Management and Control of Financial Resources in Canada - Dissertation Example

Management and Control of Financial Resources Submitted by: XXXXXXX Number: XXXXXX of XXXXXXX XXXXXXXX XXXXXXX Tutor’s Name: XXXXXX Date of Submission: XX – XX – 2010 Table of Contents Liquidity: 2 Profitability: 3 Debt: 5 Coverage: 5 Global Economic Outlook and Business Forecast: 7 Improvement Plan based on Ratio Analysis: 11 Suggestions and Recommendations: 16 Bibliography 19 Appendix – 1 21 Appendix – 2 22 Appendix – 3 24 Ratio Analysis: The financial ratios for the year 2009 are computed based on the financial statements (Balance Sheet – Appendix 1 and Income Statement – Appendix 2) of Canada Corporation. The ratios are tabulated for the years 2007, 2008 and 2009 along with the Industry Norms in Appendix 3. A number of issues have been identified in the analysis and are listed as follows: Liquidity: The current ratio (current assets / current liabilities) has been steadily declining over the last 3 years from 250 % in 2007 to 163 % in 2009. Similar trend is observed in the acid test ratio as well as it has come down from 100 % to 75 % in the three years. It is imperative to note that both the values in 2009 are lesser than those of the industry norms (225 % and 120 % respectively). This fall in the acid test ratio ([current assets – inventory] / current liabilities) (75 %) indicates that the liquid assets available to the company have reduced and the company will not be able to meet all its current obligations with these assets (Samuels et al, 2000). Hence Canada Corporation has to improve its current liquidity position. Profitability: The gross profit margin (Gross Profit / Sales) in 2009 is slightly lesser than that of the previous year (41 %) and equal to the industry norms (40 %). However the net profit margin (Net Income after interest and taxes / Sales) has fallen from 17 % in 2007 to 10 % in 2009. This is also relatively lesser than the industry norms of 15 %. It is evident that the company has to improve its net income margin so that it at least meets the industry standards. The ratios such as the receivables turnover (Net Sales / Receivables) and the inventory turnover (Cost of Goods sold / Inventory) indicate that the company is not operating efficiently. This is also reflected by the net income margin discussed in the previous section. The receivables turnover period (365/Receivables Turnover) and the inventory turnover period (365 / Inventory Turnover) are computed as shown below: Efficiency Receivables Turnover Period Inventory Turnover Period Canada Corporation (2009) 114 days 60 days Industry Norms 214 days 91 days (Samuels et al, 2000) The receivables turnover in 2009 (3.2) indicates that the time period taken to collect the receivables is around 114 days (365 / 3.2) whereas that of the industry norms is just 60 days. Similarly the time period taken to convert inventory into revenue in 2009 is computed as 214 days whereas that of the industry norms is around 91 days. The company has to consider these issues as critical and has to address them at the earliest. Debt: The debt to capital ratio (Long-term debt / Total Capital) indicates that about 54.5 % of its capital is raised from long term debts whereas the industry average is only 33 %. It is evident from the trend that the company has availed significant long term loans in 2009. This high value of debt is an issue to the management as it is under the obligation to pay the interests before paying the shareholders (Pendlebury and Groves, 2004). This will have a significant impact on raising equity capital in the future. Coverage: The overall interest cover is the ratio of Net Income before interest and taxes to the Interest on the long-term loan. It indicates the company’s ability to cover its interest charges from its operations (Pendlebury and Groves, 2004). It is evident from the graph that the interest cover has also been steadily declining since 2007 and its current value 7.7 (in 2009) is lesser than the industry norms (10.0). The interest cover is a critical value, as banks and other financial institutions analyse the interest cover before providing long term debts to the company. It is an indication of the company’s ability to effectively pay the interests on the long term debts and hence has a significant effect on the borrowing capacity of the company. The return on assets (Net Income before Interest / Total Assets) and the tangible asset turnover (Sales / Total Assets) are lower than the industry norms in 2009. It is evident that they have been reducing steadily from 2007. Hence the management has to ensure that they do not reduce further in the next year. The rate of return on equity (Dividends Paid / Common Stock) (29.3 %) is significantly higher than the industry norms (20 %). Similarly the net operating profit return of 20% (Net Operating Profit / Sales) is better than the industry norms (17.5%) and has been increasing since 2007. Global