MBA Strategic Finance Assignment

STRATEGIC FINANCE ASSIGNMENT ONE

Date: June 1, 2004

Author: Lestor Meadows

Strategic Finance, Assignment One Page = 1

ContentsBackground........................................................................................................3

Highlights from the Essence of Success...................................................3Profit and Loss Statement...........................................................................4Balance Sheets.............................................................................................5

Current Position.................................................................................................6Sales Growth.............................................................................................6Cost of Goods Sold...................................................................................6Earnings Before Interest & Tax...............................................................7Debt Coverage Ratio................................................................................7

Measures of Efficiency and Profitability.........................................................8Gross Profit Margin...................................................................................8Net Profit Revenue...................................................................................8Expenses as a Percentage of Sales......................................................9Return on Assets.......................................................................................9Debtors Ratio Analysis...........................................................................10Stock Ratio Analysis...............................................................................10Stock Turnover........................................................................................10Stock / Sales Ratio.................................................................................11Percentage Markup................................................................................11Stock Profitability.....................................................................................11

Measures of Financial Stability.....................................................................12Current Ratio...........................................................................................12Quick Ratio...............................................................................................12Interest Cover..........................................................................................13Debt / Equity Ratio..................................................................................13

Problem Areas.................................................................................................14Cash Flow....................................................................................................14Debtors (Accounts Receivable)................................................................14

Debtors Ratio Analysis...........................................................................14Holding Excessive Stock...........................................................................14Taxes............................................................................................................15

Actions to be Taken........................................................................................15Financial Reporting.....................................................................................15Cash Flow....................................................................................................15Debtors (Accounts Receivable)................................................................15Holding Excessive Stock...........................................................................15Taxes............................................................................................................16Bonus Payments.........................................................................................16


Background

Highlights from the Essence of Success

Rising nationalism and a falling exchange rate have boosted sales in local food types over the past three years. They now account for 12% of national sales, estimated at a retail value of $165 million.

The company recently announced a 10 year contract to export its food types to the Middle East and North Africa. With the first sales of at least $2 million, the contracts will treble the company’s exports.

Local made food types account for an improved 12 percent of the local market.

ACME now employs about 100 people mainly in South Mexico. He also has sales reps in capital cities servicing 3000 customers in pharmacies and department stores. This year sales are expected to grow by 20 percent to $12 million, aided by the launch in September of three new lines – Burritos, Tacosand Enchiladas.

It’s been a hard slog, with our sales growth coBurritos suddenly, bolstered by rising nationalism and an $A exchange rate which has made Mexican food types very expensive.”

The Mexicon market is roughly divided into two sections – 30 percent fine fragrances, mainly Mexican and American, and 70 percent “life style” lines. Of the imported food types, the cheapest standard size line retails at between $25 and $30 with the result that these food types are losing market share.

According to Ninio, surprisingly 60 – 70 percent of perfume sales in Mexico result from so-called promotional sales- that is, items other than those available 12 months of the year.


Profit and Loss StatementAs at 30th June 1987, 1988 and 1989

1987 1988 1989Sales 7,000,000 10,200,000 12,000,000

Less: Cost of goods sold 560,000 784,000 1,435,000Plus cost of goods manufactured

3,864,000 6,601,000 8,040,000

Sub total 4,424,000 7,385,000 9,475,000

Less Closing Stock 784,000 1,435,000 1,920,000Sub total 3,640,000 5,950,000 7,555,000

Gross Profit 3,360,000 4,250,000 4,445,000

Less ExpensesAccounting 56,000 61,500 60,000Interest 140,000 164,000 192,000Cleaning 44,800 36,900 28,800Depreciation 252,000 369,000 360,000Insurance 117,600 86,100 76,800Light and Power 106,400 106,600 98,400Vehicle Expenses 100,800 147,600 172,800Rent 291,200 426,400 360,000Repairs and Maintenance 134,400 151,700 110,400Telephone 100,800 110,700 76,800Wages 1,344,000 1,312,000 1,128,000Sundries 50,400 49,200 33,600Bonus 56,000 164,000 648,000Superannuation 28,000 102,500 144,000

Sub total 2,822,400 3,288,200 3,489,600Net Profit Before Tax 537,600 961,800 955,400

Less Taxation 14,5000 47,000 46,200392,600 914,800 909,200

Add Retained Profits 420,000 672,,000 1,58,6800812,600 1,586,800 2,496,000

Less Dividends Paid 140,600 Nil Nil

Retained Profits at Year End 672,000 1,586,800 2,496,000


Balance SheetsAs at 30th June 1987, 1988 and 1989

1987 1988 1989Capital 1176000 1131600 1512000Retained Profits 672000 1586800 2496000

