ASSESSMENT TWO: S7 – S10

Accounting, learning and online communicationJessica Hall12143734 | CQU

Step 7: Contribution Margin

Throughout my journey in ACCT1159 I have learnt a lot about Schaffer Corporation. As a

firm, Schaffer is extremely diverse in their services and operations as you can explore here:

https://accjourneywithjess.wordpress.com/2020/03/24/my-firm/. In choosing my three

products, I wanted to reflect this diversity. One major area of Schaffer’s operations is in

Automotive Leather, selling quality leather to car manufactures. Another area is Schaffer’s

sale of precast products. I have chosen two of these, one being the Deltacore Concrete Plank

and the other being DeltaFLOOR precast concrete flooring. My three products are as listed

below:

1. Division: Automotive Leather (83% owned subsidiary)

Product: Automotive Leather

2. Division: Building & Construction, Delta Corp (Precast Products) –

Product: Deltacore precast concrete plank

3. Division: Building & Construction, Delta Corp (Precast Products) –

Product: DeltaFLOOR precast concrete flooring

Selling price

1. Automotive Leather

Schaffer manufactures and sells their own leather. However, I could not find a real

selling price for this product. After some research and, learning how leather is made, I

found an average price for leather per square meterage. The price for each leather unit

is therefore $70.00.

2. Deltacore Concrete Plank

Deltacore concrete planks are usually made at 1.2m wide and can be any length. Sticking

with an estimated length of 7metres. This would put our fictional plank at 8.4 SQMTRS.

For the sake of this assessment, based on some internet research on hollow pre-cast

concrete planks, the price can vary considerably per SQMTR ordered for the concrete.

These can be a bit thicker than our DeltaFLOOR products. I am going to price them at

$100.00 a SQMTR. With all considered, the approximate fictional price per plank is

$840.00.

3. DeltaFLOOR

Similar to the Deltacore plank, I will be pricing the flooring at $75.00 a SQRMTR * the size

of the slab, in this case 11SQRMTRS. The DeltaFLOOR slab is fictionally priced at $864.00.

Variable costs:

The variable costs are similar as all three products are manufactured by Schaffer (not simply

purchased and sold). However, the percentages of variable costs are lower for the automotive

leather division when compared to the pre-cast concrete structures; as leather can be mostly

processed by machinery. In addition, it is important to note that for all three products staff

labour is often considered a variable cost. Each product does require human intervention to

be manufactured. This means when the volume of product increases, human labour must also.

1. Automotive Leather

Automotive Leathers variable prices are considerably lower than that of the precast

structures. However, to manufacture leather is quite the process. This includes the

cost of raw materials (hides), chemicals for processing, utilities for powering

machinery and labour costs.

Raw materials: $7.00

Chemicals: $5.00

Utilities: $10.00

Direct Labour: $10.00

Total: $32.00 (45.7%)

Contribution Margin = Sales – Variable Costs

CM = 70 – 32

CM = 38.00 (54.3 %)

2. Deltacore Concrete Plank

To manufacture the Deltacore Concrete Plank requires a large amount of human

labour to pour and skeet the concrete, and add structures such as steel and foam to

each layer. Machinery is often used to mix and pour the raw materials into the cast.

The whole process includes higher variable costs for direct labour (multiple staff are

required for one product), raw materials (concrete bags, stones), utilities and

distribution costs.

Raw materials: $150.00

Direct Labour: $200.00

Utilities: $10.00

Distribution: $200.00

Total: 560.00 (66.7 %)

Contribution Margin = Sales – Variable Costs

CM= 840 – 560

CM= 280 (33.3%)

3. DeltaFLOOR

Similar to the concrete plank, the DeltraFLOOR concrete slab requires human labour

to pour concrete, skeet concrete and add structures. The same machinery is used to

mix and pour the raw martials (concrete, stone). Utilities vary to power the machinery

and the product is expensive to distribute to various construction sites.

Raw Materials: $180.00

Direct Labour: $200.00

Utilities: $10.00

Distribution: $200.00

Total: 590.00 (68.3 %)

Contribution Margin = Sales – Variable Costs

CM= 864 – 590

CM= 274 (31.7%)

Contribution Margin Analysis:

Product Contribution Margin

Automotive Leather CM = 38.00 (54.3 %)

Deltacore Plank CM= 280 (33.3%)

DeltaFLOOR CM= 274 (31.7%)

The contribution margin allows managers to compare how a product or service is

contributing to fixed costs and overall profit. Fixed costs are expenses that will remain the

same regardless of the output or sales of a product and they must be paid. Whereas variable

costs, are dependant on sales and the output of product. Where sales and output begin to

increase, the variable costs will follow suite.

From my understanding looking at the above contribution margins, Schaffer’s three products

are contributing towards fixed costs and profit, however, the pre-cast concrete products fall

significantly short of the automotive leather division. I believe this is due to the expensive

nature of producing and distributing these pre-cast products. They require much more

expensive raw materials than the automotive leather, and although all three products utilise

machinery; direct labour is significantly more expensive when creating the pre-cast concrete

products. Automotive may only use one person per unit sold, compared to two to three for the

pre-cast planks and floors. Further, the only significant difference between the two pre-cast

concrete products is realistically their size. Both have an almost identical production process

(on the most basic level), it’s simply that the flooring slabs are larger in surface area and

require more raw materials, labour and distribution costs to produce and distribute.

There are many motives behind Schaffer’s diverse operations and why they produce an

assortment of products. Firstly, Schaffer’s birth was in the construction industry and they

have built their empire here. In the early days, Schaffer found its feet through the

manufacture and distribution of bricks. In modern times, they are involved in large

commercial building projects and development. The Deltacore range of pre-cast concrete has

become many builder’s choice in the Western Australian market. With this in mind, Schaffer

does need to provide a range of products to meet these commercial needs, which is where we

acknowledge the demand for pre-cast plank and the pre-cast floor. Although similar, both

contribute differently and equally to these large commercial projects. This is why they have

to be sold as two separate products.

Next the Automotive Leather is an extremely different product and in a completely different

industry, with a much larger contribution margin. This alone would be very appealing to

Schaffer, a company that prides itself on discovering opportunities to deliver more value to

their shareholders. The production and supply of automotive leather has allowed Schaffer to

diversify, break into overseas markets and partner with some huge, well known brands

globally.

