“Afternoon Tea and Two Free Gateau Slices?

Due to unforeseen circumstances this offer has been suspended as of 10/09/2018.

All vouchers already purchased will still be honored as per the original terms of the offer.

Apologies for any inconvenience caused.”

The above is from Patisserie Valerie’s website, posted one month before the discovery of “accounting irregularities”. Did HMRC quietly access the website, as they are owed £1.14 mill, and file a winding-up petition on 14 September?

We thought we would have a look at the financials of the company and found the following issues:

Working capital

An analysis of the balance sheet suggests there was a significant investment in working capital during the year of over £2m. Most of the move was from a substantial increase in trade and other receivables, the biggest component of which was prepayments on leases:

Balance sheet 9/2016 9/2017
Trade receivables 668.0 423.0
Other receivables 695.0 588.0
Prepayments 9,641.0 11,316.0
Trade and other receivables 11,004.0 12,327.0
Inventory 4,862.0 5,980.0
Corporation tax 1,896.0 1,668.0
 Total operational assets 17,762.0 19,975.0
Trade and other payables 5,081.0 5,167.0
 Operating working capital 12,681.0 14,808.0
 Implied cash flow (2,127.0)

However, when we compare this to the cash flow statement it is evident that while the inventory and trade and other payable numbers tie exactly, there is a significant difference from the implied cash flow movement in the balance sheet to the actual cash flow movement on the cash flow statement:

Cash flow statement Implied by balance sheet
Inventory (1,118.0) (1,118.0)
Trade and other receivables (559.0) (1,323.0)
Trade and other payables 86.0 86.0

Lease expenses

Linked to the issue above are these prepayments which primarily relate to leases. In 2016, the operating lease rental expense was £12.9m which grew to £14.2m in 2017, an increase of £1.3m or 10%, not too far from the 8% growth in new stores from 184 to 199.

However, it’s odd to see a ‘prepayment’ on operating leases. Typically, landlords will grant rent-free periods rather than a discounted rent (as the property is valued on the headline rent after the rent-free period). From an accounting point of view, these rent-free periods should be amortized over the life of the lease for example:

No present values for simplicity  
Five year lease   Year 1 Year 2 Year 3 Year 4 Year 5
Lease payment 0.0 100.0 100.0 100.0 100.0
Total payments 400.0
Average payment 80.0
Rent expense 80.0 80.0 80.0 80.0 80.0
Cash payment 0.0 100.0 100.0 100.0 100.0
Balance sheet impact
Cash 0.0 (100.0) (100.0) (100.0) (100.0)
Retained earnings (80.0) (80.0) (80.0) (80.0) (80.0)
Accrued rent 80.0 (20.0) (20.0) (20.0) (20.0)

So, we should expect a liability rather than an asset.

Property, Plant & Equipment

The business has approximately £200k of equipment (note, not fixtures and fittings) per store. This seems high for what is a glorified coffee shop. Also, capex is approximately £436k for each new store – much higher than I would expect as this is mostly equipment (fixtures and fittings are very low).

Three areas of financials which do not make sense to us – cake anyone?

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