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Analysis of ABC Company

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Introduction

ABC Company is a manufacturing company that concentrates in building cedar roofing and siding shingles. The current annual sales of the company are around $1.2 million, a 25% rise from the last year. The company has a violent growth target of achieving $3 million annual sales in next 3 years. The Chief Executive Officer of the company is keen to search additional goods that can influence the present employee skillset of ABC as well as the production facilities. The Chief Executive Officer is working on a new opportunity. The Chief Executive Officer is planning to use some of the shingle scrap materials to construct cedar dollhouses. This new product line would increase additional raw materials and will take lesser time to produce in comparison to cedar shingles. Although this product line will need extra expenses, it will generate extra revenue and gross profit and will assist in achieving the growth targets.

Risk Profile

Risk can be called as the ambiguity involved in a given thing or event. Risk is observed in every part of life. Two types of the risks are faced by business enterprise as well namely, Systematic Risk and Unsystematic Risk. The Systematic Risk is in-built to the whole market known as un-diversifiable risk or market risk. It cannot be diminished by using diversification instruments and influences all the business enterprises. Unsystematic Risk can be called as the risk related to a given business and it can be certainly diminished. Another name for unsystematic risk is diversifiable risk. Therefore, it can be said that identification of the risk involved is very necessary and diminish it by implementing variety of instruments. Examples of systematic risk are economic conditions, governmental law, policies, natural calamities etc. Examples of unsystematic risk are strike, governmental regulation for a particular type of manufacturer, poor relation with suppliers etc.

Systematic Risk can be controlled by the management of this company as well; instead they should pay some attention in managing the unsystematic risk. The possible unsystematic risk faced by the company includes expected price of product, manufacturing of new goods, whether there will be enough demand for new goods, choosing of supplier for extra requirement of raw material, whether current facilities will be able to manage the new production, method of financing i.e. debt or equity.

ABC COMPANY

Cash Flow Statement

For the year ended 31st Dec, 19x2

Cash from Operating Activities:

Cash Received from customers (Note - 1) $1,260,000

Cash Paid to Suppliers and Employees (Note - 2) $1,080,000

Cash Generated From Operations $180,000

Less: Income Tax Paid -

Cash Flow before Extra-ordinary Items $180,000

Cash Flow from Investing Activities:

Purchases of Equipment $(100,000)

Cash Flow from Financing Activities:

Dividend Declared $(100,000)

Net Increase/Decrease in Cash and Cash Equivalents: $(20,000)

Cash and Cash Equivalents As at beginning of the year $70,000

Cash and Cash Equivalents As at End of the year $50,000

Note - 1: Calculation of cash received

Total sales $1200000

Less: Opening Balance of Debtors $180000

Add: Closing Balance of Debtors $120000

$1260000

Note – 2: Calculation of cash Paid to Suppliers

Cost Of goods sold $800000

Less: Opening Stock $280000

Add: Closing Stock $350000

Total Purchase $870000

Add: Opening Balance of Creditors $210000

Less: Closing Balance of Creditors $250000

Total Cash Paid $830000

Add: Selling and Distribution Expenses $250000

$1080000

Sources & Uses of Funds

Sources:

1. Operating: Cash received from debtors

2. Investing: None

3. Financing: None

Uses:

1. Operating: Payment to suppliers

2. Investing: Purchase of equipment

3. Financing: Payment of dividend

Steps for improvement of cash flows

Implementation of following techniques will assist in improving the cash inflows from debtors:

1. Providing discount on early payments.

2. Regular reminders for payment.

3. Discount on immediate cash payments.

4. Automated system for accepting payment like credit card, debit card.

5. Implementation of debt factoring.

6. Evaluating credit worthiness of the client before granting debt.

Similarly, to improve the cash outflows, the company shall try to avail the benefits offered by the creditor or the lending institutions.

Financing Options

Any new investment or project or expansion of existing project can be made by two ways namely, by taking money from lenders or owners. These are known as debt financing and equity financing.

Advantages of Debt Financing:

1. Control over ownership

2. Interest paid is tax deductible

3. Flexibility

4. Less complicated in terms of paper work

Disadvantages of Debt Financing:

1. Principal borrowed is to be repaid and creates an obligation on borrower.

2. Excessive debt increases the riskiness and affects the reputation of the company.

Advantages of Equity Financing:

1. Money taken is not required to be repaid.

2. No obligation of regular interest payments.

Disadvantages of Debt Financing:

1. Ownership is lost.

2. Requires complex paper work at the time of issuance.

Statement Showing Product Cost for the Expansion Product

Statement Showing Total Cost of Existing Product, Expansion Product and overall cost of Products

The cost of existing product has increased due to the expansion by $0.06 per unit.

Calculation of Selling Price for the new Expansion Product

Sales Mix:

Existing: 80,000 units

Expansion: 5,000 units

Statement Showing Contribution margin and Break Even Points

Break Even Sales = Fixed Cost

P/V Ratio

= 389250

64.96%

= 599,215

Sales Mix Ratio 80:5 or 16: 1

Break Even Sale : Existing = 563,967

Expansion = 35,248

a)

Net Present Value of the proposed investment = $(1,366)

b) Depreciation = 42000/ 5 = $8,400

The straight line method of depreciation will lead to increase in the fixed cost. There will be no effect on the cash flows because non-cash item like depreciation is not taken into account while calculating cash flows.

c) The equipment shall not be purchased because the net present value from equipment is negative.

Conclusion

The new project does not seem to be going well with the company as there is increase in the per unit cost of existing product, its manufacturing is quite time taking, demand for the product cannot be estimated with certainty. All these lead to doubt regarding the achievement of target profits and cash flows. The net present value of $1,366 is generated from the new equipment.

Preparation of detailed budget with fixed and variable cost is the responsibility of Controller and Management Accountant. He is liable for maintaining up to date cost records and ensuring effective cost controls. He is responsible for ensuring that production is carried out with the rules, regulation, laws laid down by the government. An effective production process required continuous monitoring, and any imperfections shall be modified.

The Chief Executive Officer shall work strategically by proper planning, evaluation of market conditions, analyzing the resources available, detailing the resources needed. The market for the product shall be stimulated by implementing promotional instruments. Extensive marketing will lead to increase in the demand for the goods. Healthy relationships with stakeholders like customers, suppliers, lending institutions, regulatory authorities shall be maintained. In production process, the cost can be decreased by reducing the waste, increasing the efficiency and adequate training and motivation of employees.

References

Ronald W. Hilton, Michael W. Maher, Frank H. Selto, (2006), Cost Management: Strategies for Business Decisions, 3e