Procurement Finance and Inventory Control - Assignment Example

 Finance and Inventory Control Executive Summary Understanding the financial health of the organization is a key aspect of reacting to today’s increasing rigid financial reporting requirement. In order to mitigate risk organization must quickly identify and analyze financial ratios and trends in assets and liabilities. Financial analysis includes the ratio analysis which refers to the evaluation of a business in order to deal with the planning, budgeting, forecasting, monitoring and improving of all the financial aspects within the organization. So, this report will focus on the ratio analysis of the organization and will also suggest the ways in order to improve the cash flow situation of the company in order to minimize its bank borrowing on overdraft. It will further focus on the reasons to hold stock and will further focus on the factors which are to be considered in order to select a location for a new warehouse and will also suggest the organization about the design and layout of the warehouse which will best suit the organization. Table of Contents Introduction 3 Q. 1. 3 Financial Analysis 3 Ways to improve cash flow situation 5 Q. 2. 6 Reasons for Holding Stock 6 Cost Implication of Holding Stock 8 Kraljic Matrix 9 Q. 3. 10 Factors Considered in Choosing a New Warehouse Location 10 Factors to be Considered in Designing the Layout of Warehouse 12 Conclusion 14 Appendices 15 Work Cited 17 Introduction The financial analysis of a company is done in order to evaluate and interpret the financial data along with the other information in order to plan an assessment of the present and future financial condition of the company. The supplier with whom the organization is dealing has been experiencing cash flow problem. So, to deal with the problem, the income statement analysis and the balance sheet analysis has been done. The main objective of the income statement analysis is to make adjustment to the income statement in order to arrive at sufficient cash flow. It focuses on the revenue growth, earnings and net income of the company. Balance sheet analysis is done in order to know the status of the company at a given point of time. It indicates the financial position of the company (Johnston and Johnston, 71-72). Both the income statement analysis and the balance sheet analysis are included in ratio analysis or financial analysis. This report will focus on the reasons to hold stock and will further focus on the factors which are to be considered in order to select a location for a new warehouse. Q. 1. Financial Analysis Financial analysis includes the ratio analysis which is done to know the financial health of the company. It provides insight into the liquidity, profitability, efficiency, solvency and capital structure position of the company. It helps the management in planning future policies, evaluating the performance of organization, planning and forecasting the future, ensures efficient cost control and helps in investment decisions (Thukaram 83). Current ratio: It shows the level of cover that the company has from its current assets in order to pay its current liabilities. It is an important measure of the company’s liquidity. An ideal current ratio is 2:1 but here required to maintain only 1:1. The current ratio for the year 2011 is 1.73:1 which has increased to 1.90:1 in 2012. And also the ratio for both years is more than actually required which indicates the good liquidity performance of the company. It signifies that the company can easily pay its short term obligations. Acid test ratio: It assesses the ability of the company to use its quick assets in order to pay its current liabilities. The ideal quick ratio is 1:1. The ratio for the year 2011 is 0.96:1 which has increased to 1:1. It indicates that the performance of the company is improving and also it has maintained the required ratio. It further signifies that the company will be having no problem in meeting its current financial obligations with the existing quick funds on hand. Earnings before interest, tax, depreciation and amortization (EBITDA) margin: It is used to analyze and compare the profitability of the company. It is used by the debt holders in order to evaluate the creditworthiness of the company. The EBITDA margin for the year 2011 is 7.01% which has increased to 10% which indicates the good profitability position of the company. The increase in the margin indicates that the company can efficiently cover their debt payments. Debtor days: It measures how promptly cash is collected from debtors. The longer the company takes to collect, the greater the number of debtor collection period. The debtor collection period should be lower for efficiently carrying the business. The debtor collection period for the year 2011 is 58 days which is less than 60 days credit which is allowed by suppliers which is good for the company. However, it has increased to 70 days in 2012 which indicates the inefficiency, potential bad debts and poor performance of the company. Creditor days: The creditor payment period measures how long it takes an organization to pay its creditors. The company that have a desire to increase its cash flow should take as long as possible in order to pay its bills but it should not take more time than permitted by the supplier. Otherwise, the company will have to pay the late payment charges. The creditor payment period for the year 2011 is 60 days which has decreased to 50 days in 2012. It signifies that the company is taking slightly less time to pay its creditors. Stock turnover ratio: It measures the efficiency of the business in terms of managing its inventory. The inventory turnover ratio for the year 2011 is 5.61 times which has reduced to 4.87 times. It indicates the ineffective management of inventory. It also indicates over investment in inventories, stock accumulation and poor quality of