Assignment 2 Steps 1 - 6
- Daniel Doyle
- May 24, 2025
- 30 min read
Updated: May 29, 2025
Dunelm Group PLC Annual Reports:
Step 1
KCQ 1 Cost Objects
Beginning reading chapter six, the first key concept I wanted to explore was cost objects. From my understanding, cost objects are anything in a firm that managers wish to assign costs to, that costs the firm money. Understanding cost objects is important because it is directly relevant to my current role as a chef and was critical to my previous role as a head chef.
Thinking back to my time as a head chef, much of my time was spent focusing on the concept of cost objects, particularly direct costs. A key part of my role as a head chef was considering products as cost objects, as every week I would order the raw ingredients we would use for the next few days and from there I could estimate the amount of profit those raw ingredients would net for the business if we sold 100% of the product that we bought. Understanding the cost of the raw ingredients also helped me cost the menu so the business could sell meals at a profit.
Learning more about cost objects has made me realise that understanding cost objects is critical to managers, as it helps with predicting profit and helps managers make informed decisions within the business.
After reading this section, I wondered what the limitations of using products as cost objects in hospitality as wastage and variability can be high. Also, how do different industries apply the concept of products as cost objects, considering the differences across industries?
KCQ 2 Product and Period Costs
Understanding the difference between product and period costs was the most difficult part of this chapter, and it took some time to wrap my head around this concept. To me, product costs are the costs that management has attached to a product. These costs can include materials, labour, or other expenses linked with production. Furthermore, when the cost is attached to a product, the cost is recorded as an asset and only becomes an expense when the product is sold. On the other hand, period costs are all other costs incurred that are not assigned to a product. They are expensed in the period in which they occurred, regardless of whether any product is sold.
The best way I can relate to this concept is through my experiences in hospitality. When food is ordered, prepared and cooked, those processes are assigned a product cost. The food is considered an asset the moment it arrives, and the business considers it an expense when the food is sold because, until the food is sold, it has the potential to be sold and generate revenue for the business. However, when a head chef takes time away from the kitchen to complete administrative paperwork or plan menus, then the head chef's wage during that time would be considered a period cost, as during that time the head chef was not involved in the food service, and those costs are expensed regardless of whether any food was sold during that time. Another example may be the rent of the building, which needs to be paid regardless of how many meals are sold.
After reading this section of the study guide, I was left with the question, “What are the risks of incorrectly allocating product and period costs, and how does this affect management's evaluation of profitability?”
KCQ 3 Indirect costs
I found learning about indirect costs through the Cadbury factory example interesting. Indirect costs are expenses that are not directly tied to products or essentially “the cost of doing business.” For example, in a kitchen context, indirect costs may include the rent of the building, electricity, gas, water, refrigeration, cleaning chemicals, waste disposal, and first aid kits.
When I was a head chef, I used to bring these indirect costs to my reporting manager and query how we were supposed to cover these added costs into the food price, as the management team I was working under was very adamant that the menu prices were never to exceed a certain price. I was often brushed aside and told they would work it out and get back to me or told not to worry about it. As a result, I would reflect on the hospitality sector and wonder how we were making any money, considering the amount of indirect costs involved in running a restaurant. It was not until I worked under a different chef who was mindful of indirect costs did I started to understand how important it was to factor indirect costs into menu planning and decision making.
After reading this section, I could not help but wonder how firms react when outside influences raise or lower their indirect costs? For example, during the COVID-19 pandemic, when PPE such as gloves were in low supply and high demand, how did businesses cope with the sudden increase in costs?
Step 2
How did you find this learning task?
I found this task simple in some areas and difficult in others. I found that I understood the concept quickly, and attributing operating and financial costs to Dunelm’s line items was easy to do, except for some line items, such as lease liabilities, taxation,
Did you find it frustrating, confusing or enlightening?
Lease liabilities were confusing, and I was unsure if they were operating or financial costs. I eventually characterised lease liabilities as operating costs because it seemed that these were leases held by Dunelm for storefronts. However, after looking through note 11 on Dunelm’s financial statements, it did not clearly express what the leases were for. The reason I have assumed the lease liabilities are for storefronts is that I can see on the financial statements that it is recorded as a debit instead of a credit, so it made sense to me that they are paying the lease on storefronts.
Taxation was another part of the financial statements that I found difficult. The line items, such as current tax liability and liability for current tax, seemed to be operating costs; however, the taxation line item was more unclear and sent me on a deep dive. What confused me was that Dunelm was paying tax in instalments on its profits at a rate of 25%. To me, this appeared as if taxation was a kind of debt owed to the government and, therefore, would be a financial item. However, I eventually decided to classify taxation as operating because paying is a part of doing business in the country where the firm operates.
