Financial Management - Jools Furniture Industries Ltd - Case Study Example

 Table of Contents Table of Contents 0 Introduction: 1 Analysis of Current Financial Performance: 1 Suggestions for Improvement: 9 Role of Financial Director 11 Current Systems and Role: 11 Possible Improvements: 13 Sources of Finance 17 Loans and Alternative Options 17 Introduction: Jools Group has been in the market since 1990. The company over the years has grown and developed its various divisions. The main aim of this paper is to analyse the company and to make a brief analysis of the company’s current position. The paper also focuses on the current role of the financial manager and based on the analysis a detailed discussion for improvements has been included. The paper also assesses loans for the investment proposal and two suitable alternatives have been discussed. Analysis of Current Financial Performance: Ratio analysis has been used here to identify the company’s position in terms of the profitability, efficiency, liquidity and financial structure. (Drury, 2005) Here the paper analyses the financial results of the four divisions over the past three years, based on which the business improvements in terms of the aid planning, control and performance management in the future have been discussed. The results are as discussed below: Profitability: Based on the profitability ratios, it has been noted that the Quality Product Division has seen an improvement in terms of the net profit margins. The company has moved from a loss to a profit of almost 3.36% which shows growth. Also the Return on Equity has also grown from a negative result in 2007 to almost10% which is close to the company’s required rate of return. The gross profit margin for the company however has been stable. Quality Products Division Profitability 2009 2008 2007 Gross Profit Margin 41.37 % 40.45 % 38.91 % Net Profit Margin 3.36 % 1.98 % -9.90 % Return on Equity 9.99 % 5.63 % -26.30 % In the case of the Kitchen Division, again the gross profit margin has more or less remained constant while there has been a drop in terms of the net profit margin and the return on equity. There has been a gradual decline in all the ratios which indicates the need for higher efforts in the Kitchen division to gain higher profitability as well as operational efficiencies (Garrison, Noreen, & Brewer, 2009). Kitchen Division Profitability 2009 2008 2007 Gross Profit Margin 37.61 % 36.20 % 39.22 % Net Profit Margin 3.51 % 3.27 % 4.97 % Return on Equity 11.54 % 11.65 % 16.73 % The Bedrooms and Office Divisions on the other hand have seen constant increase and decline in each of the ratios. In the case of the Bedroom Division it is important that the management increases the funding to the division to help raise the level and improve the performance (Gitman, 2008). Bedrooms Division Profitability 2009 2008 2007 Gross Profit Margin 29.78 % 31.44 % 26.37 % Net Profit Margin 3.22 % 3.27 % 2.48 % Return on Equity 11.86 % 13.35 % 12.85 % The Office Supplies Division although new has shown excellent performance here and the results have shown stabilized profitability. The company however needs to ensure that enough investments and attention is given to the division to help keep up the performance (Jiambalvo, 2009). Office Supplies Division Profitability 2009 2008 2007 Gross Profit Margin 36.97 % 33.64 % 38.90 % Net Profit Margin 4.86 % 4.64 % 5.53 % Return on Equity 13.38 % 12.05 % 13.55 % On the whole, the Kitchen’s Division requires attention to assist in improving the current profitability levels. Efficiency: The efficiency ratios indicate the level of revenue generated by the assets and the rate of return from these assets. The efficiency ratios of the quality products division is presented below: Quality Products Division Efficiency 2009 2008 2007 Return on Assets 13.33 % 12.58 % 1.83 % Asset Turnover 1.03 x 0.99 x 0.87 x It is evident that the return on assets has increased steeply over the last three years from 1.83 % to 13.33 % in 2009. However the revenue generated by the assets are almost constant in the last two years. In the case of the kitchen division (as depicted in the following table), the assets are more effectively utilized to generate higher revenues (2.19 times the assets in 2009). Moreover the return from the assets is also higher. Kitchen Division Efficiency 2009 2008 2007 Return on Assets 16.15 % 16.10 % 20.60 % Asset Turnover 2.19 x 2.29 x 2.14 x Comparatively the bedrooms division has the lowest return on assets (8.49 % in 2009). From the ratios, it is evident that the efficiency of the division has been steadily declining over the years. It is essential that the revenue stream from this division does not decline further as it will heavily affect the effective utilization of the assets (Samuels, Wilkes, & Brayshaw, 1995). Bedrooms Division Efficiency 2009 2008 2007 Return on Assets 8.49 % 9.28 % 9.12 % Asset Turnover 1.66 x 1.78 x 2.09 x The efficiency ratios of the office supplies division clearly indicate that it is relatively the most efficient division within the company. The asset turnover is significant at 2.10 and exhibits a growing trend (Samuels, Wilkes, & Brayshaw, 1995). The return on assets is also significant at 24.42 % which is significantly higher than the other divisions. Office Supplies Division Efficiency 2009 2008 2007 Return on Assets 24.42 % 23.90 % 25.99 % Asset Turnover 2.10 x 1.90 x 1.68 x Liquidity: The Quality division has shown a significant improvement in terms of the current ratios and the acid test ratio however in terms of the stock turnover, debtor days and creditor days, the division has shown a major decline. Quality Products Division Liquidity 2009 2008 2007 Current Ratio 1.33 x 1.09 x 1.13 x Acid Test Ratio 0.63 x 0.47 x 0.59 x Stock Turnover 113.84 days 99.51 days 