Assessment of the Progress of Strang Steel Ltd over the Years of 2003, 2004 and 2005 - Essay Example

Assessment One Assessment of the progress of Strang Steel Ltd in terms of profitability, liquidity and efficiency over the years of 2003, 2004 and 2005: 2003 2004 2005 Profitability Ratios: Gross Profit Margin 73000/228000=0.32 64800/250800=0.26 52680/275880=0.19 Net Profit Margin 38810/228000=0.17 17619/250800=0.07 14124/275880=0.05 Return on Equity 38810/260310=0.15 17169/262179=0.07 14124/259765=0.05 Liquidity Ratios: Current Ratio 76260/25800=2.95 85179/29000=2.94 48815/22300=2.19 Quick Ratio (76260-36400)/25800=1.54 (85179-38612)/29000=1.61 (48815-30889)/22300=0.8 Efficiency Ratios: Avg Collection Period (30360/228000)*365=49days (39660/250800)*365=58 days (14800/275880)*365=20days Inv Turnover in days (36400/155000)*365=86 days (38612/186000)*365=76 days (30889/223200)*365=51 days Total Asset Turnover 228000/342110=0.67 250800/347179=0.72 275880/305065=0.9 Gross Profit Margin: This ratio tells the profit of the firm in relation to sales, after the cost of producing the goods is deducted. Over the three years, the gross profit has been declining showing the inefficiency of Strang Steel's operations. Net Profit Margin: This ratio depicts the profit in relation to sales that a firm earns after taking account of all the expenses and taxes. It tells a firm's net income per dollar of sales. The net profit has also been declining over the three years showing that Strang Steel's sales profitability has declined. This could be attributed to the expenses rising steadily over the three years and eating out of the profits. Return on Equity: This ratio shows the return earned on the funds invested by the shareholders of the company. This ratio is also on the decline over the three years showing that the shareholders are getting less and less of their worth and the company is providing weak investment opportunities. Since all the three profitability ratios have been on the decline, it shows that the management has not been effective in generating profits from year to year. Current Ratio: This ratio measures the firm's ability to meet short-term obligations. It shows the effectiveness of the utilization of current assets to meet short-term liabilities. Strang Steel's current ratio has declined steadily in the three years showing that the current assets are proving less and less useful in meeting the current liabilities and hence the inability of the company to pay its bills. Quick Ratio: This ratio is more conservative in its approach to measuring a firm's liquidity position as it excludes inventories (the least liquid portion of the current assets). This ratio is between currents assets excluding stocks and current liabilities. From the year 2003 to 2004, the quick ratio has increased showing that the firm is efficiently meeting its short-term obligations but from year 2004 to 2005, the ratio has dipped showing the current assets have not been utilized in the proper manner to maintain the rising trend of the previous years. Average Collection Period: This ratio tells us the average number of days that receivables are outstanding before being collected. From the year 2003 to year 2004, the days have risen showing that Strang Steel has a very lenient policy with regard to collecting its receivables and the debtors are taking a long time in paying their dues. Having too many receivables is not good for the money as a lot of money is tied up which could be invested elsewhere. However, from the year 2004 to 2005, the number of days has sharply declined showing the change of the management's policy regarding receivables and the debtors paying up in just 20 days. Inventory Turnover in Days: This ratio illustrates the number of days on average before inventory is turned into accounts receivables through sales. The number of days has declined over the three years showing that Strang Steel has gotten effective each year in turning its inventory into sales. Total Asset Turnover: This ratio shows the relationship of sales to total assets. This ratio has increased over the three years clearly showing that Strang Steel has been effective in generating more and more sales revenue per dollar of the asset investment. The above performance indicators used show that Strang Steel is not operating very profitably and its liquidity position is also not very solid but it is managing to be effective in its operations and staying in the business. It now just needs to reduce its expenses and earn more and more profits. Assessment Two Jan Feb March April May June Sales 90 110 130 190 190 190 Selling price 850 850 850 850 850 850 Dollar Sales 76500 93500 110500 161500 161500 161500 Purchases 130 130 130 150 150 150 Cost Price 600 600 600 600 600 600 Dollar Purchases 78000 78000 78000 90000 90000 90000 (i) Cash Flow Forecast of the first six months of 2006 Jan Feb March April May June Receipts: Opening balance 6420 10420 -580 -69080 103420 10320 Receipt from debtors 81000 72000 54000 76500 93500 110500 Share Capital 200000 Sale of Machine 1500 87420 82420 54920 207420 196920 120820 Payments: Creditors 66000 72000 78000 78000 