I found understanding and classifying cash flow hedges the most difficult part of this task. My initial decision was to classify cash flow hedges as financial activities because cash flow hedges are a form of risk management and seemed to be money invested in foreign currency to help mitigate liquidity, interest rate, and foreign currency risks. This made sense to be a financial activity, but I began to wonder if risk management was a part of operating as a large company. After digging into the topic, I realised that cash flow hedges should remain labelled as a financial activity because while risk management is a part of operating as a large business, purchasing foreign currency to do so was not a part of Dunelm’s core revenue-generating activities.
And what exactly do you feel you have learnt, or not learnt, about your firm and its financial statements from classifying its financial statements?
Classifying Dunelm’s financial statements has given me more understanding of how different items represent core operations and reflect Dunelm’s broader financial strategies. Items such as lease liabilities, taxation and cash flow hedges initially seemed simple, but became more complex once I began determining whether they related to operations or financial activities, and it was not until I took the time to look closely at Dunelm’s notes that I gained a better understanding of how Dunelm operates. I was surprised to see how many line items I categorised as operating activities; however, upon reflection, it makes sense that most of a firm's activities would fall under operations. Through this task, I believe I have gained more confidence in navigating and understanding the notes of Dunelm’s financial statements. However, I did struggle at times, particularly with the notes regarding cash flow hedges and taxation, as I found them to be particularly difficult to understand due to the limited information in the tax notes and the language in the cash flow hedges notes made things harder to understand.
Step 3
Dunelm’s Products and Services
Dunelm is the UK’s leading homewares retailer, they have 184 stores and specialising in bedding, curtains, furniture, beds and mattresses. For this step, I will focus on beds, mattresses and curtains, and the selling price has been taken from Dunelm’s retail website
Product | Selling Price (GBP) |
339 | |
219 | |
55 |
As Dunelm offers a wide range of products within these product categories, I decided to take the highest prices from the products offered. I am assuming that variable costs for beds, mattresses, and curtains include materials, labour, packaging and freight. I am also assuming that the variable cost accounts for 45% of the selling price of beds and mattresses and 35% for curtains.
Variable Cost Price
Beds: 45% of £339 = £152.55
Mattresses: 45% of £219 = £98.55
Curtains: 35% of £55 = £19.25
Contribution Margins
Beds: £339 – £152.55 = £186.45
Mattresses: £219 - £98.55 = £120.50
Curtains: £55 - £19.25 = £35.75
Discuss why the contribution margins for each of your firm’s three products/services might differ or be similar
In Dunelm’s case, the contribution margins for these products differ due to the materials used, the labour involved in making the product, and the cost of shipping. Dunelm makes a bed, they need to source the wood or metal and pay the labour needed to produce the frame. Furthermore, due to the weight of the bed, it costs more to ship. This contributes to the higher variable cost; however, due to the higher selling price of the bed, Dunelm can maintain a higher contribution margin for beds.
Mattresses may have similar costs to beds, as the materials needed are specialised, the labour is more intensive, and they are heavy items, causing higher freight costs. While they are not as expensive as beds, mattresses still have a high contribution margin.
However, curtains are simpler to produce, are produced in less time and may cost less to freight due to the decreased weight. Although the selling price of curtains is much lower than that of beds and mattresses, their lower variable costs may result in a higher contribution margin in terms of percentage when compared to beds and mattresses.
Why might your firm produce a range of products/services with different contribution margins?
Dunelm positions itself as an environmentally sustainable business. Because of this, Dunelm may offer a range of products with different contribution margins because it is limited by the number of resources it can sustainably source. If Dunelm’s management were to only focus on producing beds or mattresses without consideration for the resources, those decisions could run counter to Dunelm’s overall goal of being sustainable.
Why not only produce the product/service with the highest contribution margin?
Producing only products with the highest contribution margins may benefit equity investors but could also negatively impact other stakeholders. For example, customers may experience reduced accessibility or affordability for certain items. Additionally, focusing on items with high contribution margins may result in job loss due to reduced product lines. This may increase tensions with unions as employees experience job insecurity. Furthermore, suppliers who provide raw materials to Dunelm may experience revenue loss due to the reduced product lines. Lastly, Dunelm’s reputation within the community may suffer, as job losses combined with reduced product lines could alienate parts of their customer base.
Also, comment on how valuable (or not) you think use of contribution margins is for management in making decisions
The use of contribution margins is important for management in decision making, as contribution margins can assist with product-mix decisions. For example, Dunelm may find that some products have negative contribution margins and either need to be removed from their product line or may be priced incorrectly. Additionally, knowing the contribution margins of different products can help management determine the right ‘mix’ of products.
What decisions that management need to make might be supported by information on contribution margins?
Supported by contribution margins, management might make decisions related to product offerings and resource allocation. For example, management may choose to limit product offerings if certain products have a negative contribution margin. Furthermore, managers may choose to prioritise products which have a higher contribution margin and allocate resources such as warehouse space and raw materials towards those products.
Identify (or guess) one or more resource constraints your firm may face, and perhaps any market constraints you feel may impinge on your firm.
