Inventory and Service Costing - Example

Apple Inc. Capstone project Affiliation Table of Contents Table of Contents 2 Executive Summary Apple Inc. is a giant multinational corporation based in California America. It provides several multimedia solutions. It develops designs and markets several lines of home electronics and software products for computers (Phorbes, 2012). It is popularly known for the Mac computers, iPod players, iPhone Smartphone and the iPad tablets. Software products include the iOS and OSX operating systems, iTunes, Safari Internet Browser, the iLife, the iWork and various production and video editing suites. Since its incorporation in 3 January 1977, Apple has grown tremendously in the industry in all parameters including revenue collections, market capitalization, and market share. Apple had 394 official retail stores in 14 nations in the world by November 2012 (USSEC, 2012). It also maintains an online Apple Store as well as the iTunes Store. The company is currently ranked second in the Information Technology industry by revenue following South Korea’s Samsung Electronics. It is also ranked the third biggest mobile phone manufacturer following Samsung electronics and the Finnish Nokia. By market capitalization, it is ranked the second biggest in the world at $404,978.2. It is facing cutthroat competition from Google’s Android, which is worrisome. It has dug into substantial fraction of the Apple’s market share. The corporation has key features, which gives it competitive advantage. It is boasting a loyal customer base. The iPod product has enjoyed very good sales and has surmounted competition. It is a strong brand name in the industry posting high revenues. Further, the introduction of the Nano iPod has even contributed to more revenue for the multinational. The cash position is generally impressive. It however has a no of debts. Constant innovation in the company gives it competitive advantage. 2. Financial Condition The table below contains statements of comprehensive income for the years 2009 to 2012. The table is extracted from Bloomberg Business Week (Bloomberg, 2013) “Currency in Millions of USd” 26 Sep 2009 25 Sep 2010 24 Sep 2011 29 Sep 2012 “Revenues” 42,905.0 65,225.0 108,249.0 156,508.0 “TOTAL REVENUES” 42,905.0 65,225.0 108,249.0 156,508.0 “Cost of Goods Sold” 25,683.0 39,541.0 64,431.0 87,846.0 “GROSS PROFIT” 17,222.0 25,684.0 43,818.0 68,662.0 “Selling General & Admin Expenses, Total” 4,149.0 5,517.0 7,599.0 10,040.0 “R&D Expenses” 1,333.0 1,782.0 2,429.0 3,381.0 “OTHER OPERATING EXPENSES, TOTAL” 5,482.0 7,299.0 10,028.0 13,421.0 “OPERATING INCOME” 11,740.0 18,385.0 33,790.0 55,241.0 “Interest and Investment Income” 407.0 311.0 519.0 1,088.0 “Other Non-Operating Expenses, Total” -81.0 -156.0 -214.0 -749.0 “Other Non-Operating Income (Expenses)” 52.0 -156.0 -2.0 -94.0 “Gain (Loss) on Sale of Investments” -- -- 110.0 183.0 “EBT, INCLUDING UNUSUAL ITEMS” 12,066.0 18,540.0 34,205.0 55,763.0 “Income Tax Expense” 3,831.0 4,527.0 8,283.0 14,030.0 “Earnings from Continuing Operations” 8,235.0 14,013.0 25,922.0 41,733.0 “NET INCOME” 8,235.0 14,013.0 25,922.0 41,733.0 “NET INCOME TO COMMON COUNTING EXTRA ITEMS” 8,235.0 14,013.0 25,922.0 41,733.0 “NET INCOME TO COMMON WITHOUT ADDITIONAL ITEMS” 8,235.0 14,013.0 25,922.0 41,733.0 Apple Inc. is observed to have swollen their revenues to $156.5 Billion from $108 Billion. It is worth noting that the management has managed to cost cut on the proportion of transactions going to the cost of products sold to 56% to 56.13%. This certainly improves the profit for the corporation. The fiscal period runs through 52 or 53 weeks in the year, ending in the last Saturday of the September. The last three years ended in the dates shown in the financial statements above. It is true that the devices running android operation system has taken a substantial market share for the Apple IOs; the effect on the profitability on apple has not been of the same proportion (Duncan, 2011). Apples financial condition is still stable and it will be able to fulfill the company’s strategic objectives. One of Apples objective is to increase the market share, to widen their sales to the people who have never or do not have apple products currently. The strategy therefore is to equally widen their network of distribution to reach more customers. The company is well positioned to achieve this objective. They have placed various adverts and have opened more official stores so that the products are more available to potential customers. It has also widened the market such that iPhone Smartphone sold their products to various internet sites like Smartone, CSL and 3. Smartone aim to selling long time plans for the iPhone. Another objective is to provide products, which are hassle and stress free to ensure that customers get full service and value for their purchase. If the consumers enjoy the use of their products, they become loyal. This can only be achieved by investing in Research and Development. Apple