goods. The stock turnover days signifies that during the period how many times the stock has been converted into sales. The stock turnover day for the year 2011 is 65 days which has increased to 75 days which signifies the good efficiency position of the company. For the formulas and calculations of the financial ratios (See Appendix A). Ways to improve cash flow situation Cash is regarded as the main asset of any business. Despite efficiently managing its cash flows some companies may deal with a sudden cash flow shortfall. It sometimes happens when companies depend too much on overdraft facilities and when the debtor days exceed and when the cash flow forecast is not done properly. The main disadvantage of the overdraft is the call by the bank and the rate of interest floats, which is the bank base plus risk premium and the organizations, has to absorb this interest rate risk. Followings are the four ways to improve the cash flow situation, so that the company can reduce its bank borrowing on overdraft. First action is recognizing due debts from customers and collect quickly. This action is required because debtor days have gone up which signifies a lack of credit control. There is huge amount of cash locked up in debtor which should be released quickly. So, the company is required to improve its credit control policies (Wilson and Bates 192). Second action is to do efficient cash flow forecasting and therefore improve its cash management. Often, the organizations are not prepared for all the rising costs. More sales indicate more employees and more inventories. So, when more sales are taking place then more cash is going out in payment process to the employees. So, the company should improve its cash flow forecasting to avoid the problems in future (Wilson and Bates 194). Third action requires the company to formulate the business plan and visit the manager of the bank in order to secure overdraft (Wilson and Bates 194). Fourth action is to consider purchase order funding. If the company will give services to other companies that involve purchase order then the company can generate short term funding which will be used to finance the purchase of specific goods. Q. 2. Reasons for Holding Stock Stocks are high-priced, due to the cost of tied up capital, protection, insurance, loss, warehousing, deterioration, packaging and administration. Then the question arises that why organization need to hold stock. There are various reasons behind this and all are based on the need for a buffer between demand and supply. But the main reason is to provide a cushion between variable and tentative supply and demand. They avoid disruptions and let the operations to continue smoothly (Waters, 7-8). Other reasons for holding stocks involve: Meet the expected and unexpected demand: The business must make sure that it has enough supplies in order to meet expected demand for its goods, despite the consequences of whether it is a production environment. Where a business has high demands, at that time having stock in storage helps the firm in meeting its expected and unexpected demand (Waters, 8). Give cover for emergencies: Holding the stock plays an important role and act as insurance against future shortage. Unanticipated shortage in the supply of finished goods affect the ability of the business to meet its demand and also the production run of a business. Holding stocks provides a degree of continuity for the process of the company. Therefore it gives cover for emergencies (Waters, 8). Benefit from discounts on large orders: Most frequently suppliers propose trade discount for large purchases, once those purchases are beyond a certain amount. The company can minimize the unit cost of materials and also its import duties and delivery costs by purchasing a large amount of goods in order to hold in stock (Waters, 8). To deal with dissimilarity in usage or demand: Usage means the production consumption in a process of manufacturing. Increased usage leads to the increased demand for materials. This is the consequence of either increased production levels or increased inefficiency. Sometimes the company can have high seasonal demand or might cater for special orders. At that time, it requires additional inventory in order to ease such occurrences. To assist the production process: Holding stock permit the manufacturing process to flow economically and also provide assistance to the company to respond quickly and efficiently to contingencies. Provide cover in times of supply shortage or high inflation: Holding huge supplies of stocks can be a conscious strategy in response to difficult economic conditions. The company might not want to purchase stock in times of high inflation, at increasingly high prices. Once the company decides that it is possible to hold additional stock beyond the normal levels, then it is a very prudent strategy. Apart from all these, further reasons for holding stock includes it allow for deliveries which are too small, allow for differences between the finest rate of supply and the genuine rate of demand, and compose full loads of delivery and minimize transport costs (Waters 8). Cost Implication of Holding Stock The costs which are associated with holding the stock are the holding cost and it includes physical costs and the financial costs. Holding cost is referred as the cost related with holding one unit of piece in inventory for one period of time including elements to cover capital costs for stock, storage, rent for the required space, materials, equipments, security, labour to operate the space, taxes, administration, insurance, handling, obsolescence, shrinkage and deterioration and other direct expenses. The Financial cost which is associated with holding inventory is the cost of capital. Although goods are in storage they signify an investment of working capital. If the company make funding of its stockholding with capital which is borrowed