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BScAllProgrammes
UNDERSTANDING FINANCIAL
STATEMENTS
Coursework Assessment Brief
September 2016
Submission deadline: 11:59 PM on 20 December 2016
Submission mode: Turnitin online access

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BPP University Business School: September 2016

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1. General AssessmentGuidance
 YoursummativeassessmentforUnderstandingFinancialStatementsisaCoursework
submission.
 The deadline for submission is 11:59 PM on 20 December 2016
 Youarerequiredtosubmityour assessment viaTurnitin online access.Onlysubmissions made
via the specified mode will be accepted and hard copies or any other digital form of submissions
(like via email or pen drive etc.) will not be accepted.
 For coursework, the submission word limit is 1,500 words. You must comply with the word count
guidelines. You may submit LESS than 1,500 words but not more. Tables, diagrams,
bibliography, appendices, annex andheadings are NOT included within word count calculations.
You must specify total word count on the front page of your report.
 Forcoursework,pleaseusefontsize12forbodytextandthetypeface(font)shouldbeArialor
Times New Roman with minimum 1.5 spacing.
 Forheadersandtitles,pleaseusefontsize 14.Yoursubmissionmust havestandardmargins and
page numbers.
 Please use English (UK) as your language in the submission.
 Donotputyournameorcontactdetailsanywhereonyoursubmission.Youshouldonlyputyour
studentidentificationnumber(SRN)whichwillensureyoursubmissionisrecognisedinthe
marking process.
 A total of 100 marks are available for this module assessment and you are required to achieve
minimum 40% to pass this module.
 Youare required touse only Harvard Referencing System inyour submission. Anycontent which
isalreadypublishedbyotherauthor(s)andisnotreferencedwillbeconsideredasacaseof
plagiarism.
YoucanfindfurtherinformationonHarvardReferencingintheonlinelibraryontheVLE.Youcan
use the following link to access this information:
http://my.bpp.com/vle/mod/data/view.php?d=223&rid=596
 BPP University has a strict policy regarding plagiarism and in proven instances of plagiarism or
collusion,severepunishmentwillbeimposedonoffenders.Youareadvisedtoreadtherules
andregulations regardingplagiarism andcollusionintheGARandMOPPwhichareavailableon
VLE in the Academic registry section.

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 You should include acompleted copyofthe Assignment Cover sheet. Any submission without
this completed AssignmentCover sheetwillbe consideredinvalidand notmarked.
2. Assessment Brief
IMPORTANT POINTS TO NOTE
You must submit a Word document (NOT PDF) via the turnitin link.
Donotincludeinappendicesanywork youwishthemarkertoconsider aspartofyouranswer. The
markers will NOT read appendices.
USE OF EXCEL
You may use excel to support your workings. However please take note of the following points:
1. You must NOT submit an excel file. It will not be considered by the markers.
2. YoumayNOT‘embed’excelfilesintotheWorddocument.Ifyouareunsurewhatismeant
by this see: https://support.office.com/en-us/article/Link-or-embed-an-Excel-worksheet-
41bf021e-ba7c-44ef-9914-0d7e88062257
3. YoumaycopyandpasteworkingsfromexcelintoyourWordsubmission.Howeverthe
layoutmustbesuchthatthemarkerscanunderstandyourcalculations.Inotherwordsdo
not simply copy a series of calculations. You must include explanations of each step of your
workings. Failure to do so will result in a significant loss of marks.

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2.1 CASE STUDY – HORIZON LIMITED (LTD)
Background – Horizon Ltd
Horizon Ltd (Horizon) was formed in 2004 as an energy exploration company. Exploration
is the process of trying to find oil and natural gas trapped under the Earth’s surface.
The exploration is done on behalf of energy producers (businesses such as BP, Shell, Exxon
Mobil). Production is the process of recovering those hidden resources for processing,
marketing anduse.
What is Energy Exploration?
IMPORTANT – This section is for information, an understanding of it is NOT
important for this assessment. However, you may find it interesting, and it
should give relevant context to your understanding of the industry which will
be useful particularly for the Commercial Awareness assignment.
There isn't any way to be absolutely sure where new oil and natural gas reserves are
located, so exploration companies (such as Horizon) need to collect clues as to what lies
deep beneath the earth's surface.
Engineers can gather surface (above-ground) clues
using airplanes and satellites to map the earth’s surface,
to identify promising geological formations, and to look for
oil and natural gas escaping to the surface (known as
seeping or seeps). Ships can do a similar task on
exploring the ocean floor.
But engineers often get much more useful information by looking at geological structures
and rock properties below the surface. They use a
number of methods including:
Seismic surveys are done by sending high-energy
sound waves into the ground and measuring how long
they take to reflect back to the surface. Since sound
travels at different speeds as itpasses through different
materials, computers can use seismic data to create a
3-D map of what lies below thesurface.
Geologists and geophysicists – known as “explorationists" – use these 3-D seismic images
to look for pockets (reserves/reservoirs) of oil and natural gas. Engineers then use the
data to plan the safest, most cost-effective well path to the reservoir.