Constraints:

After much research, it is evident that Schaffer is faced with a variety of constraints. In the

construction division (which covers their pre-cast concrete products), Schaffer is constrained

by project delays resulting in production and sales being lower than projected. In addition, the

construction industry in Australia is experiencing many challenges resulting in more and

more competition amongst firms for large project contracts. If Schaffer fails to secure these

large, often government contracts, the demand for large pre-cast structures drops

significantly. Further, during challenging times, it can be difficult to locate the skilled labour

required to create pre-cast concrete products. The use of trucks, concrete equipment and

tricks of the trade all require individuals with qualifications in concreting, or tickets in truck

and forklift driving. Where these people are working for competitors, or aren’t secured in

constant work by Schaffer, they could end up searching for work elsewhere. Without these

skilled staff, Schaffer cannot possibly create any pre-cast concrete products. The prerequisite

for direct, skilled labour is simply to high.

Next, their automotive division, although it has a higher contribution margin, can almost be

more greatly affected by constraints. This is because the automotive leather is manufactured

overseas across various markets. One processing plant is located in Europe, the other in Asia.

Right now, Schaffer is experiencing distribution delays in all markets due to the COVID-19

pandemic that will most definitely affect production and distribution. In conjunction, lack of

car sales will always directly impact the resource demand for automotive leather and sales.

More specifically in 2019, it was noted that demand in the Asian markets slowed impacted by

ongoing trade disagreements with the united states. Global automotive sales fell as Brexit

caused concerns in the European market. Emission requirements also slowed across the

automotive leather industry, impacting production volumes.

** List how: All of these various constraints, impact resource production and sales in one way or another. Where sales volume are lower, production is lower consequently effecting sales. Where sales are low, production must slow with it to avoid fixed and variable costs

overtaking profit margins.

Step 8: Ratios

Please find ratio calculations in the accompanied Schaffer spreadsheet.

When I opened the task sheet for assessment two and skimmed over step 8, I was a little

terrified. I shouldn’t have been, but my brain was alarmed when I read “please allow 9-10

hours to complete this step”. If the time I took to complete step 7 was any indication, I knew I

was going to be here for a lot longer than that. Again, I can thank the heavens enough for Dr

Maria Tyler’s helpful videos. With multiple tabs open, I was able to follow Maria’s guidance

and note down some of the hints that related to my results (you can read more about my

thoughts and reflections here at: https://accjourneywithjess.wordpress.com/2020/05/28/ratios-

reflections-step-8/

Profitability Ratios

Net Profit MarginCalculated as: Total CI / Total Revenue

Schaffer Corporations Net Profit Margin aims to show a percentage value of how much each

dollar of sales is being converted into profit when all expenses are paid. This is one of the

most important calculations and heavily indicates Schaffer’s financial health. Under these

circumstances, we are aiming to see a higher percentage value as this indicates that Schaffer

is generating enough profit from sales to contain their expenses.

Schaffer Corporations Net Profit Margin was calculated using Total Comprehensive Income

(net profit figure after tax) and Total Revenue (as the sales figure in this equation). The Sale

of goods figure in the financial statement is not an accurate figure as it lists zero Sales of

Goods for both the years 2018 and 2019. Knowing Schaffer, I can identify that this isn’t an

accurate representation of their sales. These sales figures have likely been divided under

different headings in the individual 2019 and 2018 annual financial statements. Knowing this,

it is best to use total revenue for this ratio analysis.

Figure 1.0 – Schaffer Corporation - Net Profit Margin

2019 2018 2017 2016

14% 47% 32% 23%

I was pleased to see that Schaffer Corporations Net Profit Margin showed a steady increase

from 23% in the year 2016 through to 47% in the year 2018. However, in 2019 there is a

massive decrease back to 14%. This is an extremely large shift from the previous year. I

suspect this fall could be the result of losses in the automotive leather division. In 2019,

global automotive sales fell due to equipment manufacture struggles to comply with new

emission requirements and concerns over Brexit. The Asian market demand also slowed due

to trade disagreements with the USA. All of these factors combined could be the instigator

for such a large fall. Although I am convinced this is the most likely scenario, the only other

consideration is that during the second half of the 2019 financial year, Schaffer’s Delta

Corporation division was impacted by project schedule delays. Such delays caused losses in

revenue and production. Despite this large fall, I am still pleased to see that Schaffer remains

with positive figures. Upon comparison and discussions with other students in this units

Facebook group, I can now see it is entirely possible for a firm to be completely in the

negative.

Figure 1.1 – Tesserent Limited - Net Profit Margin

2019 2018 2017 2016

-83.1% -58.1% -64.1% -4.6%

Return on AssetsCalculated as: Total CI / Total Assets

Schaffer’s Return on Assets (ROA) indicates how profitable they are relative to their total

assets. This may indicate how efficiently Schaffer uses their assets to create earnings. The

results are shown using a percentage value. Ideally, one would hope to see a higher ROA as

this indicates a firm is generating more earnings from lesser investment. Generally, here one

would expect to see similar trends to that of the Net Profit Margin. In this instance, the ROA

was calculated, again using Total Comprehensive Income (net profit after tax) and a Total

Assets figure.

Figure 2.0 – Schaffer Corporation – Return on Assets

2019 2018 2017 2016

13.7% 15.1% 4.9% 3.3%

In comparison, both Schaffer’s Net Profit Margin and their Return on Assets do show a

similar trend as predicted (you can also see this in figure 2.1 for Tesserent Limited also).

However, Schaffer’s ROA experiences fewer substantial jumps. We can see the same steady

increase in years 2016 and 2017 followed by a substantial increase in 2018. As expected, we

have experienced a fall in the year 2019, however this time the decrease is not as significant.

One area to explore is the large increase in both Net Profit Margin and ROA from the year

2017 to 2018. This surge is likely to have been caused by growth in their Automotive leather

division. During this growth Schaffer established additional leather finishing and cutting

facilities in Slovakia. These opportunities caused large increases in the profitability of this

division. At the same time, new technology to increase efficiency created further costs

savings, again contributing to this surge.

At this stage I feel Schaffer is utilising their assets well to generate a return. The decisions

made in 2017 have evidently affected the firm positively leading into the 2018 financial year.