78000 90000 Admin & Selling exp 11000 11000 11000 26000 28600 28600 Purchase of Machine 35000 Dividend Paid 80000 -77000 -83000 -124000 -104000 -186600 -118600 Cash 10420 -580 -69080 103420 10320 2220 (ii) Strang Steel's year begins with a cash inflow of $10420 in the month of January. However in February, there's a cash outflow because the company receives less from the debtors that were due from the previous years and pays more in amounts owing to others. March also sees a cash outflow because Strang Steel has bought a machine in additions to paying out more and more cash in settling debts. The purchase of machine has put a huge dent in the company's cash position and hence a large amount of cash outflow. In the month of April, Strang Steel shows a large amount of cash inflow. This is due to the fact that the company has issued shares and they are fully paid up resulting in the cash generation. The month of May also shows a cash inflow but very less compared to the previous month because the company is expected to pay dividends in the month of May that will cause the cash to flow out of the company. Strang Steel is expected to have a cash inflow in the month of June but again on the decline because a huge amount is to be paid up for purchases previously made. Strang Steel is expected to have very extreme changes in its cash position from month to month. To avoid this, the company should spread out its receivables and expenses evenly so that drastic positions can be avoided. It should also employ a strict credit policy whereby the debtors pay on time and too much money is not tied up in receivables. Assessment Three 1(i) Contribution/unit: Sales Price -Variable Cost Machine 1 50-25=25/unit Machine 2 50-34=16/unit 1(ii) Break-even point in units: FC/Contribution in units Machine 1 520000/25= 20800 units Machine 2 240000/16=15000 units Breakeven in Sales value: Machine 1 20800*50= $1040000 Machine 2 15000*50=$750000 1(iii) Annual profit at the forecast level of Sales: Machine1 Machine2 Sales 1500000 1500000 Less: Total Cost FC 520000 240000 VC 875000 1190000 1395000 1430000 Profit 105000 70000 1(iv) Maximum annual profit if sales exceed the forecast: Machine 1 Machine2 Sales 1750000 1750000 Less: Total Cost FC 520000 240000 VC 875000 1190000 1395000 1430000 Profit 355000 320000 $'000 Machine 1 Sales Revenue TC 1040 VC Breakeven 520 FC Output 20800 $'000 Machine 2 Sales Revenue TC 750 VC Breakeven 240 FC Output 15000 2. Machine 1 has a high fixed cost, is highly efficient and has a low variable cost. The high fixed cost could be associated with the expensive cost of installing that machine. Since it is capital intensive, less labour is required to operate the machine. Even when Strang Steel will not operate this machine to produce output, it will still have to pay its fixed cost. However, as output will increase the average fixed cost will start falling and will fall throughout. The average variable cost will initially fall, will reach a minimum and start rising once the law of diminishing returns sets in. The profits earned from Machine 1 are going to be high but it's going to be more risky as the breakeven point is at a very high number of units and whenever there is high risk, there is high return. Machine 2 is less efficient with a low fixed cost and a high variable cost. The low fixed could be attributed to the low cost of the machine. Since the machine is labour intensive, a large number of personnel will be required to operate that machine and sufficient training will be required which will add to the variable cost. The profits earned from Machine 2 are less than Machine 1 and the breakeven point is at a low number of units in comparison to Machine 1. Since the breakeven point is reached early that means that this machine is a less risky investment. The directors should go for Machine 2 because it has a low contribution margin and Strang Steel will only have to produce 15000 units when they will achieve breakeven. Anything produced beyond that point would result in profits for the company. Machine 1 should not be chosen because the breakeven is at 20800 units and all output produced less than 20800 units will result in losses for the company. So Machine 2 is a much viable option for Strang Steel as profits will be realized sooner. 3. Advantages of Break-even analysis: Break even analysis tells the owner or managers of the company when they are finally making a profit or loss It is easily calculated and shows profits/losses at varying levels of output. Due to its simplicity, a new business can present a break-even analysis to show it to a bank to get a loan. Break-even analysis also tells whether an increase or slowdown in production is called for. Break-even analysis is a vital part of a business owner's life. Disadvantages of Break-even analysis: Not all costs can be categorized as fixed or variable. It assumes that everything produced is sold. It also assumes that all output is sold at the same price; there are instances when a business has to reduce price to boost sales. Bibliography: Randall, Harold. Advanced Level Accounting. London: Letts Educational Aldine Place. Read More