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When surface clues indicate a likely site for oil and natural gas reserves, an exploration well
is often drilled. Rock samples from the well are brought to the surface and analysed. Well logs
measure the electrical, magnetic and radioactive properties of the rocks.
By examining this information, a geologist can learn a great deal about
the sub-surface structures and whether or not the site is likely to produce
oil and natural gas at a volume which will allow the producer to make a
profit.
Gravity and Geomagnetic Surveys are a relatively
inexpensive techniques which can identify potential oil and
natural gas bearing sedimentary basins (rock structures
whose shape might indicate the existence of natural gas or
oil). High-resolution aero-magnetic surveys done by special
aircraft can also show fault traces and differentiate between
different rock types near the earth’s surface.
Recent events at Horizon
In 2011, the company decided to expand into exploration of sites suitable to produce
renewable energy (including wind farms, solar farms and hydro plants). As commented on
in Exhibit 4 the company struggled to make a profit in this area. So Horizon decided to sell
this division off to an established renewable energy producer at the end of 2014..
With the company now focusing on Oil and Gas exploration, Horizon has been able to take
advantage of the discovery and growth in Shale Gas production in the United States.
To learn more about Shale Gas see [http://geology.com/energy/shale-gas/] . (A technical
understanding of how fracking works is not required for this assignment, but you may find this
interesting.)
Keen to maximise the opportunity of this new resource, the Board of Horizon arekeen
to expand their coverage in Shale Gas exploration. They have identified a company
(Naxol) which specialises in Shale Gas exploration in Western Europe which they wish
to buy.
The 2015 financial statements for Horizon have been recently released and at the last
board meeting the board members raised a number of questions which you agreed you
would respond to at the next meeting.

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Your role
You are the Finance Director of Horizon, Clara Jones
You have been asked to analyse the financial performance and position of the company
and produce a Board report which sets out your findings and makes arecommendation
as to whether Horizon should buy Naxol. This will be your assignment for
Understanding Financial Statements.
You will also produce a report on various matters concerning the acquisition of Naxol,
and about the potential for Horizon to become a Public Limited Company (PLC). This
will be your assignment for Commercial Awareness.
To assist you with this task you have been supplied with the following information:
Exhibit 1: Extracts from Horizon’s Financial Statements for 2015.
Exhibit 2: Additional Financial information which supports the financial statements
in ExhibitOne.
Exhibit 3: Key ratio analysis for 2014 and 2015 of Horizon’s financial statements.
Exhibit 4: Finance Director’s notes.
Exhibit 5: Naxol Ltd Financial statements for 2015, & notes about the company.
Exhibit 6: Two different views of fracking.

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Horizon Limited: Statement of Financial Position as at 31 December 2015
2015 2014
£'000 £'000
ASSETS
Non-current Assets
Property, Plant and Equipment 1,000 1,880
Patents and Trademarks 150 330
Development costs 250 440
1,400 2,650
Current Assets
Trade and other receivables 7,963 8,213
Cash and cash equivalents 2,143 0
10,106 8,213
Total Assets 11,506 10,863
EQUITY AND LIABILITIES
Equity
Share Capital 5,000 5,000
Retained Earnings 2,621 1,101
Total Equity 7,621 6,101
Non-current Liabilities
Long term loans 1,850 3,500
Current Liabilities
Trade payables 2,035 1,062
Bank overdraft 0 200
2,035 1,262
Total Liabilities 3,885 4,762
Total Equity and Liabilities 11,506 10,863

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Exhibit 4: Finance Director’snotes
The notes taken below are to assist me (The FD) in preparing the board report.
Board members without a financial background raise the following queries.
In reviewing Non-Current Assets on the Statement of Financial Position (SOFP),
what are patents andtrademarks?
The advanced technology we use in resource exploration means that we spend
significant sums on Research and Development (R&D). When a piece of
technology is developed we are able to protect it for a period of time (usually 25
years) from competitors using it via the registering of a patent (for which the
Patent Office charges us a fee. This fee is reflected in the SOFP.
In reviewing Non-Current Assets on the SOFP, what are development costs?
This relates to the R&D mentioned above. The general research undertaken in the
field of exploration is charged to administrative expenses (see Note 1 on Exhibit
2). When that research moves onto the specific development of exploration
technology which we can use, accounting standards allow it to be categorised as
an Asset (when it meets certain criteria). All the development costs shown as a
Non-Current Asset in Exhibit 1 meet this criteria.
What is included in Other Operating Income on the Income Statement?
This includes an element of the contracts we have with energy producers, which
is in addition to the fees paid for the exploration (which we show in our revenue).
If the exploration successfully discovers Oil or Gas we receive a small commission
based on the volume of Oil or Gas extracted. This is paid to us on an annual basis.
What is Amortisation?
Where we charge depreciation to reflect the use of tangible Non-Current Assets,
amortisation is the equivalent of this for intangible Non-Current Assets.
Why do we spend so much money on Legal and Professional Fees?
Our contracts with the big energy producers are specific to the sites and the type
of resource being explored. Due to their length and complexity we use a legal firm
who specialise in these types of contract to develop them on our behalf.
Discussion with the Chief Executive
Though expansion into renewable energy made strategic sense in 2011, this is an area in
which we have struggled to make a good level of profit. We found that:

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 The exploration methods are simpler and therefore we have not been able to
charge a high price for the work undertaken.
 Because we are relatively new to the area, we were spending relatively high
amounts on research with only a small proportion developing into usable
exploration technology.
Therefore following the board’s review of the company’s profit and cash position during
2014 we decided that we needed to either stop this activity or sell it to another company.
An established renewable energy provider called Iberdrola was interested in gaining
access to the UK renewable energy market and therefore we were able to negotiate a sale
of the division at the start of 2015. The sale included:
 Exploration plant and equipment used to identify suitable renewable energy sites.
 Patents (including associated development costs) related to the technology used
in the plant and equipment above.
 The divisional director, geologists, sales team and back office support (finance,
Human resources) for the renewable energy division. (This was done by
transferring the employment contracts and people to Iberdrola – all the staff
affected agreed to the transfer so no redundancies wererequired).
The sale did not include £1.65 million of loans linked to financing the division between 2011
and 2014, which we repaid once the sale of the division was finalised.
Whether we decide to buy Naxol or not, Shale Gas is a major opportunity and could see
our company significantly expand in the next few years. To help finance such an expansion
we are considering listing the company on the London Stock Exchange and becoming a
Public Limited Company (plc). I understand that this might increase our costs so that we
comply with the UK Corporate Governance requirements, I will be interested to get your
views as to what types of cost we might incur if we decide to list.
Discussion with the Operations Director
Reviewing the segment analysis (Exhibit 2):
 We were able to secure new contracts during 2015 as a result of the
expansion of Shale Gas production in the USA.
 The scarcity of Oil and Gas resources (with the exception of Shale Gas) makes
successful exploration important to the energy producers and therefore we have
had the opportunity to raise the price of the exploration fees we charge.

