ABC Company Latisha Barker Carolyn Woods ACC 206: - Research Paper Example

? ABC Company Latisha Barker Carolyn Woods ACC 206: Principles of Accounting II July 14, Table of Contents Table of Contents 2 Introduction 3 I.Overall Risk Profile 3 II.Current Cash Flow of the company 4 III.Cost of the Product 6 IV.Potential Investments 7 V.Conclusion 8 References 9 Introduction Risk profile is the representation of a company’s overall exposure to some specific risks or group of risks at a given point of time. A company’s desired and targeted risk profile depends on its corporate governance approach, overall strategic objectives and risk appetite. I. Overall Risk Profile The two basic types of risks that the company ABC might face based on the current economic and industry issues are- Systematic Risks- It influences a large number of assets and protection against such risk is virtually impossible. Unsystematic Risks- It is sometimes referred to as “specific risks”. Diversification is the only way to prevent unsystematic risk. The other fundamental risks that the company might face are- Credit or Default Risk- It arises when a company will be unable to pay the contractual principle or interest on its debt obligations. Liquidity Risk- It arises when the liquid resources available to a company will be unable to pay the current dues. Interest Rate Risk- It arises when the value of an investment changes due to change in interest rates (Yusof, 2007, p.7). Political Risk- It represents financial risk, which arises when the government of a country changes its policies suddenly (Yusof, 2007, p.9). Market Risk- It arises as a result of day-to-day fluctuations in stock prices, so it is also referred as volatility. Business Risk- It may arise internally as a result of human, technology, or physical factors, or externally due to economic, natural, or political factors. II. Current Cash Flow of the company a. Cash Flow Statement of ABC Company   Amount($) Amount($) Amount($) Cash from operating activities-               Sales     1,200,000 (+) Decrease in Accounts Receivable     60,000 Cash collection     1,260,000 Less:-       Cost of goods sold 800,000     (+) Increase in inventory 70,000 870,000   (-)Increase in account payable   40,000   Cash paid for purchase   830,000   Selling & Development Expenses   250,000   Interest expenses   0   Income taxes 30,000     (-) Increase in Income tax payable 30,000 0 180,000         Cash from financing activities-               (-)Payment of dividend 100,000   (100,000)         Cash flow from investing activity-               (-)Purchase of equipment 100,000   (100,000)         Net decrease in cash     (20,000) Add:- Opening cash balance     70,000 Ending cash balance     50,000 b. i. The cash flow statement of the company shows that the sources of fund or cash to the company are less as compared to the expenditure made. The statement above shows a decrease in cash, which resulted due to increase in expenditure as compared to the revenue generated. Expenditure is incurred in the financing and investing activities of the ABC Company out of the cash generated from operations, which lead to decrease in available cash as a result of excessive investment. There has been only three sources of fund, two in the process of generating liquid cash, and the third source though generates cash but not in liquid form, as the cash is due to be realized. The two liquid sources are sales and decrease in accounts receivable due to realization of cash that was due. The source from which cash is yet to be generated is inventory. The cash generated has been utilized in various activities as depicted by the statement given above. ii. So as to improve the cash condition, the company ABC needs to reduce the expenditure as per the generated revenue. This is said so based on the cash flow statement which shows a decrease in net cash after performance of all the operations. The other alternative present to the company is to increase the revenue generation so as to meet the rising expenditure. If the company does not take any step as per the present scenario and continues its operations accordingly, the company ABC may soon face a shortage in liquid cash which shall affect its operations. iii. The new expansion project cannot be financed with the current cash flow from the company. The company does not have enough cash balance as depicted by the statement given above. This amount of liquid cash-in-hand must be present with the company so that it is able to meet its daily expenses and current dues and liabilities on time, inspite of which the company may face liquidity risk which may lead to several contingencies in the future and shall also affect productions and operations. iv. The sales of the company ABC has increased by 25% from the previous year, and the company has a target which it shall attempt to achieve within a period of 3years. Thus the company is in a verge of growth and expansion. If the company needs additional financing beyond what the company can provide internally (since the cash balance is not enough to fund from internal sources), the company must opt for corporate debt because though the shall be obliged to pay a fixed