has the resources needed to carry out the needed research and development. It has been observed that the generations of iPhone have constantly been improved. For example in the year 2007, the iPhone generation one had of as high as $500 00 in the first two days of introduction (USSEC, 2012). The third strategic objective is to become a leading business in the mobile market. The strategy here is to become a search machine online and a platform for advertising. Apple will therefore have the market divided into two segments. The first one will consist of the common feature devices, which have limited computer features. The second segment will be the iPhone platform. This will certainly need more resources for research and development to stem up the competition with peers like Google and Yahoo (USSEC, 2012). 3. Profitability From 2008, Apple has been enjoying high sales and high profitability. From the above statement of comprehensive income, it is evident that profitability has been rather dwindling (DeWitt, 2013). A closer analysis however shows that the profitability may improve towards the end of 2013. The quarterly gross margin of Apple was impressive at 47.4%, a rise from 29% in the previous quarter. Somehow, it went down to 36% in the following quarter; they went to between 37.5% and 38.5 in December 2012. Some financial analysts commented that the times of Apple achieving a 40% and above are over (DeWitt, 2013). This could be attributed to various reasons, like competition. The gross profit ratio stands at 44.4%, which is impressive (ADVFN , 2013). This shows that the average mark up the goods cover Apples expenses fully. The average gross profit ratio for the last 5years has been 42.9%. This shows that the company is very stable with the ratio being greater than the average for the 5years (Bernstein & Wild, 2000). The last five years have in fact shown an increase in gross profit ratio, signaling a favorable trend in profitability. There was however a recent drop in the gross profit ratio owing to a drop in profitability. Various circles have termed the recent drop in profitability as a worrisome trend (Blodger, 2012). The management of Apple Inc. has implemented certain actions and changes so that they can stem up the profitability of the company. It includes making considerable but subtle changes in pricing strategy and development of the product itself. The main reason for the drop in profitability was due to the loss of the market share of the Smartphone product (Blodger, 2012). Both the Google android devices and iPhone dominate the Smartphone industry but iPhone is losing relative the adoring product. Apple needs to lose the ‘premier’ tag and introduce affordable Smartphone. Affordability has made players like Samsung to crash apple in large markets like India, which is very sensitive to prices. Another change is to reduce the restrictions, which the Smartphone has like in Bluetooth transfer, tethering, and other file sharing methods. This will make the product more user-friendly. 4. Cash Position Apple Inc has generally been doing well financially, especially in the last stretch of five years. Most of the releases did very well in the market; they were innovative and would give the customers value for their money. Apple was a nimble multinational corporation; the capital base was extremely well when compared to the volume of sales (Lewi, 2012). Capital investment is not appropriate for this company. It currently has a high cash load. The cash balance for apple is mainly offshore; it would therefore cost the company to transfer it to the US to share it with shareholders in form of dividends or any other method (Savitz, 2012). The supply chain for apple is not in good state. Even though it has experienced more than 5 years of high productivity, the situation has slightly changed and the companies in the supply chain are not receiving the usual returns of their investment. The leverage for Apple’s cash generation is the low capital base. This has caused some of stakeholders like suppliers to fall into dire financial states (Lewi, 2012). The products in the market are still doing well, but it is important to note that the imbalance of investment and profit that harms the supply chain. The Apple ecosystem should enjoy a more even spread of profits. That will ensure that it generates sufficient return above the cost of capital so that they are able to afford capital expenditures. From the cash flow statements, apple has increased the capital expenditure to 4% in 2011 from 2.5% in 2009. That means that less cash remains for the investors. The price-earnings ratio reduces. To enable Apple to normalize the invested capital, it may have to spend $50 billion more. This will include $20 billion to the working capital. This will improve the sales to invested capital to 5 times. These capital investments will greatly boost Apple’s cash position. The balance sheet of 1Q12 shows that Apple has $7.8 billion of property, plant and