Breeze House: Current Financial Performance - Essay Example

Table Budgeted Profit and Loss for Breeze House February March April May Budgeted Sales 110,000 160,000 40,000 320,000 Beg Inv 41,250 60,000 15,000 120,000 Purchases 82,500 120,000 30,000 240,000 End Inv 60,000 15,000 120,000 172,500 COGS 63,750 165,000 (75,000) 187,500 Gross Profit 46,250 (5,000) 115,000 132,500 Labour costs 5,500 8,000 12,000 16,000 Expenses 6,000 8,000 12,000 16,000 Total Expenses 11,500 16,000 24,000 32,000 EBIT 34,750 (21,000) 91,000 100,500 Income Tax 10,425 (6,300) 27,300 30,150 Net Income 24,325 (14,700) 63,700 70,350 Table 2 Cash flow for Breeze House with brewery sale February March April May Cash flow from operating activities Cash collections from revenue 72,000 93,000 143,000 110,000 Cash payment for expenses (75,250) (181,000) 51,000 (219,500) Net cash used by operating activities (3,250) (88,000) 194,000 (109,500) Cash flow from investing activities Investments in long term operating assets (12,000) Cash flow from financing activities Increase in long term payables 50,000 Payments on long-term debts (4,792) (4,792) (4,792) (4,792) Dividends (11,000) Net cash provided by financing activities 45,208 (4,792) (15,792) (4,792) Net increase of cash during month 41,958 (104,792) 178,208 (114,292) Beginning cash balance 1,000 42,958 (61,833) 116,375 Ending Cash balance 42,958 (61,833) 116,375 2,083 Table 3 Budgeted profit and loss for Breeze House with brewery sale February March April May Budgeted Sales 110,000 160,000 257,500 320,000 Beg Inv 41,250 60,000 96,563 120,000 Purchases 82,500 120,000 193,125 240,000 End Inv 60,000 96,563 120,000 172,500 COGS 63,750 83,438 169,688 187,500 Gross Profit 46,250 76,563 87,813 132,500 Labour costs 5,500 8,000 24,875 16,000 Expenses 6,000 8,000 12,000 16,000 Total Expenses 11,500 16,000 36,875 32,000 EBIT 34,750 60,563 50,938 100,500 Interests 7,500 7,500 7,500 7,500 Taxable Income 27,250 53,063 43,438 93,000 Tax 8,175 15,919 13,031 27,900 Net Income 26,575 44,644 37,906 72,600 Breeze House Current Financial Performance Report Breeze House’s current financial situation is critical. The company needs to incur a debt of £50,000 in order to have a better cash flow that would be needed for the company’s operating activities. As reflected on the cash flow (see Table 2), the net cash used for operating activities is negative. This is caused by the two factors. First, the revenues generated by the company through its sales will only be accounted after two months of service completion. Second, the accounts receivables of the company is out of control with 10% of sales incurred as bad debts and almost 74% of the outstanding debts have been due for 90 days or more. As a business, the accounts receivables are one the company’s sources of cash. Accounts receivable is like cash in the bank. It shows up as an asset on the balance sheet because it means value in the business. (Muckain, 1998) When looking at the budgeted profit and loss statement of the company (see Table 1), the net income of the company is not stable. This means that revenues and expenses that are incurred for the month are actually revenues and expenses that should have been incurred on a different month. As mentioned, this situation happens because of the long turnover of accounts receivable while the accounts payable are settled within the month. However, the practice of the company of maintaining inventory stocks with a lead time of half of the next month’s demand is commendable, since it is enough to satisfy the demand of the market while preventing over-stocking or under-stocking of inventory. Breeze House needs to improve their current financial performance by increasing their cash flow and controlling the credits to the company or accounts receivable. Implementing Credit Control System Effective credit control is one way of improving the cash flow of the company. A good credit control system increases sales, reduces bad debts and increases profits. The credit control can also increase the creditworthiness of the company and build confidence in the banks. An effective control system focuses on the accounts receivable of the company. (Brealey, Myers, & Marcus, 2001) It is a practice of companies to allow a delay in payment if it cannot demand cash on delivery. However, the customer’s promise to pay for their purchases constitutes a valuable asset (Tracy, 2002). As a valuable asset, credit must be managed properly and promptly. At Breeze House, the company has overlooked the importance of managing its accounts receivable such that they incurred losses in the long run and acquired problems with the cash flow. This paper recommends implementing a credit control system for Breeze House. The implementation program starts by using control points in order to keep track of the accounting receivables. The first control point is verification of all account receivable balances. The transaction must account enough information to allow the verification of such transaction. Information such as sales invoices, cash receipts batches, deposit tickets, bank statements and credit memos. (Muckain, 1998) Second control point is prompt invoicing. Good invoicing habits exhibit good records management and financial reliability for the company. On the other hand, bad invoicing habits delay the payment as well as hurt the company’s financial performance. Even so, bad invoicing creates difficulties for customers. (Muckain, 1998) A good credit control system must provide proof that all invoices have been correctly posted to the customer accounts. A good practice is to have the posting done by a different person other than the person normally responsible for accounts receivable. The third control point is accounts receivable posting. (Muckain, 1998) The next control point is the reporting on receivables. A good credit control system provides regular reports on the state of accounts, identifying delinquent customers and those that have purchased over their credit line. The system must indicate how many accounts have aged and by how much. (Muckain, 1998) Credit entry is another control point in the credit control system. Payment, credit memo and journal entry are ways for the account to be credited. The credit control system should address amounts in disputes, returned items, and errors as well as to write off accounts that are considered uncollectible. (Muckain, 1998) A credit control system is not a good system unless there’s agreement among subledger balances such as general ledger accounts receivable balance, and detailed customer transaction records. Balancing these accounts should be the system’s routine maintenance processes. With all the credit control system proposed to be implemented in the Breeze House Company, it requires a full time bookkeeper and an accountant that would go over the system and manage the accounts receivable. A part time bookkeeper will not have enough