104.85 days Debtor Days 42.69 days 27.58 days 43.54 days Creditor Days 36.09 days 47.25 days - The Kitchen division has had a major increase in terms of the current ratio and the acid test ratio; however there has been an increase in terms of the stock turnover and debtors days to a great extent as well. Kitchen Division Liquidity 2009 2008 2007 Current Ratio 2.02 x 1.56 x 1.52 x Acid Test Ratio 0.99 x 0.78 x 0.83 x Stock Turnover 70.97 days 59.08 days 63.11 days Debtor Days 37.89 days 31.82 days 30.14 days Creditor Days 24.35 days 28.12 days - Although all of the divisions have shown steady improvements in terms of the current ratio, the office supplies have been faced with a steady decline in terms of the acid test ratio. Each of the divisions has shown varying results in terms of the stock turnover however due to the nature of the business, the office supplies show the best results as compared to the rest (Gitman, 2008). Bedrooms Division Liquidity 2009 2008 2007 Current Ratio 1.27 x 1.22 x 1.17 x Acid Test Ratio 0.59 x 0.50 x 0.53 x Stock Turnover 117.27 days 121.02 days 91.19 days Debtor Days 61.63 days 51.37 days 45.75 days Creditor Days 92.45 days 65.52 days - The bedroom division although has been able to improve the current ratio and acid test ratio steadily over the last three years, there has been a major slip in terms of the debtor days and the stock turnover and it has been noted that the division has seen a significant increase in these areas. Office Supplies Division Liquidity 2009 2008 2007 Current Ratio 1.49 x 1.44 x 1.31 x Acid Test Ratio 0.69 x 0.71 x 0.73 x Stock Turnover 39.77 days 42.64 days 50.16 days Debtor Days 18.17 days 21.14 days 29.91 days Creditor Days 49.35 days 44.76 days - Of all the four divisions, the Kitchen Division has shown the highest and healthiest current ratio and Acid test ratio, while the Office Supplies has shown the best stock turnover ratio (Drury, 2005). In terms of the debtor days, the office supplies has the best and lowest time while the bedroom division has been able to keep the creditors days as the highest among the four divisions. In terms of the overall liquidity, the Office Supplies has proven to be the best performing team. The division has a high current ratio (1.49), and also a significant acid test ratio, along with an excellent stock turnover period as well. Hence as compared to the rest of the divisions, the Office Supplies proves to be the best performing in terms of liquidity (Samuels, Wilkes, & Brayshaw, 1995). Financial Structure: The quality products division is the highly geared one in the company. About 62 % of the division’s capital is secured from borrowings. The gearing has been almost constant over the last three years. However the interest cover has risen significantly in 2008 & 2009 as shown in the following table. Quality Products Division Financial Structure 2009 2008 2007 Gearing 61.91 % 60.83 % 62.24 % Interest Cover 2.11 x 1.53 x -1.32 x The kitchen division has significantly lower borrowings and hence the financial leverage is lesser than 10 % in 2009 (refer the following table). Moreover, the interests payable are also lower. Hence the division exhibits a healthy interest cover from its profit before interest and taxes. Kitchen Division Financial Structure 2009 2008 2007 Gearing 8.63 % 10.93 % 7.77 % Interest Cover 10.48 x 10.54 x 14.42 x Though the bedrooms division does not have any long term loans, its short term debts are relatively higher. Hence the gearing ratio is around 24 % in 2009 as shown below. The interests payable on the short term loans are normally higher due to the urgency involved in securing the short term debts (Graham, Smart, & Megginson, 2009). Hence the interest cover is lower than that of the kitchen division in spite of the absence of long term debts. Bedrooms Division Financial Structure 2009 2008 2007 Gearing 23.45 % 29.56 % 35.13 % Interest Cover 5.30 x 5.08 x 3.41 x In 2007, the office supplies division had a relatively higher debt as it was newly formed. However more equity has been added to the division in 2008 & 2009 and this has led to a significant decline in the gearing ratio. The division also has a very high interest cover. It is evident that the division is not fully utilizing its borrowing power (Garrison, Noreen, & Brewer, 2009). Office Supplies Division Financial Structure 2009 2008 2007 Gearing 0.33 % 1.12 % 14.99 % Interest Cover 135.13 x 64.37 x 7.01 x Suggestions for Improvement: It is evident from the current scenario that the office supplies division has been penalized for being relatively new. However, it is imperative to note that the profitability of the division is significantly higher. The net profit margin indicates that the division has the highest operational efficiency in the company. The efficiency in utilizing the assets to generate revenue and the liquidity position are also superior when compared to the other divisions. The division is performing well above the other sections financially. Hence it is evident that the current performance appraisal solely based on rate of return is not effective. A more holistic approach should be adopted and the directors should be rewarded based on the overall financial performance of the various divisions. As required by the chair person, all the divisions currently provide a return higher than 10 %. However, the profits from the quality products division have been unsteady over the last three years, mainly due to varying expense levels and income from overseas markets. The quality products division is a major income source for the company and hence it is essential that there are no liquidity issues in the day to day operations. The acid test ratio indicated that there is room for improvement. Hence the division should focus on reducing its work in progress and inventory