equipment. The working capital stocks, accounts payables and accounts receivables were $-8.1 billion. The amount outstanding for the suppliers is $18.9 Billion. This clearly shows that the financing of Apple comes completely from the suppliers; there is no invested capital and an unlimited Return on Investment. Apple’s cash condition was to improve when a free ride presented when the partnering app developers upgraded the iPhone to a free software store. The strong attraction, which the free apps provided, caused apple to make billions passively (Lewi, 2012). However, Google set in the app market with even more free software products for mobile and tablets with the Android platform. The cash condition of a company is important because it has a direct effect to the growth, capital needs and margin. It is observable that apple does not evaluate the capital needs and the margin seriously. If they currently do, they should lay more emphasis. They have over concentrated on growth. The implication is that there has been investor disappointment. The cash position in the March 2012 was in excess of $100 billion but it does not need that size of cash to run Apple’s kind of business (Savitz, 2012). It has currently invested in opening retail outlet stores and investing in research and development. It is expected to continue with this trend in the future; it is planning to construct an office complex (Savitz, 2012). Apple should use the cash to pay dividends to investors and will attract more investors giving Apple a wider and stronger investor base. 5. Inventory and Service Costing Apple’s success is attributable to many aspects. It has mainly been attributed to the company itself owing to its commitment to value for customers and constant innovation. However, an important practice, which Apple owes its success from, is the inventory management (Victor, 2012). It has one of the best inventory management methods. Their costing method also contributes immensely to making this company powerhouse in multimedia products. Apple has taken advantage of inventory management to maintain a competitive advantage. This can be told from the fact that the CEO, Tim Crook, is a qualified and a seasoned inventory manager (Berka, 2009). The CEO’s philosophy was that ‘No one wants to buy sour milk.’ He estimated that inventory loses value at the rate of 1% to 2% every week it stays in the shelf under normal conditions (Victor, 2012). With the First In First Out system (FIFO), Apple Inventory turnover has been high, although it has dropped recently. It currently stands at 71.1% (Bloomberg, 2013). In 2009, the firm has very high turnover, beating most of its peers. It stood at 5 days inventory each day. The competitor in the industry such as HP has 32 days, Intel with a low 89 days and Lenovo at 15 days. It has released the iMac, iMac mini and the updates of Mac Pro (Berka, 2009). The management’s inventory management vision has enabled its post success stories like the sale of over 37 million iPhone in Q4 2011. It became the market leader that time. Historically, inventory management at apple has been reputed to be extremely efficient. It has been able to react quickly even to sudden changes in demand. Customers order online and the product is transported from the manufacturing plant in China directly. Managing shortages is certainly important for the king of business industry Apple is operating. It may cause sales opportunity loss to the company. It is important however to consider that maintaining high inventory ties up resources and most importantly for Apple, it loses value. Maintaining low inventory reduces the risk of losses owing to the products’ failure to move Target costing has been the costing method at Apple. Target costing is preferred for its simplicity and straight forwardness. It does not require complex systems and a pride of experts. For a corporation like Apple, it is advantageous for it ensures that resources are channeled to other areas of the company which give the company a competitive advantage. Apple’s inventory management and costing methods are its strengths and source of competitive advantage. It is always advisable for computer companies to have few units in the stock. Apple has achieved this with excellence. As competition sores, Apple can reap substantial gains from its excellent inventory management system. What remains is to make it more efficient by ironing out inefficiencies like delays. Opening more outlets will improve the inventory turnover ratio. 