Economic Outlook and Business Forecast: Global Economic Outlook The world economy has been faced with a number of issues over 2008. The synchronized global downturn that was present in the late 2008 and early 2009 has left a number of countries with extremely low performing overall economies. The industries have been affected in two ways; one is the destruction of the demand and the credit market squeeze. The economies around the world have been through a major decline and the economic crisis across the world has created a ripple through almost all sectors and industries. Developed countries like US and UK had faced a complete slowdown. As explained by Jim Jubak one of the best financial advisors, China is currently in a situation where the economic crisis that has been faced by other countries has not affected the country. He however explains, ‘Im more concerned about a slide into a crisis that will be an extension of the Great Recession. That slide could begin, I estimate, sometime in the next 12 to 18 months’ (Jubak, 2010). He explains that the economy of China and the political systems of the country are so different from the US, UK and other developed countries, and the relationship with the global financial markets is so unique that the chances of moving towards the global crisis like the one faced by the world in October 2007 is very low (Jubak, 2010). Considering this, the main economic forecast that can be made is that the country will provide a good breeding ground for the plastic industry and will allow the industry to grow and develop to global levels. Reports by the UN highlight that the second quarter of 2009 has been a relatively better for almost all economies and a number of countries have shown positive results. The international trade and the global industrial production have also seen a recovery. The report by UN also explains, the possible fall in the World Gross Product of almost 2.2% for 2009 and has expressed that this would classify as the first contraction since the Second World War. A number of countries especially those present in the Asian Continent have shown excellent growth and improvements in the economies. The major policy actions that have been taken by the economies like United Kingdom and United States have helped to a great extent in stopping any further destruction of the worldwide economy. Also the changes in the global inventory cycle have also led to the changes in the markets. Recession has led a number of companies to cut down on the industrial production and also in the shedding of the inventories. However post the improvements of the financial markets and an overall improvement of the businesses and consumer behavior a new scene of positivism has been noted in the companies which in turn simply means the production activities and all related processes have been set back to normal. This to a great extent explains how the economies have been able to return back to the positions in the market. Also together the inventory cycle and the major policies have led to the increase in the industrial production which in turn has provided a chance for renewed growth of the commodities. However there is a rather uneven recovery across the countries and there is not clear indication of a clear lasting possibility. Table: World Economic Situation and Prospects (United Nation, 2010) As seen in the table above, it is clear that China has seen a constant growth in the past following which it experienced a clear dip in the overall GDP of the country. However since the second quarter of 2009, the country has also seen a slow and steady growth and this has been a trend in the third quarter as well. Based on the following business forecast can be made for Canada Corporation Ltd. Business Forecast for Canada Corporation Limited As discussed earlier, there is a clear increase in the economic condition of most countries, and China is not an exception. Canada Corporation is majorly aimed at concentrating on the Chinese markets. Another report by Hutchinson explains, ‘In China, the picture is unclear. The IMF estimates growth of 7.5% in 2009 and 8.5% in 2010, by far the best performance of any major economy, but this both takes Chinese statistics at face value and underestimates the risks facing China’s economy’ (Hutchinson, 2009). An increase on this level in terms of the markets in China simply implies that there will be an increase in the demand for the commodity products as well. Canada Corporation Ltd. needs to work towards building a stronger organization and a globally competitive organization. Also, in terms of the sales of the organization it is clear that the overall markets have been faced with an increase in the sales of the plastic products, hence Canada Corporation needs to consider this and build all their financial accordingly and should also aim at being able to meet the sales increase in 2010 and 2011. Another major aspect that will influence the overall working of