Dunelm may face several resource constraints, such as materials, warehouse space, and supply chain risks. Dunelm requires raw materials to produce its in-house product line and faces constraints with sustainably sourcing natural resources such as wood for beds. Additionally, bulky items such as beds and mattresses occupy significant storage space and may limit Dunelm’s storage capacity for other items. Lastly, Dunelm has noted in its annual reports that attacks on shipping lanes in the Red Sea have disrupted supply chains. These disruptions may represent a supply constraint if they limit Dunelm’s access to the materials needed for production.
Market constraints such as inflationary pressure on consumers, competition in the retail sector, and product reputation may impact Dunelm. Dunelm has stated in its annual reports that inflationary pressures have changed consumer behaviours and noted that failure to respond to this may undermine growth. Additionally, increased competition in the retail sector may also represent a market constraint, as competition may limit Dunelm’s price flexibility. Furthermore, Dunelm has identified product reputation as a risk to growth, as a perceived decline in quality or value may lead to decreased demand.
In what ways might these constraints be relevant when deciding whether (and how much) of the three products or services of your firm that you have identified, your firm should produce and sell?
These constraints are relevant for Dunelm when deciding whether they should produce a product and how much of each they should produce. Material and storage constraints may limit how many beds and mattresses Dunelm can produce or keep in stock. Furthermore, supply chain issues can impact how reliably Dunelm can access the materials it needs to produce its in-house brand. When considering market constraints, inflation may make consumers less likely to purchase expensive items, which could result in Dunelm focusing on lower-priced products such as curtains. However, Dunelm has noted that product reputation is a key risk factor; therefore, quality must be maintained, which may lead to higher production costs.
Step 4
What do these ratios tell you (or not tell you) about your firm? How do you make sense of them?
Profitability Ratios
Gross Profit Margin
The gross profit margin shows, for every dollar of sales, how much has been turned into gross profit. Dunelm’s gross profit margins have remained consistent over the last four years, ranging between 50% in 2020 to 52% in 2024. Dunelm’s gross profit margin tells me that the firm's cost of goods only accounts for half of its total revenue. However, gross profit margins alone do not tell the full story, as other costs, such as distribution and administrative costs, are not represented.
Net profit margin
Similar to gross profit margin, the net profit margin ratio shows, for each dollar of sales, how much has been turned into net profit. Dunelm's net profit margin has been inconsistent over the last four years. In 2020, Dunelm’s net profit margin was 9% and climbed to 13% in 2022. Falling to 9% in 2024. Looking through Dunelm’s financial statements, Dunelm’s increased net profit margin in 2022 was due to strong sales growth and improved operational efficiency. However, net profit margin fell in 2023 and remained at 9% in 2024 because of wage inflation, supply chain expenses and shifts in consumer behaviour due to inflation. This tells me that Dunelm’s net profit is vulnerable to changes in the social landscape.
Return on Assets
Return on assets reveals, for every dollar of total assets, how much net profit Dunelm receives. In 2020, Dunelm’s return on assets was 13% and climbed to 22% in 2024, while experiencing an increase to 27% in 2022. This shows that Dunelm is seeing increasing revenue generated from its assets than in previous years, excluding 2022. In Dunelm’s financial statements, they state they have experienced strong sales performance and have continued to expand their locations across the United Kingdom. I believe these are the reasons for the growth of the return on assets. However, this ratio does not show what specific assets are contributing to the return. For example, some product lines and store locations could be performing better than others.
Future Implications and Management Decisions
Dunelm’s stable gross profit margin is a good indication of how well they manage their cost of goods, and that seems unlikely to change in the future. However, Dunelm’s net profit margin shows the impact of external factors such as supply chain issues, wage inflation and increases in the cost of living. This tells me that Dunelm is susceptible to rapid social, political and economic changes in the UK and will continue to be in the future. The changes in the return on assets ratio show the need for management to investigate which assets are the strongest performers and divert resources to maximise their potential. Additionally, to improve these ratios, management can continue to improve operational efficiency by sourcing materials and products closer to the UK to reduce supply chain costs.
Efficiency (or Asset Management) Ratios
Days of Inventory
The days of inventory ratio can show the average time it takes to turn over stock from the warehouse or storefronts. In 2020, stock took an average of 82 days to turn over, while in 2022, this time increased to 105 days. Currently, Dunelm takes an average of 99 days to turn over stock. Interestingly, 2020 was the lowest average days of inventory Dunelm experienced in the last 4 years. According to Dunelm’s 2020 annual report, their online sales increased 105%, which may be due to the COVID-19 pandemic, so this could explain the lower average days of inventory in 2020 and may also explain why days of inventory returned to 97 days in 2021. However, in 2022, days of inventory rose to 105 days. These ratios appear to be high, but after some research, the days of inventory ratio seems typical of retail companies.