6. Risk: Internal Control Environment In its continued operation, Apple is without a doubt faced with various risks both internally and externally. For the internal environment, the management is in charge of ensuring that the company is not exposed to high risks. This begs the question of the adequacy of risks. From the audited financial statements, The Ernst and young report on internal control standards reported that there was compliance with internal control standards (USSEC, 2012). The internal control system in Apple Inc is well maintained by the internal auditors and the Auditing committee is charged with responsibilities, which in the end should reduce the Inherent, control and the detection risks. ISA 400 spells that the internal control setting in the general outlook, knowledge and the actions of the management concerning the internal control system as wells as its significance to the entity. Therefore, Apple’s control environment greatly influences the risk and the effectiveness of the specific control systems and procedure employed. Apple’s board of directors is very independent in function from members of the audit committee. This ensures efficiency in application of internal control procedures. The management philosophy puts much emphasis on individual accountability ensuring that the employee are less likely to flout rules for they will incur consequences individually and it will be easy to track them. The organization structure goes further to make it easy to enforce controls. Apple keeps strictly specialized working force and every individual works on a narrow tasks. This in addition gives the organization advantage of top class employees (Victor, 2012). It also reduces the chances of misrepresentation owing to the losses accruing to e.g. tying innovation, which fails. Since the organization structure assigns authority with the employees’ clearly predefined roles, responsibility is easily secured. The employees therefore understand the limits in their authorities and responsibilities. This isolation of responsibility promotes integrity. For example, one employee authorizes a transaction; a different employee keeps the records of resources authorized. The human resource policies also have an impact on the internal control environment. Apple places heavy emphasis on the quality of their employees. The staff is hired according to their ability to perform the tasks given. Further training is given after hiring. This makes them more efficient, increasing their chances of adhering to the internal control policies in the organization. 7. Risk: International Risk Exposure Like any multinational corporation, Apple is significantly affected by the global economic conditions. In the 2012 period, the company’s domestic net sales were 39% while the international net sales closed at for 61%. This shows how global economic conditions are important for this company whose international sales are more than the domestic sales. Additionally, the company depends on international partners who form part of the supply chain. There are several outsourced services mainly from Asia and Europe (USSEC, 2012). The company is exposed to the foreign exchange risk. Apple translates assets and liabilities of the subsidiaries, which do not use the US dollar to US dollars. The rates used are the rates in the prevailing money market conditions at the end of the fiscal period. The reporting of financial situation to the headquarters therefore is done in US dollars. The same happens to the revenues and expenses. Margins from the selling the products in foreign markets, on sales of products and purchase of components of the products from the outsourced foreign partners can be adversely affected in the event of fluctuations in exchange rate. International trade regulations also can significantly impact on the performance of the corporation. Some countries have tough tariffs for foreign countries in efforts to protect their own companies or simply that is how their national principals have been. Other challenges could arise from antidumping rules and penalties. Apple’s financial statements show that they adhere squarely on the International Reporting Standards. The auditors’ independent opinion on the financial statements shows that the company is indeed following the International Accounting and auditing standards. The company is able to tolerate the risks due to their excellent supply chain management and pricing strategy 8. Ethics Vulnerability Recently, ethical behavior by companies has been taken to be an important component of the company and can be used to obtain competitive advantage. Employers and customers want to be associated with ethical companies. Investors are also attracted when the company has ethical practices. The overall reputation is also boosted when the company is ethical. Apple has faced a couple of accusation regarding ethical behavior (Calahan, 2012). From the company’s financial statements, it is complex and unclear how the company comes up with the tax payable amount. Some analysts have suspected that the company may easily evade tax owing to this complexity. Tax evasion is one of the common unethical practices by companies. . In the website, Apple indicates that it is committed to ensuring that high standards of socially responsive behavior are exhibited; they have been observed not to be walking the talk. This company has been previously been accused of tax evasion previously (Calahan, 2012). There have been calls for Apple to participate more in Social responsibility. 