Although we can acknowledge a drop into 2019, the result is still somewhat steady. It is sad I

am not able to review the 2020 annual report as I predict this will yield some very interesting

results in reference to our current global crisis. Had this global crisis been avoided I would

have felt confident that Schaffer would remain steady into the coming financial year.

However, 2020 is a great example of unexpected circumstances (or surprises) a firm would

not have prepared for. My wishes for Schaffer are that they do not fall into negative patterns

such as those experienced by Tesserent Limited in figures 1.1 and 2.1.

Figure 2.1 – Tesserent Limited – ROA

2019 2018 2017 2016

-114.5% -66.4% -49.6% -2.2%

Efficiency (or Asset Management) Ratios

Efficiency (or Asset Management) Ratios are an effective measure of how well a firm uses its

assets all whilst managing its liabilities. Schaffer has two large divisions (Automotive

Leather & DeltaCorp Construction Materials) that specifically produce product, meaning in

this instance efficiency ratios are a very useful tool. Efficiency Ratios are a great tool to

assess and compare firms within the same industry to determine which of these firms are

better managed.

Days of InventoryCalculated as: Inventories / Cost of Sales and Services

Rendered / 365

A Days of Inventory Ratio can be utilised to investigate the number of days a firm holds

inventory before that same inventory is sold. For Schaffer, the Days of Inventory Ratio was

calculated using Inventories, Costs of Sales and Services Rendered. Initially once the ratios

were calculated, this returned a negative result! I realised I needed to amend this to reflect the

desired format being in days. From here, I can see that on average in 2019, Schaffer holds

around 101 days’ worth of stock.

Figure 3.0 – Schaffer Corporation – Days of Inventory

2019 2018 2017 2016

101.76 87.92 112.65 116.68

In reviewing Schaffer’s Days of Inventory, I quickly noted that I am dealing with larger

numbers. This means that Schaffer is turning over their inventory slower than other firms

might be. This has been steadily improving since year 2016. The slip in 2019 would easily be

attributed to the previously noted issues affecting both the Automotive Leather division and

the Construction Division (DeltaCorp):

1. Global Automotive sales drop

2. Production struggles

3. Slower demand in European and Asian markets.

Equally, the drop experienced in 2018 could also be attributed to the increased production

demand (and capabilities) that the new Slovakian facility gifted Schaffer in that particular

financial year. Once this demand slowed into 2019, it makes sense that we would see a larger

value reflected.

(Need to compare to another firm in a similar industry)

Total Asset Turnover RatioCalculated as: Total Revenue / Total Assets

The Total Asset Turnover Ratio measures a firm’s capacity to produce sales from its assets.

If the ratio is less than one it can indicate that the total assets are not able to produce enough

revenue at the close of the financial year. In contrast, if the ratio is higher than one this means

that the firm is generally able to produce revenue for themselves. In this instance, to keep

consistency throughout the analysis, the Total Asset Turnover Ratio has been calculated

using Total Revenue as a representation of all Sales.

Figure 4.0 – Schaffer Corporation – Total Asset Turnover Ratio

2019 2018 2017 2016

0.98 1.16 1.02 1.14

For Schaffer, it is alarming that each year the firm has experienced a decrease in this ratio.

However, each increment has been remarkably small. In year 2019 Schaffer has only fallen

just under the benchmark ratio of one. This indicates that at this stage, Schaffer’s total assets

are not producing enough revenue. This is the same 2019 drop that we have consistently been

experiencing throughout this analysis.

Liquidity Ratios

Current RatioCalculated as: Current Assets / Current Liabilities

The Current Ratio measures a firm’s capacity to pay short-term obligations and is essential to

management accounting. An ideal Current Ratio is between 1.2 and 2, where a firm can

demonstrate that they have enough current assets to cover their liabilities if required. This is

extremely important and a great ratio to review as an optimum ratio between a firm’s assets

and liabilities indicates that a firm could make urgent payments if required. A successful

combination between current assets and current liabilities indicates strong Asset Liabilities

Management in a firm.

Figure 5.0 – Schaffer Corporation – Current Ratio

2019 2018 2017 2016

1.91 2.27 1.93 1.91

Schaffer is performing extremely well according to their Current Ratio. The ratio indicates

that if Schaffer’s debts were to fall immediately, they would be able to pay these. As

indicated in figure 5.0, Schaffer experienced a steep rise in 2018 (keeping with our

aforementioned 2018 surge). Despite this surge in 2018, all surrounding years return a

positive result and remain consistent. From these results one can deduce that Schaffer is

succeeding in the management of their assets and liabilities.

Financial Structure Ratios

Debt/Equity RatioCalculated as: Debt / Equity

The Debt to Equity Ratio is able to measure how much a firm is able to finance their

operations through debt over independently owned funds. This ratio particularly is also able

to measure whether or not shareholder equity could cover a firm’s debts if it were to fall

immediately.

Figure 6.0 – Schaffer Corporation – Debt / Equity Ratio

2019 2018 2017 2016

79.4% 90.3% 121.0% 136.6%

In review of the above results, we have learnt that for every dollar that shareholders have put

into equity, Schaffer has borrowed 79 cents in the year 2019. This used to be much, much

higher. However, this is decreasing which it an increasingly positive result for Schaffer. This

could be due to increased cash flow, resulting in a lesser need to borrow funds from the bank.

Equity RatioCalculated as: Equity / Total Assets

Most simply, the Equity Ratio determines what percentage of the firm is financed by the owners of that firm.

Figure 7.0 – Schaffer Corporation – Equity Ratio

2019 2018 2017 2016

55.7% 52.6% 45.3% 42.3%

From the above results we can determine there is an increasing trend in Schaffer’s owners

ability to fund the firm. This makes sense as where the Debt / Equity Ratio decreases, the

Equity Ratio has an opportunity to increase. By 2019, Schaffer’s owners are now able to fund

over half of the firm themselves. This is an extremely positive result and is a trend that I

would encourage to continue into the future.

Market Ratios

Market Value Ratios are tools that can help us evaluate the share prices of firms. These ratios can help us to identify whether or not stock is overvalued, undervalued or priced accordingly.

Earnings Per ShareCalculated as: CI / Number of issued ordinary shares

The Earnings per share ratio represents the amount each dividend in Schaffer would be paid

at, if all the profit was split up amongst shareholders. This ratio is useful to compare a firm’s

growth earnings each year. We hope that this ratio reveals a growth in EPS each year

opposed to falling each year. If the EPS falls, there is generally a cause as to why this is.

