The Financial Situation - Assignment Example

1. (a) Do you think the finances of the company are healthy Comment on how you would improve the financial situation using accounting ratios as a reference for your answer. To look into the financial status of the organisation we will have to look into some financial ratios: Current Ratios One of the best-known measures of financial strength of a company is its current ratio. It answers the question of whether the current assets of the company can meet the payment schedule of its current debts with a margin of safety for probable losses in The Current Assets. Ratio is one of the best-known measures of financial strength. It is figured as shown below: Current Ration = Total Current Assets / Total Current Liabilities = 0.7/0.5 = 1.4 Which is better that the minimum acceptable value of 1:1 but much less than the generally accepted ratio of 2:1. The suggested actions for remedy are: Paying some debts. Increasing current assets from loans or other borrowings with a maturity of more than one year. Converting non-current assets into current assets. Increasing your current assets from new equity contributions. Putting profits back into the business. Working Capital Working Capital is more a measure of cash flow than a ratio. It is calculated as shown below: Working Capital = Total Current Assets - Total Current Liabilities = 0.7M - 0.4M = 0.3M A positive Working capital is a good health sign. Net Profit Margin Ratio Net profit margin ratio is the ratio of Net Profit before tax to the Net Sales value. It provides a good opportunity to compare the organisation's "return on sales" with the performance of other companies in the industry. It is calculated before income tax because tax rates and tax liabilities vary from company to company for a wide variety of reasons, making comparisons after taxes much more difficult. The Net Profit Margin Ratio is calculated as follows: Net Margin Ratio = Net Profit before tax / Net sales = 1M / 12M =0.0833 Inventory Turnover Ratio This ratio reveals how well inventory is being managed. It is important because the more times inventory can be turned in a given operating cycle, the greater the profit. It is stated that inventory turn over is three times a year. Return on Assets Ratio This measures how efficiently profits are being generated from the assets employed in the business when compared with the ratios of firms in a similar business. A low ratio in comparison with industry averages indicates an inefficient use of business assets. The Return on Assets Ratio is calculated as follows: Return on Assets = Net Profit Before tax / Total Assets = 1M / (1.2M + 0.7M -0.5M) = 1M / 1.4M = 0.714 Return on Investment (ROI) Ratio Return on Investment Ratio is the ratio of percentage of return on funds invested by the owners. The ROI is perhaps the most important ratio of all. The ROI should be high enough for an investor to invest in risk taking business proposition. The ROI is calculated as follows: Return on Investment = Net Profit before Tax / Net worth. (Word Count = 497) 1. (b) Do you think the above structure is satisfactory How would you change the structure and why would you change it To find answer to the above question first we have to look at what is an Organisation Structure I will just quote one, which I feel gives the essence of organization structure. 'The structure of an organization [is] the sum total of the ways in which it divides its labor into distinct tasks and then achieves co-ordination among them' (Mintzberg, 1989).' In analyzing the organization structure of Tees Valley Doors (TVD), I find that the organization structure is lacking some vital points. 1. This is a top-heavy organization structure. The total no. of employees are 70. For which there are 3 whole time Directors, 6 managers. 2. The allocation of jobs to the Directors are also not proper e.g. the Distribution Manger is having 4 assistants under him and the Warehouse manager is having 5 operators under him. I feel the posts of Managers here are superficial. It should be the job of supervisors to handle operators and assistants. However as the jobs are important in nature, the post of senior level person like manager may be justified. 3. Order Entry Supervisor is a single person section, why the need of a supervisor 4. In manufacturing, one supervisor report to the Production Manager. The total manufacturing activities is the responsibility of a single supervisor, which shall make him over burdened. 