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 Advanced technology which came into use during 2015, has revolutionised the
exploration process for oil and gas, and helped us identify potential reserves with
greatly improved accuracy. This has resulted in fewer exploration wells, and
reduced exploration costs for the company.
Other matters
 The board’s review of the cash position in 2014 involveda closer look at how we
manage working capital.
o There was no flexibility in the credit terms we provide to our customers,which
are big energy producers. These are big companies which tend to dictate the
payment terms for our invoices, and the industry standard is 90 days
between undertaking the exploration and receiving the money for the fees
we charge for theexploration.
o The industry standard noted above for the renewable energy sector was 60
days.
o Our suppliers are mainly specialists we use on a sub-contracting basis
when undertaking exploration anywhere across the world. (We hire local
expertise) We found that we were paying the subcontractor as soon as we
received their invoice. However, standard invoice terms are for payment 30
days from the invoice date, and therefore we decided to use that credit
period to manage our cash position.
Financial Criteria for deciding on whether to buy Naxol
ALL the financial criteria below need to be achieved by Naxol for the Finance Director to
recommend that the company is purchased by Horizon:
 Return on Capital Employed (ROCE) above 20%
 Profit margins that are no less than 5% below Horizon’s profit margins in 2014
(for instance if our profit margin was 20% then Naxol’s would need to be greater
than 15%) – this is on the basis that Horizon believes it could find cost savings
following the purchase of Naxol to bring the profit margin up to Horizon’s present
levels.
 Relevant Liquidity and Solvency ratios are within the standard industry safety limits.

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Exhibit 5; Extracts of Naxol's 2015 Financial Statements
Naxol Limited: Statement of Profit or loss for the year ended 31 December 2015
2015
£'000
Revenue 9,317
Cost of Sales (8,264)
Gross Profit 1,053
Overheads
Administration expenses (598)
Operating Profit 455
Finance costs (142)
Profit/(Loss) before Tax 313
Income Tax expense (94)
Profit/(Loss) for the period 219
Naxol Limited: Statement of Financial Position as at 31 December 2015
2015
£'000
ASSETS
Non-current Assets
Property, Plant and Equipment 635
Patents and Trademarks 101
Development costs 96
832
Current Assets
Trade and other receivables 2,614
Cash and cash equivalents 0
2,614
Total Assets 3,446
EQUITY AND LIABILITIES
Equity
Share Capital 500
Retained Earnings 661
Total Equity 1,161
Non-current Liabilities
Long-term borrowings 1,000
Current Liabilities
Trade payables 1,263
Bank overdraft 22
1,285
Total Liabilities 2,285
Total Equityand Liabilities 3,446

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Environmental Impacts
Many concerns have been raised about environmental risks associated with the
fracking process. The Trust considers that the most significant local issues for
biodiversity are:
 The impact of the footprint of the physical development e.g. buildings, parkingareas,
waste water storage tanks and well-heads
 The impact from flaring off of gasses and light pollution
 The impact of the transport footprint on the landscape, wildlife sites and noteworthy
habitats and species
 The safe disposal of waste
 The use and management of water resources
 The climate change implications
Exhibit6: Two different views of fracking
Sussex Wildlife Trust
Is the UK fit to frack?
The Sussex Wildlife Trust recognises that all forms of energy generation will entail
some environmental costs and that the risks and benefits associated with each must
be weighed against each other and considered in the context of location and scale.
We believe that the UK Government should retain its focus on sustainable energy
production and energy conservation, and ensure that funding is prioritised for the
development and implementation of renewable energy technologies.
There are a number of improvements that could be made to the regulatory system
which would minimise the potential environmental impacts and we urge Government
and its regulators to put these into practice. However, even if these measures are
implemented, our view of the current evidence base suggests that shale gas
exploitation is not compatible with UK emissions reduction targets and wider
commitments to tackling climate change.
We are deeply concerned about the impact that fracking could have on the species
and habitats of Sussex.

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Nick Grealy
from ReimagineGas
THU RSDAY, SEPTEMBER 29, 2016 0 COMMENTS
Would 'fracking', the nasty sounding word for what is in reality a mundane process of
onshore natural gas extraction, lock us 'into an energy infrastructure that is based on fossil
fuels long after our country needs to have moved to renewables' as Barry Gardiner MP told
the Labour Party conference[…]?
It need not. It should not. It cannot. It must not. 'Fracking' and renewable energy isn't an
either/or choice. It's both - and many another besides.
Energy is not electricity. Many technologies can produce not only the light we need to shed
on the UK climate debate, but also the heat, industry, mobility and connectivity upon which
we all depend. Natural gas, the lowest carbon fossil fuel has led not to damage, (or at least
little any US tort attorneys have discovered) or an increase in CO2 emissions. Shale gas
makes up 70% of US production, passing the 'unconventional' stage long ago and is the new
normal in natural gas. Gas cut CO2 and empowered wind and solar power in the US as the
coal to gas switch accelerates. It clearly need not lock out wind: Texas produces 40% of its
electricity from wind, double the UK share. It doesn't compete or replace solar technology as
drops in price worldwide accelerate. The COP21 Paris climate treaty was made possible by
the all of the above (except coal) energy strategy proposed first by President Obama and
Hillary Clinton and then jointly with China. The foundation was the extensive, ubiquitous and
lower carbon resources uncovered by the shale revolution.
COP21 arose because the vast majority of climate scientists don't make Barry Gardiner's, or
the Friends of the Earth's, mistake of making a perfect future the enemy of the present good.
Natural gas isn't perfect. It isn't the only solution. But the shale revolution, founded not only
on fracking but also with horizontal drilling and thus an extremely low surface impact shows
the nearest gas is the best gas.

