FAE Core Simulations - Paper SIMULATION 1: Fuel the Future Limited (FTF) (Suggested time: 90 minutes) You are Rose Johnson, the newly appointed Financial Controller of Fuel the Future Limited (FTF*), a biofuels company. FTF buys its inputs (primarily rapeseed cil) from farmers and processes them into biodiesel, which is as efficient as fossil diesel. It is an indigenous Irish company, built up from small beginnings by the founder and current CEO, Conor Kerrigan, a man who exudes passion for the company. FTF has a strong focus on sustainability, as stated in its mission statement: "to be the ieading biofuels company, delivering sustainable growth by providing @ renewable and clean fuel, in partnership with our local stakeholders.” When you arrive on your first day in early January 2014, Conor calls you into his office to welcome you and direct you on your initial responsibilities. After some words of welcome, Conor gets directly to your key priorities “The previous financial controller had the accounts in great shape before she left in mid-December Since then, we've had a few late sales which you will need to look at but | don't think there were many other changes. Obviously we'll need you to oversee the finalisation of the accounts in the next week or so, but for now I have something more pressing to discuss. “We've been going through a period of rapid growth, and we project that the market will double again in the next five years. We've been anticipating this growth and we built a new, state-of-the-art factory two years ago, and it currently has spare capacity, so that we can continue to grow with the market. We have the highest market share in treland and are determined to maintain this. But here's the problem: demand is outstripping supply. We have large clients that we are contracted to supply, and the volumes they require are huge. If we can't meet our customers’ needs, they could go elsewhere in the future and that would be disastrous for us.” Thinking rapidly, you reply, “If we have the spare capacity in the factory, and the demand is why is there a problem?” increasing, then Conor continues, “It’s the inputs — we've been buying from local farmers for years now, but they can't keep Up with our production needs so we need to look at other options. We have a number of options, all with an initial outlay of approximately €/£ 1 milion, and we have the spare capacity to take on one of them. My Preference is to begin leasing land from the farmers and to produce the inputs ourselves. I've identified some farms where the crops would be ready for harvesting in good time for us. Our projections suggest that it could help us increase production by 50% over the next five years. We need to act fast, though, because good farming land is scarce, When | got into this business I was determined to make sure that we produced a clean, renewable fuel and that we brought the local communities along with us, and this is a. great ‘opportunity to do that. It wll allow us to Keep that personal touch we have with our customers and suppiers, which I'm so proud of, “Some members of the management team disagree that this is sustainable or good for the local economy, but | don't see the problem. It ensures that the local farmers receive a secure income, and it's easier for them than using the land to produce the other crops that they sell in the local economy.” ‘You ask Conor for some information on the alternative strategies proposed by the rest of the team, and he is Quite forthcoming: “Some of them think we should accept a proposed deal with FAST FOOD ple, the global fast food chain. They buy a lot of oil from farmers, but at very low prices. | should know — | was a farmer before | started this company and, with three of their restaurants in the town, | did a lot of business with them. There's a proposal that we buy their waste oils to use as inputs for our biofuel at a fixed price for the next five years. Waste oils are as effective and efficient as fresh oils, so the quality of our product would not suffer, once we make our initial investment in the required machinery. We'd start with just the restaurants in this county, which could increase our production by 40%. But | just don't see how this relationship would fit with our mission. FAE 2014 CORE SIMULATIONS ~ PAPER aFAE Core Simulations - Paper “There is another project that has everything | wanted when | set up this company: its entirely renewable, susiainable, and clean, and it could yield more fuel than any of the oils that we currently use. | have been ‘approached by a start-up company involved in research and development, who are suggesting that we work together to produce biofuels from an algae farm, for which we have the capacity. Their idea is patented and, with the appropriate investment, it could be commercially viable on a large scale within 10 years. Our company has the potential