percentage of interest to its creditors, yet the company shall not face problem as its revenue is in the verge of increase due to increase in sales. In addition to it, the company shall be entitled to receive a tax shield and it would be cheaper as compared to equity because cost of debt is lower than cost of equity. The company shall also be able to retain a part of profit after paying the dues. III. Cost of the Product a. The cost of the expansion product under absorption costing is $17.45, and under variable costing is $10.80. b. On addition of the new expansion product to the existing product shall absorb the fixed factory and sales expenses, leading to a reduction in the per unit fixed cost. Due to the addition of the expansion product, per unit fixed cost of a product gets reduced by $0.69, which also makes the existing product cheaper by an amount of $0.69. c. If it is assumed that ABC Company wants a 40% gross margin for the new product, the selling price of the expansion product should be set at $24.43. d. If it is assumed that the sales mix of the existing product and the expansion product is the same, the products achieves a breakeven point when sales reaches to $778,500, and achieves contribution margin when sales reaches to $641,013. IV. Potential Investments a. The net present value of the proposed investment is negative, i.e. NPV of the investment in purchasing the additional equipment is less than zero, which suggest that investment should not be made or the cost must not be incurred. The cost of the project is $42,000. If the future generated savings is converted to its present value, i.e. the value on the date of investment, then the total value amount to $40,634, which is less than $42,000. This depicts that since the savings generated from the equipment in the future is not even able to generate the cost that was invested to purchase the equipment, so the investment must not be incurred. b. If it is assumed that the equipment purchased shall depreciate on a straight line basis over a period of 5 years, then the cost of depreciation shall increase the factory’s fixed cost as well the implied product cost. Since depreciation is a non-cash expense, so it would not have any effect on the direct cash flow of the company. c. On the basis of the impact of the cash flow statement and the time value of money, it is recommended that ABC Company must not purchase the equipment. This is said so because, the company having a cash balance of $50,000, if invest in purchasing the equipment shall be left with a very little cash-in-hand of $8,000, which shall be very less to meet the liquidity requirements of the company, and thus shall face shortage of cash or liquidity risk. On the other hand, the present value of the savings generated in the future by the equipment is even not equal to its incurred cost, i.e. NPV is negative. So, if the investment is incurred the company shall suffer a loss. V. Conclusion a. The major risk factors that this project entitles are- The time required to produce the product is twice as compared to the existing product. This can affect the demand of the product in the market. The new expansion product is launched with an expectation to reach the targeted sales of $3 million within next 3 years. A new product is often preferred if its cost is low since the customers are not aware about the qualities of the product. But if Company ABC launches the new product it shall bear a high price, which would affect the sales as customers may not prefer to buy a new product at a high price. Thus, the company may face hazards in reaching the target. The company with a limited cash resource cannot fund the new product. So it shall take corporate debt so as to fund the project. But if the estimated sales do not match with the actual sales, then the company may fail to generate enough revenue so as to pay off the dues. If the project is unable to generate estimated revenue, the company might suffer a loss and other contingencies. b. The responsibility of the controller and management accountant in this project is to check and suggest the appropriate price of the product after considering the cost incurred profit margin to be maintained, and studying the price requirement of the targeted customers. The target sales, growth, and estimated profit must be properly acknowledged. c. As per the recommendation of the controller and management accountant, the CEO should move forward to launch the new product, but the risk factors must also be kept in mind and proper steps must be taken accordingly so as to minimize the chances of the occurrence of the risk undertaken so as to launch the product. References Yusof, Y. (2007). Managing Financial Risk for Multinational Companies in South East Asia. USA: AuthorHouse. Blach, J. (2010). Financial Risk Identification based on the Balance Sheet Information. Retrieved from: http://www.ekf.vsb.cz/miranda2/export/sites-root/ekf/konference/cs/okruhy/rmfr/prispevky/dokumenty/Blach.Joanna.pdf Plewa, F.J. and Friedlob, G.T. (1995). Understanding Cash Flow. USA: John Wiley & Sons. Needles, B.E., Powers, M. and Crosson, S.V. (2008). Financial and Managerial Accounting. USA: Cengage Learning. Read More