's existing asset base against existing debts. It signals the capacity of current assets to settle emerging liabilities. (Megaravalli and Sampagnaro, 2018) A higher ratio denotes more current assets than current debts, implying ease of paying near-term bills. However, an excessively high current ratio flags idle asset. Typically, a 2:1 ratio is ideal. 
 

Analysis:

1.    In 2021 and 2022, the company's current assets exceeded its current debts. With ratios of 2.57 and 1.45 respectively, it could have paid all immediate debts without tapping long-term assets.  

2.    By end of 2023, the picture changed slightly. With a 0.90 ratio, current assets no longer covered short-term obligations. Although absolute current assets rose in 2023, current liabilities jumped 75% mostly from a 131% increase in payables and 71% increase in taxes.  

3.    Inventory has also grown in 2022 and 2023 over 2021. To pay near-term bills, inventory must convert to sales and cash from customers. This lengthens the conversion cycle. Despite acceptable 2021 and 2022 current ratios, the underlying cash is less than receivables or inventory, indicating vulnerability. The 2023 liability spike is primarily from purchasing supplies on credit from a single vendor.  

Acid Test (Quick) Ratio: The quick ratio is a more precise, meaningful liquidity metric than the current ratio. Rather than using total current assets, it isolates the most liquid assets - cash, short-term investments, and receivables. It excludes illiquid inventory and prepaid expenses. (Megaravalli and Sampagnaro, 2018). 

As Durrah, O. et al., (2016) explain, this ratio exclusively considers the most fluid current assets against liabilities. Growth in its value signals strong company liquidity. Harder-to-convert inventory and prepaid expenses are omitted. A 1:1 ratio is considered excellent. Missing inventory could be tough to sell at market rates in a timely manner.
 

Analysis: 

1.    With 2021's quick ratio exceeding 1.71, the company was in reasonable shape to pay debts as liquid assets exceeded short-term obligations.
 
2.    However, the ratio dropped below 1 in 2022 and 2023, to 0.87 and 0.98 respectively. With more limited quick assets, the company may now struggle covering immediate liabilities. This decline traces mainly to the recent jump in current obligations.

The quick ratio matters internally and to external investors because it indicates risk of a cash shortfall. It also has more signaling value than other liquidity metrics since it takes the most conservative view of a company’s ability to generate cash.

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2.    Leverage Ratios: 

Financial leverage ratios demonstrate a company’s long-term viability. A firm’s “leverage” refers to its relative debt burden. Leverage ratios evaluate how heavily a company utilizes long-term borrowing and its resulting financial risk exposure (Goel, 2015).

Strong solvency suggests reliable enough cash flows to regularly service debt principal and interest payments. Given debt's inherent risk, lenders frequently impose leverage ratio covenants on business loans, seeking assurance that firms can survive economic adversity (Goel, 2015).  

Debt-Equity Ratio: The debt ratio gauges leverage by quantifying assets financed through debt rather than equity. A high ratio signals heavy long-term debts relative to equity (Goel, 2015). It equals total debts divided by total shareholder equity.
 

Analysis: 

The company maintained low debt-equity ratios across all three years. This indicates operations are not heavily dependent on external borrowing. While positive in terms of modest interest costs and bank reliance, opportunities to fuel growth via outside financing may be missed.

Interest Coverage Ratio: This ratio shows the cushion between a company’s pre-interest, pre-tax profits and its interest expenses. (Robinson, 2020). For investors and lenders, debt service capacity matters. The interest coverage ratio displays excess cash flow remaining after interest payments, indicating default risk. Ratios near one suggest high bankruptcy risk, while higher ratios provide a comfortable buffer should business decline. (Bragg, 2012).

Analysis:  

1.    In 2021 and 2022, sufficient pre-tax profits existed to cover interest obligations, although the coverage ratio markedly improved in 2022 on higher pre-tax, pre-interest income.

2.    By 2023, the ratio dropped 45% versus 2022, signalling inconsistent profitability and raising questions on consistent debt service capacity going forward."

3.    Profitability Ratios: 

A company's ability to generate profits relative to investment is called profitability. Profitability ratios indicate competitive standing and management caliber, encapsulating success or failure. (Robinson, 2020).

Gross Margin: This ratio reflects sales' capacity to produce gross income before considering operating costs. High ratios suggest high selling prices and low production expenses. Competitively advantaged products in cost or quality terms can increase profitability. (Robinson, 2020).  
 

Analysis: 

1.    In 2021, £1.83 million in sales faced high costs of goods sold (COGS), limiting gross profits and yielding a 15.57% gross margin. 2.    By 2022, gross profits rose on increased revenues and lower COGS, lifting gross margins to 35.26%.
3.    In 2023, an 8% sales dip and 12% COGS increase caused a 45% gross profit decline, deteriorating margins.

Typically, every £1 sale generates 21 pence of pre-expense profit. Higher ratios signal products command bigger profit margins before deducting operating costs.

