The Ultimate Goal of an Enterprise - Case Study Example

1.0Introdcution The ultimate goal of an enterprise is shareholders value creation and maximization and for this to be realized, receipts and payments or expected stream of cash inflows (Receipts) should be compared with the outflow (payments) (Penman 2003). Berlin & Lexa (2003) argue that most of us and certainly all businesses are constrained by limitations on their capital. We can't have everything all at once and so, we need to make choices among the possibilities available to us. The best alternative should be made at any one time in terms of choices. Faced with the increasing complexities, conflicting and multiple objectives and capital constraint common to businesses, organizations have to make important choices taken into consideration the time value for money. Many metrics have been developed to ease this process. Faced with too much information, Investors at times get confused with no clear indication of what the true prices of stocks should be. (Penman, 2003). Under such circumstances, the investor either make decision based on his or her instinct, such investors according to Penman (2003) are intuitive investors while others who make their decision based on capital market efficiency are referred to as passive investors. This part of the question addresses the performance of a new venture to be set up to enable us make informed judgment as to a hold a buy or sell decision. Thus, the objective of this question is to analyse the liquidity, the profitability and solvency position of the new set up from information extracted from the projected profit and loss account, the balance sheet and the cash flow statement. The report do not only provide a financial overview of the new venture for the projected three years period. The question also, guide potential investors on where the business is coming from and where it is heading to. 3.1Analysis of Sales and Profit Gross profit margin assumes that in the absence of other expenses what percentage of sales comes to the corporation as profit, while net profit margin takes into consideration all the expenses and measures what percentage of sales comes in as profit after all the other expenses must have been deducted. It is important to note here that, ratio analysis in them is useless except when compared with the industry benchmark or other competitors. 2010 2011 2012 Key Data Sales 488000 536312 589943 Cost of Sales 277650 358168 392947 Gross Profit 210351 178144 196996 Operating Profit/Loss 39441 84173 93080.8 Percentages % 2010 2011 2012 Growth in Sales (%) 10.0 10.0 Gross Profit Margin (%) 43.2 33.1 33.4 Net Profit Margin (%) 8.1 15.7 15.8 From the above analysis and interpretation, one will see that our proposed new venture is a feasible and profitable business. While gross profit margin for the first three years under projection is above 30%, net profit margin also portrays a favorable situation. Analysis of Capital Employed According to Penman (2003), assets and liabilities are distinguished based on the nature of the operations the underlying operation and the funding structure. The underlying operation is represented by the operating assets of the business. Operating assets are also known as capital employed - the amount of capital that is employed in the business. Here, it is defined as being the total assets without any deduction for the creditors of the business. 000s 2010 2011 2012 Key Data Current Assets 131079 167081 229919 Fixed Assets 33362 89033 127526 Total Assets 164441 256114 357445 Percentages % 2010 2011 2012 Current assests 80 65 64 Fixed Assets 20 35 36 Key data & ROCE 2010 2011 2012 Total Assets 164441 256114 357445 Profit Before Interest& Tax 52588 112230 124108 ROCE (%) 32 44 35 This ratio ROCE measures how well a business has performed in terms of the capital used to carry out the daily operations. According to Penman (2003), it is a key performance indicator and may show a decline even though the net profit margin has gone up. This will reveal the fact that the increase in assets invested in the business has increased faster than the profit margin. 3.3Managaement of Working Capital Liquidity measures the degree of convertibility of a company's assets to cash. In other words it measures how quickly a company can settle its obligation without compromising the required deadline. Two important ratios are important for measuring a company's liquidity, the current and quick ratio. The current ratio divides current assets by current liabilities. The quick ratio removes stock from current assets before computing the ratio. 000s 2010 2011 2012 Key Data Current assets 131019 167081 229919 Current assets less stock 131019 167081 229919 Current liabilities 75000 82500 90750 Ratios Current ratio 1.75 2.01 2.53 Quick ratio 1.75 2.01 2.53 The current and quick ratio shows that, our proposed new venture is highly liquid. This is because we strive at zero level of stock, since no two stocks are identical with respect to our different clients. 