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2.2 Questions
You are the Finance Director of Horizon, Clara Jones. You have been asked to
analyse the financial performance and position of the company and produce a
Board report which sets out your findings (based on the questions below) and
makes a recommendation as to whether Horizon should buy Naxol Limited..
1. Purpose and key features of Horizon’s Financial Statements (22 marks)
The table below is relevant to question 1a
The Board has heard the following descriptions discussed in board meetings during
2015 and are interested to know how they have been treated in Horizon’s financial
statements.
Description 1 During the year Horizon received and paid an Invoice for
£50,000 from their legal advisors for drafting contracts
agreedwithenergyproducersintheperiodJuly-September
2015.
Description 2 Horizon paid £20,000 to the patent office in March 2015 to
register the design of a new piece of exploration equipment.
The registration allows Horizon exclusive use of the
equipment for 25years.
Description 3 Horizon received a supplier statement from a subcontractor
whoprovidesshipstoundertakeSeismicSurveysaroundSouth
America. The statement indicates that Horizon owe the
subcontractor £90,000 asat 31 December 2015.
Description 4 Horizonpaid£40,000ininterestchargestoHSBConbank
loans which are due to be repaid in 2025.
a. For Horizon, consider the FOUR descriptions above and for each of them:
i. Choose whether the description relates to a transaction in the
Statement of Profit or Loss and Other Comprehensive Income
(SPLOCI) or balance in the Statement of Financial Position
(SOFP).
(4 marks)
ii. Explain where the transactions would be specifically allocated in
the Statement identified in 1a(i) above.
(8 marks)

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b “Where we charge depreciation to reflect the use of tangible Non-Current Assets,
amortisation is the equivalent of this for intangible Non-Current Assets.”
i. Describe ONE key difference between tangible and intangible Non-
Current Assets
(2 marks)
ii. Using the criteria from the conceptual framework for recognising an
asset, explain why Horizon’s expenditure of £150,000 on patents meet
these criteria and is therefore recognised as an asset.
(8 marks)
2. Interpretation of the StatementofProfitorLoss(SPLOCI)(32 marks)
a. The board’s review of the 2015 SPLOCI has led to some confusion, raising the
question of “How has a decrease in our revenue between 2014 and 2015
resulted in our gross profits increasing during the same period?”
Using the segment analysis in Exhibit 2:
i. Calculate the gross margin ratio for each division in 2014 and 2015;
(5 marks)
ii. Apply a trend analysis to ascertain the movement in total revenue
between 2014 and 2015;
iii. Apply a trend analysis to ascertain the movement in both Gas
and Oil exploration revenue between 2014 and 2015; and
(2 marks)
(4 marks)
iv. Using the information calculated above along with information from the
case study give ONE reason as to why Horizon’s revenue has
decreased and ONE reason as to why gross profit has increased.
(6 marks)
b. Use the case study information to analyse and comment on THREE
movements in Horizon’s SPLOCI (financial performance) in Exhibit One
during the year 2015 compared to2014.
EXCLUDE Revenue, Cost of Sales and Gross Profit from your selection
(covered in part a above).
Use the additional financial information in Exhibit 2 and the relevant ratios
shown in Exhibit 3 to enhance the quality of your analysis.
For each item you select to analyse and comment upon
i. Ensure you use an appropriate financial technique (Ratio, Trend
analysis) to ascertain the movement between 2015 compared to
2014;
(3 marks)

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ii. Reflect and comment upon whether the movement is a
positive or negative indicator of financial performance; and
(3 marks)
iii. Use the case study to identify and explain at least ONE reason why
each movement analysed in part 3b(i) has happened.
(9 marks)
3. Interpretation of the Statement of Financial Position (25 marks)
a. Use the case study information to analyse and comment on TWO
movements in Horizon’s Statement of Financial Position (financial condition)
in Exhibit 1 during the year 2015 compared to 2014.
Use the information in Exhibit 2, and the relevant ratios shown in Exhibit 3 to
enhance the quality of your analysis.
For each item you select to analyse and comment upon
i. Ensure you use an appropriate financial technique (Ratio, Trend
analysis) to ascertain the movement between 2015 compared to
2014;
(2 marks)
ii. Reflect and comment upon whether the movement could have a
positive or negative impact on Horizon’s financial condition (which
could cover Liquidity, Solvency or Efficiency) ; and
(4 marks)
iii. Use the case study to identify and explain at least ONE reason why
each movement analysed in part 3a(i) has happened.
(6 marks)
b. Using Naxol Ltd’s financial statements set out in Exhibit 5:
i. Calculate the followingratios:
 Return on Capital Employed (ROCE)
 Gross profit margin
 Operating profit margin
 Current ratio
 Interest Cover
 Gearing ratio
(6 marks)
ii. Compare your calculations in 3b(i) with the criteria set out in Exhibit
4 and recommend whether Horizon should buy Naxol Limited.
(7 Marks)

