McPhee Distillers: Financial Health Evaluation for a Whisky Distillery Business

Smartly MBA Accounting Case Study Report

1. Executive Summary

This report provides an analysis and evaluation of financial health for a whisky distillery business named McPhee Distillers in Vancouver, Canada based on the prepared financial statements. Methods of analysis include ROE by DuPont Analysis as well as measure such as EBITDA margin. Results of analyzed statements show that the business is losing money due to limited margins between the sale price and the costs despite a meaningful cash flow improvement. Kingsley needs to take into consideration this output to develop a proper strategy for the future.

The report finds the prospects of McPhee Distillers in its current financial situation are not very promising. The management needs to take remedial action to reverse the crisis situation. Discussed recommendations included as following and explained in section 3 for each case:

• Increase the sale price. • Reduce the costs. • Increase the production and sales. • Renegotiate deal with Piercy.

To support the preparation and analysis of the financial statement, the following assumptions have been made in order to fill in the statement:

• Sales of whisky are treated as revenue and paid in cash • First-in, first out (FIFO) method to calculate the Cost of Goods Sold (COGS) • No returned sales and no taxes • All fixed costs fall under Selling, General and Administrative expenses (SG&A) • No dividends are paid • Assumed selling price: 10,000 CAD • Discount to Pierce 25% • Assumed service life of equipment 10 years

2. Financial Statements

The financial statements were derived from provided accounting case: McPhee Distillers: Accounting Policy Choices in the Preparation of Financial Statements. Published by Ivey in 2016 [1]. Yearly ledger changes, income statement, balance sheet and cash flow statements over period 2014 - 2016 are presented below as table 1 to 4. The corresponding journals and ledgers for each year are included in the appendix section.

Table 1: Yearly ledger changes over 2014 - 2016.

Table 2: Income statement over 2014 - 2016.

Table 3: Balance sheet over 2014 - 2016.

Table 4: Cash flow statement over 2014 - 2016.

3. Evaluation & Conclusion

Analysis of the financial statements of McPhee shows some difficulties between 2015 and 2016. Despite an almost constant revenue, there is a contraction of the profitability of the business as the net income dropped significantly between the two actual years of activity, being also negative in the second one.

Furthermore, looking at ratios like the EBITDA margin (see figure 1) we can clearly see that the "efficiency" of the business is decreasing as costs per dollar earned increased. Likewise, also the total assets of the company have dropped, making the picture even worse. The business is not even attractive to new investors as the ROE in the last year of activity has been negative, meaning that for every dollar invested in the business produced a loss. Besides, ROE coefficient went down from 0.25 to -0.15. Kingsley needs to take into consideration this output to develop a proper strategy for the future.

In summary, the business is losing money due to limited margins between the sale price and the costs despite a meaningful cash flow improvement. The founder needs to reconsider the business model she embraced. For this reason, 4 possible approaches are suggested in the following cases:

CASE 1: Increase the sale price • Assuming that the market is not sensible to the selling price, since is a restricted niche, the price of the barrels can be increased without a relevant contraction of sales.

CASE 2: Reduce the costs • Lower the costs, risking to reduce the quality of the whisky, or increase production efficiency.

CASE 3: Increase the production and sales • Assuming that fixed costs are independent to production, increasing production and sales would lower the share fixed cost per item produced. Of course, this is valid only if also sales are increased which is not probable looking at the trend of sales.

CASE 4: Renegotiate deal with Piercy • Being Piercy a shareholder of the company, is in its own interest to make the company profitable (unless only interested in the discount from sale price), hence a new deal could be signed to reduce the discount and to increase the number of barrels bought by the company.

4. Bibliography

[1] McPhee Distillers: Accounting Policy Choices in the Preparation of Financial Statements. Richard Ivey School of Business Foundation. Richard Ivey School of Business Foundation, 2016.