levels, in order to improve the liquid assets in hand. The stock turnover evidently is higher for the quality products division. The bedrooms division has to focus on reducing the stock turnover (number of days required to move inventory to sales). Though the division has a favorable creditor days figure, the time taken to collect debts is relatively on the higher side. Hence the debt collection policy of the division needs to be revised. The kitchen division, on the other hand, has maintained a healthy balance of the debtor and creditor days. Overall, the liquidity position of the kitchen division is better than that of the bedrooms division. Regarding the capital structure, more equity has to be directed to the quality products division in order to maintain a healthy gearing ratio of 50 %. This will improve the confidence of the potential lenders. On the other hand, the office supplies division is not effectively utilizing its borrowing power. As the demand for the office supplies is currently high, the division should exploit the demand to the highest possible extent and improve its market share. Hence the office supplies division should seek a long term loan from the management in order to expand its operations. Role of Financial Director The financials of Jools is managed by David Green. The following sub sections will detail the current system and role of Green within the company. Also based on the information provided, a detailed discussion of the possible improvement that can be made has also been included below. Here elements like planning, control and performance as well as management have been included. Current Systems and Role: David Green is currently responsible for the financial aspects of the business, since he lacks the flair and vision for the business like Julius Smith – Brown. Both Smith –Brown and Green work as co directors, and since Smith – Brown has inherited wealth, he has tends to take a number of vacations leaving David in charge of the day to day activities within the company. David is strong, reliable and is well versed with the complex financing of the company. The company currently uses a very complicated financing system. The company presently has been noted to use a different approach towards the performance measurement within each division. Here the performance of the divisions are checked based on the basic criterion of meeting a target of 10% of the return on investments, over and above which are given as bonus to the employees. However there are numerous loop holes in this method of control and performance management. David’s role within the organisation is not only to manage the loans and finances of the various divisions but also on the checking for the performance of the divisions as well. Since Julius Smith-Brown the Chair of the company although has a strong business sense and excellent vision for the company, tends to be on extended exotic vacations this leaves David Green with the responsibility of the day to day business. David although strong and reliable lacks on the business flair and vision which in turn impacts the decision making to a great extent. Here there are a number of loop holes in the current role that David fulfils for the organisation. For instance, although he is responsible for the performance management of the various divisions, it is evident that the approach being adopted by the company is inaccurate and inconsistent to a great extent. Also in terms of the aid planning, David is required to go through the requests that each division puts in for the long term loans. Here again this approach being used is not the most effective manner of dealing with the financial aspects of the company. Based on the current role that David Green plays in the company, there is clearly a need for bettered approaches to the financing of the company as well as the performance management of the company. Also the laissez-faire form of management being adopted by the company clearly requires changes to help improve the overall performance of the company as well. The following section details the areas where the improvements can be incorporated. Here a set of approaches and techniques have also been included to gain better overall performance, management and also aid planning. Possible Improvements: There are currently a number of areas in the company’s activities which need to be improved to gain a higher and better overall performance for the group. Firstly, in terms of the control and performance, it is crucial for David to conduct regular meetings with the heads of each of the divisions, i.e. Kitchen, Bedroom, Quality and Office. Keeping track of the divisions will help the company focus more on the overall objectives of the group and will help make a well directed approach for the company. In terms of the management of the organisation, the company currently uses the laissez-faire form of management, here although this approach provides the managers a free reign to manage the company as they seems fit, this method does not form the best and most appropriate approach to managing the company. This method tends to leave the company steer in various directions as per the views of the managers and division heads. Here this can lead to issues like moving away from the main aims and objectives of the group as well as having each division pull in different directions. This clearly is not an effective manner of dealing with the overall management of the organisation. It is crucial that the company goals and objectives are the same and all divisions follow the same goals, aims and objectives. Furthermore about this aspect of the role has been discussed in the following paragraphs. Recommendations to improve this situation have also been discussed further. Also, in the current time, the company deals with each