Accuracy of Assessment of the Financial Performance of the Company - Assignment Example

Business finance By Question Analysis of financial performance of Morley Construction Products Limited. The rationale behind choice of ratios for analyzing the financial performance is that the analysis ratios must be evident and from within the factual information of the company that is accessible and the financial implications(s) of such ratios with regards to liquidity, and operational efficiency (Carey, Knowles & Towers-Clark, 2011). Sales growth ratio reveals the percentage change in sales since this is the source of revenues generation. The company has a negative growth in sales indicating a declining performance. Operating self-efficiency ratio measures the extent to which the expenses of a business are covered by its core business and independent of grant revenue or other funding. The company is experiencing a decreasing trend thus showing grant or other external fund dependency. Current ratio – measures the ability of a business to pay off its short-term obligations using its current resources. This is critical to the analysis of financial as the lenders are very keen on this ratio to arrive at a decision of whether to avail credit to a business or not. The lenders use this ratio to determine the credit worthiness of a business (Carey, Knowles & Towers-Clark, 2011,pp112-123). Moreover, for a business to perform as expected, it cannot avoid leverage as this would cushion it from the high tax expense. The inclusion of debt in the capital structure of a business constitutes a tax shield in favor of that particular business. The current ratio fluctuates but still a good indicator that the company can meet its short-term obligations. Quick ratio – measures the extent to which a business could be able to settle its short-term obligations when they fall due at a point using its current resources in exclusion of considering the inventories as part of the available current resources. The quick ratio, also known as acid-test ratio indicates the credit worthiness of a business at a glance in that it excludes inventories which are not easily convertible into cash. The quick ratio fluctuates but still a good indicator that the company can meet its short-term obligations should they fall due at a point. It gives a sense of the company’s ability to turn inventory into cash, that is, the efficiency of the operating cycle of the company. Working capital turnover illustrates how effectively a company uses its working capital to generate sales. The company has a declining capital turnover indicating management inefficiency of working capital. Gross profit margin ratio – this ratio is critical as it measures the proportion of each dollar which is translated into gross profit to cover the operating expenses of a business from the generated revenues (Carey, Knowles & Towers-Clark, 2011, pp234-267). The gross profit margin fluctuates but the company still translates a significant of each dollar generated as revenues into gross profits. Net profit margin ratio – this ratio is appropriate in the financial performance analysis of a business as it measures the proportion of each dollar generated from sales that is finally converted into net profits of the business. Ability to cover all operating costs, indirect costs inclusive. Declines continually indicating drop in profits. Return on equity is the most important ratio to investors. It measures the adequacy of the profits made by the business in relation to the compensation of the risks associated with being in business. Negative for the firm indicating inability of profits to cover risks. Question 2: Accuracy of Mr. Michael’s assessment of the financial performance of the company. Cash conversion cycle tries to measure the amount of time period during which each dollar net input is tied up in the production and sales process before its conversion into cash through sales to customers. This metric evaluates the amount of time required to sell inventory, the amount of time required to collect the receivables – debtors’ collection period and the amount of time given by creditors of the company to pay off its obligations without incurring penalties (Carey, Knowles & Towers-Clark, 2011, pp112-156). This cycle is very important to retailers and businesses of similar nature. It