5. Two vital activities, which have serious impact on the functioning of the organization, do not get mentioned. a. 80% of the raw materials are imported. There is different lead-time for different types of timber. The lead-time is six weeks for the more common timber cut sizes and twelve weeks for the less popular sizes. At least thirty different sizes of timber are imported to reduce timber waste during the manufacturing process. The need for a different purchase section for the imported items is very much essential. b. High value steel security doors are the more profitable product for the organisation. There should be a separate section for that product. My suggestions for the organisation structure shall be as follows: 1. There is no need of three directors. The function of Warehousing, Distribution, and sales are inter-related and can be clubbed to one commercial Director. 2. Under commercial Director there can be Warehousing Manager and Sales cum Distribution Manager again because the sales and distribution activities are inter-related. 3. I suggest a Purchase Officer under Warehousing Manger who needs to organise timely supply of raw materials under warehousing supervisor. The warehousing also have two different sections namely for raw materials and finished goods. 4. The total Manufacturing activity shall be under Production Director. Under him there should be Production Manger and Production Planning Manger. Under Production Manager, Production supervisors for 1) cutting, Processing and finishing and 2) special steel doors. 5. Financial manager with 2 accountants shall remain as it is. (Word Count = 471) 2. (a) What are the payback periods for the projects PAYBACK PERIOD Project A Year Annual Cash Flow Cumulative Cash Balance 0 (today) (2,00,000) (2,00,000) 1 28,000 (1,72,000) 2 75,000 (A = 97,000) 2.776 = Payback 97,000 0 3 1,25,000 B = 28,000 4 55,000 83,000 5 12,000 95,000 Payback Period = Where, A = Cumulative Cash Balance for year 2 = 97,000 B = Cumulative Cash Balance for year 3 = 28000 X = no of years before the cumulative cash balance becomes positive = 2 years Therefore, Payback Period = 2+ 97000/(97000+28000) = 2.776 years PAYBACK PERIOD Project B Year Annual Cash Flow Cumulative Cash Balance 0 (today) (3,15,000) (3,15,000) 1 9,000 (3,06,000) 2 29,000 (2,77,000) 3 68,000 (2,09,000) 4 1,75,000 (A=34,000) 4.1511 = Payback 34,000 0 5 (2,25,000) (B= 1,91,000) Where, A = Cumulative Cash Balance for year 4 = 34,000 B = Cumulative Cash Balance for year 5 = 191,000 X = no of years before the cumulative cash balance becomes positive = 4 years Therefore, Payback Period = 4 + 34000/(34000+191000) = 4.1511 years 2. (b) Assuming an interest rate of 10% calculate the discount factors over the five year period and the Net Present Values of the two projects. FORMULA TO CALCULATE NPV Net Present Value = Discount Factor x Cash Flow Cash Flow = income - expenditure Discount factor = 1/ (1+i)n Where, i = the forecast interest rate (Discount rate) n = the number of years from start date Example for calculating the Discount Factor using the formula at a discounted rate of 10% at the end of Year 1, 1/(1.1)1 = 0.9091 At the end of Year 2 0.9091/(1.1)2 = 0.8264 Similar way we can find for Year 3, 4 and 5 Discounted rate Discount Factor Year 1 Year 2 Year 3 Year 4 Year 5 10% 0.9091 0.8264 0.7513 0.6830 0.6209 Therefore Net Present Value = Discount Factor x Cash Flow For Project A Year Year 0 (Today) End of Year 1 End of Year 2 End of Year 3 End of Year 4 End of Year 5 Initial Investment (Expenditure) 2,00,000 0 0 0 0 0 Annual Operations Cash Flow (Income) 0.00 28,000 75,000 1,25,000 55,000 12,000 Total Cash Flow (Income - Expenditure) -2,00,000 28,000 75,000 1,25,000 55,000 12,000 Discount Factor (at a rate of 10%) 1.0000 0.9091 0.8264 0.7513 0.6830 0.6209 Present Value for Annual Cash Flow (Total Cash Flow X Discount Factor) -2,00,000 25,455 61980 93913 37565 7451 Total Net Present Value over 5 years * Assume 10% Discount Rate = (25455+61980+93913+37565+7451) - 200,000 = 23,364 For Project B Year Year 0 (Today) End of Year 1 End of Year 2 End of Year 3 End of Year 4 End of Year 5 Initial Investment (Expenditure) 315000 0 0 0 0 0 Annual Operations Cash Flow (Income) 0.00 9000 29000 68000 175000 225000 Total Cash Flow (Income - Expenditure) -2,00,000 9000 29000 68000 175000 225000 Discount Factor (at a rate of 10%) 1.0000 0.9091 0.8264 0.7513 0.6830 0.6209 Present Value for Annual Cash Flow (Total Cash Flow X Discount Factor) -315000 8182 23966 51088 119525 139703 Total Net Present Value over 5 years * Assume 10% Discount Rate = (8182+23966+51088+119525+139703) - 315,000 = 27464 PROJECT SELECTION USING NPV The greater the NPV value of a project, the more profitable it is. This method can be used to rate and compare the profitability of several competing options. Project A Project B Initial Investment 200,000 315,000 Positive net cash flow in: Year 1 28000 9000 Year 2 75000 29000 Year 3 97000 68000 Year 4 125000 175000 Year 5 12000 225000 Total net cash flow over 5 years 337000 506000 Total Net Present Value (NPV) 23364 27464 Using the NPV method Project B will be selected as it generates more profits than Project A over a period of 5 years. 