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4. Interpretation of the Cash Flow statement (16 marks)
In reviewing the 2015 financial statements a member of the board commented that:
“Since deciding to review our cash position in 2014 it is good to see our
Statement of Cash Flows shows we have made a significant improvement in
2015.”
i. Identify the SPECIFIC part of the Statement of Cash flow which indicates
Horizon’s cash position has significantly improved.
(2 marks)
ii. Reviewing the Operating Activities section of the Cash Flow
Statement, identify ONE figure that has been taken directly or been
derived from the SPLOCI, and ONE figure that has been taken
directly or been derived from the SOFP.
(4 marks)
iii. Explain, using the information in the case study and the ratios in
Exhibit 3, how the company has been able to ‘improve its working
capital’ (receivables and payables) to improve its cash flow.
iv. Identify TWO other reasons for the improved cash flow from the
statement of cash flows.
(6 marks)
(4 marks)
5. Professional report format (5 marks)
Marks are allocated for setting out your answer in the format of a professional
business report.
(5 Marks)
TOTAL: 100 MARKS
The report should be no longer than 1500 words (excluding tables, diagrams,
bibliography, appendices and headings), a suggested format in which to incorporate
your answer is set out below.

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Assessment Marking Scheme
The assignment is marked out of 100. The following table shows the mark allocation and the
approach required.
Assignment Part Mark Approach
Q1 Features of Horizon’s
Financial Statements
22 A good knowledge of the content from weeks
1-4 will help with part a.
You will also require the ability to apply the
conceptual framework to a particular
balance/transaction.
Suggested report format
To: The Board of Horizon Ltd
From: Clara Jones, Finance Director.
Date: Assessment Day
Title: To complete
Introduction: To complete
Executive summary: To complete
Main Report:
Include Subsections/Paragraphs etc for each of the 4 main areas listed
below
Part one - Purpose and key features of Horizon’s financial
statements
Part two - Interpretation of the Statement of Profit or Loss
Part three – Interpretation of the Statement of Financial Position
Part four - Interpretation of the Statement of Cash Flows
Part five – Analysis of the potential purchase of Naxol Ltd.

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Q2 Interpreting the
SPLOCI
32 There are a lot of requirements in this
section, so it is important to approach them
systematically and ensure you cover ALL the
requirements.
The content from weeks 1, 7 and 8 will help
with this question.
You will need to be comfortable with the
following to answer the questions in this
section
 Calculating trends and ratios using
financial data
 Reviewing case study narrative to
identify why movements in figures
have occurred
 An understanding that some
movements in numbers are explained
by other numbers
 An understanding of how gross profit
interacts with revenue and cost of
sales, and that net profit is the profit
after deduction of all the costs.
Q3 Interpreting the SOFP 25 As above, there are a lot of requirements in
this section, so it is important to approach
them systematically and ensure you cover
ALL the requirements.
The content from weeks 2,3,7 and 8 will help
with this question.
In part b) you will be comparing results of
ratios with criteria to determine whether
Horizon should take over Naxol. This is one
of the main uses for the interpretation of
Financial statements. Remember to use
Naxol’s accounts here, not Horizon’s!

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Q4 Interpreting the SOCF 16 The content from week 6 will help with this
question. You will need to be able to link the
financial statements by identifying a figure
from the SPLOCI and the SOFP (or derived
from those figures) which is shown in the
SOCF.
This section also calls on your understanding
of the working capital (efficiency) ratios, to
explain how the company has improved its
cash flow by improving its working capital.
Q5 Professional report 5 See section 2.3 above for approach.
Since this is a business report, you should
include a recommendation in your executive
summary as to whether Horizon should
acquire Naxol ltd.
Total 100

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Report to Board of Horizon Ltd
From: Clara Jones, Finance Director
Date: 20 Dec 2016
Title: The Horizon Ltd financial performance analysis and the decision to buy Naxol Ltd
1. Introduction
This report uses the recent financial reports of the Horizon Ltd in 2015 and 2014 to make the
financial performance analysis of this company in different dimension of profitability,
liquidity, operating efficiency. The Horizon Ltd is the newly energy exploration company,
formed in 2004 and the business focus is on Oil and Gas exploration. So this report also give
analysis about the financial performance and other factors of Naxol Ltd, specializes in shale
gas exploration so to make decision whether Horizon Ltd should take over Naxol Ltd.
2. Purpose and key features of Horizon’s financial statement
The following descriptions during 2015 would affect the statement of profit and loss and
statement of financial position as below:
Case Detail Statement of
Profit and
Loss
Statement of
Financial
position
Description 1 During the year Horizon received and paid an Invoice for
£50,000 from their legal advisors for drafting contracts agreed
with energy producers in the period July-September 2015.
X
Description 2 Horizon paid £20,000 to the patent office in March 2015 to
register the design of a new piece of exploration equipment.
The registration allows Horizon exclusive use of the
equipment for 25 years.
X
Description 3 Horizon received a supplier statement from a subcontractor
who provides ships to undertake Seismic Surveys around
South America. The statement indicates that Horizon owe the
subcontractor £90,000 as at 31 December 2015.
X
Description 4 Horizon paid £40,000 in interest charges to HSBC on bank
loans which are due to be repaid in 2025.
X