demonstrates how quickly a company can convert its products into cash through sales. The shorter the cycle, the less time capital is tied up in the business process, the better the company’s performance. Where: DIO - Day’s inventory outstanding measures how long a company turns inventory into sales, the lower is better since money is king. DIO = Inventory/COS x 365 2799/37068 x 365=27.56 days (2007), 2338/38059 x 365=22.42 days (2008), 1963/28898 x 365=24.79 days (2009), 2760/22716 x 365=44.35 days (2010). DSO - Days sales outstanding (Debtors’ collection period) It is in the best interest of the company to collect its accounts receivables as quick as possible. This would enable the company to re-invest and make more sales. The investors are interested in aspect of the company to determine whether a company wants to disguise weak sales. Thus, the shorter the period the better performance of a company. Cash flow is king in that the more the cash at hand the more resources to be invested back into the business. The company’s DSO is very high implicating that the company is not managing its cash collection process in an optimal manner. If not so, it is either possible that the industry or economy at large is undergoing a down cycle making people to take abnormal periods to pay off or that the customers of the company are experiencing financial constraints that make it difficult for them to pay within the shortest time possible as would be preferred by the company. (Accounts receivable/total credit sales) x 365/12 6090/2716 x 31 = 70 days (2007), 6644/2950 x 31 =70 days (2008), 4832/2591 x 31 = 58 days (2009), 3254/1298 x 31 = 78 days (2010) DPO - Days payable outstanding (Creditors’ collection period) Ending accounts payable / COS x 365 2716/37068 x 365 = 26.74 days (2007), 2950/38059 = 28.29 days (2008), 2591/28898 x 365 = 37.73 days (2009), 1298/22716 x 365 = 20.86 days (2010) There is need for balance of the creditor’s collection period. The longer the period the better for working capital and free cash flow in the business. When this period is too long, creditors may be unhappy, and they may react to this by refusing to extend credit in the subsequent transactions with the company, offer less favorable terms. The company may also forego discounts that the creditors offer for early payments. The creditors’ collection period for most companies is about 30 days. CCC = DIO + DSO + DPO 2007 2008 2009 2010 DIO 27.56 22.42 24.79 44.35 DSO 70 70 58 78 DPO 26.74 28.29 37.73 20.86 CCC 124 121 121 143 Mr. Michael’s assessment of the company’s financial performance is not accurate. The company’s CCC fluctuates and is high and above 60 days as he said. The debtors’ collection period was below 30 days in the previous three years but is currently 44.35 days. Thus, cash has been king to the company as he said. He must have based his statement on the previous DIOs. The profits of the company is declining. Question 3. Computation of net cash inflows from changes in distribution network. $ $ Delivery charges billed to business customers 29,000, 000 Resale value of delivery van vans 30, 000 Total project cash inflows 29, 030, 000 Cost of tracking the location of deliveries (25, 000) Salaries and pension contributions of directors (300, 000) Handling costs of additional deliveries (28, 000) Costs of market research during the first year (10, 000) Costs of investing in and installing the distribution boxes (250, 000) Annual running costs of customer service call centre (225, 000) Replacement cost of delivery vans (120, 000) Annual cost of running the Finance department (100, 000) Advertising the new service on Facebook (50, 000) Annual depreciation of delivery vans (27, 000) 10% annual depreciation of new distribution centre in Oxford (100, 000) Historical cost of the company’s delivery vans (100, 000) Total project cash outflows (1, 335, 000) Net cash inflow 27, 695, 000 Computation of net cash inflows from training project. Workings; Total number of days = 4.5 x 40 = 180 days Total number of hours for two courses = 2 x 3 x 180 = 1080 hours Cost of hotel hire = (2 x 1000 x 180) = $ 360000 Cost of booklets = (2 x 20 x 180) = $ 7200 Total number of training courses = 2 x 180 = 360 training courses Training costs = (20x$400) + (340x$400) = $ 144000 Administrator’s fee = $ 20000 Cost of hire 360, 000 Cost of booklets 7, 