Strategic Account for Decision Making - Essay Example

Strategic Account for Decision Making 1.a) Ratio Analysis (Fitness Forever): The key financial ratios for Fitness Forever (Cardiff) are computed and presented in table 1.1. Table 1.1 Comparison of Ratios S.No. Ratio Best Firm FF (Cardiff) 1 Operating Profit 36% 125000 24% Operating Assets (476000+50000) 2 Operating Profit 10% 125000 8% Sales 1650000 3 Sales 3.6 x 1650000 3.13 x Operating Assets £278 526000 £319 4 Expenses 90% 1525000 92% Sales 1650000 5 Sales 3.94 x 1650000 3.47 x Fixed Assets £254 476000 £287 6 Sales 41.7 x 1650000 33 x Current Assets £24 50000 £30 7 Sales 181.8 x 1650000 206.3 x Stock £5.50 8000 £4.50 8 Sales 153.85 x 1650000 117.85 x Debtors £6.50 14000 £8.50 9 Sales 83.3 x 1650000 59 x Bank £12 28000 £17 10 Current Ratio 1.8:1 50000:30000 1.7:1 11 Quick Ratio 1:1 42000:30000 1.4:1 12 Gearing Ratio 25% 10000/490000 2% 1.b) The ratios of both Fitness Forever (Cardiff) and the best performing club are presented in table 1.1. In order to understand where Fitness Forever (Cardiff) stands when compared to the most profitable club, it is essential to critically analyze the ratios and the underlying causes to pin point the strengths and weakness and to devise an action plan for the near future. Comparison: To start with, the profitability of the two clubs is in the ratio of 36% to 24%. The best performing club (BPC) is 12% more profitable than FF (Cardiff). The reasons for this high difference may be due to many factors. These are assessed in order. Margin: 8% to 10% Value of Assets: £323 to £278 It is evident that BPC is performing better in both. The margins indicate that FF(Cardiff) has still some more opportunities to cut down costs and increase the margin by about 2%. This is also substantiated by the Expenses/Sales ratio (90% to 92%). However, FF(Cardiff) uses about £41 (£319 - £278) more to generate £1000 sales, i.e., the asset turnover rate is lesser in FF(Cardiff). This is significant difference and so, FF(Cardiff) has to take some action to optimize the use of assets. In order to figure out whether this increased usage of assets occur in the fixed or current assets, the next two ratios (5 and 6) are compared. Fixed Assets: £254 to £287 Current Assets: £24 to £30 These figures indicate that FF(Cardiff) does not utilize both fixed and current assets to the optimum extent. The ratios indicate that there is a major problem with fixed assets, i.e., BPF utilizes about £254 of fixed assets to generate sales of £1000 whereas FF(Cardiff) takes about £287 worth of fixed assets to generate £1000 sales. This difference (£33) indicates that the processes used by FF(Cardiff) are not efficient. The current assets too have a major impact on sales (41.7x to 33x). In order to estimate the extent to which each current asset contributes to the issue, the next three ratios (7, 8 and 9) are compared with those of the best performing club (BPC). Stock: 181.8x 206.3x £5.50 £4.50 Debtors: 153.85x 117.85x £6.50 £8.50 These values can be used to compute the stock turnover and debt collection periods of BPF and FF(Cardiff). Stock turnover period (365/x): 2 days 1.7 days Debt collection period (365/x): 2.4 days 3.1 days The stock turnover period indicates that FF(Cardiff) is more efficient in moving the stock. However, FF(Cardiff) can improvise on debt collection period, since it takes 3.1 days for FF(Cardiff) to collect cash whereas BPF does it in 2.4 days. Thought the amount in Bank is volatile, it is worthwhile to compare the ratios of the two clubs, as the other current assets do not differ much. Bank: 83.3x 59x £12 £17 These figures indicate that FF(Cardiff) takes about (365/59) 6 days to convert cash in the bank to sales, whereas BPF takes about roughly (365/83.3) 4 days to convert cash to sales. This is a significant difference (2 days), but it is not of great importance. However, FF(Cardiff) can focus on reducing the cash in the bank and convert them to sales at a faster rate, as cash kept idle does not reap any profits. As far as the liquidity ratios are concerned, there is no much difference in the current ratios (1.8:1 and 1.7:1). But the quick ratios (1:1 and 1.4:1) indicate that FF(Cardiff) is in a stronger liquidity position comparatively and can meet the liabilities very easily. Gearing of the two clubs indicate that BPF is effectively utilizing its sources of finance (25%) whereas FF(Cardiff) has a very low gearing ratio (2%). This indicates that FF(Cardiff) has to increase its gearing ratio to an optimum of 50%. By generating more finances, FF(Cardiff) can invest more in the business and effectively improve the sales. From this comparison, the following issues are to be given great importance: The asset turnover rate is lesser and the fixed assets are not utilized efficiently. This may be due to faulty or aged machinery which has in turn affected the efficiency of the machines. FF(Cardiff) has very low gearing. By increasing the gearing ratio, FF(Cardiff) can move towards faster growth. These two issues indicate that FF(Cardiff) should increase the finances