Udoka corporation case study - Essay Example

?Udoka Corporation Case Study Table of Contents Part A 3 Introduction 3 Brief of Udoka Corporation 4 Analysis of Operational Performance 4 Issues Uncovered through Analysis 6 Recommendation 9 Conclusion 10 Part B 12 Introduction 12 Function of Treasury in Improving Cash Flow 12 Need for Financial Restructuring 14 Summary 15 Reference 17 Part A Introduction There is close relation between the operational activities and financial activities as both of these areas are inter-dependent on each other. Proper financial planning for operational activities increases its performance which helps to achieve better operating financial performance. Operational process is the core area that has to be very efficient to retain the sustainability of a company. Therefore, in order to maintain a higher level of operational process, proper evaluation and controlling activities are inevitable. The evaluation of operational analysis can be done using the financial evaluation techniques specifically the ratio analysis. Besides, the management decisions and future strategies should also be analysed for determining the future growth of company in terms of operational performance. Hence, in this regard necessary information is essential like the financial data and management planning for operational process. However, merely computing the operational ratios will not offer very clear picture of a company’s performance. The results of evaluation must be compared with the peer rivals and with industrial average performance. There are also other financial techniques apart from the ratio analysis like horizontal analysis which is helpful in comparing company performance in comparison to performances in previous years. As this report aims to evaluate operational performances of Udoka Corporation, outcome from the horizontal analysis can be used to assess improvements or degradation in Udoka’s performance. The primary aim for this analysis to is identify the underlying issues in Udoka’s operational performances and accordingly a set of plausible and specific recommendation will be offered. Brief Description of Udoka Corporation Udoka Corporation is engaged in mobile manufacturing business and technology and innovation is the base of this company. It is operating in a highly competitive business environment where every aspect of performance is crucial for sustaining in such severe competitive market. It is expected that in coming years the industry competitive will be fiercer and hence, it is necessary for Udoka to take necessary action to acquire an upper hand position in the market. The management of Udoka is considering for investing for ensuring Udoka’s future, and in this process, it is very necessary to make proper decisions based on prevailing condition of finance and based on industry forecast. Analysis of Operational Performance Operational process includes the management cash receivable, cash payable, inventory turnover etc. Using these parameters, cash conversion cycle and operational cycle can be determined. To make better decisions for future growth, the proper evaluation of current status is indispensible which also offer indication of prevailing operational performance (Walton and Aerts, 2006, p.261). Using the financial data of Udoka Corporation, operational performance of the company has been determined. Table 1 represents horizontal analysis of Udoka’s financial statement and the table 2 depict the analysis of its operational performance. Table 1: Horizontal Analysis of Udoka’s Financial Statements Financial Analysis 2011 2,010 2,009   Actual Actual Variance % Actual Variance %   ?m ?m ?m   ?m ?m   Total sales 50,710 45,639 5,071 11% 41,075 9,635 23% Cost of sales 33,337 26,471 6,866 26% 24,645 8,692 35%                 Ratio of CS/Sales 66% 58% 8% 13% 60% 6% 10%                 Gross profit 17,373 19,168 -1,795 -9% 16,430 943 6% Gross margin 34% 42% -8% -19% 40% -6% -15%                 Operating expenses               Research and development 5,968 5,500 468 9% 5,300 668 13% Sales, general and administration 5,660 3,250 2,410 74% 3,800 1,860 49% Other expenses 775 550 225 41% 500 275 55% Total operating expenses 12,403 9,300 3,103 33% 9,600 2,803 29% Ratio of OE/Sales 24% 20% 4% 20% 23% 1% 4% Profit before interest and tax(EBIT) 4,970 9,868 -4,898 -50% 6,830 -1,860 -27% Corporation tax 1,081 2,171 -1,090 -50% 1,503 -422 -28% Net profit 3,889 7,697 -3,808 -49% 5,327 -1,438 -27% Ratio of NP/Sales 8% 17% -9% -55% 13% -5% -41% Liquidity Analysis               Current ratio 1.2 1.24           Acid test 1.08 1.13           stock/turnover ratio 0.05 0.06           Performance Analysis (Days) (Days)           Inventory days 28 39           Debtor days 68 83           Creditor days 57 76           Capital employed 19,227 21,034           Return on capital employed(ROCE) 0.258 0.469           Financial gearing Analysis               Debtor/Equity ratio 1.4 1.57           Table 2: Analysis of Operational Performance Working Capital Analysis 2011 2010 Industrial Average Actual Variance % Actual Variance % Inventory days 27.7 38.6 -10.9 -28% 30.32 -2.62 -9% +Debtor days 68 83 -15 -18% 32.04 35.96 112% -Creditor days 57 76 -19 -25% 39.71 17.29 44% Operating cycle 95.7 121.6 -25.9 -21% 62.36 33.34 53% Cash Conversion cycle 38.7 45.6 -6.9 -15% 22.65 16.05 71% Turnover 