Figure 8.0 – Schaffer Corporation – Earnings Per Share

2019 2018 2017 2016

2.03 2.03 0.55 0.38

In line with the overall trend, Schaffer experienced steady growth in their EPS during 2016

and into 2017. As expected, a surge was experiences in 2018. Surprisingly, the EPS did not

drop in 2019. However, it has not increase, it has remained steadily the same. Only looking at

these last four years shows a positive trend in EPS, one that is also remaining steady.

Dividends Per ShareCalculated as: Dividends / Number of issued ordinary

shares

Investors often use Dividends Per Share (DPS) ratios to calculate the income they would

receive per share if they were to invest in the firm.

Figure 9.0 – Schaffer Corporation – Dividend Per Share

2019 2018 2017 2016

1.04 0.45 0.28 0.21

The above results were the first in this analysis to truly surprise me. Although the ratios

represent a positive, increasing trend for investors. I was surprised that 2019 did not

experience a fall. Instead, 2019 has more than doubled from the previous year. I wonder if

this is due to Schaffer’s investment activities and overall mission to improve shareholder

value.

Price Earnings RatioCalculated as: Market price per share / Earnings per share

The Price Earnings Ratio can help investors measure the dollar amount they need to invest in

a firm, to receive one dollar of earnings. From what I gather, a higher Price Earnings Ratio

indicates that investors are willing to pay more as good growth is predicted in the firm’s

future activities. However, a lower price indicates a shorter amount of time to make back

your investment.

Figure 10.0 – Schaffer Corporation – Price Earnings Ratio

2019 2018 2017 2016

6.72 6.53 12.71 13.53

The good news is each year is getting better for Schaffer. 6 years is not the worst amount of

time to receive your money back from an investment. Especially when compared to results in

2016.

Ratios Based on Reformulated Financial Statements

Return on Equity (ROE)Calculated as: Total CI / Total Equity

The return on equity ratio helps investors learn how much money a firm could generate from

their money. A ratio of one describes that one dollar of equity will generate one dollar of net

income.

Figure 11.0 – Schaffer Corporation – Return on Equity (ROE)

2019 2018 2017 2016

24.49% 28.76% 10.91% 7.89%

Schaffer’s results are very consistent. As expected, we have a slow, steady increase for the

years 2016 and 2017. A nice leap in 2018, followed by a fall in 2019. What we an learn from

these results is that Schaffer’s ROE of 24% means that for every dollar of equity in the firm,

Schaffer was able to earn 24cents. This is still a really positive result.

Return on Net Operating Assets (RNOA)Calculated as: Operating income after tax (OI)/net

operating assets (NOA)

Return on net operating assets, otherwise known as its acronym RNOA, is a method used to

assess a firm’s performance. RNOA is similar to ROA, in that the RNOA was developed as a

variation to zoom on a firm’s operations. Many enjoy that the RNOA better represents core

business activity as it is only comprised of operating activities as opposed to all of a firm’s

activities (financial, investment etc). Ideally, we hope for a positive number here, the higher

the better. However, what is ‘ideal’ is relative and should be compared to firms within

particular industries. Whilst a positive number may look seemingly ideal, it may not be

meeting the benchmark set by other firms within the same industry. Thus turning a positive

result, into something slightly more sinister.

Figure 12.0 – Schaffer Corporation – RNOA

2019 2018 2017 2016

27.84% 38.57% 11.94% 9.53%

ROA

13.7%

ROA

15.1%

ROA

4.9%

ROA

3.3%

In comparison to Schaffer’s own ROA and in removing financial operations, we can

determine that the firm’s operations are at a minimum, trending similarly. However, the large

conclusion that can be drawn from these results are that Schaffer’s operating assets are

performing better than originally depicted in the ROA alone. This is one of the pinnacle

reasons to calculate this ratio. Although we can be pleased to see a positive result for Schaffer

corporation, we need to compare these results to other firms within the same industries. There

are obviously firms in circulation that have produced alarming results, some well into the

negative. What would be really interesting, is to compare Schaffer’s ROA and RNOA with

their competitors.

Net Borrowing Cost (NBC)Calculated as: Net fin. expenses after tax/net financial

obligations (NFE/NFO)

Net Borrowing cost or NBC is the cost of interest accumulated over the amount of debt the firm has.

Figure 13.0 – Schaffer Corporation – Net Borrowing Cost (NBC)

2019 2018 2017 2016

-35.90% -10.60% 16.01% 13.16%

This is one of those interesting leads that you can read about in my reflection. Reading these

results initially I was a slightly confused. One certainty is that Schaffer has started the trend

in 2016 and 2017 with net financial obligations, resulting in quite a high interest rate.

However, in keeping with the trend, we have a massive change in 2018 which has resulted in

net financial assets, making these results difficult to interpret. This trend continues into 2019.

In looking at Schaffer’s restated financial statement it is evident that the cause of this was in

2018 and 2019. This is where Schaffer has derivative financial instruments (2016 and 2017

do not have these) along with an increase in cash and cash equivalents.

The derivative financial instruments include forward currency contracts and interest rate

swaps. Derivatives are described in the 2019 annual report as assets when their value is

positive and as liabilities when their value is negative. The annual report also lists cash and

cash equivalents as cash and short-term deposits, net of outstanding bank overdrafts. So what

does this mean for Schaffer? In short, I feel that the 2019 and 2018 results just aren’t

comparable to that of 2017 and 2016. Operationally and financially the firm has transformed

and differs extremely from the previous two years.

However, for the sake of this interpretation, as previously noted, Schaffer’s NBC in 2016 and

2017 wasn’t the worst but wasn’t the best either. (need to compare to other firms)

Profit Margin (PM)Calculated as: Operating income after tax (OI)/sales

Profit margins or PM, is a profitability ratio that measures how a firm’s activities are making

them money. The percentage shows how much of sales have been turned into a profit. This is

comparable to Net Profit Margin (NPM) in that both are able to indicate whether a firms

management is leading to higher sales all whilst controlling associated costs. In contrast, PM

allows us to again, isolate our operations.

In calculating PM for Schaffer corporation, I had to think a little bit outside of the box. There

were some differences in the labelling of my sales/revenue over the four years. In this case

my amounts were listed under two different headings. Please see the below example

(highlighted in yellow). This was the only option to generate a result capable of being

interpreted.