Canada Corporation is the possibility in the rise of the RenMinBi (RMB) value. An important aspect that also needs to be considered before making any forecasts for the company is the relationship of plastic products and the petroleum industry. The costs in the oil industry and the oil prices have seen an intense growth over the year. Based on the above discussion it is clear that Canada Corporation has a high scope to improve its overall sales. Also considering that 2010 would be the first year of operations here, hence the estimates need to be kept a little low. The company can forecast a growth in the sales revenue of almost 20% which totals to $ 24 million for the year 2010. Improvement Plan based on Ratio Analysis: The ratio analysis conducted earlier revealed that the company requires an immediate and effective improvement plan to stabilize its financial position and improve its performance in the future years. Cash Collection from Clients Canada Corporation has to increase its cash reserves so that the current assets are higher. The credit sales ($ 16 million) form a significant part (80 %) of the revenue whereas the cash sales amount only to 20 %. The company has to revise its sales policies and insist that the clients settle the transactions in cash in a short period of time. This will improve the cash inflow in the company. This will also have an effect on the time period taken to collect the receivables and hence improve the receivables turnover as well (Samuels et al, 2000). Inventory Management The value of inventory (stock in hand) in 2009 is $ 7 million which forms more than 53 % of the current assets. Hence the acid test ratio has fallen below the industrial norms. The company has to improve its production process and employ better demand forecasting methods so that the level of inventory is lesser. The inventory turnover also indicates that the company has to effectively convert the inventory into sales so that they are not stored for longer periods in the company. This will improve the inventory turnover ratio and bring it closer to the industrial norms. Capital Structure The company has borrowed significantly in 2009 and hence the debt to capital has increased to 54.5 % from 40 % in 2008. As discussed earlier, the high debt ratio indicates higher obligations in terms of the interest to be paid and hence will have an impact on the shareholders’ trust. The company has to reduce the debt to capital ratio by raising more capital through equities. The objective is to reduce the ratio to the industry norms (33 %). The return on equity is currently higher than the industry norms and has been steady over the years (Pendlebury and Groves, 2004). Production Process The operating efficiency has to be improved in order to increase the net profit margin. One of the main reasons for the decrease in net profit margin in 2009 is the interest payments made, as the long – term debts increased in 2009. The company can increase its net margin by reducing the wastage of materials, overheads and general expenses. Wastage of raw materials can be reduced by implementing strict quality check processes. The production process has to be analysed to eradicate idle times to make it more effective. This will lead to the increase of net margin in the next year. Expansion Program of the Canada Corporation: Canada Corporation aims at expanding its operations into three new cities, namely Shanghai, Beijing and Chungxin. These three new offices will function as business development units generating additional income and customer base in the respective cities. The staff recruited will also take care of payment and billing, order processing and fulfilment and also serve as customer support centres for the clients in their cities. Each office will hire 8 staff – including the office head, 4 Business Development Executives and 3 personnel handling the order processing, payments and fulfilments. The office area will be an average of 100 square meters in a commercial area. The capital investment required for the three branches are estimated based on the economic environment in the three cities. Though the requirements are similar across the branches, the capital investment per branch will differ due to these factors. The initial investment is estimated as shown below: Capital Investment (in US $)   Shanghai Beijing ChongXin Fixed Assets       Furniture & Fixtures $2,800 $2,500 $1,900 Computers (8 each) $4,000 $4,000 $4,000 Printers, Fax, etc.. $1,000 $1,000 $1,000 Total $7,800 $7,500 $6,900 Setup costs $5,500 $3,200 $2,500 Total Cost $33,400 The operation expenses of the branches for the first year will vary based on the city of operation, as the cost of labour, rent and other facilities are dependent on the city’s economic factors. The operation expenses for the first year are estimated as shown below: Operating Expenses (in US $)   Shanghai Beijing ChongXin Cost to Company (Salary)       Office Head (1) $32,000 $28,000 $25,000 Sales Personnel (4) $50,000 $44,000 $40,000 Admin Personnel (3) $36,000 $30,000 $27,000 Total CTC for Employees $118,000 $102,000 $92,000 Rental and Office Costs       Rent for 1 Year $38,400 $34,200 $25,200 Security Deposit $6,000 $5,000 $4,000 Utilities (Phone, Power,..) $2,400 $2,160 $1,800 Total CTC for Employees $46,800 $41,360 $31,000 Total for each Branch $164,800 $143,360 $123,000 Total Operating Costs $431,160 Sources of Funds The total investment required for the operation in three branches in China amounts to $ 464,560. As the interest rates are lower due to the recession and Government’s steps to control inflation, this amount can be financed by long term loans at an annual interest rate of 7.0% APR for 5 years. This amounts to a repayment of ($9,200 * 12) $110,400 per year totally. Break Even Analysis A break even analysis is conducted to compute the minimum sales required to achieve by the three branches so that the company does not incur any losses. The minimum gross profit required to cover the expenses are computed as shown below: Required Gross Profit (in US $)   Shanghai Beijing ChongXin Operating Costs $164,800 $143,360 $123,000 Loan Payment $42,324 $36,611 $31,464 Min. Gross Profit Required $207,124 $179,971 $154,464 Assuming that the cost of goods sold remain at the current levels based on the gross margin of 40%, the additional revenue that has to be raised by the three branches are computed as shown below: Required Sales (in US $)   Shanghai Beijing ChongXin Gross Profit $207,124 $179,971 $154,464 Gross Margin 40% 40% 40% Sales Revenue $517,811 $449,929 $386,160 Total Revenue $1,353,900 It is evident that the three branches have to generate additional sales of $ 1.35 million in 2010 in order to breakeven. It has been estimated earlier, that the three branches are expected to bring in additional sales volume of at least 20 % of current levels which is $ 4 million. It indicates that the company stands to earn a profit of at least $ 2.65 million in the first year of its operations in the three cities. Hence Canada Corporation should invest in the three branches in China. Suggestions and Recommendations: There are two main suggestions that can be made to the Board of Directors. Firstly, the company can work on using the current condition of the markets and capitalize on them by building their stock levels. This will prove to be useful in earning high levels of profits when the demand is high and the supply is low. Also, in the long run, as suggested by one of the leading personalities in the plastic industry, Mr Ashok Goel, one of the important things that need to be kept in mind is that plastic companies should change their mindsets relating to the adoption of best practices. He explains that the industry is such that companies need to ‘start benchmarking the best in class industry or sector to be ready to face any future challenges’ (Plasticopedia, 2010). Canada Corporation Ltd. has a number of possible improvements that can be made to be in track with the current economic condition and to work towards building a stronger competitive advantage in 2010 – 2011. Canada Corporation, the best option for the company will be to merge with another company of equal size. This will help the company expand its operations and will also permit the company to improve its reach to the markets. From the financial analysis, it is evident that the company has a weak liquidity position. The best option for Canada Corporation is to merge with a local company and improve its efficiency of operations. The income of Canada Corporation has been declining over the last three years and hence a merger with another company would help the organization stabilize its operations and improve the overall performance to a great extent (Miller, 2008). This will enable the company’s expansion plans to be fruitful. However there are a few pros and cons for this process as well. The main advantages are that there will be access to the local knowledge and will also be a possibility of government relationships. This will also provide leverage for the established brands and the marketing and distribution channels. However on the negative aspect, there will be high levels of set up costs and differences in the management styles and the culture of the company. There is also a high possibility for conflicts with the Chinese partners as well. By merging with a company of similar size, Canada Corporation will be able to raise the additional capital ($6 million) required for the three branches. The $1 million long term debt can be avoided and hence will result in interest saving of $ 50,000 per year. The costs involved in raising additional equities will be reduced. As the current return on equity is significantly higher than industry norms, Canada Corporation can afford to reduce the return on equity to match the industry standards and thus, save on the cost of raising additional capital. Canada Corporation can also