by borrowing. It should then invest in new machinery and in processes to improve the efficiency of the machineries, so that the fixed assets generate more sales, thus in turn, increasing the asset turnover rate. 2. The expenses incurred by the Fitness Forever (Cardiff) is identified and apportioned to the cost centres in the tables 2.1 and 2.2. The cost drivers for the expenses specify the percentage to be used to apportion the expenses to the cost centres. The last expense (Dept. Specific) relates to any specific expenses incurred by that cost centre. Table 2.1 Expenses of Cost Centres 1 to 4     Cost Centre Expenses Cost Driver 1 2 3 4 Asset Value n/a 30% 10% 2% 5%             Rates & Ins. Asset Value 75000 25000 5000 12500             Fuel & Power A.V. 30000 10000 2000 5000             Rep. & Main. A.V. 22500 7500 1500 3750             Security A.V. 15000 5000 1000 2500             Cleaning Mtls. A.V. 7500 2500 500 1250             Salaries Given Sal. % 95000 30000 175000 35000             Salary rel. costs Given Sal. % 23750 7500 43750 8750             Depreciation A.V. 12000 4000 800 2000             Head Off. OH A.V. 45000 15000 3000 7500             Dept. Specific Area (1 & 2) 25000 5000   80000      (Chemicals)  (Chemicals)    (Supplies) Total Expenses   350750 111500 232550 158250 The total expenses on chemicals amount to 30,000. This is allocated to the two pools (1 and 2) based on the proportionate area covered by each of the swimming pool (in the ratio of 1750:350). Table 2.2 Expenses of Cost Centres 5 to 8     Cost Centre Expenses Cost Driver 5 6 7 8 Asset Value n/a 40% 5% 3% 5%             Rates & Ins. Asset Value 100000 12500 7500 12500             Fuel & Power A.V. 40000 5000 3000 5000             Rep. & Main. A.V. 30000 3750 2250 3750             Security A.V. 20000 2500 1500 2500             Cleaning Mtls. A.V. 10000 1250 750 1250             Salaries Given Sal. % 45000 25000 35000 60000             Salary rel. costs Given Sal. % 11250 6250 8750 15000             Depreciation A.V. 16000 2000 1200 2000             Head Off. OH A.V. 60000 7500 4500 7500             Dept. Specific         100000            (Supplies) Total Expenses   332250 65750 64450 209500 The expenses are apportioned for the eight cost centres as shown in the tables 2.1 and 2.2. In order to compute the profitability of each profit centre, it is essential to apportion the expenses incurred by the cost centre no:3 (Reception/Admin) to the other seven profit centres. This cost is allocated based on the proportion of the ‘number of users’ of each centre, as the admin and reception are mostly involved in registering members and other similar services. The profits of each centre are computed as shown in the table 2.3. Table 2.3 Earnings of Profit Centres   Admin Exp.s (232550)   Profit Centre Revenue Expenses Difference % Users Proportion Profit 1 500000 350750 149250 20% 46510 102740 2 120000 111500 8500 10% 23255 -14755 4 240000 158250 81750 10% 23255 58495 5 250000 332250 -82250 25% 58138 -140388 6 150000 65750 84250 10% 23255 60995 7 60000 64450 -4450 5% 11627 -16077 8 330000 209500 120500 20% 46510 73990           232550             Net Income 125000 The profitability ratios can be computed as given in the table 2.4. Table 2.4 Profitability   Assets (526000) Sales Centre Profit Overall Profit Profit Centre % Value Revenue Asset TO Rate Centre Profit CP/ Assets Profit Profit/Sales 1 30 157800 500000 3.17x 149250 0.95x 102740 20.5% 2 10 52600 120000 2.28x 8500 0.16x -14755 n/a 4 5 26300 240000 9.13x 81750 3.11x 58495 24.4% 5 40 210400 250000 1.19x -82250 n/a -140388 n/a 6 5 26300 150000 5.7x 84250 3.2x 60995 40.7% 7 3 15780 60000 3.8x -4450 n/a -16077 n/a 8 5 26300 330000 12.5x 120500 4.6x 73990 22.4% The Asset turnover rate (Revenue/Assets) is computed for each profit centre. The efficiency of utilizing the assets in each profit centre is estimated using the Centre Profit (without admin charges) and the assets utilized to generate that profit. The final estimate gives the ratio of overall profit (with admin charges) to the revenue generated by the profit centre. There are a number of issues that can be clearly picked out from the above table. These issues and the rationale behind all centres not being profitable are discussed in the following section. As it can be seen from table 2.4, larger swimming pool generates high profit comparatively, whereas the children’s swimming pool generates low centre profit and when admin charges are included, it equates to a loss. However, the children’s swimming pool utilizes the assets efficiently (revenue is 2.28x times the assets used). Hence it is essential that it continues to operate, as it makes efficient utilization of the assets to generate sales. Centres 4 and 8 (licensed bar and snack bar) have a high asset turnover rate and generate high centre profits. Snack bar is very efficient, as it generates revenue which is 12.5 times the asset value, whereas the licensed bar (though utilizes only 5% of assets), generates a high revenue and also high profit margins (about 40.7%, including the