Figure 14.0 – Schaffer Corporation – Profit Margin (PM)

2019 2018 2017 2016

15.57% 14.32% 7.50% 5.89%

NPM

14%

NPM

47%

NPM

32%

NPM

23%

In isolating Schaffer’s operational profit margin (PM) we can see a slightly altered trend than

our net profit margin. This variation happens in the year 2019, where instead of a drop in PM,

we experience a slight increase. From my research on how to improve operational profit

margins, I believe this is a result of Schaffer’s strategy to improve operational efficiencies

across all three divisions. These operational efficiencies were to counterattack some of the

exterior operational threats Schaffer had been experiencing. By isolating the operational

profit margin, we are able to see that these attempts are in fact holding.

Asset Turnover (ATO)

Calculated as: Sales/net operating assets (NOA)

The operating asset turnover (ATO) ratio helps us to identify the capability of a firm’s asset

to generate revenue. This is similar to the previously explored total asset turnover ratio

(TATO) however, the ATO allows us to again, isolate a firm’s operational capabilities.

To accurately calculate the ATO for Schaffer corporation, I had to again think out of the box.

In my student discussions I was concerned some of my spreadsheet results were returning

zero as a result and to me this just didn’t make sense. Another student prompted me to have a

second look if I was concerned. In doing so, I noticed that my sales figures needed to be

adjusted again, this time for the years 2016 and 2017 (please see why below – in yellow).

Figure 15.0 – Schaffer Corporation – Asset Turnover (ATO)

2019 2018 2017 2016

1.79 2.69 1.59 1.62

TATO

0.98

TATO

1.16

TATO

1.02

TATO

1.14

By isolating Schaffer’s operating asset turnover, we are able to identify an obvious increase

to what was previously explored through total asset turnover. The results are again, consistent

with previous trends explored throughout this analysis. From 2016 to 2018, Schaffer

experienced a positive increasing trend, meaning for every dollar of operating assets sold

Schaffer was able to generate $2.69 of sales by 2018. They experienced a more significant

drop in 2019. I believe this would be due to the decline in sales in both their automotive

leather sales (lower demand in European and Asian car sales) and their building material

sales (slow construction industry). However, this is a much better result than that discovered

by the TATO earlier in this analysis.

Economic Profit

Economic ProfitCalculated as: (RNOA - cost of capital) x net operating

assets (NOA)

Figure 16.0 – Schaffer Corporation – Economic Profit

2019 2018 2017 2016

$19,613.08 $23,461.66 $2,038.60 -$538.90

Once I had finally finished my ratio analysis to the best of my current ability. I sighed very

long and loud about having to spend so much more of my time analysing my firm's economic

profit and its drivers. I was beginning to feel very stressed and burnt out. I do love these

assessments, but when you're constrained by time and other assessment pieces in different

units, it feels a bit like the never-ending story. To remain awake and efficient, I quickly

followed Maria's advice (let's be honest, I would be lost without her videos). I needed to

develop a deeper understanding of each driver and how they affected the end game, being my

overall economic profit. I couldn't remember exactly which chapter this was covered in, so I

went on a CTRL - F adventure through every single reading searching for gold. I found it in

chapter four.

Once I started to try and begin my evaluation, I hit a brick wall. I don’t know if this was from

lack of sleep or lack of understanding. From what I gather, economic profit is greatly affected

by a few key drivers. The first being RNOA, next being the cost of capital and lastly, the

NOA. The relationship between the three can be best illustrated in the below equation:

(RNOA - cost of capital) x net operating assets (NOA)

In reading chapter four, Martin explains that the first step is to understand how Schaffer’s

RNOA impacts their overall economic profit. Here Martin explains that the more a firm can

invest in NOA at returns above their cost of capital, the more value a firm can create. I

decided that the best place to start was by comparing my OI with my NOA. I had to ask, is it

my OI experiencing these increases or is it my NOA. Looking at my assets I had expected it

to initially be my NOA. I was wrong. My NOA actually fluctuates a little, but is fairly

consistent and doesn’t really match the trend I was seeing. Especially since 2016 is my worst

year for economic profit, yet according to my NOA it is performing better than 2018 (see

below).

It was as crystal clear once I looked into my OI. Here I could see the increasing trend that I

had been searching for.

And this was the result:

Knowing this, and reviewing my overall economic profit, I can see that initially Schaffer was

not doing very well at all in 2016 being at -$538.90 or at an RNOA of 9.53%. Although I am

not surprised to see this. Overall, throughout my entire ratio analysis, everything is much less

manageable in 2016. The economic profit is a mirror reflection of those activities. The only

additional information. In 2016 Schaffer experienced restructures and changes to operational

efficiencies ultimately led to inefficiencies over the period. Yet, I was still confused at how I

could have returned a negative number when individually my NOA, my OI and my RNOA

all returned positive results (hold that thought!). In saying that, in 2017 we are able to

observe a positive economic profit value. From my research, 2017 was the year that paved

many future successes for Schaffer. I discovered that RNOA can be heavily affected by an

increase in operating liabilities. Which leads me to believe that Schaffer’s 2017 increase was

caused by a decrease in operating liabilities or even an increase in efficiencies. Some notable

circumstances 2017 that I believe have contributed are:

Lower processing costs in Slovakian factories

Reduction in raw hide costs

Lower freight costs

This trend continued to effect 2018 positively, resulting in a huge surge. However, I do not

feel this surge can be fully appreciated just by looking at my RNOA. Nor can the drop in

2019’s overall economic profit only be explored through RNOA (although I can acknowledge

these trends are evident in my RNOA).

Enlightened and confused I was ready to consider where my cost of capital was driving my

economic profit. My first obstacle here was struggling to find my firms individual weighted

cost of capital (WACC). This was not able to be located with my firm’s annual reports or

through any amount of google searches. Believe me, I tried very hard to find this thing. As

instructed by Maria in the unit’s instructional video, I chose to utilise a cost of capital rate of

10%. Now, in hindsight, once I checked the task sheet, I did see that we could use a rate of

8%, however, I had already completed the video and I have enjoyed the results. In using a

rate of 10%, the rate has overpowered my RNOA in 2016 of 9.53%. This is why Schaffer’s

overall economic profit has returned a negative result. Interestingly enough, if I had used a

rate of 8% my overall economic profit would have totalled to $1,759.40.