attempt moving into a Wholly Owned Foreign Enterprise (WOFE) or a Joint Venture in the country. Again these also have a number of positive as well as negative aspects. Firstly, the positive aspects are that it will allow the company to have a complete control on the operations and complete management, making it more flexible and also allows a higher commitment to the markets. However the down sides of this form of entry into the market is that there is a high registration capital needed and the company will also be faced with an issue of higher time to gain access to the local knowledge and gain contacts in the markets. With additional selling offices in three new regions, additional business will be created and it is necessary to have effective manufacturing processes and resources to meet the estimated increase in demand. Mergers will also lead to additional customer base of the other organizations and thus increase the market share. The overall performance will also be improved as the organization will be able to balance its operations and finances with the merged organization and the operations together will be more effective. While moving to a new city or market, the company will also have lowered risks as the amount of investment will be spread across the two organizations. Bibliography Beijing, 2010, ‘About Beijing’, Accessed on 27th March 2010, Retrieved from http://www.ebeijing.gov.cn/BeijingInformation/ Changxing, 2010, ‘Changxing Overview’, Accessed on 25th March 2010, Retrieved from http://wwb.zjcx.gov.cn/en/stat/overview.htm Freeland,S., 2007, ‘Mergers and Acquisitions’, 11th January 2007, Accessed on 26th March 2010, Retrieved from http://ezinearticles.com/?Mergers-and-Acquisitions&id=415137 Hutchinson, M., 2009, ‘Who Will Have The Best Performing Economy In 2010?’, 14th July 2009, Accessed on 1st May 2010, Retrieved from http://www.nuwireinvestor.com/articles/who-will-have-the-best-performing-economy-in-2010-53277.aspx Jubak, J., 2010, ‘The coming economic crisis in China’, 14th January 2010, Accessed on 24th March 2010, Retrieved from http://articles.moneycentral.msn.com/Investing/JubaksJournal/the-coming-economic-crisis-in-china.aspx Miller, E.L., 2008, ‘Mergers and Acquisitions: A Step-by-Step Legal and Practical Guide’, 9th January 2008, Wiley Publications Pendlebury, M. & Groves, R., 2004. Company Accounts – Analysis, Interpretation and Understanding, 6th edn, Thomson Learning, London Plastciopedia, 2010, ‘Ashok Goel - President PlastIndia Foundation Chairman & MD - Essel Propack’, 2nd December 2009, Accessed on 25th March 2010, Retrieved from http://www.plastopedia.com/interviews/60-interviews/3063-ashok-goel.html Samuels, J. M., Wilkes, F. M. and Brayshaw, R. E., 2000, Management of Company Finance, 6th edn, Thomson Learning, London Shanghai, 2010, ‘Business’, Accessed on 26th March 2010, Retrieved from http://www.shanghai.gov.cn/shanghai/node23919/node23934/index.html United Nation, 2010, ‘World Economic Situation and Prospects - Statistical Annex’, Accessed on 1st May, 2010, Retrieved from http://www.un.org/esa/policy/wess/wesp.html Appendix – 1 Canada Corporation Ltd. - Balance Sheet December 31, 2009 Assets Liabilities and Shareholders Equity Cash $ 1,000,000 Note payable $ 4,000,000 Accounts receivable $ 5,000,000 Accounts payable $ 2,000,000 Inventory $ 7,000,000 Accrued wages & taxes $ 2,000,000 Fixed assets, net $ 15,000,000 Long-term debt $ 12,000,000 Excess overbook   Preferred stock $ 4,000,000 values of assets   Common stock $ 2,000,000 acquired $ 2,000,000 Retained earnings $ 4,000,000 Total assets $ 30,000,000 Total liabilities & equity $ 30,000,000 Appendix – 2 Canada Corporation Ltd. Statement of Income and Retained Earnings Year Ended December 31, 2009 Net Sales     Credit   $ 16,000,000 Cash   $ 4,000,000 Total   $ 20,000,000 Costs and expenses     Cost of goods sold $ 12,000,000   Selling, general & admin expenses $ 2,000,000   Depreciation $ 1,400,000   Interest on long-term debt $ 600,000 $ 16,000,000 Net income before taxes   $ 4,000,000 Taxes on income   $ 2,000,000 Net income after taxes   $ 2,000,000 Less: Dividends on preferred stock   $ 240,000 Net income available to common stock   $ 1,760,000 Add: Retained earnings at 1/1/2010   $ 2,600,000 Subtotal   $ 4,360,000 Less: Dividends paid on common stock   $ 360,000 Retained earnings at 12/31/2009   $ 4,000,000 Appendix – 3 Canada Corporation Ltd. Ratio Comparison Table No. Ratio 2007 2008 2009 Industry Norms 1 Current Ratio 250% 200% 162.5% 225% 2 Acid-test ratio 100% 90% 75.0% 110% 3 Receivables turnover 5.0 4.5 3.2 6.0 4 Inventory turnover 4.0 3.0 1.7 4.0 5 Long-term debt/Total capitalization 35% 40% 54.5% 33% 6 Gross profit margin 39% 41% 40.0% 40% 7 Net profit margin 17% 15% 10.0% 15% 8 Rate of return on equity 25% 30% 29.3% 20% 9 Return on assets 15% 12% 6.7% 10% 10 NOP rate of return 18.3% 17.5% 20.0% 17.5% 11 Tangible asset turnover 0.9 0.8 0.67 1.0 12 Overall interest coverage 11 9 7.7 10 Read More