50,710 45,639 5,071 11%       Ratios               Stock/Sales 5% 6% -1% -17%       Debtors/Sales 18.60% 22.90% -4.30% -19%       Creditors/Sales 7% 10.50% -3.50% -33%       Working capital/Sales 16.6% 18.40% -1.80% -10%       Issues Uncovered through Analysis In the previous section a thorough analysis has been done on the operational and financial position of Udoka Corporation. A number of issues have been found after analysing the past three years records of the company. From the point of view of operational efficiency the position of Udoka Corporation has decreased in the last few years. The sales have indeed increased in number but the percentage increase in sales has declined in last three years. This shows the efficiency of Udoka Corporation has declined in last three years. A matter of concern of Udoka Corporation is that its cost of sales is mounting up year by year which had indeed drastically affected its gross margin. From the figures given in the previous section it is clear that the gross margin which was 40% in the year 2009 has come down to 34% in year 2011. This shows the operational and managerial inefficiency of Udoka Corporation. Another important thing to notice is the rising cost in form of operating expenses. The operating expenses have increased by 33% in year 2011 which surpassed the rate of increase in operating expenses of 2010. Increases in operating expenses had adversely affected the operating profit which decreased by 50%. This is a matter of great concern as for any company profit from its core operation is very important. Interestingly the expenses regarding sales and administration have increased but as rate of revenue decreased over the period it will not be wrong to say that the management failed to budget its expenses properly. It can be seen from the previous section that there has been a considerable increase in operating expense ratio. Operating expense ratio signifies that how much operating expense have been incurred for generating one pound of sales. As there has been a considerable increase in the operating expense ratio so it can be said that the management has to incur more operating expenses for increasing its sales. This again points out the management’s inefficiency in controlling its operational expenses while increasing its turnover. Udoka Corporation has spent more in research and development; this may be because of their plan of launching new mobile in emerging markets. As the management was inefficient in controlling the cost the net profit has also declined. Net profit after tax reflects the company’s ability of generating shareholders’ wealth in terms of earning per share. Hence the inefficiency of management has also adversely affected the shareholders’ earning. With the help of analysis many hidden things have also been found in liquidity position of Udoka Corporation. The current ratio of Udoka Corporation has reduced from 1.24 to 1.2. This means that previously Udoka Corporation had 1.24 pound of current assets to meet up every 1 pound of current liability but now it has only 1.2 pound to meet up one pound of current liability. This means that the liquidity position of Udoka Corporation has slightly decreased but current ration includes inventory which cannot be converted into cash immediately hence the acid test ratio has been calculated to know Udoka Corporation’s ability in maki8nfg immediate expenses. The acid test ratio has decreased by 4.42%. Hence the company is not having enough liquid assets to meet emergency expenses. A positive aspect of the management can also be traced from their analysis. The management has efficiently reduced the stock turnover that is the stock is converted into sales in a faster rate compared to 2010. Moreover the management has successfully reduced the period of collecting money from the debtor but the creditors have reduced the credit period as a result the company has to clear their dues more fast. Apart from this the management was not efficient enough in using its invested capital in generating income. This is evident from the decrease in return on capital employed. Return on capital employed shows the management’s efficiency in employing its capital for generating income. Apart from the financial analysis a working capital analysis has also been done comparing last two years’ figures and industrial standard. From the analysis it is clear that days of holding inventory has reduced from the year 2010. The industrial average is 30.32 days while in 2011 Udoka Corporation has held the inventory for 27.7 days. This means that the company is losing sale as there is a demand of goods in the market and the company is not having enough stock to sell in the market. In 2010 again the management made wrong assessment of the market demand and carried stock for more days than the industrial average. As per the management’s efficiency in receiving the payments from the debtors has improved compared to the year 2010 but the management’s performance in this respect is far below than the industry slandered. It can be said that the management has improved a lot in getting its payments fast from its debtors but there is still room for improvement. The creditor period availed by the company from its creditors has decreased but it is more than the industrial average. Hence it can be said that Udoka Corporation has