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The first situation when Horizon received and paid invoice for £50,000 from their legal
advisors for drafting contracts agreed with energy producers in the period July-September
2015. This deal should be recorded as legal and professional fee and is categorized as
administration expense.
The second case when Horizon paid £20,000 to the patent office in March 2015 to register the
design of a new piece of exploration equipment. Because the registration allows Horizon
exclusive use of the equipment for 25 years so according to the definition this patent would
earn fee and this fee should be recorded in the SOFP. (IAS 38 Intangible asset)
The third case is when Horizon receive an invoice of £90,000 from supplier so a company
should have recorded a Debit in current liability because this is a short-term obligation.
Therefore, according to IAS 37, there is a rise of Current liability in the SOFP.
The final case when Horizon paid the interest charges of £40,000 to HSBC on bank loans
which maturity date is 2025. As a result, this interest expense should be recorded in the
SPLOCI as the rise of finance cost.
The tangible asset is the physical asset which can be touched such as building, machinery and
it is often be charged depreciation to reduce the value. Meanwhile, the intangible asset is the
nonphysical such as goodwill, trademark and franchises. So this asset’s value is reduced by
amortization.
Under the guidance of recognizing an asset, the Horizon's expenditure of £150,000 on patents
satisfies with the criteria of protecting for a period of time of usually 25 years. Hence, the
patent is recorded as the intangible asset because there is a certain that Horizon can use this
asset to generate a benefit.
3. Statement of Profit and Loss analysis
a. The board's review of 2015 SPLOCI has led to some confusion because there was a reduction
in revenue but the gross profit still rose. However, the rise of gross profit is due to the huge
reduction of cost of sale from £34,749 in 2014 to only £25,638 in 2015, a reduction of over
26%. Here is the gross margin for each division in 2014 and 2015:
Table 4.1: The Revenue by division of Horizon from 2014 to 2015
Gas exploration Oil exploration Renewable energy Total
Year 2015 2014 2015 2014 2015 2014 2015 2014
Revenue 20,432 17,423 9,802 8,962 - 11,247 30,234 37,632
COGS (17,183) (15,623) (8,455) (8,041) - (11,085) (25,638) (34,749)
Gross profit 3,249 1,800 1,347 921 - 162 4,596 2,883
Gross profit margin 15.9% 10.3% 13.7% 10% N/A 1.4% 15.2% 7.7%

29
In 2015, there is the reduction of revenue of nearly 20% from £37,632m in 2014 to only
£30,234m in 2015. Meanwhile, while both gas and oil exploration revenue rose significantly
in 2015 compared to 2014 of 17.3% and 9.4% respectively.
Graph 4.1: The revenue movement of Gas and Oil exploration between 2015 and 2014
The reason for total revenue reduction of Horizon is the abandon of revenue from renewable
energy of £11,247m in 2014 because company had sold this division at the end of 2014. While
the reason for the rise of gross profit is the large reduction of cost of goods sold of over 26%
from £34,709 m in 2014 to only £25,638m in 2015.
b. Here is the table that displays the movement of Horizon’s income statement in 2015 compared
to 2014:
SPLOCI 2015 2014 +/-
Revenue 30.234 37.632 (7.398)
COG (25.638) (34.749) 9.111
Gross profit 4.596 2.883 1.713
Other operating income 162 158 4
Overhead -
Administrative expense (1.935) (2.663) 728
Operating profit 2.823 378 2.445
Finance cost (92) (189) 97
PBT 2.731 189 2.542
Income tax expense (819) (57) (762)
Net income 1.912 132 1.780
First, there is a reduction in the administrative expense £728 in 2015 compared to 2014,
mainly due to the reduction of employee expense from £1,343m in 2015 to only £1,078m in
2014. This significant reduction is because of the selling of renewable energy so there was a
Oil exploration

30
large reduction of number of employee. Another decrease of research costs to only £101.3m in
2015 from £394.1m in 2014.
Secondly, there is the reduction of finance cost of £97m over two years, mainly due to the
reduction of long-term loan from £3,500m in 2014 to only £1,850m in 2015. There was a
positive capital structure movement because Horizon was not relying much on debt source so
this company can reduce the financial distress. (Opler & Titman (1994)). As a result, the
interest cover ratio of company rose quickly from just 2 times in 2014 to 30.68 times in 2015,
indicates that company is operating more safely.
Thirdly, the Profit before tax rose sharply in 2015 compared to previous year. This is easy to
understand because of the rise in operating profit as well as the reduction of administrative
expense as explained above.
4. Statement of Financial position analysis
There were two selective movements in financial statement of Horizon over two years
Year 2015 2014
Items £'000 £'000
Cash and cash equivalents 2.143 -
Trade payables 2035 1.062
There was an appearance of cash and cash equivalent of £2,134m in 2015, which comes
basically from the positive cash flow from operation as well as proceed of sale of fixed asset.
This rise of cash makes a high increase of current asset but at the same period there was a rise
of current liabilities as well, which came from the nearly double of trade payable over two
years. While the total current asset just grew 1.2 times, current liabilities grew 1.6 times,
making the current ratio reduce from 6.51 times in 2014 to only 4.97 times in 2015. This
movement affect negatively to the liquidity situation of Horizon because company uses more
current liabilities. But on the other side the use of short-term debt reduces the burden of
relying on long-term debt, which is often more expensive so a company can reduce the interest
expense. (Titman, S. (1984). As a result, the interest cover ratio of Horizon rose sharply over
two years as mentioned above.
5. Statement of cash flow analysis
From the statement of cash flow in 2015, it can be concluding that Horizon made a significant
improvement. This was displayed by both the positive net cash flow from operating and from
investing activities, which were very small or even negative respectively in 2014.