time to control the credit and will not have the full commitment of keeping track of records. Furthermore, a full time personnel can improve the proposed credit control system in order to best fit with the company’s transactions. For overdue accounts, this paper recommends a four step method of collecting accounts receivables. First, the company shall attach a notice of overdue account to the statement. Second, authorized personnel shall send a letter asking for settlement of debt. Third, a second or third letter if first is ineffectual. When all else fails, the last resort is threaten legal action through a legal firm. (Tracy, 2002) Collecting receivables is not an easy job. The nature and the financial position of the business of the customers may be some factors that could affect their creditworthiness. A constant reminder through a written notice is necessary in order to allow formality in the transaction as well as keeping record that Breeze House has indeed ask for settlement of the customer’s obligations. The accounting function responsible with managing the accounts receivable must do a fine job in footing and cross-footing the customer’s account. If the collection is still not effective in reducing the accounts receivable and minimizing the bad debts, the company can also hire a collections firm that would quickly clean up the past due accounts. A collections firm can reduce the hassle of collecting overdue accounts as well as free up the accounting function of the Breeze House. (Muckain, 1998) It is also recommended that the company would lower the percentage of bad debts in accordance to industry standards. Also, the company must reserve funds against the inevitable occurrence of bad debts and write offs. The accounting function should include estimating the projected level of bad debt and establishing a separate account of funs to offset the losses. To accommodate the need to accrue bad debts, the company can set up an account based on aging categories or on a certain rate multiplied by sales. A transaction such as records accrual for bad debts, the accountant debits bad debts expense and credits reserve for bad debt expense. When an account receivable fails to materialize, the company reduces the reserve for bad debts and accounts receivable transactions, such that both accounts are lowered. As a proactive measure, customers that have low creditworthiness shall be blacklisted from any transactions from the company until they have settled their debts. Also, authorized personnel should investigate the current financial performance of customers especially for newly acquired customers in order to assess its creditworthiness. If the company waits until a debt goes bad and the customer has gone away, the likelihood of collection is low. It must be another function of a salesperson to take time in qualifying the account, checking bank references, and ensure that the customer is a quality company with a good financial record. The accounting function can help in the collection through timely accurate statements to customers in reminding them about the debt that they owed. Improving Cash Flow and Working Capital Businesses run the risk of sinking funds into the wrong end of the operation and then not having enough cash when it is desperately needed (Drury, 2001). The company must adequately reserve funds for growth especially during the early days of the business. If management hopes for the best but reserve for the worst, they will find themselves in a better position when cash crunches arrive. With the brewery sale, the company can generate additional revenues. However, some policies currently practiced by the company should be changed in order to improve the cash flow. First, the company must require a deposit for the services that the company has offered. With regards to the brewery sale, a deposit of £50,000 would elevate the cash flow of the business. An initial deposit must be required in order to acquire cash needed for operating activities. Even if the brewery sale will have a 4 months credit, the deposit would be helpful in maintaining the solvency of the company (Higgins, 1995). Furthermore, it is recommended that the company set up payment plans with suppliers to pay for all of inventory or at least part of it. In this way, the actual payment for the inventory will be sourced from the fund received from customers paying their bills. Since the aging of the accounts receivable is long, the company must have a payment plan with suppliers at par with the accounts receivable turnover. In this way, the accounts receivable and the accounts payable will at least balance out. Most suppliers can understand that no company can sell without inventory which is similar to the concept that most customers cannot pay cash on delivery. It is imminent that the supplier will understand that Breeze House can pay their obligations shortly after the company has been paid by the customers. A good supplier relationship with a fool proof creditworthiness of Breeze House would ensure that the company can extend its accounts payable as long as both supplier and the company settle on a definite date and agreement. Furthermore, Breeze House can canvass suppliers that offer longer payment and favor them as a priority supplier. Changing suppliers may be necessary in order to improve the cash flow and working capital. Also, keeping a tighter control over the inventory and turn it over as quickly as possible can help improve the cash flow. Although the current inventory level of 50% from the next month’s demand is good, the company may opt to lesser the inventory level by improving the processes and productivity of the business. Another method of improving the cash flow is cutting back on the space that the company occupies. Since the company operates on two sites, renting one site will be very helpful in generating added income for the company. The store warehouse has a rent value of £5,000, renting this space can acquire added revenues that would mean added cash for the company. Even if the cash flow and financial performance of Breeze House is at critical level, the company has several alternatives and options to be considered in order for it to be put back on track. It is important that the management implement the programs effectively in order to assure sustainability for the business. A company without a steady and stable source of cash is a company that does not do business for profit. Works Cited Brealey, R., Myers, S., & Marcus, A. (2001). Fundamentals of Corporate Finance. Boston: McGraw-Hill Publishing. Drury, C. (2001). Management Accounting for Business Decisions (2nd ed.). London: Thomson Learning. Higgins, R. (1995). Analysis for Financial Management (4th ed.). Chicago: Irwin, Inc. Muckain, M. (1998). Finance and Accounting. New York: Alpha Books. Tracy, J. (2002). Fast Forward MBA in Finance. New York: John Wiley & Sons. Read More