a good reputation in the market in terms of making payments to its creditor but may be because of its declining income and liquidity position the creditors have reduced the credit period. The management is also not efficient enough to turn its investments in to income fast compared to the other companies operating in the industry. This is evident from the operating cycle and cash conversion cycle. Both operating cycle and the cash conversion cycle have decreased compared to the figures of 2010 but still above the industrial slandered. Hence there is still room for improvement in this part. Every pound of sales in 2011 include 0.186 pound of credit sales which is less than 2010. This means that in 2011 more cash sales have been generated from total sales compared to the figures of 2010 which provides more cash to the company for disbursement. The management was also inefficient in generating more working capital from sales compared to year 2010. In all, the management’s efficiency has reduced in operational as well as financial activities. Recommendation After analysing the operational and financial performance of Udoka Corporation the following recommendations have been made: 1) As we have seen that Udoka Corporation’s operating cycle and cash conversion cycle is much more than the industrial standard which in turn is affecting the liquidity position of the company. Hence it is advised that the management of Udoka Corporation take necessary steps so that the less time is spent on converting investment into income. In this regard increase in operational efficiency is a must. 2) As the company is planning an expansion in 2012 it will require huge amount of cash with the increase in operational expenses, cost of sales and increase in debtor’s days th3e cash flow from operations is adversely affected. Hence it is advised that the management should try to reduce the operational cost and analyse the debtors from the point of view of their credit worthiness before selling goods on credit. 3) Before selling goods on credit the debtors should be rated as per the cost incurred and income generated from the credit sales and their credit worthiness. Considering this analysis the credit sales should be made. 4) The demand of the goods should be properly made deciding on the inventory level. 5) Management must take necessary steps to increase the sales without increasing the operational expenses so that the company can generate more income and can increase its return on capital employed. Conclusion As per the analysis done on the operational and financial position of Udoka Corporation we can conclude that the management have to increase its efficiency in managing the operational activities. Reduction in return in capital employed clearly indicates that the management failed to use the capital efficiently in generating income from its core operation. As the percentage of increase in sales has decreased and operational expenses have increased it can be said that management has to concentrate more in increasing its efficiency in operations. Part B Introduction In every company the treasury department is very important. The aim of the treasury department is to maximise the shareholders’ wealth. This is done by concentrating on various activities of the company. In the present case the importance of the treasury department on improving the cash flow of the company deciding on the need of financial restructuring of the company has been highlighted. Udoka Corporation is a mobile manufacturing company which is planning to produce mobile having all the latest features at low price especially for the emerging markets. They also had a plan to use latest technology for their mobile phones. A lot of investment is required for implementing all the plans. Selling hi tech mobile at lower price means the profit margin will be less compared to their present products. Investments will require a lot of cash. Hence the treasury has to take care of the availability of cash. Function of Treasury in Improving Cash Flow Treasury is a department of a company which ensures the liquidity position of the company. It forecasts the cash requirements and takes the decisions of investing excess funds and also decides on how funds can be raised (Brag, 2010, p.3).The main function of treasury is to take all the decisions regarding the financial activities of the company. It assesses the areas in which investments should be made. It also locates the most appropriate sources from where the funds can be raised. It manages the risk by identifying the risk associated with all the activities like investment activities, financial activities and operating activities. Udoka Corporation increased its investment in fixed assets in 2011. This means that they have blocked more cash in fixed assets in 2011. In 2011 cash has been generated from current assets. Cash has been generated from the sale of inventories and receipts from debtors. There is a decrease in current liabilities which means that cash has been flown out from the company in terms of payment towards trade creditors and outstanding expenses. The company has increased its retained earnings may be because of the investments of 2012. The treasury has to locate the various areas from where cash can be generated so that the company can continue with growth plans. There are mainly three