32
CF 2015 2014
Net cash from operating activities 2,943 336
Net cash flow from investing activities 1,050 (350)
There are items of Profit before tax that is picked up directly from SPLOCI of £2,731m in
2015 and £189m in 2014. The item of decrease in trade and other payable and the increase in
trade payable, which all made the positive cash flow from operating activities for Horizon in
2015.
The company working capital has been improved because a company can generate a sufficient
cash to meet its short-term obligation. The trade and other receivable reduced means that a
company reduce sale on credit, making its easier to collect cash from customer. In addition, a
company rose trade payable so it can extend the days to pay its suppliers latter. (Sean Butner,
2015). The payable days was over double from just 11.16 days in 2014 to 28.97 days in 2015.
There were two reasons that lead to the improved cash flow position of a company. Firstly,
Horizon had a profitable year in which profit before tax rose dramatically, making large
contribution to the high net positive cash flow from operating activities. Secondly, there was a
sale of fixed asset, mostly came from the selling of renewable energy division at the end of
2014, bring £880m in 2015 for Horizon.
6. Potential purchase of Naxol Ltd
Here is the following key financial ratio for Naxol in 2015
Ratios 2015
ROCE 13,2%
Gross profit margin 11,3%
Operating profit margin 4,9%
Current ratio 2,0
Interest cover 3,2
Gearing ratio 66%
According to the requirement of Horizon’s board of directors, Naxol fail to reach the ROCE of
greater than 20%. Meanwhile the gross profit of Horizon was just 7.7% in 2014 so profit
margin of Naxol was 11.3%, satisfies the condition of no less than 5% below Horizon. Other
ratio such as Current ratio of 2 times and interest cover of 3.2 times all meets the industry
safety limit. Therefore, Naxol is the potential target company for Horizon to buy.

33
Before, I explain in brief the movement of financial performance of Horizon by trend as well
as ratio analysis over two years from 2014 to 2015. If you have any question, please contact
me and I am willing to response to you as soon as possible.
carry ing amount of an asset or liability in the s tatement of financial position and its tax bas
Sincerely,
Clara Jones

34
Reference
IAS 38 Intangible Asset, [online] Available at: http://www.iasplus.com/en/standards/ias/ias38
[Accessed 05 Dec 2016].
IAS 37 — Provisions, Contingent Liabilities and Contingent Assets, [online] Available at:
http://www.iasplus.com/en/standards/ias/ias37 [Accessed 05 Dec 2016].
Opler, T. C., & Titman, S. (1994). Financial distress and corporate performance. The Journal
of Finance, 49(3), 1015-1040.
Titman, S. (1984). The effect of capital structure on a firm's liquidation decision. Journal of
financial economics, 13(1), 137-151.
Sean Butner, 2015. “How to Handle Accounts Payable in the Cash Flow Statement”, [online]
Available at: http://smallbusiness.chron.com/handle-accounts-payable-cash-flow-statement-
61323.html [Accessed 05 Dec 2016].

35
Report to Board of Horizon Ltd
From: Clara Jones, Finance Director
Date: 20 Dec 2016
Title: The Horizon Ltd to become a public limited company and the acquisition of Naxol
1. Executive Summary
The purpose of this report is to present the issues related to Horizon become a public limited
company such as the advantage and drawbacks of being a plc and the UK corporate
governance requirements. In addition, the role of the CEO and the skills necessary to become
the potential candidate for this position would also be discussed. The PESTEL analysis of
Horizon when it operates in the shale gas industry and how the decision of take over Naxol
would affect this business condition. And for the company operates in natural resource
exploration like Horizon, the issue of “corporate social responsibility” should be put highly
attention to communicate effectively with stakeholders, especially those from the against side
such as environmental group, local communities.
2. Business structure and corporate governance
a. The main difference between a plc and a private limited company, firstly is the
ownership in which the private limited company is own privately by a single or limited
owners, while the plc is owned by many shareholders and their share are traded publicly. So
the share of plc is listed on the stock exchanges as when Horizon is seeking a listing on the
London stock exchange (LSE).
The advantages of Horizon become plc is firstly it has ability to raise capital through issuing
share or it has power and reputation to borrow capital from financial institution. (Pagano,
Panetta & Zingales(1998). Horizon can issue share to shareholders through first IPOs (Initial
public offering) so it can have large amount of capital to expand business. Secondly, because
the share of Horizon can be transferred freely through the stock exchange so this provides
more liquidity to the company shareholders. (Chemmanur & Fulghieri(1999). However,
besides the advantages, there are some drawbacks related to form a plc such as Horizon must
follow a lot of rule and regulations. For instance, it must follow UK corporate governance

36
code if it desires to be listed on London stock exchanges. This would cost Horizon a lot of
legal and consultant fee. Another drawback is the loss of control as Horizon now become the
asset of many shareholders so the CEO is not only the person who can make business strategy
but it must be approve through a board member by voting method. So according to Jenkinson,
& Ljungqvist (2001), this can lead so slow business decision and reduce the flexibility of
business operation.
b. There are many requirement of the UK corporate governance code which applies to all
the companies listed on LSE according to Council,(2010). First, for leadership, the code
requires that Horizon should be leaded by an effective board and there must be a separate role
of the chairman and the CEO. There is the requirement of at least 50% of the board, not
including the chairman should include independent non-executive directors. Secondly, the
audit committee of Horizon should comprise at least three members or for smaller company, at
least two independent non- executive directors comprises the audit committee. Thirdly, for
risk management and internal control, there is a requirement of a remuneration of the CEO
should be linked mainly to the corporate governance. Finally, for the relationship with
shareholders, the Horizon must be responsible for having a dialogue with shareholders and the
board should hold annual general meeting to listen to the desire of investors.
3. The role of management
a. The role of the CEO includes a decision-making, the planning and organization and leadership
skill. In case of Horizon company, the first requirement for CEO is that he need to be a
decisive person, making the right decision at the right time for the benefits of both long-term
and short-term of a company. For instance, the decision of takeover or not Naxol, a company
operate in the same industry and has quite a safety financial ratios, excluding the high
requirement of the board of ROCE is greater than 20%. So the responsibility of CEO is to
consider both the financial and non-financial dimension of Naxol to make the decision to buy
this company or not and to persuade a board of directors.
The second requirement is making the appropriate business plan and organization. The CEO
should be a person can build the strategic plan for business in the next year as well as long-
term target. (Marden et al (2003). CEO should create and implement the long-term strategy
and position the business for case of Horizon for instance, after acquiring Naxol so CEO must
put target for a company to rank in the UK shale gas industry.