admin charges). Gymnasium (centre 5) utilizes a lot of assets (40%) but generates revenue which is only 1.19x times the assets utilized. The calculations indicate that the gym makes a loss. But, it is important to understand that it has the highest number of users (25%). This obviously, has a profound effect on the licensed bar and snack bar profits. However, the gym can be refurbished with new equipment and additional premium charges can be collected for other valued services. This will increase gym membership and also improve the profits to a great extent. The squash court (centre 6) effectively utilizes the assets and generates overall high profits. Hence, the number of squash courts can be increased in the future at the expense of some space from the gymnasium, as it is not a highly profitable investment. As many people frequent the squash courts, an increase in the number of courts will also increase the number of visitors and in turn, increase the licensed bar and snack bar revenues. The table tennis court, though efficiently utilizes the assets to generate revenue (3.8x) make a loss, as the % of people using the facility is very less (5%). If this continues to be the case, it will be worthwhile to get rid of this facility and extend the snack bar area, as it generates higher profits. 3. Budgetary Planning and Control: It is evident that currently, Fitness Forever (Cardiff) does not have any budgetary planning under operation. Introducing budgetary planning and control will have a major impact on the various aspects of the business. Hence, it is essential to completely understand the benefits of budgeting control before making the decision. It has already been understood that all profit centres do not make equal profits and some of them, even operate under losses. Also, it has been found that there are some areas which can be improved significantly. All these issues can be effectively addressed by introducing a system of budgetary planning and control. Benchmarking: By comparing the performance of the most profitable club, the areas that can be improvised can be identified and the expected future performance can be put down in the form of a budgetary plan. This will give clear and measurable goals for the managers and the staffs. Room for Continuous Improvement: Setting a budget which is achievable and also beneficial to the organization will eventually lead to its achievement. The budget can then be assessed and the weak areas can again be rectified in the future budgets. Hence there is a room for continuous improvement. Motivation: Setting incentives for meeting the budgetary requirements can motivate the managers to completely focus on the improvement of processes. It has been depicted in the case that the managers are not completely motivated to involve themselves in improving the profits (Dennis young waiting to go home). Incentives can definitely drive them to put in more efforts and energy to improve the business. Contributions: From the current account statements, it is clear that FF(Cardiff) does not differentiate between fixed and variable costs. These fixed and variable costs can be identified for each profit centre and integrating this with the budget for the profit centre will enable the manager to get a clear picture of the contributions of the profit centres. This will enable the manager to apportion the assets to the profit centres effectively, which will in turn have a profound effect on the total profits. Better Pricing: As said above, budgetary planning will throw light on the fixed and variable costs. The budget will then enable FF(Cardiff) to compute the monetary benefit (CVP analysis) of getting one more customer/member for the profit centre. This will enable FF(Cardiff) to focus on acquiring new members to the profit centre by conducting some campaigns (similar to the youth membership for the table tennis court). The budget for these campaigns will also be easier to analyze as FF(Cardiff) already knows how much it is going to earn from one additional customer. Better Quality of Service: Staffs have to be trained and should be made aware of the benefits of each return customer to the club and also the benefits of a new customer. Budgetary control and incentives on meeting the targets will motivate the managers and in turn the staff to provide better service to the customers. Also involving all the managers in the budgetary process will ensure that the quality of materials, machinery and service are not affected. Eliminating Inefficient Processes: Results of the financial year can be compared to the budgets set and this comparison along with data from the past can easily identify processes / machinery which have not been performing efficiently. Analysis can be done to capture the root cause of the issues and steps can be taken to improve the processes. For example, it is evident from the data that the Youth club for table tennis has not been performing effectively. Setting a budget and goals to achieve can help FF(Cardiff) drill down to the root causes for the ineffective functioning of this effort (only 5% of the total visits are towards the table tennis centre). These are some of the benefits to Fitness Forever (Cardiff) on introducing budgetary planning and control. 