categories of activities from where cash is generated; they are operating activities, investing activities and financial activities. Cash is generated from sales. Sale can be both on cash and credit. To generate more cash from operations treasury will concentrate on investment made on debtors. As per the customer profitability analysis the most profitable customer is Worldman Ltd but they had a larger turnover compared to most of the other debtors. It takes more than 60 days to make the full payment to Udoka Corporation. The treasury will value John Goteery more than Worldman as its profitability and turnover are quite impressive. The main function of treasury for increasing cash from operation will be to concentrate on debtors’ turnover that is how frequent debtors are paying the money and then identifying the best debtor. It will also suggest the ways in which cost associated with debtors can be reduced. In this way the treasury can improve the cash flow from operation. Another way in which treasury can help the management in increasing the cash from operations is by giving suggestions on effective inventory turnover. Lesser the inventory turnover more cash will be available for disbursement. In case of long term investment, the main function of treasury will be to assess the financial viability of the investment. Suppose the management is considering on buying a new machine, treasury will assess the financial viability of the proposal with the help of capital budgeting techniques. The main capital budgeting techniques used in this respect is the net present value method, the internal rate of return etc. The function of treasury also includes identifying the sources from where long term funds can be generated keeping in mind the organizational goals and plans. In this way the functions of treasury can help the company to solve the potential cash flow problems of April/May 2012. Need for Financial Restructuring Financial restructuring is mainly done to make changes in the capital structure. The capital structure can be done by changing the proportion of debt and equity. Financial restructuring is done to correct the faulty capital structure or to make the capital structure appropriate for implementing the organisational plans. Udoka Corporation has many investment plans for the year 2012. It has decided to offer quality mobile at affordable prices in emerging markets. It will also enter into a partnership with Japanese company, Technocraft Corporation to build a mobile ecosystem. It has also plans for renovating its Series 77 mobile phones by adding new features. All these plans will require huge investments in technology. It will have to purchase new computers, photocopiers, transport vehicles etc. It will have to hire new service engineers. Implementation of all the plans will require funds. At present the capital structure of the company has equal amount of debt and equity. In equity the major part consists of retained earnings. The debt equity ratio of Udoka Corporation in 2011 is 1.4 which was 1.57 in 2010; this mean the company had reduced debt from its capital structure. Now the company is in a more balanced position in terms of risk compared to its position in 2010. It can use more debt which is a cheaper source of capital than equity. The company must try to utilize the capital efficiently so that profits can be earned from the capital employed. Presently the company’s return on capital employed is 0.25 which is far below than the returns of 2010. Hence with restructuring the capital the management should also make sure that the capital is used efficiently. The financial leverage is used for deciding whether the company can use more borrowed funds in its capital structure or not on the need of borrowed funds. The financial leverage represents the degree or the level to which the company uses funds from borrowing for financing its assets (Madura, 2007, p.582). The company can use more debt in its capital structure. It can borrow some more funds which can be used for investments in future. There is a decrease in working capital. Therefore the company can make some changes to improve the condition of the working capital. The prepaid expenses and the accrued expenses have been piled up in year 2011. This will lead in less generation of fund which are to be used in business for meeting up short term expenses. The capital structure should be changed in such a way so that more cash and cash equivalent are available to the company. Summary Hence, it can be said that the treasury plays a major role on improving the cash flow of the company. The treasury department of Udoka Corporation will have to play a major role on the implementation of the company’s future plans. This will include not only deciding on the avenues in which cash flows can be increased but also whether the capital structure should be changed or not. These types of decisions include a lot of risk. In the present case the company should restructure its capital structure so that its plan can be successfully implemented. Reference Brag, S. M. (2010). Treasury Management the Practitioner's Guide. USA: John Wiley and Sons. Madura, J. (2007). Introduction to business. Canada: Cengage Learning. Walton, P. and Aerts, W. (2006). Global financial accounting and reporting: principles and analysis. Cengage Learning EMEA. Read More