division separately as separate entities and the focus of the each division is to ensure that the target met is ten percent of the return on investments. This is a performance evaluation factor for the divisions and the employees. However it is crucial to note that using this form of performance measures are very misleading and cannot be considered to accurate measures of performance (Dessler, 2007). Firstly, the use of this as a measure for performance can prove to be inaccurate. This method is effective for departments and teams which are already well established. Here taking into consideration the Office supplies department, it is the newest division and hence, the possibility of achieving the target of 10% on return on investments can prove to be very difficult (Johnson, Scholes, & Whittington, 2006). All departments in the starting stages are bound to have more number of losses and expenses than profits or revenues. Considering this, it is clear that despite the best efforts of Giles Granger and the team, there are little chances that the division can met the level, this however does not mean that the performance of the team is low. The start up costs tends to take up a great deal of the revenues of the division. Hence while the company uses 10% on return on invest as the mark of performance, this clearly cannot judge the performance of the company and clearly can lead to inaccurate results. Hence it is essential that finance director here implements a newer system of performance management. This can include elements like focusing the business towards the three R’s of business, i.e. everyone doing the Right thing and doing them Right at the Right time (Walton & Deming, 1988). These form a more important part of the business rather than mere numbers and returns on investment. It is common that the companies use a number of strategic plans, policies and also goals which provide an insight into the intent and goals of the company, however it is crucial that the management system practices are well aligned within the organisation and that these plans and management styles improve the overall company (Beer, Lawrence, Mills, & Walton, 1985). Here it is evident that the company operates as separate entities and only in times if financial elements the divisions get in touch with the main office. It is crucial that the finance manager focuses on developing more regular meetings and discussions (weekly or monthly) with each of the division heads and help ensure that all divisions are focused towards the same objectives i.e. those of the group (York, 2009). It is important that the performance is monitored in terms of the groups rather than the divisions individually. The company can adopt the Deming’s circle of Plan – Do – Check – Act, which is a never ending circle. This will help ensure that the employees and every division have a clear and focused objective to work towards (Latzko & Saunders, 1995). Also this ensures that the company has a well updated and involves constant improvements at all times. Hence it is crucial that David implements a better performance management system within the company to help identify the performance of the divisions both individually as well as together. Also, in terms of aid planning, the finance director needs to work in close relation with the rest of the directors like human resources, marketing, and heads of all the divisions. This will help gain a more rounded view of the company. Also the decision making, keeping all sections of the company in focus makes the decision more informed. On the whole, it is recommended that David Green focuses on developing more interaction among the directors and the heads of each division to help and assist in better overall performance of the group as a whole. Following this technique will also assist the company in better planning and will assist in working together towards the aims and objectives of the group as a whole. Developing a system where the company uses The Baldrige Criteria for Performance Excellence can allow the company to improve the overall effectiveness of the company as well as can help encourage employees to perform better as well (Brown, 2008). This criterion focuses on a wide range of aspects of the company including leadership, strategic planning, costumer focus, measurement and knowledge management, workforce focus, process management and results (Baldrige National Quality Program, 2010). The use of this will prove to be very beneficial as it allows the company to gain a well rounded approach to decision making keeping several elements in mind. Also, since this approach does not only focus on the results alone, this will prove to be fair and an ethical approach towards all the divisions irrespective of the time period that the divisions have been functioning (Latham & Vinyard, 2009). Also, with this approach, the efforts of the divisions and teams will be recognised instead of only focusing on the overall results. The main improvement for the company needs to be focused on control and performance management. This will help provide ensure that the group is more effective and the performance is better within the group. Hence it is important for David Green as the Financial Director to take up the role of implementing the Baldrige approach. This will prove to be very beneficial for the company as it is a non prescriptive approach and is one which does not tell organisations how the processes need to be, but is focused on what the organisations need to do for better performance. Leaving the choice to the organisation based on the culture and goal (Grizzell, 2004). Hence this will prove to be very beneficial for Jools Groups. Sources of Finance Jools Furniture has a number of options to raise funds required for the projects. These sources can be broadly classified