from financial institution, it has to pay the rate of interest. Financial cost also includes the opportunity cost and when the financial cost fails to permit that the company may earn higher return on this capital through investing it in some other operation then it undervalues the opportunity cost of investing capital in stocks. While in storage, stock can be damaged or can be depreciated or it can physically deteriorate, therefore insuring against these unforeseen events can add to the financial costs. The physical costs are referred as the cost of providing; furnishing and operating storage facilities in order to hold stock (McKinnon 89-90). The physical costs which are associated with holding inventory are the overhead cost, opportunity cost, scrap cost and the cost of staff, warehouse space and the equipment cost. Overhead costs are referred to the cost involved in running a business and it vary with the variation in the level of activity in the organization. Kraljic Matrix It is one of the most significant of all purchasing analyses. It connects the significance and risk of an item to a suitable sourcing strategy. It plots the supply risk in opposition to the impact on financial results through spend category (Cheverton and Velde 85). Bottleneck: Here the customers have a low profile with the supplier with whom they assume there could be strategic potential. This is a complicated area and basically the customers have two options depending mostly on why they have decided their profile is low with particular supplier: to raise their profile by increasing their spending and change to a supplier with whom the customers could have a higher profile. Non-critical: Here the customers have low profile with the supplier in whom they don’t see strategic possibility. Leverage: Here the customers have high profile with a low profile supplier which means that the customers see no advantage in developing strategic potential with the suppliers. Strategic: Here the customers have high profile with high profile suppliers with whom they believe that they will be offered the potential to do interesting things (See Appendix B). Q. 3. Factors Considered in Choosing a New Warehouse Location When it comes to deciding about the location of a warehouse then various factors have to be taken into consideration. This will include the budget which will be incurred in setting the warehouse, the infrastructure of the area and building, customer’s needs, transportation costs of parking the vehicles, the cost of labour, operation costs, the strategic view of its expansion in the future, where the most central customer locations are and whether the community will welcome a warehouse in their area. By taking the time in order to consider all of these factors, the company can then make a decision on not only the warehouse location but also the order of development other warehouse in order to aid in business growth. While budget is the main factor but within that structure various factors need to be included which may be the capacity of the building, layout and flow of building, staging facilities involving handling equipment and accessibility including trailer storage, off ramps from freeways and street turning lanes. Labour cost is also one of the main concerns while choosing the location of a particular warehouse. Labour is one of the biggest expenditure that needs to be controlled for cost management of warehouse. When considering the location, it is important to know the labour market of that specific location. Healthy local labour employment opportunities and demands can drive up labour costs. To know the key client is also one of the important factors while considering the warehouse location. It is beneficial to locate the warehouse in such area which is close to the key clients. Having the strategic view about the expansion of the business in near future is another area of concern for selecting the location. When developing the distribution chain, it is essential to look at future growth. If the company have a small warehouse accompanied by a huge amount of customer growth then it should close that warehouse in favour of a larger one and locate the new one in a customer centric area. As the business expands, development in the current location will cut cost and also allow elasticity that will help to make the business competitive. Continuing in a cost effective area will cut the overhead cost by permitting to bargain long term rates that will manage overhead costs if space allocation requirements should increase in the location due to growing business demand. Other factors include that the warehouse should be located within near proximity of good communication network; on higher lands supported with good drainage system; clear approach to the main road; provided with fair entrance and exit route to the main road; located close by the industry location; should be closer to the sea ports, rail heads and communication centres; good cell phone, radio, telephone and wireless communication coverage should available; nearer to water and electricity provisions; better provision for fire control; and should be secured and hygienic location. The main objective in choosing the location should be the reducing incoming and outgoing transportation costs, budgets, strategic view of the business, labour cost and to know the key client. Minimizing transportation costs requires forecasting or knowing points of origin of demand. The selection of the individual location includes a trade-off between the cost of purchase or land rental, taxes and real estate, and such factors as sufficiency of community attitude, utilities and potential for expansion (Roberts 147). Factors to be Considered in Designing the Layout of Warehouse The warehouse designing is one of the crucial aspects in order to attain the logistical objectives in terms of service and cost level. It identifies the use of the