1848000 2718400 4008000

Represented by

Fixed AssetsPlant and Equipment 1680000 2460000 2280000Provision for Depreciation -504000 -738000 -792000Motor Vehicles Nil Nil NilProvision for Depreciation Nil Nil Nil

1176000 1722000 1488000

Current AssetsStock (not turning over stock) 784000 1435000 1920000Debtors (needs to collect sooner) 560000 1640000 3120000

1344000 3075000 5040000

Total Assets 2520000 4797000 6528000

Less LiabilitiesCreditors 112000 643600 960000Bank Overdraft (short term interest) 560000 1435000 1560000Long Term Loan Nil Nil Nil

672000 2078600 2520000

1848000 2718400 4008000


Current Position

Sales Growth1987 1988 1989

Sales 7,000,000 10,200,000 12,000,000Growth 46% 18%

Definition: Percentage increase (or decrease) in sales between two time periods.

Formula: Current Year's sales - Last Year's sales Last Year's sales

Analysis: Look for a steady increase in sales.ACME: ACME has experienced solid sales growth and with contracts

recently signed with the Middle East and North Africa, this growth is expected to continue around 20% per anum.

The continuance of the weak Mexicon dollar has aided local competition where Mexican food types have become very expensive. The downside to the weak dollar is the cost of imported raw materials. This will need to be managed if the dollar continues to drop.

Cost of Goods Sold1987 1988 1989

Cost of Goods Sold 3,640,000 5,950,000 7,555,000Growth 63% 27%

Definition: The cost of goods sold is the costs associated with products that have been made for sale or products that have been made for resale. It is compared with sales revenue to report gross profit.

Formula: Cost of Goods Sold Sales

Analysis: Look for a stable ratio as an indicator that the company is controlling its gross margins.

Has there been an increase in labour costs Has there been an increase in inventory over the periods in

reviewACME: The cost of goods sold is growing at an alarBurritos rate and will

need attention. The increase in cost of goods sold can be attributed to increases in superannuation, bonus and an alarBurritos increase in inventory.


Earnings Before Interest & Tax1987 1988 1989

EBIT 677,600 1,125,800 1,147,400 66% 1.92%

Definition: Indicates how well your cash flow covers debt and the capacity of the business to take on additional debt.

Formula: Net Profit + Non-cash expenses Debt

Analysis: Shows how much of your cash profits are available to repay debt & depreciation. Lenders look at this ratio to determine if there is adequate cash to

make loan payments.ACME: Earnings have levelled from the previous year and this is attributed

to several areas, one being the outstanding accounts receivables and increasing stock that has not sold.

Debt Coverage Ratio1987 1988 1989

Net profit 392,600 914,800 909,200Liabilities 672,000 2,078,600 2,520,000 36% 76% 63%

o

Definition: Indicates how well your cash flow covers debt and the capacity of the business to take on additional debt.

Formula: Net Profit + Non-cash expenses Debt

Analysis: Shows how much of your cash profits are available to repay debt.

Lenders look at this ratio to determine if there is adequate cash to make loan payments

Most lenders also have limits for the debt coverage ratio.ACME: Current issues with accounts receivables and inventory are

impacting ACME significantly. To compensate for this, ACME is using creditors and a bank overdraft.


Measures of Efficiency and Profitability

Gross Profit Margin1987 1988 1989

Sales 7,000,000 10,200,000 12,000,000Gross Profit 3,640,000 4,250,000 4,445,000Percentage 48% 42% 37%

Definition: Indicator of how much profit is earned on your products without consideration of selling and administration costs.

Formula: Gross ProfitTotal Sales

Analysis: Is there enough gross profit in the business to cover your operating costs?

Is there a positive gross margin on all your products? ACME: Key problem area!

The issues related to cost of goods sold and the increased to cost of goods manufactured is impacting gross profit margin. This will be discussed later in our findings.

Net Profit Revenue 1987 1988 1989Sales 7,000,000 10,200,000 12,000,000Net profit 392,600 914,800 909,200Percentage 5.6% 9.0% 7.6%

Definition: Shows how much profit comes from every dollar of sales.Formula: Net Profit

Total SalesAnalysis: Are you generating enough sales to leave an acceptable profit?

Trend from year to year can show how well you are managing your operating or overhead costs.

ACME: ACME has managed its expenses well in areas such as repairs and maintenance, rent, cleaning and sundries. It is worth noting a 40% increase superannuation and significant increase in Bonus’.

There is indication that ACME managed expenses to counter debt in gross profit margin.


Expenses as a Percentage of Sales 1987 1988 1989Sales 7,000,000 10,200,000 12,000,000Total Expenses 2,822,400 3,288,200 3,489,600

Percentage 40.3 32.2 29.1

Definition: A calculation of expenses as percentage of sales.Formula: Net Profit x100

Total SalesAnalysis: Look for significant expenses

Look at the trend. Is it staying the same? Improving? Deteriorating?