Next, I needed to understand how PM and ATO drive my RNOA. As previously stated in my

ratio analysis, my PM and my ATO have followed the same rises and falls as most of my

ratios have. There have been few exceptions to the rule. I decided to explore this relationship

as mentioned at the very end of chapter four. When I tried the calculation RNAO = PM x

ATO I was able to replicate my RNOA. I started really looking into these values and I learnt

something interesting. In 2017 and 2016 the relationship between Schaffer’s PM and ATO,

was very, very consistent. They seem to rise and fall almost equally with eachother.

However, in 2018, where Schaffer experiences this huge surge, my PM seems to almost

double. My ATP also experiences a rise, but not nearly to this extent. Upon closer inspected I

can see that my PM is calculated using my OI. This truly leads me to believe that my OI is

still my largest contributor in this surge.

It starts to get even more interesting where this relationship is altered again in reverse in

2019. I’ve mentioned numerous times Schaffer experiences a slight decrease; we know the

overarching reasons as to why but to discover this in the ratios was exciting. In 2019 we find

that my PM is increasing, where my ATO falls almost back to where it was in 2017.

Which leads me to investigate specifically, my NOA and total CI (in place of sales) in 2019. I

was expecting my NOA to show a decrease, however this was not the case. My total CI

(sales) is where the fall is experienced. Which completely lines up with the decrease in sales

experienced by the automotive division and the construction materials division.

Evaluating the drivers of Schaffer’s economic profit, breaking this down into tiny bits and

pieces truly felt like a reverse investigation. Completing this task, I felt like I was following a

trial of breadcrumbs backwards to one individual figure that has affected the others overall. It

was really rewarding, really interesting and I feel like I a lot of previously grey areas have

started to gain a lot more colour.

Need to add discussion with peers here as everyone starts to post their drafts

Reflection / Insights

Breaking my firm Schaffer into pieces not only allowed me to truly view my firm underneath

a microscope, but it also forced me to develop a deeper understanding of what these ratios

were trying to tell me! At the start of this task, I believed I wouldn’t be able to interpret my

firm’s ratio results. However, as you complete the task you begin to see patterns and trends.

From these patterns, anything that doesn’t match seems to stick out like a sore thumb. Once

you find this, you have to get your hands dirty. Why is this happening? Where can I find this

information? What does this type of ratio result tell me? My experience during this task could

be likened to a massive investigation.

Reflections, Ratios and Step Eight – Blog post – 29/05/20

In skimming the task sheet for step eight, I felt intimidated. Although I have learned

multitudes throughout this unit, I will never profess to “know everything.” I do not believe

anyone honestly can. Thus, it is my mission never to indulge in those thinking patterns or to

measure others against it. The kicker here is that this didn’t do wonders for my confidence in

approaching step eight. I genuinely believed that in interpreting my firm’s ratios, I would be a

lost cause. The good news is that starting with such low expectations of myself, provided

much delight as I began my journey through the task.

To keep it brief, after having viewed less than a handful of other firm’s ratios during the

drafting process so far, I have been able to determine Schaffer isn’t doing all that badly. In

fact, I was quite impressed. I was also surprised that I was able to see such a healthy pattern

throughout my analysis. For Schaffer, this was a steady increase between 2016 and 2017,

followed by a big jump into 2018, ending on a seemingly harmless decrease in 2019. This

was consistent, and where it wasn’t (only once or twice throughout my ratios), I put my

detective cap on to follow my new found lead. I will admit, aside from any delicious insights

I gained, the task did start to become a little mundane towards the end. I don’t know about

you, but there are only so many ways you can describe the same circumstance that has

affected multiple ratios. So, what were these circumstances?

In short, the notable surge in 2018 I suspect was due to purchases of new manufacturing

facilities in Slovakia (Automotive Leather Division). This created a boom. Increased output

did wonders and affected the entire firm positively. The slight decrease in ratios in 2019 was

most definitely attributed to many outside factors that affected sales across multiple divisions.

The automotive leather division was impacted by lower demand due to fewer car sales across

European and Asian markets. Schaffer’s building division also suffered from the weak

structure of the Australian construction industry. The construction industry is plagued by

fierce competition. Often this results in price battles, firms undercutting each other to secure

contracts. This usually results in small losses here and there just to ensure workflow. Then, if

you add a project delay or scheduling issue on top of that, you have a cocktail that is likely to

decrease your ratios.

Thoughts and questions after step eight?

I feel that Schaffer’s operations have been shifting considerably over the years. The Debt to

Equity ratio was a great example of this. They were quite a risky business to invest in early

on. This has obviously turned around quite significantly. However, I wonder if this will all

come unstuck due to the current global pandemic. Looking at the ratios alone, I would have

predicted future results to remain similar to 2019. I just don’t think this will be the case now.

It really is an excellent example of those ‘surprises’ a firm can unexpectedly experience.

Firm Comparisons

Is your firm in a similar industry? How do our firms and their ratios differ?

This is something I am excited to discover as everyone begins to upload their drafts. Often in

researching each ratio and learning what they can uncover, I saw a lot about how they are

most effective in measuring and comparing firms in similar industries. Although I am unsure

if anyone is entirely in the same boat as Schaffer, if you are connected to someone in this unit

that might be in Construction or Materials, please comment their blog link below so I can

compare and contrast our ratios.

Obstacles

I’m sure many of us hit at least one wall in completing step eight. Early in the task, we are

required to locate our closing share price over each of the four years. Well… this was quite

the learning experience for me. Initially, I thought this HAD to be something included in a

firm’s annual report. Except for the inconvenience that my firm only includes closing prices

for a strange date in September, not on 30 June. I decided to follow Maria’s recommendation

and just go straight to the ASX. I was pretty confident I would be able to find these prices

easily. 

*I have to preface this next section by saying, none of you are allowed to laugh. None of you.

I am a people person, not a numbers person, and this unit is most certainly a first experience

for me. If you were suspect before that I might be an idiot, let me confirm it for you now. As

you were…

As I tried to locate the share prices, I discovered that for at least two years, I couldn’t single

out the price for June 30 (yep). It stopped on June 28 and jumped a few days into July (I said

don’t laugh) for two years. I was baffled. I still can’t determine if this was a blonde moment,

or I’d just fried my brain staying up so late studying. I stopped the task, got some sleep.