facility, warehouse space requirement, and layout of the facility and aisle layout. The warehouse design is directly related to the feature of the product mix in terms of their monthly or annual turnover, reliability in demand, size, weight, shape and the average size of the order to be progressed each time through the warehouse, material handling equipments needed and also the facilities needed to preserve the physical characteristics of the product intact. Provisions for additional material handling abilities, possibility for extension in the size of the warehouse and additional land requirement are to be considered whilst designing the layout of the warehouse. Identification and choice of the material handling system is considered to be one of the important factors in determining the design of the warehouse. At a warehouse, the handling of goods is usually in bulk quantity which requires the handling equipments, accompanied by improving efficiency and lowering warehousing cost. Therefore, the choice of material handling system is the important consideration in warehouse designing (Agrawal 165). While designing the layout of the warehouse, the total available storage volume in a warehouse should be properly utilised including the height, length and breadth of the building. In taller building, a general flaw is that the building height is not completely utilised. This can be solved by deciding on the racking systems which will make complete use of the existing height of the warehouse and also through the use of mezzanine floors which will offer an extra storey in the form of balcony or platform between the floor and the ceiling. Suitable warehouse design can avoid many future problems and that’s why the number of factors to be considered is: the size and shape of the storage areas in relation to the features of the items which is to be stored such as different for perishable and non perishable goods; free space between the ceilings and the stored goods and the admissible loads on floors needed to be considered. Proper coding system should be there in front of each rack in order to enable visibility, accessibility and easy recognition of the goods. The environment inside the building should also be taken into consideration such as the air conditioned temperature; there should be less humidity for non perishable goods and for those goods which easily gets spoiled. It is essential to observe inventory in order to determine the most suitable layout. If the inventory consists of huge numbers of identical product, then it is required to use deeper rows. The space should be utilised properly so that most products can be stored in the smallest space without giving up the safety concern. The equipments used should also be taken into consideration. The unused and old equipments should be removed because it takes up precious space and also could be danger to daily operations. When choosing the equipment it should be noticed that it fits the specific needs of the inventory and warehouse. Other factor is unitization. It is universal way to unitize a load. Unit load are generally cube shaped and usually capable of being stacked. The advantage of unitization is that it enables the use of handling and storage equipment, make more efficient use of space and cause reduction in losses which have occurred through damage and pilferage. Conclusion This report focuses on the financial factors which are to be taken into consideration in order to understand the financial health of the organization, through the analysis of different ratios. It also takes into consideration the ways to improve cash flow situation and the reasons for holding stock in order to a cushion between variable and tentative supply and demand. It further focuses on financial and physical costs associated with holding stock and also focuses on the factors considered in choosing a new warehouse location and designing the layout of warehouse. Appendices Appendix A: Formulas and calculations Current ratio: current assets / current liabilities 2012: 3245000/1710000 = 1.897:1; 2011: 2669000/1544000 = 1.728:1 Quick ratio: (current ratio-inventory) / current liabilities 2012: (3245000-1528000) / 1710000=1.004:1; 2011: (2669000-1180000) / 1544000= 0.964:1 EBITDA margin: (EBITDA / revenue) * 100 2012: ((716000+179000) / 8950000)*100 = 10%; 2011: ((468000+78000) / 7788000)*100 = 7.01% Debtor days: (debtor / revenue)*365 2012: (1717000 / 8950000)*365=70.023 days; 2011: (1238000 / 7788000)*365=58.021 days. Creditor days: (creditors / cost of sales)*365 2012: (1020000 / 7435000)*365 = 50.073 days; 2011: (1088000 / 6615000)*365 = 60.033 days. Stock turnover days: (stock / cost of sales)*365 2012: (1528000 / 7435000)*365 = 75.013 days; 2011: (1180000 / 6615000)*365 = 65.11 days. Stock turnover ratio: 365 / stock turnover days 2012: 365 / 75.013 = 4.866 times; 2011: 365 / 65.11 = 5.606 times. Appendix B Kraljic Matrix Work Cited Agrawal, D. Supply Chain Management: Strategy, Cases and Best Practices. United Kingdom: Macmillan, 2010. Print. Cheverton, Peter, and Jan, Velde. Understanding the Professional Buyer: What Every Sales Professional Should Know About How the Modern Buyer Thinks and Behaves. United Kingdom: Kogan Page Publishers, 2010. Print. Johnston, David, and Daniel, Johnston. Introduction to Oil Company Financial Analysis. Oklahoma: PennWell Corporation, 2006. Print. McKinnon, Alan. Physical Distribution Systems. United Kingdom: Taylor & Francis, 1989. Print. Roberts, Mary. Direct Marketing Management. 2nd Edn. United States: Prentice Hall PTR, 1999. Print. Thukaram, Rao. Management Accounting. New Delhi: New Age International, 2007. Print. Waters, Donald. Inventory Control and Management. 2nd Edn. New Jersey: John Wiley & Sons, 2008. Print. Wilson, Peter, and Sue, Bates. The Essential Guide to Managing Small Business Growth. New Jersy: John Wiley & Sons, 2005. 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