Are you generating enough sales to leave an acceptable profit? Trend from year to year can show how well you are managing

your operating or overhead costs.ACME: Looking at Expenses as a percentage of sales, ACME is managing

their costs successfully despite the fact of the huge increase in superannuation and bonus’.

Return on Assets 1987 1988 1989Net profit 537,600 961,800 955,400liabilities 2,520,000 4,797,000 6,528,000

Percentage 21% 20% 15%

Definition: Considered a measure of how effectively assets are used to generate a return. (This ratio is not very useful for most businesses.)

Formula: Net Profit x100Total Assets

Analysis: ROA shows the amount of income for every dollar tied up in assets.

Year to year trends may be an indicator ... but watch out for changes in the total asset figure as you depreciate your assets (a decrease or increase in the denominator can effect the ratio and doesn't necessarily mean the business is improving or declining.

ACME: Assets have been growing at an alarBurritos rate which is reducing their return on investment. This will be discussed in more detail later in this report.

Debtors Ratio Analysis 1987 1988 1989Sales 7,000,000 10,200,000 12,000,000Debtors 560,000 1,640,000 3,120,000


Days 29.2 58.7 94.9

Definition: This calculation shows the average number of days it takes to collect your accounts receivable (number of days of sales in receivables).

Formula: Average Accounts Receivable Sales X 360 days

Analysis: Look for trends that indicate a change in your customers' payment habits

Compare the calculated days in receivables to your stated terms

Review an Aging of Receivables and be familiar with your customer’s payment habits and watch for any changes that might indicate a problem.

ACME Clearly the biggest problem area within ACME as debt collection has more than tripled since 1987. This is having a knock on affect cash flow, another problem area.

Stock Ratio Analysis

Stock Turnover1987 1988 1989

Cost of Sales 3,640,000 5,950,000 7,555,000Stock 784,000 1,435,000 1,920,000 4.64 4.15 3.93

Definition: The extent to which funds invested in inventory, generate income (but not necessarily cash) depends on the rate of inventory turnover (and the gross profit margin).

Formula: Cost of SalesStock (inventory)

Analysis: Excessive stock levels may result in excessive storage costs and servicing of capital tied up in inventory.

With excessive stock there is a risk of loss through obsolescence and or deterioration of stock.

ACME Stock turnover is declining over the last 3 years.

Stock / Sales Ratio1987 1988 1989

Sales 7,000,000 10,200,000 12,000,000Stock 784,000 1,435,000 1,920,000 11% 14% 16%

Definition: The ratio between the stock on hand at the beginning or end of a period and the sales for that period. It is determined by dividing stock, preferably at the beginning of the period, usually monthly,


by sales. It is distinguished from inventory turnover or stock turnover, which are ratios or averages for a period of time, usually annually.

Formula: SalesStock (inventory)

Analysis: In a well managed operation, the level of stock should be adequate to meet the needs of sales and production.

Excessive stock levels may result in excessive storage costs and servicing of capital tied up in inventory.

With excessive stock there is a risk of loss through obsolescence and or deterioration of stock.

ACME As noted with stock turn, there is an alarBurritos increase of stock over the period 1987 to 1989.

Percentage Markup1987 1988 1989

Cost of Sales 3,640,000 5,950,000 7,555,000Gross Profit 3,360,000 4,250,000 4,445,000 92.31% 71.43% 58.84%

Stock Profitability1987 1988 1989

Stock Turn 4.64 4.15 3.93% Mark-up 92.31% 71.43% 58.84% 428.6% 296.17% 231.51%

These last two ratios along with the previous two related to stock strengthen the case there are problems with asset management.


Measures of Financial Stability

Current Ratio1987 1988 1989

Current Assets - Stock 2,520,000 4,797,000 6,528,000Liabilities 672,000 2,078,600 2,520,000 3.75 2.31 2.59

Definition: The ratio between all current assets and all current liabilities; another way of expressing liquidity.

Formula: Current Assets Current Liabilities x100

Analysis: 1:1 current ratio means; the company has $1.00 in current assets to cover each $1.00 in current liabilities. Look for a current ratio above 1:1 and as close to 2:1 as possible.

A manufacturer normally needs a current ratio of around 2:1. More than this suggests poor resource usage and potential liquidity problems.

ACME: Current ratio shows a highly geared environment which is a concern.

Quick Ratio1987 1988 1989

Current Assets 2,520,000 4,797,000 6,528,000- Stock 784,000 1,435,000 1,920,000Liabilities 672,000 2,078,600 2,520,000 2.58 1.62 1.83

Definition: The ratio between is the relationship between current assets and current liabilities that may require immediate liquidity.