When I woke up the next morning, my light-bulb moment was literally in the shower (how

cliché). It occurred to me that the reason the share price wasn’t listed separately for June 30 is

that it didn’t change? There’s no need to update the chart every day, only when the price

experiences a rise or fall. WHY DID THIS TAKE ME SO LONG TO REALISE?! (you can

laugh now). 

Anyways, now that I’ve exposed how silly I am, my next obstacle was searching for my

firm’s weighted average cost of capital. That was, of course, missing (just my luck). So was

my sales figure for two years (here we go again!), so I chose to use total revenue to provide

the most accurate ratio analysis as I felt it at a minimum covered all three divisions of the

firm.

Next, I completed my Profit Margin and returned zero results for the years 2016 & 2017. I

understand mathematically why my spreadsheet says 0. However, I can’t shake the feeling

that I may have missed something here. (please let me know in the comments, god knows I

need the help).

I hope that in reading this post, you can walk away feeling: 

1. Much more intelligent than you did before (you’re most welcome)

2. Less alone 

3. Confident (because if I’ve made it this far, you’ve got this!)

Economic Profit Reflections – https://accjourneywithjess.wordpress.com/2020/05/29/reflections-on-economic-profit/

Here I am, back again with another harrowing reflection of my assessment attempts. Today I'm posting some brief reflections on my firm Schaffer's economic profit results.

You can view my updated spreadsheet here!

Schaffer Economic Profit Results

Once I had finally finished my ratio analysis to the best of my current ability. I sighed very long and loud about spending so much more of my time analysing my firm's economic profit and its drivers. I was beginning to feel very stressed and burnt out. I do love these assessments, but when you're constrained by time and other assessment pieces in different units, it feels a bit like the never-ending story.

I quickly followed Maria's advice (let's be honest, I would be lost without her videos). I needed to develop a deeper understanding of each driver and how they affected the end game, being my overall economic profit. I couldn't remember exactly which chapter this was covered in, so I went on a CTRL - F adventure through every single reading searching for gold. I found it in Chapter four.

The entire process I initially read in chapter four weeks and weeks ago, did not make sense until today. I remember feeling really emotional over the fact that when I first read that chapter, I felt like an alien. Now, in looking at Schaffer's economic profit with chapter four in hand, I felt like I was experiencing a reverse investigation. In viewing the ratios this way, we can follow little breadcrumbs that lead us to answers we did not have before. I realised that looking at these values only once, does not tell you how they affect a firm overall. It also does not tell you how regular rises and falls throughout a firm's activity are going to interact with each other. This is where all the action happens!

Although mundane at times, I learned a lot about my firm's economic profit. I learned that it is profoundly affected by the capital investment rate. Although I could not locate my firm's exact rate, I had a lot of fun playing with different investment ones. Especially when I learned how this can return both positive and negative results using the same sets of numbers produced by your firm.

e.g., In 2016, Schaffer returned a negative economic profit result using a capital investment rate of 10%. This is because the rate of 10% outweighed my RNOA of 9.53%. A capital rate of 8% instead, would have produced a positive economic profit.

I was also able to see how my PM and ATO interact with each other and affect my RNOA. This lead me on a path to discover that some of my rises and falls were indeed affected by similar circumstances. Still, there is always an exception to the rule, and that's why we have to do these investigations.

What have you learnt about your firms economic profit? Are our firms similar? Is there anything I have missed!

Stay tuned for my VERY rough draft upload, coming soon! :)

Discussions with other students:

At the beginning of this unit I was a member of the unit Facebook group (until I needed to

concentrate and submitted for Facebook to delete my account permanently!). Although it is

the end of the unit now, I decided to create a new Facebook profile for myself and re-join the

unit Facebook page so I could more actively participate in discussions with others

(sometimes our blogs can get a little quiet). Please find some of these comments and

discussions below.

Blog posts

Ratios, Reflections & Step 8: https://accjourneywithjess.wordpress.com/2020/05/28/ratios-reflections-step-8/

Reflections on Economic Profit: https://accjourneywithjess.wordpress.com/2020/05/29/reflections-on-economic-profit/

S7 – 10 Draft:

Step 9: Capital Investment Decision

Schaffer Corporation has announced a considerable expansion of their interests in the

automotive leather industry. In light of this announcement, Schaffer Corporation is

considering to expand their current Leather processing plants in the Australasian market. All

current plants are located in Kosice Slovakia, Thomastown, Victoria Australia and Shanghai,

China catering to European and Asian markets. Schaffer Corporation is considering whether

to build a new Leather processing plant in Richlands, Queensland Australia or Windsor, New

South Wales Australia allowing a larger presence in the Australian market. At this stage, the

life of the Queensland plant is estimated at 8 years. After 8 years, production is forecasted to

outweigh the Queensland facilities output capacity. The circumstances are similar for the

New South Wales plant; however, this plant is larger, therefore providing an expected life of

10 years and higher production capacities within this ten year period. Keeping with

Schaffer’s strategic plan to provide increasing value to shareholders, the new plant is the next

step for Schaffer’s leather division.

For investment opportunity one, the Queensland location has an initial purchase cost of

1.5million AUD. After 8 years, it is forecasted that this facilility will be too small to cater for

th35e increase in product demand. At this time, the facility will be sold. The residual value of

this has been estimated at 2.1 million AUD.

Investment opportunity two, the New South Wales location has a slightly higher initial

purchase cost of 1.9 million AUD with a life expectancy of 10 years. In contrast to

opportunity one, this facility is larger therefore allowing for immediate increases production.

However, this extension on production is only forecasted to withstand an additional two years

before this facility too, will need to be sold onwards. At such a time, a larger facility will be

sought to cover these new demands. This residual value of this has been estimated at 2.9

million AUD.

All cash flows generated for both investments will be acquired through the sales of

automotive leather units to affiliated automotive brands for the global manufacture of

vehicles. These cash flows are less operational expenses which can included expenses for raw

materials (hides), chemicals (for production), direct labour costs and utilities. The estimated

cash flow is based on projected sales in both the Asian, European and Australasian markets.

Breaking into the Australasian market, we would expect to see similar cash flows for both

investment opportunities, however, this trend begins to change from year 8 onwards as the

New South Wales Plant will be able to accommodate for higher production volumes. Further,

initially it is expected that due to the large initial investment costs, in conjunction with the

fact the Schaffer is expanding into the Australasian market, initial production and cash flows

will be lower and will gain momentum steadily over the lifespan of the investment.