Operating Profit Margin: This ratio evaluates core profitability based on earnings after accounting for operating expenses like overhead and sales costs. By isolating profits from core business, it indicates long-term success. (Goel, 2015). The percentage reflects profits from regular operations only, excluding unusual items and comprehensive income effects. It shows reliance on asset sales versus routine business for profits. (Bragg, 2012) 
 

Analysis: 
1.    In 2021-2022, margins rose on increased revenues and lower operating costs. 
2.    In 2023, an 8% revenue decline and surging operating costs caused a 78% profit slump, sinking margins.

Part Two: 

Areas of Potential Misappropriation

On my review of Greenway Builders' operations and finances identified several areas vulnerable to misappropriation of company assets:

1. Materials and Inventory: As operations director, David Green sources and purchases construction materials and manages inventory. The case indicates he has developed close supplier relationships. This enables potential collusion with suppliers to artificially inflate costs and misappropriate the excess funds (ACFE, 2023).  Lack of independent verification of deliveries against supplier invoices enables inventory theft.

2.   Payments to Casual Laborers: David Green hires and pays casual laborers for construction sites without oversight. He could overstate labor hours or number of workers and pocket the excess payroll funds (Omar et al., 2016). Ghost employees could be added to payroll allowing wages to be routed back to David.

3.    Accounts Receivable: As financial controller, Sarah Brown handles customer invoicing and AR collections. She could misappropriate incoming customer checks before they are recorded (Rae & Subramaniam, 2008). Checks could be deposited into personal accounts, enabled by a lack of bank reconciliation processes.

4.    Company Vehicles and Equipment: With no usage controls, company vehicles and equipment can be easily misappropriated for personal use (Pickett, 2010). Directors could siphon off fuel or supplies purchased for business purposes. Lack of physical asset security enables outright theft.

Recommended internal controls for Greenway Builders:

1.    Segregation of Duties

A key breakdown enabling fraudulent activities at Greenway Builders is the lack of segregation across critical financial duties. Currently, the three directors each oversee multiple conflicting activities within their domains that would normally be separated across different employees or departments in a larger company. 

For example, David Green is responsible for procuring construction materials and managing supplier invoices as well as authorizing payments. This creates opportunity for David to collude with suppliers to artificially increase invoice amounts, which he can then approve for payment, enabling him to collect the excess.  

Similarly, Sarah Brown handles customer billing, accounts receivable management, and cash receipting. This empowers her to improperly alter customer accounts, misappropriate incoming payments, or manipulate bank reconciliations without independent verification. She also oversees payroll which lacks oversight controls.

To resolve these issues, ownership duties like authorization over large expenditures should be separated from custody of assets and recordkeeping activities (Said et al., 2018). Operational procurement handled by David should be detached from accounts payable. Customer billing and collections owned by Sarah should be segregated from accounting and bank reconciliation.  

Tedious accounts payable and reconciliations tasks should be transferred to junior accounting clerks without spending authority. Adding additional roles that split up key tasks across multiple people makes concealing financial manipulation much more challenging.

2.    Physical Security over Assets 

With Greenway Builders undergoing rapid growth, large volumes of high-value physical company assets including construction inventory, job site equipment, vehicles and cash require sufficient safeguarding from theft or unauthorized usage. 

Access to inventory storage yards and construction offices holding plans and valuable items should be restricted to valid employees only through security badges, pin codes, or lock and key protocols (Pickett, 2010). External-facing fencing, security cameras covering facility perimeters and internal storage locations will help observe unusual activities. Surprise audits checking inventory and assets against records will identify potential shrinkage or asset loss issues. 

Company vehicles and portable equipment at sites should be counted before and after each shift to ensure appropriate usage and prevent unauthorized personal borrowing. Tool assignments should be logged and matched to specific contractors or jobs. Fuel logs and mileage reports will track vehicle usage.

3.    Transaction Authorization Limits

Currently Greenway Builders lacks financial oversight as directors self-approve expenditures within their domain without accountability. David and Sarah can authorize supplier invoices or payroll disbursements exceeding reasonable norms.

Mandatory authorization controls should dictate that all supplier invoices above £5,000 require secondary sign-off by a senior accounting clerk after appropriate supporting documentation like purchase orders and delivery receipts are verified (Power, 2013).

Payroll batches over £2,000 per week must be approved by Alice Green to prevent overstating hours.
Adding approval layers for larger transactions enables additional validation while still permitting daily operational efficiency for small purchases. Authorization limits force collusion amongst multiple parties to perpetrate major fraud schemes.

4.    Independent Verification Procedures

Finally, engaging external accounting experts to periodically conduct procedures like full inventory yard audits, bank reconciliation reviews, and random payroll batch testing independent of the directors provides objective third-party assessment over the accuracy of critical records, whether assets exist, and if controls are functioning (Gullkvist & Jokipii, 2013). 

Completely detached from daily operations, external verification introduces unpredictability around what will be evaluated and when, increasing probability of detecting control breakdowns or fraudulent behaviors. Any identified discrepancies signal either process gaps or deliberate financial manipulation worth investigating.

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Part Three: 

1.    Internal Financing Options

a.    Retained Earnings Reinvestment: Greenway Builders has been profitable in earlier years, retaining surplus earnings to fund growth rather than distributing dividends (Gibson, 2021). Reinvesting these accumulated retained earnings from prior growth periods into new projects avoids costly external debt and preserves director ownership stakes (Roberts, 2021).  

