Profitability, Liquidity, and Solvency to Determine the Recommendations on Contracting Business - Research Proposal Example

? Business Strategy - Task 2 Table of Contents Main contractor General Contractor 3 Subcontractor 4 Financial Analysis for recommendation 5 Recommendations 8 Should the company be recommended as a subcontractor? 8 Should the company be recommended to a subcontractor as a main contractor? 9 Should a supplier supply goods on credit to this company? 9 What would you recommend should be done to improve the situation at the company? 10 Reference 11 Main contractor / General Contractor A general contractor or a main contractor of project has the key responsibility to complete a project effectively within the time period. The company is responsible for day to day oversight of ongoing project to track the work performance. It needs to effectively manage the vendors as well as the traders who are related to the project. General contractors provide wide range of services to the clients for a tendered fee and a possible duration of completion of the project under an authorised contract for proposed services. Contractor can charge the fees for its services by hour of work basis, by day or lump sum basis. They generally ask for payment from the clients after completion of each part of the whole project or they can charge in pre-mentioned work duration. General contractors take contracts of new project as well as renovation of an old or damaged project. For this type of services they do an effective site visit fpo0r proper understandings of the current situation of the project which is essential for the projection of required work on that project as well as to estimate the overall cost for the renovation. In the process of estimating the total cost of a project they consider the cost of required raw materials as well as the labour and other possible costs. All these are mentioned in detail in the budget. General contractors who work for government agencies are referred as prime contractor. For a business owner perspective, they hired contractor than a group of permanent employees to get the cost advantage. Contractors provide services in a competitive rate as there is also huge competition in contracting market. Apart from this, the client can release the contractor after one project and they do not need to provide training. Subcontractor Subcontractor works under main contractor and their task and obligations are assigned by the main contractor. In a complex project or a long term project, the main contractor generally hire subcontractor to complete different part of the project. Subcontractors are generally expertise of a particular type of work for project and this they are hired by the main contractor for effective completion of the total work. When a wide range of capabilities are required for a project then subcontracting become very useful. The subcontracting part of a project is generally not under the core competencies of the main contractor and for this reason it may assist to the main contractor in diversifying the overall risk and keeping costs under control. So the general contractor receives a better service from the subcontractor which it could not have provided by itself at a lower risk. Many subcontractor works for same companies which allow them to become specialised in a particular skill. In UK, there need to respond to the frequently changing environment and to service a diverse areas of the infrastructure. It has encouraged the subcontractor community for the flexible and diversified work and they have been providing specialised skills and expertise to many general contractor companies (Wrigleys Solicitors LLP, 2009). Financial Analysis for recommendation Table 1: Balance sheet of the company LIABILITIES Amount(?) ASSETS Amount(?) Issued(fully paid up) share Capital 200 Fixed Assets 100000 Revenue Reserves 60000 Depreciation 5000 Loans 200000   95000 Overdraft 120000 Stock and work-in-progress 400000 Estimated Tax payable 20000 Debtors 100000 Trade Creditors 195000 Cash 200 Balance 595200   595200 Table 2: Profit and loss statement of the company Particulars Amount(?) Amount(?) Sales   1000000 Gross profit on sales   100000 Less Admin Expenses 20000   Less Interest 35000     55000   Net Profit before tax   45000 Less Tax 20000   Net Profit after tax   25000 Dividend at 500% 1000   Retained profit   24000 Followings are the important financial ratios of the company that represents the financial health as well as operational performance of the company. a) ROCE : 100,000 – 20,000 = 80,000 / 60,200 = 132.89%  b) PBIT: 80,000 / 100,000 = 8%  c) ROE : 25,000 / 200 = 12500%  d) Debt Equity Ratio : 200,000 + 120,000 + 20,000 + 195,000 + 200 = 99.96  e) Current Ratio : 500,200 / 535,000 = 0.93  f) Acid Test : (500,200 – 400,000) = 100,200 / 535,000 = 0.19  g) Turnover Ratio : (1,000,000 – 100,000) / 400,000 = 2.25 (2.3)  h) Debtor Days : 100,000 / 1,000,000 x 365 = 36.5  i) Creditor Days : 195,000 / 1,000,000 – 100,000 x 365 = 79.1 The analysis of the above financial ratios can determine the characteristics and the financial health of the company regarding the subcontracting business. The main areas of the financial status are profitability, liquidity and solvency. Analysis of these can effectively determine the recommendations regarding contracting business. Return on capital employed is a profitability indicator because it represents a clear picture of how the use of leverage influences company’s profitability. It helps management of a company to generate earning from the total capital of the company. ROCE is more than 132% and it reflects a very high profitability trend of the company. Generally it needs to be higher than the interest rate which the company has been paying for its long term as well as short term debts. It might be far more than the standard interest rate. Return on equity of the company is much higher than usual. Only ?200 has generated a net profit ?25000 which is very high profitability of the business and also it represents a more than expected performance of the company as it is a service based company. Debt equity ratio represents the overall status of debt of the company. It compares the total liability of the company with respect to the shareholders fund. It reflects a qualitative measurement of commitment of the suppliers, creditors, lenders etc compared to the commitment of the shareholders. Debt equity ratio of the company is almost 100% that means the both the creditors as well as the investors have similar amount of investment into this