3.5Stock holding Period Our stock holding period is zero. This is so because our inventory and goods are based on command, and because no two commands and specification are the same our level of stock is zero. Here, we intend to create an efficient working capital management through just in time production and production on order method. This ratio however, measures the number of days stocks are kept in a business before sales. 3.6 Debt Collection Period According to Akalu & Eliot (2003), debt collection period measures the number of days before a customer pays the business for goods or services. The ratio compares closing debtors with the sales for the year and multiplies the ratio by 365 to convert the ratio into a more meaningful figure. The ratio is used to measure the ability of the business to measure it debts. A very low figure denotes and efficient debt management system in place while a high figure denotes the reverse. Because our products are made to order using just in time production method, our sales credit stands at zero for the three years under projection. The number of days of debt is generally overstated by using the financial accounting figures, as the debtors include VAT whereas the sales do not. But the changes over time can still be validly analyzed 3.6Common size Income Statement 2010 2010 2011 2011 2012 2012 Turnover 488,000 100.00% 536,312 100.00% 589,943 100.00% Gross Margin 210,351 43.10% 178,144 33.22% 196,996 33.39% Total operating costs 157,763 32.33% 65,914 12.29% 72,888 12.36% Operating Profit 52,588 10.78% 112,230 20.93% 124,108 21.04% Interest 0 0.00% 0 0.00% 0 0.00% Tax on Profit 13146.9 2.69% 28057.6 5.23% 31026 5.26% Retained profit 39,441 8.08% 84,172 15.69% 93,082 15.78% Common size Balance sheet Projected 2010 2010 2011 2011 2012 2012 Fixed Assets 33362 22% 89033 35% 127526 36% Current Assets 131079 78% 167081 65% 229919 64% Total assets 164441 100.00% 256114 100.00% 357445 100.00% Current Liabilities 75000 0 82500 0 90750 0 Net Assets 89441 173614 266695 Owners cap beg 50000 56% 89441 52% 173614 65% Net Income 39441 44% 84173 48% 93081 35% Capital at end 89441 100.00% 173614 100.00% 266695 100.00% From the above calculations and analysis of the financial statement using ratios, we can happily say that our new venture is worth the risk. It represents a good value for money. Thus, the company performance for the three years under projection is worth commending. Here, the common size income and balance sheet statement shows items as a percentage of total revenue earned while the common size balance sheet shows items expressed as a percentage of total assets. In examining the performance of our new venture, attention will be paid on key ratios and key change drivers. The profitability, liquidity and solvency ratios will be looked upon. According to our forecasted sales and profit and loss account we can argue that the sales have been growing from year over year, from 2010 to 2012 varying, with a constant growth rate. Net and gross profits show a stable increase over the period '2010-2012, with more than 10% increase year on year. Although profitability is stable with improved margins. The absence of credit facilities have created a large pool of liquid assets that could be easily invested into other marketable securities. The balance sheet statement shows the importance of cash and near cash items to the new venture accounting for about 78% of total assets in '2010 to about 65% in '2011. This is due to the made to order and just in time working capital management techniques that have created a pool of liquid items. However, our caution to the management is to diversify some of this liquid items into short term investment, and government securities. Thus, since all sales and production are made to order, creditors day is zero. The profitability ratios show that though the company is doing well, when compared to the industry average, the situation has greatly deteriorated when compared to the previous years that is 2010 against 2011 and 2012. There has been an improvement from 2010 in almost all the ratios. However, the situation is not all that alarming as during the year 2010, emphasis was placed on non-sales items. This is so because within these same periods, loss from discontinuing operations was decreased by 91 %.