to be not just the Irish leader, but a world leader in this. “That's where you come in, Rose. We want an objective viewpoint and | feel that your background working in 8 large auit firm has given you a wide knowledge base. Could you prepare a report for the management team, setting out your views on our strategic options? I'd really appreciate your honest opinion on the advantages and disadvantages of these and your recommended strategic option for FTF.” You are very excited by this opportunity and you tell Conor that you'd be happy to help. Before you go back to your new desk to get started, you ask if there is anything else that he would like you to include in your report. Conor is clearly impressed by your enthusiasm, and mentions another issue that has arisen, “There is fone more thing, actually ~ we have some concerns about our working capital. You should have an email (Appendix 1) from Eoin Waters, our Management Accountant, when you log in ~ could you take a look at this and include your suggestions in relation to the working capital and financial reporting concerns he raises? We can inject more equity if we need to, but | want to avoid itif at all possible.” You return to your desk, excited about the opportunity you have been given to impress the management team with your repor. AE 2014 - CORE SIMULATIONS ~ PAPER 50FAE Core Simulations - Paper SIMULATION 1: Fuel the Future Limited (FTF) Appendix 1 ~ Email from Eoin Waters to Rose Johnson To: rose johnson@fifie From: coin.waters@itt.ie Date: 5 January 2014 ‘Subject Working capital Welcome to Fuel the Future Rose. I'm emailing you the draft financial statements (Appendix 2) and to gat your views on an issue we have around working capital The company is very profitable and things keep getting better and better. In fact, only last week we recognised three substantial sales in our 2013 accounts, all with a 30% margin. Conor thought | should fill you in on them to give you an indication of just how well we're doing and that we don't have any financial reporting issue arising in this context: 1) The government transport department ordered €/£ 200,000 of fuel for delivery on 13 January 2014, They're using up their budget before year end, so they requested to be invoiced and to take title to the fuel from 27 December and we agreed. The fuel will be produced and ready for delivery by 13 January. 2) A chain of service stations is now trialling our fuels. We delivered a shipment to them on 30 December and this sale is worth €/£ 500,000 to us, but we agreed to let them pay us only whenlif they sell the fuel, and even gave them right of return of any unused fuel to ensure we got this deal. 3) We delivered and invoiced €/£ 400,000 of fuel to a large, blue chip haulage company on 31 December. However, we've agreed to allow them to pay in instalments of €/£ 50,000 per month, starting in February. ‘These sales are fantastic for the top line in FY2013, but while we've never had a bad debt, our accounts receivables are growing at a faster rate than our revenues, so we need to accelerate cash receipts and there are two potential options that I've come across. We can avail of a non-recourse factoring arrangement proposed by the bank. They would give us an advance of 80% of invoiced amounts at 3% per annum, with & 2.5% service fee, and we'd save €/£ 125,000 per year on administrative costs, Alternatively, we could offer a discount for payment within 30 days, which would cost €/€ 1.3 milion if all our customers took up this option. We had considered obtaining a bank loan but the terms offered are currently not considered favourable to us. Conor suggested that you might have a view on this and that you could incorporate it into your report to the management team. You can ignore the tax implications of the items included i ‘email and we'll consider them at a later date. Looking forward to working with you! Kind regards, Eoin FAE 2014 - CORE SIMULATIONS - APPENDICES. 64Appendix 2 — Draft Financial Statements Draft Statement of Financial Position at 31 December 2013 2013 #000 ASSETS Non-current Assets Property, plant and equipment 41,020 Current Assets Inventory 6.450 Trade receivables 6,250 Bank and cash 4.100 13,800, 54,820 EQUITY AND LIABILITIES Ordinary shares 1,000 ‘Share premium 410,000 Retained earnings 33,000 44,000 Non-current Liabilities Long term loans 5,400 Current Liabilities Trade payables Draft Statement of Profit and Loss and Other Comprehensive December 2013 2013 eff ‘000 Revenue 25,000 Cost of sales 17,360) Gross profit 7,640 Operating expenses (3,580) Operating profit 4,060 Finance costs Profit before tax Income tax expense Profit after tax FAE 2014 - CORE SIMULATIONS ~ APPENDICES 2012 ee ‘000 39,400 5,000 3,200 3,300 11,500 1,000 10,000 29,980 40,980 4,870 2012 €/f."000 18,000 (12,600) 5,400 2,593) 2,807 (487) 2,320 500) FAE Core Simulations - Paper Income for the Year Ended 31