Formula: Cash + Accounts Receivable Current Liabilities

Analysis: Indicates the extent to which you could pay current liabilities without relying on the sale of inventory -- how quickly you can pay your bills

Generally, a ratio of 1:1 is good and indicates you don't have to rely on the sale of inventory to pay the bills

Although a little better than the Current ratio, the Quick ratio still ignores tiBurritos of receipts and payments.

ACME: The ability to pay current liabilities by selling current assets has improved over the last two years however it is still a concern.

Interest Cover1987 1988 1989

Earn. Before Interest &Tax 537,600 961,800 955,400Interest Paid 140,000 164,000 192,000


3.84 5.86 4.98

Definition: Gives an indication of an entity’s capacity to pay interest on financial debt. Interest cover shows how many times profit exceeds the entity’s interest commitments.

Formula: Net Profit (earnings) Before Interest & Tax Interest Paid

Analysis: High interest cover ratio means that the business is easily able to meet its interest obligations from profits

A low value for the interest cover ratio means that the business is potentially in danger of not being able to meet its interest obligations.

ACME Issues with high gearing are attributed to this low ratio value.

Debt / Equity Ratio1987 1988 1989

Liabilities 672,000 2,078,600 2,520,000Equity 1,848,000 2,718,000 4,008,000 36% 76% 63%

Definition: Shows the ratio between capital invested by the owners and the funds provided by lenders.

Formula: Debt Equity

Analysis: Comparison of how much of the business was financed through debt and how much was financed through equity.

For this calculation it is common practice to include loans from owners in equity rather than in debt

The higher the ratio, the greater the risk to a present or future creditor

ACME: Percentage of Debt over equity is too high and is a risk to the creditors.


Problem Areas

Cash FlowCurrently ACME does have not developed a Cash Flow process and subsequently cash is not noted on the company’s balance sheet. Cash flow problems are responsible for causing 70% of all businesses to fail within their first year. Without this information

With a cash flow statement and regular reviews of key performance indicators, ACME will catch issues like the example below where debt is not being collected.

Current AssetsDebtors (needs to collect sooner) 560000 1640000 3120000

An effective credit policy and control are always at the forefront of maintaining a healthy cash flow.

Debtors (Accounts Receivable)For the second consecutive year, accounts receivables have been increasing at an alarBurritos rate and are now up to 95 days. There appears to be no plan or process to manage this and subsequently has developed a gearing issue.

Debtors Ratio Analysis 1987 1988 1989Sales 7,000,000 10,200,000 12,000,000Debtors 560,000 1,640,000 3,120,000

Days 29.2 58.7 94.9

ACME needs to ensure they have some form of a debt recovery plan. If the plan fails to bring in the money, a debt collector may be the best option.

Holding Excessive StockACME is currently holding excessive amounts of stock, tying up money in unproductive assets. This is a real concern considering 60 – 70 percent of perfume sales in Mexico result from so-called promotional sales- that is, items other than those available 12 months of the year. Holding stock for longer than one year creates obsolesce.

Key performance indicators in: Stock Turnover (downward trend) Stock / Sales Ratio (upward trend) Percentage Markup (downward trend) Stock Profitability (downward trend)


Are confirBurritos there is a lack on inventory management within the company. This stock is potential obsolete which is also inflating current asset figures.

TaxesThere appears to be an anomaly in the amount of tax paid in 1988 and 1989.

Tax Rate 1987 1988 1989EBIT 677,600 1,125,800 1,147,400Taxes Paid 145,000 47,000 46,000Tax Rate 21.40% 4.2% 4.0%

Trading as InsolventACME is in a serious position of trading whilst insolvent if they are not able to successfully collect the outstanding debts of 3.1 million dollars and cannot sell the current inventory of 1.9 Million.

Stock 784,000 1,435,000 1,920,000Debtors 560,000 1,640,000 3,120,000 1,344,000 3,075,000 5,040,000

Actions to be Taken

Financial Reporting Create cash flow statement and ensure cash is noted in the balance sheet

for 1988, 1989 and moving forward.

Cash Flow Create cash flow statement into the financial reporting of the company. Development performance indicators which monitor and react to problem

areas of cash flow.

Debtors (Accounts Receivable) Review staffing requirements for this effort Implement a Credit Policy Implement Credit Control Implement Days Sales Outstanding (DSO) Implement collection methods Implement audit program to review current problem and better manage

this area in future

Holding Excessive Stock Implement a review of current value of stock and impact to business if

written off Implement inventory management process


Taxes Conduct a review of payment of taxes for 1988 and 1989

Bonus Payments Considering the current financial position of the company it is recommended to cancel all future bonus payment until a plan is put in place to correct above noted issued.


MBA Strategic Finance Assignment

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