into short term and long term sources of finance. Long term sources of finance, as the name indicates, are required over longer periods of time (any duration that is above 1 year) whereas short term source of finance that are required within a period of one year. There are three main long term sources of finance for Jools Furniture, namely, share capital, debentures, long term loans, bank overdrafts and trade credits. Loans and Alternative Options Loans from banks and other sources are the easiest ways to raise a large amount of capital. Obtaining higher amounts of long term loans will be easier for Jools furniture as the business is well established and is making profits. However, the interest payable might be high (as it is spread over a long period of time). Hence a high interest cover should be available for the company, in order to ensure interest payments in times of a financial crisis. Increasing the long term liabilities will increase the gearing ratio (Burke and Wilks, 2007). This coupled with sustaining a high interest cover will indicate the company’s vision of long term growth and expansion. Utilizing loans for the company proves to be very helpful and effective. This can assist the company deal with the current liabilities and can also provide the company with easier access to the overall better revenues and higher company profits. Another major advantage of using loans for the company is more financial freedom and the debt obligations remains only as far as the loan payments. Businesses can also be rest assured that no further claims can be made on the business. Here it also helps in enhancing the credit rating of the company which provides better assistance in future financings as well. This is also a relatively simpler mode to administer and this does not involve complex reporting or any other aspects like equity financing. This helps the business to a great extent in the long run as it proves to be a cheaper option. However in the short term this is an expensive option for the company. A major disadvantage of this method however is the need for the monthly payments of the principle as well as the interest. In the case of Jools the company has a benefit that it has been set up and is not a young company with lack of cash flows. The pressure of the repayment is high and failure to make payments can spoil the credit rating of the company to a great extent. Also, another major disadvantage here is that banks can ask for collaterals to provide loans. Considering the advantages and disadvantages of loans, the following alternatives have been suggested for the company. The two alternative sources of funding that the company can use for the project include Enterprise Finance Guarantee and loans from commercial banks. Jools has a wide range of loans that the company is eligible to take up. These include the loans from the commercial banks. This forms an excellent option for Jools Furniture as it provides the company with a chance to have a flexible option where the loan can be repaid whenever the need is met, also since the loans are mostly for definite periods, the burden is not permanent and also a cheaper means of generating funds. Loans do not give the banks any rights to interfere in the business and thereby will permit Jools to have complete control of the company (Drury, 2005). Also, with the easy instalments system, the company will not feel too much pressure for paying back the loans. Several banks like HSBC and Citibank provide companies with a wide range of options including tailor made loans as per the needs of the company. The second alternative for the company is an Enterprise Finance Guarantee. This is a government loan guarantee scheme which is provided to companies in order to support the company for working capital requirements and investment funding. As explained by Department for Business Enterprise & Regulatory Reform, “Subject to all eligibility criteria being met, the Enterprise Finance Guarantee (EFG) will provide a 75% government guarantee to the Lender, thus giving them the confidence to lend to the business” (Department for Business Enterprise & Regulatory Reform, 2011).This form of funding is available via number of banks like HSBC. This allows the company to gain loans and investments for businesses which would normally be declined, for several reasons including lack of security. Also, as explained by Department for Business Enterprise & Regulatory Reform, “Conversion of part or all of an existing utilised overdraft into a term loan in order to release capacity in the overdraft to meet on-going working capital requirements (working capital funding)” (Department for Business Enterprise & Regulatory Reform, 2011). On the whole this will provide Jools with an excellent choice of funding opportunity. The company will be required to pay for the regular interest and capital payments along with an arrangement fee and a premium to the Department for Business Enterprise & Regulatory Reform (BERR). The needs to pay a premium totalling to approximately 2% per year of the total outstanding balance of the loan and is payable quarterly (Department for Business Enterprise & Regulatory Reform, 2011). Bibliography Baldrige National Quality Program. (2010). Baldrige. Retrieved February 10, 2011, from http://www.baldrige.nist.gov/PDF_files/2009_2010_Business_Nonprofit_Criteria.pdf Beer, M., Lawrence, P., Mills, D. Q., & Walton, R. E. (1985). Human Resource Management: A General Manager’s Perspective. Glencoe, IL: Free Press. Brown, M. G. (2008). Baldrige Award Winning Quality: How to Interpret the Baldrige Criteria for Performance Excellence. Productivity Press. Burke & Litwin. (1992). A Causal Model of Organisation Performance and Change. Journal of Management , 523–545. 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