However, with accusations of asset misappropriation and diversion by the directors, willingness to leave extra profits invested long-term may be hesitant. Standards of trust need rebuilding internally first.

b.    Director Capital Contributions: Originally, Alice and David Green each contributed £250,000 of personal equity capital to launch Greenway Builders, receiving 250,000 shares each in return, thus funding early operations (Ross et al., 2021).

Existing directors could personally inject another round of equity cash to raise the £250,000 needed for expansion projects, avoiding external financing. This allows retained control and leverages hands-on insights into future growth prospects that outsiders may lack.

However, resentment over diluted ownership from Sarah Brown’s entry may curb appetite for directors to further sink personal assets into the business if accusations persist.

2.    External Financing Options

a.    Bank Loans: Despite the latest loss, Greenway Builders has demonstrated increasing revenues and earlier profitability that could provide borrowing collateral and repayment ability to qualify for a £250,000 bank loan (Ross et al., 2021). Term loans or revolving credit facilities introduce repayment obligations but allow directors to maintain majority control while leveraging third-party funds for investment, useful amidst internal distrust issues. However, fledgling companies often lack sufficient operating history or asset bases for loan qualification without personal guarantees from directors, which may be resisted currently.

b.    Private Equity Investment: Accepting minority growth capital through sale of company shares to external private equity investors raises expansion funds from parties with allocation experience (Lépinay, 2022). It also introduces external oversight and business expertise; Sarah Brown’s past entry shows historical openness to this option already.

However, further equity sale may excessively dilute original founders, heightening accusations. Ongoing internal allegations also reduces likelihood of investor appetite to inject funds.

c.    Venture Capital Funding: Earlier stage venture capital firms may have higher risk tolerance than private equity groups to invest in Greenway Builders' growth trajectory despite recent internal disputes (Lépinay, 2022). They receive partial future company ownership in return to fund expansion plans and provide specialized industry or managerial guidance to founders.

However, venture capitalists impose very high returns expectations which may motivate extensive, disruptive changes to operations. The directors may avoid this route to retain flexibility.

Recommendation

I recommend a balanced pursuit of the fastest sources - retained earnings reinvestment and director capital infusions - while rebuilding standards of trust internally before seeking external oversight through equity or loans. This solidifies Greenway Builders’ financial position for future growth with internal alignments first.

Part 4: 

Sales Budget: 
 

Production Budget: 

Raw Material Purchase Budget: 

Labor Cost Budget: 

Overheads Budget: 

Comments on Budgets: 

The sales and production budget shows a positive trajectory, with sales volumes and production levels increasing each month over the prior year. This indicates business growth potential in 2024. Tracking as expected, raw material purchase budgets also align to production volumes. At the same time, labor availability and capacity is budgeted to meet higher production needs. 

However, the budgets expose concerning inconsistencies in production planning that could hamper operational efficiency. The number of units budgeted for production fluctuates dramatically month-to-month, from 12,140 units in January down to 6,030 units in March. Such extreme variability strains workforce planning, inventory management, and equipment utilization. 

These wide production swings manifest in the raw material purchase budgets as well, which decline 43% from January to March. This fuels significant finished goods inventory build-up, with 9,360 units of closing stock in February and 8,190 units in March. Growing inventory ties up working capital and risks obsolescence if stockpiles are misaligned with market demand.

Finally, budgeted overheads related to administration and selling are projected to increase at a faster rate than general inflation and revenue growth. Overhead budgets grow 14% from January to February and another 6% into March, while sales only expand 20% and 8% each month. Letting indirect fixed costs outpace activity levels pressures operating margins.

Thus, Greenway must smooth its production planning process, better align inventory procurement to sales forecasts, and control overhead expenses. By refining these operational and financial factors, the company can sustain strong top-line growth while optimizing profitability through the budget year and beyond. Implementing revised procurement, production scheduling, and cost control procedures is vital.

Conclusion

To summarize, my independent financial and operational review of Greenway Builders aimed to provide the directors an objective, third-party perspective to rebuild trust and enable informed decision-making in moving the business ahead despite recent tensions.  

The financial ratio analysis identified liquidity and profitability weaknesses in 2023 from a spike in short-term debts and decline in revenues that merit further investigation. Control environment vulnerabilities like lack of segregation of duties and oversight over assets also increase misappropriation risks and require priority action.  

In terms of financing £250,000 for the new product expansion, I recommend first reinvesting existing earnings supplemented by director capital infusions before considering external options, to solidify Greenway’s position while working to realign the leadership team internally.

The budget analysis also raised production planning and cost control issues needing refinement to optimize financial performance amidst growth. While accusations may linger, implementing these financial transparency and governance recommendations can help resolve uncertainty and conflicts.
With constructive solutions and open communication, Greenway Builders holds strong potential to move beyond current challenges. As an independent consultant I hope my review and proposals aid the directors in making sound decisions. My door remains open for any other support or advice needed in service of the company’s future success. 
 

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