Page 2: Turning round the business
In 1999 MFI had completed the refurbishment of most of its stores into the Homeworks format. The purpose behind this investment was to generate high levels of sales growth. However, the refurbished stores were not delivering the increased sales growth that was expected. As a result, in the period prior to 1999 MFI experienced a considerable net outflow of cash, and this had to be financed by borrowing.
In business, 'gearing' refers to the proportion of finance that a business has raised from borrowing from external sources compared with that raised internally from operations or shareholders. Highly geared companies are companies with a high proportion of external borrowing. It makes sense to borrow, but not too much. MFI's increased borrowing led to it becoming highly geared. A highly geared company has to pay large sums to its lenders in the form of interest (see below). This holds back the growth of a business because profits are reduced.
In 1999, MFI appointed a new management team with a proven track record in decision making. The team immediately set about restoring MFI's financial health. They generated cash by selling and leasing back some of the property that MFI owned outright i.e. freehold.
Sale and leaseback is an important potential source of finance from land, buildings and other valuable assets that a company owns. A business sells its freehold property to an investment company, and then leases it back for an agreed number of years. The main advantage is that the business taking out the lease no longer ties up its money capital in fixed assets, and can ensure that the funds that are released work more productively in generating ongoing wealth. At the time, sale and leaseback was the most suitable source of funds for MFI, because further bank loans or other interest bearing loans would have aggravated the gearing position further.