Total Asset Turnover Ratio
The total asset turnover ratio measures how efficiently Dunelm is utilising its assets, and Dunelm has seen an increase over the last four years. In 2020, total asset turnover was 1.48 and increased year over year to 2.50 in 2024. In 2021, Dunelm stated it had been continuously improving its supply chain and stock processes, which may explain the increase in total asset turnover from 2020 to 2021. In 2022, Dunelm also developed a remote auditing service that allows store auditing to be completed off-site, reducing auditing costs. In 2023, Dunelm introduced pump/quick lift trucks, which increased warehouse efficiency. These initiatives and Dunelm’s increasing ratios tell me that Dunelm has a focus on improving its operational efficiency to maximise the value its assets generate. However, while the total asset turnover ratio shows that Dunelm is efficiently using its assets, it is difficult to determine which specific assets contributed the most to this ratio.
Future Implications and Management Decisions
Dunelm’s efficiency ratios show that while Dunelm seems to be efficiently using its assets, and the firm holds inventory for around three months before selling. In the future, Dunelm’s high days of inventory ratio may result in increased costs, as while inventory is taking up space in the warehouse, that space cannot be used for other items with a higher turnover rate. However, Dunelm’s total asset turnover ratio has been increasing over the last five years, suggesting that if the firm continues to focus on improving stock processes and supply chain, then this ratio is likely to continue increasing. To address the high days of inventory ratio, Dunelm’s management can make use of data analytics to predict seasonal trends and adjust stock levels accordingly. Additionally, Dunelm’s management may be able to invest in new warehouse locations to enable faster restocking of products, reducing the need to hold inventory for longer periods.
Liquidity Ratios
Current Ratio
The current ratio measures Dunelm’s ability to pay its short-term debts using its assets. Dunelm has generally maintained a one-to-one ratio, starting at 1.0 in 2020 and rising to 1.04 in 2024. The exception to this is in 2021, where Dunelm’s current ratio rose to 1.34. This could have been caused by an increase in cash, as shown in note 15 of the 2021 annual report. The current ratio tells me that Dunelm has enough cash and assets to pay any short-term debts. However, financial statements only capture a moment in time, being June 30 in Dunelm’s case, and Dunelm’s current ratio may have been lower or higher throughout the year.
Quick Ratio 1
Quick Ratio 1 shows Dunelm’s ability to pay its short-term debts without relying on its inventory or prepayments. Dunelm’s quick ratio 1 has been decreasing since 2020, from 0.46 to 0.11 in 2024. The decline in 2022 may be due to Dunelm’s cash purchase of Sunflex and the opening of three new stores, which would have reduced available cash. This may also explain why the current ratio has been maintained around 1.0 while the quick ratio shows a decline.
Quick Ratio 2
Quick ratio 2 shows Dunelm’s ability to cover short-term debt without inventory, prepayments and receivables. Like the current ratio and quick ratio 1, Dunelm’s quick ratio 2 has declined over time from 0.42 in 2020 to 0.10 in 2024. This indicates that Dunelm has ten pence of liquid assets for every pound of short-term debt. The quick ratio 2 tells me that Dunelm has relatively low amounts of cash compared to its short-term debt. This might represent a challenge to Dunelm if it sees a reduction in sales or a tax increase.
Future Implications and Management Decisions
Dunelm’s liquidity ratios show that the firm is currently able to pay its short-term debts, but would struggle to do so without its assets or receivables. Dunelm may face challenges in the future, such as increased inflation, supply chain issues or new competitors in the retail space. These pressures could impact Dunelm’s cash flow and make it difficult to repay its short-term debts, as Dunelm may not be able to convert its assets to cash quickly enough. In response, management must improve Dunelm’s cash reserves by creating a cash flow budget to gain insight into Dunelm’s cash inflows and outflows and plan for potential shortfalls.
Financial Structure Ratios
Debt/Equity Ratio
The Debt/equity ratios show the percentage of money invested by outside sources compared to money invested by shareholders. Dunelm’s debt/equity ratio is high, in 2020, for every dollar shareholders invested in the company, outside sources invested three dollars, dropping in 2021 to $1.73 and rising again in 2023 and 2024 to four dollars. This increase in the ratio suggests to me that Dunelm could be overleveraged and could be in an untenable position in the long term if it does not get its liabilities under control. Although Dunelm’s debt/equity ratio is high, it seems to be mainly due to its lease liabilities; these lease liabilities could be store fronts, so the high debt/equity ratio might not be alarming as it first seems, assuming those stores are generating enough revenue for Dunelm.
Equity Ratio
Equity ratio shows how much of Dunelm’s total assets are funded by shareholders as opposed to other sources. Dunelm’s equity ratio has fluctuated over the last four years, ranging from 24% in 2020 and 2022 to 37% in 2021. In 2023 and 2024, Dunelm’s equity ratio has remained at 20%. This suggests that Dunelm is relying on debt for its operations and may represent increased risk. While a lower equity ratio suggests lower shareholder ownership of assets, Dunelm’s large amounts of assets may offset some of this risk.