37
The third skill is the leadership skill which is considered the most important for a CEO. A
person with good expertise in job but lack of leadership skill is still cannot be a CEO. So the
leadership skill includes the able to lead other people, the ability to recognizing the strengths
and weak skill of other employees to arrange them in appropriate job, the reacting to employee
need. For case of Horizon, the CEO should be the one to make arrange human resource to take
advantage of their skills to the right job.
b. When the Horizon buy the Naxol, the current CEO would be promoted to be the chairman,
while the another candidate would be choosing to be a new CEO. Becoming a new CEO of a
company that had taken over an another company would be a challenging but highly
rewarding opportunity. First requirement is that the candidate should be a CEO of another
company with nearly the same size of Horizon so he was already familiar with this working
environment. Another attribute is that the new CEO need to work in the same industry of
energy exploration because this industry is very special because it requires both high expertise
as well as legal knowledge. In addition, the third skill is the negotiating skill because after
taking over Naxol, CEO must face with many protests from stakeholders such as local
communities, the environmental group. Therefore, the new CEO must have negotiating skill to
persuade the stakeholders for the benefit of Horizon, how they can maintain the business with
the environmental limit such as CO2 cut and the requirement of finding renewable energy
instead of gas and oil. Finally, the skill is the accounting knowledge because when take over
there is a lot of accounting treatment need to be solved.
4. PESTEL analysis of the Horizon
The shale gas industry would be considered as a major opportunity for Horizon no matter it
decides to buy Naxol or not. So here is the PESTEL analysis of
Factors Influences
Political The shale gas industry is highly affected by political instability, the geopolitical
conflicts. For example, the threats from the countries which has the large
amount of natural oil resource makes the oil price changes much.
The OPEC countries has a large influence on the oil price because these
countries are the main providers but in the long-term, each country would have
different incentives than a whole organization.

38
Economic There is a high correlation between global economy and the shale gas industry
and they interact each other. There is the close relationship between the strong
currency such as USD and the oil price. The oil barrel price is the important
indicators on the stock exchange and for the interest rate referencing.
The global consumption of gas and oil affect the global economic growth.
Social The social environment concerns about the culture, religion, income,
demography.... Some social trend can affect the shale gas industry. For instance,
the rose of awareness from community to pay attention to renewable and
friendly fuels instead of natural resource such as coal, oil, gas, which makes the
revenue from shale gas industry reduced.
But on the other side, due to the global population growth, the demand for
energy would rise
Technological The technological affect directly to the oil and gas exploration because the more
advanced technology would save labor cost as well as increase the output. The
company has more advanced exploration technology would take advantage of
this find the surface area where there is highly possibility of having gas.
Environmental Because natural resource is limited so environmental group protest against the
shale gas industry because they claim that this company would explore much
and there is nothing left for the next generation. Another concern is the impact
of gas exploration process to the natural habitat as well as local community.
The waste from the exploration would be a problem because it can damage the
land and water resource.
Legal There is legal concern about the change in legal regulations would affect
seriously to the shale gas industry. The legal includes the development permit,
the drilling permit, the patent and trademark protection which all are subject to
change.
5. Horizon’s corporate social responsibility and communication with
customers
The “corporate social responsibility” is defined as the sense of a business responsibility for the
company’s impact on social and environment. The company is expected to do more than the

39
required by the regulators and by the environmental group to limit their waste and emission
effect, to contribute to social and educational program.
Fracking is a controversial industry so Naxol firstly should cooperate with their shale gas
customers to inform them about the benefit of using gas compared to other resource such as
coal. Gas actually cut the CO2 because it is the lowest carbon fossil fuel that had not led to
CO2 emission. Second, Naxol can publish the CSR annually to publish the data about the CO2
emission, the waste and other environmental indicators so persuade public that they followed
to the required environmental safety level. And finally, Naxol can participate in the social
organization or raise funds to help community.
The fracking industry can firstly issue a CRS report as the public and official communication
tool for the whole stakeholders. Another way is that it should hold a meeting directly with the
hostile environmental group to listen to their concern and discuss with each other to find the
most balanced solutions. And the third way is that it has to join the social organization to
contribute more to the community by raising fund and charity activities.
carry ing amount of an asset or liability in the s tatement of financial position and its t
Sincerely,
Clara Jones

40
Reference
Council, F. R. (2010). The UK corporate governance code. London: Financial Reporting
Council.
Chemmanur, T. J., & Fulghieri, P. (1999). A theory of the going-public decision. Review of
Financial Studies, 12(2), 249-279.
Jenkinson, T., & Ljungqvist, A. (2001). Going public: The theory and evidence on how
companies raise equity finance. Oxford University Press on Demand.
Marden, R. E., Edwards, R. K., & Stout, W. D. (2003). The CEO CFO
certification requirement. The CPA Journal, 73(7), 36.
Pagano, M., Panetta, F., & Zingales, L. (1998). Why do companies go public? An empirical
analysis. The Journal of Finance, 53(1), 27-64.

41
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