PL had been started by Loretta and Jimbo five years ago. The business is a designer and manufacturer of casual and leisure clothes aimed particularly at the younger, higher income market. Before starting the business both Loretta and Jimbo had been employed as senior managers with White Hart Plc, a large UK clothes manufacturer. They decided to create PL after their ideas for developing a new range of clothes for younger people had been welcomed by White Hart Plc but investment capital had not been available.
From the very outset, Loretta and Jimbo decided that PL would be a design and marketing led business. Much of the forward planning was concerned with integrating the product design and development with the sales and marketing operations of the business. The new business had taken a lot of trouble and spent a lot of money on employing a young and talented design team, led by Heena Hussein who had been employed previously as a chief designer for a leading sportswear brand. The range of clothes designed by Heena and her team was greeted with enthusiasm by the major buyers and this was converted into firm orders by the marketing team led by Loretta.
PL grew slowly at first. However, sales started to increase significantly as the brand gained acceptability in the UK and as export markets in France and Switzerland were opened. Loretta and Jimbo were both surprised and delighted by the speed with which the sales of the business had grown in recent years and by the growing base of regular customers. The order just received from Totspur was seen as particularly important. If Totspur became a regular customer, the sales of the business were likely to increase rapidly over the next few years and would establish PL as a major player in the market. This, Loretta and Jimbo felt, would build upon their success, success evidenced in the year to 30 September 2007 by the Cash Generated from Operations (as shown on their published Cash Flow Statement) of £6,608,000.
Loretta and Jimbo had both invested their life savings in the business and had also taken out large mortgages on their respective houses to help finance the new business. However, this provided only a relatively small amount of the total ordinary share capital needed. In order to raise the remaining share capital, friends, family and business contacts were approached. The largest shareholder of the business was Crowley Estates Ltd owned by Alan and Tim Crowley. The two Crowley brothers had made large profits by land speculation over the years but were keen to diversify into other areas as their business had been particularly hard hit by the recent recession. They had known Loretta for many years and were convinced she and Jimbo would make a success of the new business.
PL’s directors and their shareholdings were as follows:
|Loretta Long||Managing Director and Marketing Director (700,000 shares)|
|Jimbo Juggins||Production Director (700,000 shares)|
|Heena Hussein||Design Director (40,000 shares)|
|Alan Crowley||Chairman (2,000,000 shares owned jointly with brother Tim through Crowley Estates)|
|Tim Crowley||Non-executive director|
In addition to his role as production director, Jimbo tended to look after financial matters. Though the business had accounts staff who dealt with the day-to-day transactions, there was no one at PL who had any great financial expertise. When there was a problem, the business’s auditors were normally asked for advice. That said, Loretta and Jimbo had not consulted the auditors in October 2007 when they had purchased new equipment and buildings for £8,670,000, part of which had been funded by an additional bank loan.
On the day the letter from the bank was received, a meeting of the board of directors was due to take place to consider the draft financial statements for the year that had ended two months earlier. At this meeting, the letter from the bank was also distributed to board members for discussion.
Jimbo Juggins began the discussion by saying:
‘We’ve just received the draft accounts from the auditors which seem to confirm our success. Profit has more than doubled. I really can’t see how the cash situation is so poor. I know that we spent a lot on that additional plant and that we didn’t get anything from the old machines we got rid of, but most of that was covered by the bank loan. Really, the cash situation should be even better than the profit level implies because the expenses include about £2.8 million for depreciation and we don’t have to write a cheque for that.’
Loretta Long, who was still angry at what she regarded as the high-handed attitude of the bank, pointed to the difficulties that the bank’s demands would cause: ‘The bank wants us to reduce the overdraft by half over the next six months! This is crazy – I tried to explain that we have important orders to fulfil but the manager wasn’t interested. How on earth can we find this kind on money in the time available? We are being asked to do the impossible.’
Both Jimbo and Loretta had, before the meeting, hoped that the Crowley brothers would be prepared to help out by purchasing further new shares in PL or by making a loan. However, it was soon made clear by Alan Crowley that further investment was not a possible option. Crowley Estates had been experiencing considerable problems over recent years, as a result of a couple of unprofitable overseas projects, and simply did not have the money to invest further in PL. Indeed, the Crowley brothers would be prepared to sell their shares in PL to generate much-needed cash for their own ailing business. Finding a prospective buyer for the shares was not, however, a likely prospect at this point. Both Alan and Tim Crowley had been heavily involved in recent years with the problems of Crowley Estates and had taken little interest in PL’s affairs. The board meeting made them realise that they should have been much more attentive and now faced the prospect of being major shareholders of two failed businesses unless things could be radically improved.
PL’s financial statements for the past two years are set out below on the next two pages:
Opening net book value of NCAs (8,600)
Depreciation charge for the year 2,800
Closing net book value of NCAs 14,470
NCA additions during the year 8,670
The board of directors was not able to agree on a way of dealing with the financial problem faced by PL. Loretta believed that their best hope was to continue to wrangle with the bank over its demands. She felt that their was still a chance that the bank could be persuaded to change its mind once the draft financial statements for last year were made available and the bank was informed of the implications for PL of paying off such a large part of the overdraft in such a short period of time. Jimbo and Heena, on the other hand, were not optimistic about the prospects of changing the bank’s position. PL had breached its overdraft limit on several occasions over the past few years and they knew that the patience of the bank was now wearing thin. They believed that the only real solution was for the board to look for someone who was prepared to make a significant investment in the business. They felt that only a large injection of new funds could keep PL on track. Like Loretta, they believed that the financial statements demonstrated the success of PL over recent years and that this evidence would make the business attractive to a potential investor. The Crowley brothers rejected both of these views as being impractical. In addition, they were against the idea of introducing another major shareholder as this was likely to dilute their influence over the future direction of the business. The brothers believed that the board required drastic and immediate action, although they were not sure what form of action should be taken.
After several hours of discussion, it was clear that the financial issue was not going to be resolved at the meeting. Instead, it was agreed that expertise from outside PL should be sought to help the business find a feasible solution to the problem. The board decided to approach BUS021 Financial Consultants, a firm which specialises in helping businesses with financial problems, and to ask the firm to analyse the financial performance and financial health of the company.