4. Long Term Sources of Finance: The Gearing ratio of the most profitable club is 25% and that of Fitness Forever (Cardiff) is only 2%. It is evident from these figures that Don Brennan has not fully utilized the various financing options available to him. In the future, when further expansion is planned, it will be essential to consider the various sources of finance, as this will help him to effectively generate finance in a short span. Long Term Loans: Long term loans from banks and other sources are the easiest ways to raise a large amount of capital. Obtaining higher amounts of long term loans will be easier for Fitness Forever, as the business is well established and is making profits. However, the interest payable might be high (as it is spread over a long period of time). Hence a high interest cover should be available for Fitness forever, in order to ensure interest payments in times of a financial crisis. Increasing the long term liabilities will increase the gearing ratio. This coupled with sustaining a high interest cover will indicate the company’s vision of long term growth and expansion. Franchises: Franchising is another efficient way of raising finance for future growth and expansion. Currently, Fitness Forever is centrally managed. Also Don Brennan has realized the importance of treating each club as a separate business. Franchising allows store managers to invest in the club and a part of the profit will go to the franchise holders. This will ensure that the interests of Don Brennan and that of the club managers are in line with one another and will eliminate the investor-director difference of interests. Also, the responsibilities will be delegated and the club managers will be responsible for the profitability of the club. However, franchising will lead to loss of complete control over the firm and a share of the profit will go to the franchisees. Mergers: Fitness Forever can opt to merge with small players with a controlling interest on the combined firm, whenever opening a new club in a local region turns out to be very costly. Also, when it is difficult to penetrate a local market, the marketing expenses will be very high. Hence, it will be easier to gain the current market share of the small player in the local region. Also, it is one of the fastest ways of expansion. Technically, mergers involve expenditure. But many firms, when they plan to expand their operations, if they figure out the expenses of setting a new firm to be very high, opt for mergers with the small players, as it reduces the amount to be invested. Bank Overdrafts: Another way to increase short to medium term finance is through bank overdrafts. They are very beneficial, as Fitness Forever has to pay interest rates only on the amount withdrawn or utilized out of the overdraft. It is also a faster way to raise more capital and to overcome difficulties in times of liquidity problems, which will definitely occur during rapid expansion periods. These are some of the long term sources of finance available along with their relative merits and demerits. These can be utilized to the maximum extent when taking steps to ensure a long term growth and expansion of Fitness Forever. 5. The budgeted profit and loss account for the period 1/10/07 to 30/09/08 is put down based on the six month forecast made by Alison and the points raised by the team members. The changes are summarized below. Revenue: There will only be a 2% increase in second half. Rates & Insurance: 3% rise in first half and a further 1% in the second half. Fuel & Power: 1% rise in the first half and no change in the second half. Repairs & Maintenance: No change in these costs. Chemicals: 20% costlier when compared to 2007. Security: 15% rise over the year Cleaning Materials: Same as that of 2007. Salaries: 3% rise in the first half and then another 4% in the second half. Depreciation: No change in the depreciation costs. Snack Bar & Licensed Bar supplies: 5% rise in the first half and then remains the same for the second half. Head Office Overhead: Increase by 2% in the first half and then by 4% in the second. These changes are taken into account and the budgeted profit and loss account is shown in the table 5.1. Table 5.1 Profit & Loss Account - 2008 Particulars Frist six months Second six months Total % Change Value % Change Value Revenue 5% 866250 2% 883575 1749625             Expenses:           Rates and Insurance 3% 128750 1% 130038 256788 Fuel and Power 1% 50500 0% 50500 101000 Repairs and Maintance 0%       75000 Chemicals 20%       36000 Security 15%       57500 Cleaning Materials 0%       25000 Salaries 3% 257500 4% 267800 525300 Salary related costs 3% 64375 4% 66950 131325 Depreciation 0%       20000 Snack Bar supplies 5% 52500 0% 52500 105000 Licensed Bar supplies 5% 42000 0% 42000 84000 Headoffice Overheads 2% 76500 4% 79560 156060   Total Expenses -1572973   Net Income 176852 Read More