business. The company has a stable position in terms of credit worthiness as well as performance in the sense of return. Both these important stakeholders have a good trust to this business. Current ratio represents the working capital position of the company as it is one of the important indicators of liquidity of a company. It measures the performance of the company regarding its short term ability to pay the short term liabilities of the company. It is very important criteria of the company that operates as a subcontractor as it needs to pay directly and also very frequently to the supplier of raw materials and the labours. The standard current ratio for this type of company is to be more than 1%, preferably 1.33%. But this company has a current ratio less than 1 which represents that the company is not much efficient in paying its current liabilities especially the suppliers and labours. Turnover ratio represents the net sales with respect to the total assets of the company. It is broadly called as asset performance that means how the company effective manage its assets to generate substantial amount of sales with respect to its assets. The company’s turnover ratio 2.3 which represents that the company is efficient to generate its short term capital gain. It is good for the company to get short term credit either from bank or other creditors. “Creditor days” indicates that how long a company takes to pay its different trade creditors like labours raw material suppliers etc. It is also termed as ‘payable outstanding days’ which is for this company is 36.5 which is a good sign of the company to its creditors. “Debtor days” measures duration of time the company gets its receivable. It represents how quickie the company gets its due receivables from the debtors of the company. It is near about 79 days which is more than its creditor days. This is very bad scenario of the company because the company might not able to pay its creditors until it gets its due receivables. For a construction company this is very important to have smaller debtor days than creditor days otherwise the company cannot get efficient supplier who always see this current cash inflow of the company before supplying. Acid test ratio indicates that the company has enough short term assets to pay its current liabilities or not. If this ratio is less than 1 then the company cannot pay its current liabilities without the help its inventory. But for the subcontractor business, inventory means the unpaid work of the company. So, it cannot use it as it is totally depends on its debtor days which is very high for this company. Recommendations Should the company be recommended as a subcontractor? Subcontractor gets the payment of its work from the main contractor or the general contractor. They pay directly to the suppliers and the labours, so they always need to maintain ratio as well as acid test ratio. This means the company needs to have sufficient current assets like cash in bank so that it can pay its value creditors in a short time interval. According to the current financial status of the company, it has been facing a huge gap between its payable and receivable cycle. It is nearly 43 days of gap. So the company has to its creditors pay 43 days before it gets payments from its debtors. This duration happens because, as a subcontractor it gets payment in the 2nd stage of the original payment for a project. Firstly, the client of the project pays to the main contractors and then the main contractor pays to its subcontractors. So, two different creditors period works one after another and resulted a long duration in payment of this company. In this business price for a particular work does not become the competitive advantage for getting hired by a main client or by a main contractor or even for getting efficient suppliers and labour, the key characteristics is the debtor vs. creditor days of the company. So, according to the current financial position the company might not able to be an effective subcontractor. Should the company be recommended to a subcontractor as a main contractor? It can be recommended that the company can operate as a main or general contractor based on the efficient capital management and the performance of the company. Return on capital employed is good which represents a very performance standard in the form of current sales current sales. The company has reported very good return to its equity holders which is very beneficial for this company to become a general contractor as it needs a good amount of initial investment at the initial time of a project. So the company can get a good amount from its investors by issuing share. If the company operates as a general contractor then it can directly get its payment from the client and is a limited possibility to get delayed payment which will reduce its debtor day. Should a supplier supply goods on credit to this company? Suppliers generally look for few financial ratios of a contracting company. These are current ratio, acid test ratio and debtor and creditor days. The acid test ratio is much lower than the working capital ratio of the company and it represents that the company’s short term assets are highly dependent on its inventory i.e. the due payment of the completed work and only from that payment the company can pay its suppliers. Though the creditor days of the company y is good but the there is huge between the debtor and creditor days. Supplier generally preferred that company’s debtor days will be shorter than the creditor days so that the company can get sufficient amount ready to pay its supplier. So, according to the above analysis supplier might not want to supply on credit due to high possibility of delayed payment. What would you recommend should be done to improve the situation at the company? The company needs to increase its current assets rather to investing more on creation of fixed as it is already has the efficiency of capital management. It should not be highly dependent on the payment from its debtors and for this it needs to reduce its debtor days by negotiating with the debtors. It needs to fix the creditors days according to the debtor days. So, the company might be efficient in this weak area of working capital management if it operates as a contractor and get direct from the clients not the second stage payment from the main contractors. Reference Wrigleys Solicitors LLP. (2009). Subcontracting - some guidelines. [Pdf]. Available at: http://www.linkscvs.org.uk/downloads/subcontracting.pdf. [Accessed on April 24, 2012]. Read More