Times Interest Earned
The times interest earned ratio shows how many times Dunelm’s profit can cover interest. This ratio has changed a lot over the last 4 years, from 16 in 2020 to 36 in 2022, before eventually lowering to 22 in 2024. Dunelm’s increase in bank loans may have contributed to the change in the times interest earned ratio, as larger loans would result in higher interest. Despite this, Dunelm has seen increased revenue over time so the firm is in no danger of being unable to make its interest payments, especially considering that the time interest earned ratio was 22 in 2024.
Future Implications and Management Decisions
While Dunelm’s debt/equity ratio is high, it might not be a cause for concern now. Assuming the lease liabilities represent lease payments for store fronts, this might be a positive thing as more stores can generate more revenue, assuming the stores are hitting sales targets. Another positive aspect of Dunelm’s financial structure ratios is that Dunelm can make its interest payments 22 times over. Something I find concerning, however, is Dunelm’s low equity ratio because this tells me that Dunelm is leveraged too high. In the future, Dunelm could find that the cost of servicing its debt impacts its ability to expand or respond to changes in the market. As a result, management can decide to reduce the number of new stores being opened or close down underperforming locations to reduce Dunelm’s high liabilities.
Market Ratios
Earnings Per Share (EPS)
The earnings per share ratio represents the amount of money shareholders would be paid per share if Dunelm were to distribute its entire profit. Dunelm's earnings per share have generally increased over the last five years from 0.47 in 2020 to 0.74 in 2024. Interestingly, there was a large increase in 2022 to 0.94, but it returned to 0.71 in 2023. In 2022, Dunelm noted that the increase in earnings per share was due to a full year of open stores, strong gross margins and a tight operational grip on costs.
Dividends Per Share (DPS)
Dividends per share is the amount of money each shareholder gets paid for each share they own. Dunelm’s dividends per share have varied over the last five years, with Dunelm not paying any dividends in 2020 as Dunelm decided that the dividend payment should be cancelled because of store closures and lockdowns to preserve liquidity. Dividend payments started again in 2021 with a dividend per share ratio of 0.12. Interestingly, this was not the final amount of dividends Dunelm paid in 2021, as a board decision increased the dividends paid by 0.65 pence per share. In 2022, Dunelm’s dividends per share increased to 1.39, but fell again in 2023 and 2024 to 0.74 and 0.80, respectively. This tells me that Dunelm’s decision to hold back dividend payments in 2020 could have been an attempt to correct the course during the COVID-19 pandemic. Seeing as Dunelm describes itself as a conservative company, this makes sense to me, considering the uncertainty of the retail market in 2020.
Dividend Yield Ratio
The dividend yield ratio represents the percentage return shareholders receive per pound invested in Dunelm. Dunelm’s dividend yield ratio has fluctuated over the last five years, from 0% in 2020 due to the cancellation of dividend payments and peaking in 2022 to 17%. In 2023 and 2024, Dunelm’s dividend yield ratio stabilised at 7%. The stabilisation of the dividend yield ratio may appeal to investors because it shows that Dunelm is capable of giving consistent returns to its shareholders, higher than those of a UK bank.
Price Earnings Ratio
The price-earnings ratio compares the market price of a share to the earnings generated per share. It shows how many years it would take for an investor to earn back the money they paid for the share based on current earnings. Dunelm’s price earnings ratio does not follow a consistent trend, as in 2020 and 2021, the price earnings ratio remained around 25, while dropping significantly in 2022 to 8.51 and rising again in 2023 and 2024 to around 15. It is difficult to pin down exactly why this is happening at Dunelm. Comparing Dunelm’s price-earnings ratio to other firms still leaves me unsure as to the reason why. Something that stood out to me here was that in 2022, Dunelm’s price-earnings ratio was the lowest it had been in the last five years, which I felt was strange considering 2022 was a strong year for Dunelm.
Net Asset Backing Per Share Ratio
The net asset backing per share ratio shows the amount of money shareholders would receive per share if Dunelm sold all its assets, paid all its liabilities and distributed what was left over to the shareholders. Over the last five years, Dunelm’s net asset backing per share has been declining. In 2020, it was 0.85, rising to 1.39 in 2021 and stabilising in 2023 and 2024 to 0.68. This indicates that Dunelm could pay its shareholders if an external event caused Dunelm to suddenly close operations, which potentially makes Dunelm a safe investment. However, the declining net asset backing per share may cause concern for new investors.
Market/Book Ratio
That market/book ratio shows what the market thinks the company is worth compared to the firm's net assets. Dunelm’s market/book ratio has varied over the last five years. In 2020, the market/book ratio was 14 and in 2021 it fell to 10, eventually falling to 9 in 2022. However, in 2023 and 2024, the market/book ratio rose again to 17 and 16, respectively. This increase could suggest that investors are anticipating higher profits from Dunelm in the future. However, Dunelm’s high market/book ratio could also mean that the shares are currently overvalued.