2.(c) Give an indication of the most appropriate project structures for Project A and Project B. Appropriate project structure for Project A 1. Preparation of Technical requirements of the proposed machinery to be procured from various sources of suppliers and the requirement envisaged by the Production Team. 2. Purchasing Process of Identifying sources of suppliers, evaluation of suppliers, tendering and placement of Purchase Order. 3. Preparing a time bound program in association with the warehousing and purchase department for making a smooth transition of the procurement and stock system from thirty variants of timber to five variants, ensuring no overstocked items of timber variants which will not be used, on the other hand no shortage for regular production. 4. Procurement, Installation and Commissioning of the Machinery Project B 1. Preparation of the technical details of the product to be launched 2. Design, Making prototype, evaluation and validation of the product and process. 3. Establish production line, which should include preparation of manuals of various processes involved. It will require a major revamp of all the departments and shall affect most of the employees. 4. Final documentation of the process including list of parts, vendor evaluation, manufacturing process, Technical details of the final product. Required training of the employees 5. Marketing and distribution strategy and implementation. (Word Count = 199) 2.(d) How would you decide on which project to choose and give your reasons such that the manager who does not receive the go ahead remains interested in forwarding the proposal again in the future. Let's analyze the merits and demerits of the two Projects: A) Project A a. Merits: 1) One of the major drawbacks of the organisation is the no. of variants of timber it imports. The warehousing and inventory problem will drastically reduce with the implementation of the project. 2) Low gestation: the project can be completed in three months and the Payback period is 2.776 year. 3) The existing resources like electrical, mechanical maintenance and installation engineers amongst the operators can be utilized hence no major revamping is necessary. b. Demerits 1) Total net cash flow is 337000 in 5 years whereas that of Project B is 506000 2) The Net Present value after 5 years shall be 23364 whereas that of Project B is 27464 B) Project B a) Merits 1) The Net cash flow and Net present value after 5 years are higher compared to project A 2) As the available capital for the first year is 400000 it will be advisable to utilize the maximum amount from the available resources. 3) The introduction of any new product in the market always increases the bottom line of any organisation. b) Demerits 1) The Payback period is high 4.1511 years 2) High implementation period - 9 months 3) The project affects all areas of the organization, a major revamping is needed. Project B is selected to be implemented on the following strategies: 1) The Net Cash flow and Net Present Value after 5 years is higher in the project B. 2) The availability of capital is 400000. It will be wise to use the maximum amount of the available resources, which ultimately will translate to better liquidity. 3) The addition of a new product will enhance the bottom line of the organsiation, it will also reflect in the market sentiment, sending a valuable important message to the stakeholders that under new management the company has ambitious plans for future. In my opinion the following points needs to be considered: 1) For implementation of the project B, a major revamping in the organization will be required. This may cause a cultural shock to the employees, affecting their moral. It will need a careful handling. The management needs to communicate to the employees properly of the advantage of the project B, the impact it will create in the market enhancing the company image. Management should convert this handicap to an opportunity by making the employees feel that a change for the good future in the air, under the new management. With proper handling it can create a new enthusiasm among the employees. Psychologically it is proved that the image of a company in outside market is a big moral booster for the employees. 2) Organization restructuring has to be handled with care. I think the above argument is put to the Production Manager, whose project is postponed, will understand the logic. He will be in the thick of the action, as it will involve his full co-operation for the success of the Project. (Word count = 500) Read More