( See 2010/2011 income statement, section under discontinued operations. These periods again witnessed a reduction in current assets in short term activities with increase in idle cash generating no income. For example the ratio of current assets to current liabilities was increased in 2010, but in 2011, the amount of near cash and cash items almost doubled. The same argument holds for quick ratio and cash ratio when the three years under analysis are compared. The current ratios have also witnessed improvements from 2010. The current ratio and quick ratio show that our new venture has more than enough current assets to cover its short-term liabilities without facing business risk that is the risk that it might not meet its short-term commitments. However, the present situation calls for immediate rectification as it is illogical to be keeping cash, and paying interest on outstanding debts. The cash ratio shows that our new venture could cover almost or all of its short-term liabilities in 2010 and more than two times in 2011. Our business is again doing better in this domain, but cash items could be invested into short term investment. The situation should not discourage passive nor intuitive investors as the company is at the growth stage of the project life cycle. Thus cash should be efficiently invested to avoid conflict of interest between top management and the shareholders From above, it can be observed that the company uses more equity than debt in financing its activities. This is evidenced by the debt-t-equity ratio of 1:2. There are therefore no minimal effects of financial risk. That is, the risk that the firm might not meet its long-term debt obligations. In such a scenario, management could easily diversify funds for empire building, and act out of the shareholders value creation concept. 1.1Justification for the projected Profit and Loss Account In drawing up our profit and loss statement, we assume that our growth in the projected three years will be organic. We will grow by focusing on our specialty product range while simultaneously expanding our market penetration by personal contact with a large number of companies, and through on line services. We will also grow by development of new products for existing clients We will develop products for new clients. Here we have assumed of the use of made to order and just intime production techniques were we hope to generate enough cash to diversify our activities from the fourth year. Thus, our creditor's days are zero and likewise our debtors. Interest on credit is zero as the facility is intended to be paid and serviced in the 4th year. Figures used are hypothetical assumptions. Sales growth and expenses are estimated to grow by 10% yearly. Owners capital beginning is US$50,000, and bank loan of $50,000. For all the items offered apart of calendar, sales takes place in all the month. For calendar, it is often being offered in the last and first month of the year, so we assume sales for calendar takes place only in November, December and January. That's while the sales figure for the first ten months stand at zero. Our cost of goods sold is pretty much high as we believe, we add just the logos, brand name and other design to it. Judgmental methods Scenario - The scenario is a narrative forecast that describes a potential course of events. Like the cross-impact matrix method, it recognizes the interrelationships of system components. The scenario describes the impact on the other components and the system as a whole. It is a "script" for defining the particulars of an uncertain future. That is assuming that, 30% of sales goes out as credits for three months. Scenarios consider events such as new technology, population shifts, and changing consumer preferences. Scenarios are written as long-term predictions of the future. A most likely scenario is usually written, along with at least one optimistic and one pessimistic scenario. The primary purpose of a scenario is to provoke thinking of decision makers who can then posture themselves for the fulfilment of the scenario(s). The three scenarios force decision makers to ask: 1) Can we survive the pessimistic scenario 2) Are we happy with the most likely scenario 3) Are we ready to take advantage of the optimistic scenario If 30% of sales are made on credit of a three months period, this will not affect the liquidity position of the company but will however increased the debtor's days from zero to 21. Like wise our cash and profitability ratio too won't be affected. The owner should also consider the present impact of the financial crisis that may impede projections of sales and profit. Company should look around and be aware of economic situations to find out if the launching of the company is timely and have enough safeguards to cushion business effects. Projected financials of the company shows positive signals. Products offered by the company are based on holidays and activities, and people do not cut the holidays and happy occasions in every day life. In this sense, promotional items are still needed by companies and people who celebrates. References Bodie Z. Kane A., Marcus A. J. (2002). Investments. 5th Ediction. McGraw-Hill Penman S. H. (2003). Financial Statement Analysis and Securities Valuation. Second International Edition. McGraw-Hill Read More