Future Implications and Management Decisions
The future for Dunelm, when considering its market ratios, paints a mixed picture. I believe that the earnings per share are likely to continue increasing, and the dividend per share will stay consistent. Also, I think Dunelm will be able to continue to attract new investors in the company because its yield ratio is higher than the standard bank interest rate. Something that is concerning is the market/book ratio. Most of Dunelm’s market ratios are declining or inconsistent, excluding earnings per share and dividends per share, so why are investors expecting higher profits in the future? It would make sense to me that consistently upward-trending market ratios would result in a higher market/book ratio. I believe Dunelm is overvalued, but there is also an expectation of greater future performance. Considering these two factors, management might believe that further expansion is the only option available to them to meet the shareholders' expectations of growth and to attempt to maintain Dunelm’s higher value.
Comparisons and Questions
I decided to compare my firm's financial ratios with the ratios from the K&S Corporation. The K&S corporation is a logistics firm operating in Australia and New Zealand. Something that immediately stood out to me was the difference in gross profit margin, as the K&S group has a gross profit margin of 14.4% in 2024 compared to Dunelm’s 52% in 2024. This could suggest that Dunelm has more flexibility in choosing products with a higher contribution margin, being a retail company. Additionally, K&S group's days of inventory ratio in 2024 was 16.1, while Dunelm’s was 99 in 2024. This made sense to me because while both companies aim to move inventory, K&S is a logistics group and is likely more focused on moving inventory out of their warehouses faster to maximise profits. Lastly, the debt/equity ratio for K&S in 2024 was 83.3%, while Dunelm’s was 395%. This may be due to K&S needing fewer depots to operate efficiently, or K&S may not be focused on expanding its operations at this stage. Alternatively, K7S may have less bank loan liability compared to Dunelm.
These comparisons raise some questions about Dunelm’s ratios. For example, why is Dunelm’s gross profit margin higher than K&S’s? What factors contribute to Dunelm’s higher gross profit margins compared to K&S? Why does Dunelm hold its inventory for so long? Is the higher days of inventory ratio indicative of retail firms in general, or does it show inefficiencies in Dunelm’s logistics system? Lastly, why is Dunelm’s debt/equity ratio so high? In 2023, Dunelm increased its bank loan liability by £23 million and decreased its lease liability by almost the same amount. Does this mean they are buying property that Dunelm’s stores are using? If so, why did the trend not continue in 2024?
Taking a Step Back
Taking a holistic view of the ratios, Dunelm is, at this point, a profitable company that makes efficient use of its assets, and has enough of those assets combined with cash to cover its short-term liabilities. However, Dunelm’s debt/equity ratio is very high, and while it can handle this level of debt at the moment, I believe that this is going to limit the firm's ability to respond to changes in the social, political and market landscape of the UK. This is interesting because the market/book ratio is telling me that either the firm is overvalued or higher performance is expected of Dunelm. Taking the debt/equity and market/book ratios together, I believe that management for Dunelm has a difficult path to navigate in the future. Investors could be expecting more profit, and the easiest way for Dunelm to achieve this is to continue expanding, which will increase the debt/equity ratio further, reducing flexibility. Management is going to need to be sure that the new locations are going to generate enough revenue to justify opening.
This being said, expansion is not the only route management can take. Dunelm has been focusing on operational efficiency for at least the last five years. Dunelm might find it safer to invest in new technology to continue to improve its logistics system. This way, Dunelm can reduce costs without adding to its lease liabilities.
Step 5
Capital Investment Options
A New Store
Dunelm is aiming to expand its operations within the UK to increase profits. They are planning to open a new store in Winchester. The Winchester store is likely to have an initial cost of £2.5 million, and included in this cost is securing a new lease, outfitting the store, initial stock acquisition and staff hiring and training. The Winchester store is expected to remain profitable over the long term based on the total population and average salary in Winchester. However, since the wholesale and retail trade is highly competitive in Winchester, it is recommended that this project be given a length of 10 years.