9. Financial Future There has been so much in the business news lately about how Apple should use the piling cash balance. The most important bit for the stakeholders is the future of Apple. With the current competition and various challenges facing the company, everyone is concerned about the future of this company. A careful study of the financial statement shows that the Apple dividend will increase in the next 5years. The dividend yield stands slightly over average with a 2.4% annual payout at the current price levels. Preferable yields should be above 3%. For now, apple does not meet the criteria. However, the dividend has high safety. The above percentage may sometimes mislead due to fluctuations in earnings. Apple has an impressive Valuentum Dividend Cushion of 3.9. This is the ratio of the sum of cash in hand the future expected cash flows in five years divided by the expected future dividends in five years. This means that the company can cover future dividends with cash in about 4 times. This is an indication of future financial health in five years. Competition is a significant factor in analyzing the future of apple. Google and Microsoft are coming so fast to grapple for the market share. Samsung also comes with excellent hardware as witnessed in their galaxy range of smart phones. However, the sustainability of iPhone product is not in very high doubt thanks to the constant innovation at Apple. The iPhone 5 product is talked about as a cutting age device, which will stem the competition (Blodget, 2012). The future of Apple is still bright though the share price has not been doing well since the 2012 financial results were read. The analysis above has shown that it is still able to meet cash and dividend needs in 5 years. Legitimate concerns about competition cast a doubt in the company’s financial performance in the next 5 years. 10. Conclusion Apple is committed to give value and usability to the customers and create wealth for the shareholders through their constant innovation and excellent management practices. The financial condition is impressive. The profitability trends are fare but the management is implementing various strategies in innovation and supply chain management to stem the trend. The management is also armed to face the risk both internally and externally, locally and internationally. Competition comes out as the biggest challenge, the management has much to do to retain and grow their market share. 11. References ADVFN . (2013, March 6). Apple Financials. Retrieved from http://www.advfn.com/p.php?pid=financials&symbol=NASDAQ%3AAAPL Berka, J. (2009, March 6). Analyst says Apple very efficient at managing inventory. Retrieved from Ars Technica: Analyst says Apple very efficient at managing inventory Bernstein, L., & Wild, J. (2000). Analysis of Financial Statements. McGrawhill. Blodger, H. (2012, November 16). This Trend Is Very Worrisome For Apple. Retrieved from Business Insider: http://www.businessinsider.com/mobile-market-share-2012-11 Blodget, H. (2012, July 31). MAKE NO MISTAKE: The Future Of Apple Depends On The iPhone 5. Retrieved from http://www.businessinsider.com/iphone-5-future-of-apple-2012-7 Bloomberg. (2013, March 03). Apple Inc. Retrieved from Bloomberg Businessweek: http://investing.businessweek.com/research/stocks/financials/financials.asp?ticker=AAPL Bloomberg. (2013, February 3). Apple Inc. as at 12/29/2012. Retrieved from Bloomberg Businessweek: http://investing.businessweek.com/research/stocks/financials/ratios.asp?ticker=AAPL Calahan, D. (2012). Apple iCheat: How the Worlds Biggest Company Also Became the Most Unethical. Retrieved from Policy Mic: http://www.policymic.com/articles/7868/apple-icheat-how-the-world-s-biggest-company-also-became-the-most-unethical DeWitt, P. (2013, February 4). Apples declining profitability: Structural or seasonal? Retrieved from CNN Money: http://tech.fortune.cnn.com/2013/02/04/apple-profit-margins-hubert/ Duncan, G. (2011, November 15). Android conquers marketshare, Apple conquers profits: Who’s winning? Retrieved from Digitatal Trends: http://www.digitaltrends.com/mobile/android-and-apple-marketshare-versus-profit/ Lewi, W. (2012, October 10). Apples Cash Position Is Overstated By $70 Billion. Retrieved from Seeking Alpha: http://seekingalpha.com/article/916121-apple-s-cash-position-is-overstated-by-70-billion Phorbes. (2012, April). Apple. Retrieved from Phorbes: ttp://www.forbes.com/companies/apple/# Savitz, E. (2012, March 18). Apple Sets Monday A.M. Call On Cash Position; Dividend Coming? Retrieved from Forbes: http://www.forbes.com/sites/ericsavitz/2012/03/18/apple-sets-monday-a-m-call-on-cash-position-dividend-coming/ USSEC. (2012, September 29). Form 10-K. Retrieved from http://www.sec.gov/Archives/edgar/data/320193/000119312512444068/d411355d10k.htm#toc Victor, H. (2012, March 29). Apples secret sauce for success is inventory management. 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