200 Training costs 144, 000 Administrator’s fees 20, 000 Other anticipated costs Website hosting fee $ 55 Advertising costs ($ 500 x 360) $ 180000 Annual fee to professional training body $ 250 Annual insurance fee $ 250 Invoice fee (1080/3 x $ 3000) $ 1080000 Departmental training project $ Invoice fee (1080/3 x $ 3000) 1, 080, 000 Less: departmental training costs Cost of hotel hire (2 x 1000 x 180) 360, 000 Cost of booklets (2 x 20 x 180) 7, 200 Training costs (20x$400) + (340x$400) 144, 000 Administrator’s fees 20, 000 Other anticipated costs Website hosting fee 55 Advertising costs ($ 500 x 360) 180, 000 Annual fee to professional training body 250 Annual insurance fee 250 (711, 755) Net cash inflows 368, 245 Question 4. Advice to the directors The company directors should not implement the departmental training project since it has a negative margin of safety ratio which implies a net loss. This project will result into losses before the break- even revenues are generated. The directors can go ahead to implement the distribution network project as it has a positive margin of safety ratio which constitutes a net gain from the project. Bibliography Carey, M., Knowles, C. & Towers-Clark, J. (2011). Accounting, a Smart Approach. Oxford: Oxford University Press. Atrill, P. & McLane, E. (2007). Management Accounting for Decision-Makers, FT/Prentice Hall Perks, R. & Leiwy, D. (2010) Accounting, Understanding and Practice, 3rd edition, McGraw- Hill Higher Education Proctor, R. (2009) Managerial Accounting for Business Decisions, Pearson Hussain, A. (1989). A textbook of business finance. Nairobi, Heinemann. Gosling, J. (1995). Maths for business & finance. Glebe, N.S.W., Pascal Press. Cherry, R. T. (1970). 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Appendix Ratio analysis computations W 1: Sales growth ratio = (Current period sales – Previous period sales) / Previous period sales (51697-52059)/52059= -0.7% (2008), (40372-51697)/51697= -21.9% (2009), (30072-40372)/40372= - 25.5% (2010) W 2: Operating self-efficiency ratio = Business revenue / Total expenses 1 means no dependency 1674/13317= 0.13 (2007), 1261/12377=0.10(2008), -7380/18854= -0.39 (2009) -2653/10009= -0.27 W 3: Current ratio = Current assets / Current liabilities 27659/15844= 1.75 (2007), 25165/11932= 2.11(2008), 30303/15957= 1.90(2009), 21444/10175= 2.11 (2010) W 4: Quick ratio = (Current assets – Inventory) / Current liabilities (27659-2799) / 15844=1.57 (2007), (25165-2338) / 11932=1.91 (2008), (30303-1963) / 15957=1.78 (2009), (21444-2760) / 10175= 1.84 (2010) W 5: Working capital turnover = Sales /Working capital Working Capital = Current Assets – Current Liabilities 52059 / (27659-15844) =4.44 (2007), 51697 / (25165-11932) =3.91 (2008), 40372 / (30303-15957) =2.81 (2009), 30072 / (21444-10175) =2.67 (2010) W 6: Gross profit margin ratio = Gross profit / Sales 14991 / 52059=28.8% (2007), 13638 / 51697=26.4% (2008), 11474 / 40372=28.4% (2009), 7356 / 30072=24.5% (2010) W 7: Net profit margin ratio = Net profit / Sales 1674/52059 = 3.2% (2007), 1261/51697 = 2.4% (2008), -7380/40372 = -18.3% (2009), -2653/30072 = -8.8% (2010) W 8: Return on equity = Net profit / Shareholders’ Equity 1674/16155= 0.10 (2007), 1261/17412=0.07 (2008), -7380/14652= -0.5 (2009), -2653/12465= - 0.21 (2010) Computations of Break-Even revenues and Margins of safety. Departmental training project BEP= Fixed Cost/ (Contribution / Revenue) = 711, 755/ (368, 245/1, 080, 000) = $ 2, 087, 456 Margin of safety = Projected revenues – BE revenues = 1, 080, 000 – 2, 087, 456 = ($ 1, 007, 456) Margin of safety ratio = Margin of safety / Projected revenues x 100 = - 1, 007, 456/1, 080, 000 x 100 = - 93.28% TR line Graph TR line TR/TC ($) BE point 20874564 FC line Margin 1080000 of safety 0 1080000 20874564 $ Network distribution project BEP = Fixed Cost/ (Contribution / Revenue) = 1335000/ (27695000/29030000) = $ 1, 399, 352 The company should implement the project. A positive margin of safety represents a net gain. Margin of safety = Projected revenues – BE revenues = 29, 030, 000 – 1, 399, 352 = $ 27, 630, 648. Margin of safety ratio = Margin of safety / Projected revenues x 100 = 1399352/29030000 x 100 = 5.06 The BEP Graph for Network distribution project TR/TC ($) TR line 29030000 FC line BE point 1399352 Margin of safety 1335000 0 1399352 29030000 Read More