A New Warehouse
Dunelm is looking for opportunities to increase its operational efficiency to reduce costs and has identified Winchester as a potential location for a new warehouse. By doing this, Dunelm hopes to expand its delivery network and reduce the days in inventory ratio across stores in the area. Dunelm is expecting to purchase an existing warehouse and renovate the site to suit its needs. The initial costs will include the purchase of real estate, outfitting the warehouse, the purchase of warehouse equipment and hiring and training of new staff. It is recommended that this project be re-evaluated after ten years to ensure the new warehouse is sufficiently improving operational efficiency. Dunelm is expecting to sell the warehouse or lease it after ten years, depending on its impact on finances and the real estate market.
| Store Front | Warehouse |
Original Cost | £2,500,000 | £5,000,000 |
Estimated Life | 10 years | 10 Years |
Residual Value | £250,000 | £400,000 |
Discount | 8% | 8% |
Estimated Future Cash Flows | ||
Year 0 | -£2,500,000 | -£5,000,000 |
Year 1 | £-1,000,000 | £-2,000,000 |
Year 2 | £500,000 | £-1,000,000 |
Year 3 | £750,000 | £500,000 |
Year 4 | £1,000,000 | £1,100,000 |
Year 5 | £1,500,000 | £1,700,000 |
Year 6 | £1,750,000 | £1,800,000 |
Year 7 | £2,000,000 | £2,000,000 |
Year 8 | £2,200,000 | £2,400,000 |
Year 9 | £2,300,000 | £2,500,000 |
Year 10 | £2,350,000 + Residual | £2,600,000+ Residual |
Figures are reasonable assumptions and are not indicative of actual costs/returns
Analysis and Recommendation
| New Store (Option 1) | New Warehouse (Option 2) | Recommendation |
NPV | £5.1 million | £890,000 | Option 1 |
IRR | 25.9% | 9.8% | Option 1 |
PBP | 5 years, 10 months | 8 years, 4 months | Option 1 |
The most strategically beneficial investment option for Dunelm is option 1. Firstly, the payback period (PBP) for option 1 is sooner than option 2, showing that Dunelm will recover the initial cost of opening a new store than if it opened a new warehouse. Secondly, the net present value (NPV) for option one is greater than for option 2. While both options are expected to increase organisational wealth, the NPV for option 1 shows a larger amount of wealth generated. Lastly, the internal rate of return (IRR) for option 1 is higher than the discounted percentage and higher than the IRR of option 2. Considering the PBP, NPV and IRR of option 1 is greater in all aspects when compared to option 2, the best decision for Dunelm is to invest in opening a new store.
Strengths and Weaknesses
Strengths
Using the PBP for investing in a new store is advantageous for Dunelm, as it shows how long it will take for the firm to make its money back on the investment. The lower PBP of option 1 will reduce the chances of future loss, because the sooner the investment has recouped its original cost, it cannot incur a future loss on the investment. Additionally, since option 1 has a higher NPV, Dunelm will receive more organisational wealth from option 1. Lastly, a higher IRR represents higher profits sooner for Dunelm, which is attractive for the firm as profits today are more valuable than profits tomorrow.
Weaknesses
One of the disadvantages of Dunelm making investment decisions based on PBP is that it ignores cash flows beyond the investment's end date. While option 1 will recover investment costs sooner, option 2 may generate more long-term profit if permitted to continue past the ten-year end date. Additionally, while NPV is directly related to increased wealth for Dunelm, it is based on cash flow estimates only. Considering that the future is uncertain, there is no guarantee that Dunelm will receive the projected wealth. Lastly, the IRR does not take into account the amount of money spent on an investment. In Dunelm’s case, option 2 has a lower IRR but requires a larger investment, which results in more value added to the firm.
Reflections on Learning
Overall, my experience learning in this unit has been positive. The elements I found the most helpful were the videos by Maria, the spreadsheet templates, the weekly overview and the study guide podcast. Maria’s videos were helpful when I was inputting my financial statements, completing the ratios and figuring out the capital investment options. At first, when I read the assignment tasks, I felt a bit overwhelmed with the spreadsheet component, having limited experience in using Excel before this unit, so I found the videos to be critical in helping me complete those aspects of the task.
Additionally, having the spreadsheet templates provided was a huge help. As I mentioned, I have almost no experience with Excel since leaving high school, so it was a relief to find the spreadsheet templates at the beginning of the unit. Furthermore, the weekly objectives were very useful to me because they helped me stay on track. I feel it is easy to get lost or overwhelmed in the first year of university, so having the objectives every week was valuable.
Something I did not realise until much later in the term was how valuable the study guide podcasts would be for me. On top of studying full time, I balance work and being present for my fiancé and daughter. At times, it felt like I did not even have an extra hour to do the readings. Well, that all changed when I decided to start consuming the podcasts. Suddenly, I went from just working to working and studying, from doing errands to errands and studying. The study guide podcasts were so valuable to me that I am concerned about studying further units without similar resources.
My main contributions and interactions with other students this term were through the feedback sheets in assignments one and two. At first, I was uncomfortable with giving feedback to other students because I had never had to give academic feedback before, and I felt I was in no position to tell other students what I thought about their work, considering I was in the same situation as they were. Also, I felt like I was criticising my peers. Despite this, I ended up enjoying giving feedback. I realised that feedback is not criticism; I feel that in this unit, it’s a good way to help each other out and lift each other so we are all successful. If I approached giving feedback with that mindset, it made a huge difference to how I felt, and I look forward to giving and receiving feedback now and in the future.