Schaffer forecasts their initial investment in this opportunity will occur on the 25th of June

2020, with forecasted future cash flows to be received on the 25th of June each year thereafter.

The original cost, the estimated life, residual value and estimate future cash flow of each

investment opportunity are set out in the table below in Australian dollars (AUD). A

discounted rate of 8% will also be applied.

Richlands, QLD Plant Windsor, NSW PlantOriginal Cost -$1,500,000 -$1,900,000Estimated life (1) 8 years 10 yearsResidual value (2) $2,100,000 $2,900,000Estimated future cash flows (3)2021 $70,000 $70,0002022 $70,000 $70,0002023 $70,000 $70,0002024 $150,000 $150,0002025 $150,000 $150,0002026 $150,000 $150,0002027 $200,000 $200,0002028 $200,000 $200,0002029 N/A $250,0002030 N/A $300,000

1. Estimated life is how long Schaffer Corporation expects to own the Leather Processing Plant.

2. Residual value is the expected cash flow when each processing plant is sold to another buyer at the end of its ‘estimated life’.

3. Estimated future cash flows are estimated cash flows from automotive leather sales and services. 4. The investment would be made on the 25th of June 2020. The estimated future cash flows are expected to be received of the 25th

of June each year.

Results (NPV, IRR, PP)

Investment Opportunity 1 – Queensland Processing Plant (O1)

NVP = $ 346,580.70

Note (s): A positive NPV indicates that projected earnings exceed anticipated costs. An opportunity with a positive NPV can be assumed to be profitable.

IRR = 11.37%

Note (s): This opportunity has an IRR above the discounted rate of 8%. This indicates this opportunity would most likely return a profit based on predicted cash flows.

Payback period = 7 years and 3 months

Note (s): To recover the cost of this investment opportunity it would take approximately seven years and three months.

Investment Opportunity 2 – New South Wales Processing Plant (O2)

NVP = $ 419,297.45

Note (s): A positive NPV indicates that projected earnings exceed anticipated costs. An opportunity with a positive NPV can be assumed to be profitable.

IRR = 10.62%

Note (s): This opportunity has an IRR above the discounted rate of 8%. This indicates this opportunity would most likely return a profit based on predicted cash flows.

Payback period = 9 years and 2 months

Note (s): To recover the cost of this investment opportunity it would take approximately nine years and two months.

Results Discussion

Net Present Value (NPV)

The Net Present Value, otherwise referred to as NPV is an accounting tool a firm can use that

indicates whether or not an opportunity is an intelligent financial decision. The NPV does this

by using the present value of all forecasted cashflows and taking away the cost of the initial

investment. In doing this, many hope their opportunity will return a positive result as this

indicates that cash inflows are greater than cash outflows. Theory states that where an NPV is

positive, there is value in going ahead with the investment. If an NPV is negative, this is a

strong indication that the decision should be refused. Further, when an NPV is zero, there is

neither no gain, nor loss in the investment. Upon review of the above analysis, both

opportunities have returned positive NPV results, indicating that either decision should

produce profitable results if all predicted cash flows were sustained. Comparatively, the New

South Wales processing plant (O1) returned a somewhat significantly higher NPV than that

of Queensland (O2). This was a difference of $72,716.75.

Internal Rate of Return (IRR)

The Internal Rate of Return, otherwise known as the IRR is another accounting method one

can use to predict whether a long-term opportunity or investment is a good decision or not so

much. The IRR utilises expected future cash flows to find the interest rate (usually displayed

as a percentage) where the NPV of all cash flows equals zero. More simply, the IRR can

illustrate if an investments return will outweigh its initial cost. The reason this is so great in

comparing opportunities is because by using a percentage, it can be easier for all parties to

understand. In analysing an opportunity, it is ideal that the IRR be greater than the discounted

rate of return (in this case it is 8%). In this instance, both opportunities have again returned a

result that surpasses the discounted rate of capital. However, in this instance the Queensland

processing plant (O1) has return only a slightly higher result.

Payback Period (PP)

Simply put, the Payback Period (PP) is the length of time it takes to recover the cost of the

initial investment. In this case, the payback periods differ by only two years. This is not

overly significant as New South Wales processing plant (O2) has a higher initial investment

and a two year longer lifespan. Comparatively, both opportunities only reach their break even

point one year before the end of their predicted lifespans. Due to this, I do not find this a

notable consideration when comparing the two opportunities.

Investment Decision

If both opportunities were independent of each other, both opportunities would realistically

be recommended. However, in this case, we must make a decision on which opportunity is

best for Schaffer Corporation to invest in. The difficulty here is that due to differing cash

flow patterns, we are left with an example of conflicting NPV and IRR results. One

opportunity has a higher NPV and lower IRR whilst the other has a slightly higher IRR and a

lower NPV.

In this case, both opportunities are mutually exclusive investments, meaning that one will

exclude the other from consideration. After careful deliberation, I believe NPV is a more

preferred and absolute measure and should be rated independently higher than that of an IRR

in this particular instance. This is because the IRR is a relative measure and assumes that cash

flows can be reinvested at the internal rate of return. NPV instead, assumes that reinvestment

occurs at the cost of capital, which I believe is a safer more reliable and realistic option.

With that in mind, this would make the processing plant in New South Wales the opportunity

I believe Schaffer is safest to invest in due to the significantly higher Net Present Value

(NPV).

Thoughts/ personal discussion:

Throughout my analysis of this capital investment decision my thoughts were running wild!

As I’ve mentioned in previous KCQ’s, I don’t overly enjoy guesswork. Yet, I understand this

is one of the best methods we have towards long-term decision making. In this case, luckily I

was able to discover the NPV method is generally the more superior method when one is met

with conflicting results. I just can’t shake the feeling that in this particular case, as both

investment options share some similarities, it would only take the alteration of one cash flow

to generate completely different results. The NPV, IRR and the Payback period are only as

good as the inputs. We must acknowledge that a large portion of these NPV assumptions are

indeed based on assumptions, guessing and educated predictions. In saying this, I am glad

there was a distinction of a superior method as I was beginning to feel very stuck attempting

to make my final recommendation. I can see that long-term investment decisions are rarely

cut and dry.

Step 10: Peer Feedback

To be completed