The three most important things to do to keep your sanity in this unit are to attend/watch the tutorials, allocate enough time for the assessment and stay up to date. Over this term, I was constantly watching the tutorials, either from Maria or Martin, and I found them to be an invaluable resource for me when trying to gain insight into the assessment. I was often unable to attend, so being able to watch the recorded tutorials later contributed to keeping my stress under control and myself focused.
The second thing to do is to manage your time appropriately. Something I particularly valued was Martin’s “runsheet” of how many hours I should be allocating to the unit materials and assessment. However, sometimes, it took longer, and that’s ok, but building some flexibility into your schedule to account for it is a must. I took longer than 20 hours to complete step 4, which resulted in some late nights and too many coffees the next morning to recover. This is an effective way to lose your sanity, so plan accordingly.
Finally, stay up to date with the learning materials. Falling behind is one of the most stressful situations to be in at university. Fortunately, there are a lot of different ways to engage with the learning materials, such as the podcast, as opposed to physically reading the study guide. It is important to find the delivery method that works best and engage with it.
Step 6
KCQ 1: Everything is limited
A key learning point I found from reading chapter 8 was the concept of opportunity cost. Put simply, when a business decides to take an action, it chooses not to take a different action. In business, the decision is based on resources and scarcity. For example, a cabinet maker has enough wood to make ten cabinets or four kitchen counters. If the cabinet maker decides to build the ten cabinets, then the opportunity cost is the four unmade kitchen counters.
I found learning this concept interesting because I have observed this concept in my previous workplace around menu specials. Previously, I had worked at the coffee club, which at the time had a strict “no specials” policy. The reason for this was that the franchisor required all locations to offer the same items across all its stores, like McDonald's. I remember watching the kitchen manager at the time throw away pork that had gone out of date and thinking “such a waste”. The opportunity cost of following the franchisor's policy was missing out on the value of that pork if we were able to repurpose it into a new dish before it expired.
In my experience, identifying opportunity costs and making the best decision has usually been obvious. However, I wonder if in larger businesses, when the right decision is less clear or when both decisions seem equal. How do managers make those decisions? Also, are there external factors that are not present in the numbers that might influence those decisions?
KCQ 2: Contribution margins, product mix decisions
A key idea I connected with in chapter 8.2 was the concept of product mix decisions. Product mix decisions are essentially what products firms offer based on contribution margins and resources. To me, this sounds like a menu. For example, a restaurant might expect to have limited access to eggs in the future, so it would need to examine the contribution margin of each menu item using eggs and decide which menu items to keep and which to remove.
Recently, the restaurant I was working in had difficulties sourcing eggs from any of the local suppliers. After many emails and phone calls, we found there was a large delivery of eggs coming, but in two days. This was a problem because many of our breakfast items included eggs, as did our pasta, and we did not have enough stock to supply all the menu items. After reviewing the menu costings, we removed some breakfast menu items to conserve the eggs we had for the dinner service. We did this because the profit margins on pasta were far greater than anything on the breakfast menu, also pasta needed fewer eggs to prepare, around half as many. Therefore, it made sense to us that we should focus on having enough eggs to supply pasta for dinner.
Reflecting on my experience, I wonder what managers of larger firms do if there is an unexpected scarcity of resources? For example, in Dunelm’s case, their supply chain was disrupted by regional conflict, so what do managers do if something similar impacts their ability to source resources suddenly?
KCQ 3: Time value of money
The time value of money is the concept that money in our hands today is worth more than money promised to us in the future. This is because money in hand today has more uses than money coming to us later. For example, money on hand can be used to pay debt, invest or acquire new resources.
I found I can see this in practice when observing the cost of living in Australia. Let's say I spend $100 to fill my friend's petrol tank with the agreement that next time we are together, and I need petrol, he will do the same for me as repayment. If it takes an extra month before that situation arises and petrol prices have increased. I am getting less petrol for that $100 than what my $100 originally bought; essentially, I have lost value because petrol is worth more, and the repayment does not go as far.
Something I thought about when reading chapter 8.3 was that since rising inflation will make money in the future worth less and inflation is uncertain, how do managers plan for that when making capital investment decisions?
KCQ 4: NPV
In chapter 8.4, an important concept was net present value. To my understanding, net present value is how much value a firm will receive on its capital investment. Put simply, it shows how much money the firm will make.
Something I found interesting about net present value was that it is one of the most widely used approaches to determining which investment opportunity a firm chooses. Previously, it made sense for a firm to select an investment opportunity with the highest NPV since a higher NPV indicates a higher return on investment. However, when I found that determining the discount rate used for NPV involved guesswork, I was surprised. I was also surprised that it is based on the future cash flow estimates and not guaranteed.
Since managers can be responsible for investing large amounts of other people’s money, I wondered what kind of tools or safeguards are in place to reduce the amount of uncertainty when discount rates and future cash flow estimates are determined.
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