Analysis of ABC Company
Student’s Name
Institution Affiliation
Analysis of ABC Company
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 aviolent growth target of achieving $3 million annual sales in next 3 years. The Chief Executive Officer of the companyis 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 Officeris 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 toproduce in comparison tocedar 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 ambiguityinvolved 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 (Brealey, Myers & Marcus, 2003). It cannot be diminishedby using diversification instruments and influences all the business enterprises. Unsystematic Risk can be called as the risk related to a givenbusiness and it can be certainlydiminished. Another name forunsystematic risk is diversifiable risk (Hilton, Michael & Frank, 2006). Therefore, it can be said that identification of the risk involved is very necessaryand 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 (Ross, Randolph & Bradford, 2006).
Systematic Risk can be controlled by the management of this company as well; instead they should pay some attention in managing the unsystematic risk (Brealey, et, al. 2003). 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 and method of financing i.e. debt or equity (Williams & Robert, 2002).
ABC COMPANY
Cash Flow Statement
For the year ended 31st Dec, 19×2
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:
Operating:Cash received from debtors
Investing:None
Financing:None
Uses:
Operating:Payment to suppliers
Investing:Purchase of equipment
Financing:Payment of dividend
Steps for improvement of cash flows
Implementation of following techniques will assist in improving the cash inflows from debtors:
Providing discount on early payments (Williams & Robert, 2002).
Regular reminders for payment.
Discount on immediate cash payments.
Automated system for accepting payment like credit card, debit card (Hilton et al, 2006).
Implementation of debt factoring.
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:
Control over ownership
Interest paid is tax deductible
Flexibility
Less complicated in terms of paper work
Disadvantages of Debt Financing:
Principal borrowed is to be repaid and creates an obligation on borrower (Ross, Randolph & Bradford, 2006).
Excessive debt increases the riskiness and affects the reputation of the company.
Advantages of Equity Financing:
Money taken is not required to be repaid.
No obligation of regular interest payments.
Disadvantages of Debt Financing:
Ownership is lost.
Requires complex paper work at the time of issuance.
Statement Showing Product Cost for the Expansion Product
Particulars Calculation Amount
Units produced and expected to be sold 5000 units
Machine Hours 5000 Hours
Direct Material 5.60 x 5000 28,000
Direct Labor 4.00 x 5000 20,000
Factory Overhead Variable 1.00 x 5000 5,000
Fixed –
Selling Expenses Variable 0.20 x 5000 1,000
Fixed –
Total Cost 54,000
Statement Showing Total Cost of Existing Product, Expansion Product and overall cost of Products
Particulars Existing Expansion Total
Units produced and expected to be sold 80,000 units 5,000 units 85,000 units
Machine Hours 40,000 units 5,000 Hours 45,000 Hours
Direct Material 104,000 28,000 Direct Labor 224000 20,000 Variable Factory Overhead 40000 5,000 Variable Selling Expenses 16000 1,000 Fixed Factory Overhead 198000 198000
Fixed Selling Expenses 191250 191250
Total Cost 773250 54000 54,000
Cost per unit 9.67 10.80 9.73
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
Particulars Calculation Amount
Total Cost 54000
Profit Margin on sales 40% on sales
54000 x 40
60 36000
Total Sales 90000
Selling Price 90,000 / 5,000 18 per unit
Sales Mix:
Existing: 80,000 units
Expansion: 5,000 units
Statement Showing Contribution margin and Break Even Points
Particulars Existing Expansion
Sales 1,160,000 90000
Variable Cost 384,000 54000
Contribution 776000 36000
P/V Ratio 66.70% 40%
Total Sales 1250000
Total Contribution 812000
Total P/V Ratio 64.96%
Fixed Cost 389250
Total Profit 422750
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
Year Cash Flows PVF @ 12% Product
0 Outflow $ 42000 1 (42,000)
1 Inflows $15000 0.8929 13,394
2 $13000 0.7972 10,364
3 $10,000 0.7118 7,118
4 $10,000 0.6355 6,355
5 $6,000 0.5674 3,404
Net Present Value (1,366)
Net Present Value of the proposed investment = $(1,366)
Depreciation =42000/ 5 =$8,400
Year 1 2 3 4 5
Savings in Fixed Overhead 15000 13000 10000 10000 6000
Less: Depreciation 8400 8400 8400 8400 8400
Savings Before Tax 6600 4600 1600 1600 (2400)
Less: Tax – – – – Savings After Tax 6600 4600 1600 1600 (2400)
Add: Depreciation 8400 8400 8400 8400 8400
Cash Flows 15000 13000 10000 10000 6000
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.
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
Brealey, R.A., Myers, S.C., & Marcus, A. J. (2003). Fundamentals of CorporateFinance. 7th edition.. Boston : McGraw-Hill
Hilton, R. W., Michael, M., & Frank, H. S. (2006). Cost Management: Strategies for Business Decisions. Boston, MA: McGraw-Hill. Print.
Ross, S. A., Randolph, W., & Bradford, D. J. (2006). Fundamentals of Corporate Finance. 7th ed. Boston: Irwin/McGraw-Hill. Print.
Williams, J. R., & Robert, F. M. (2002). Financial and Managerial Accounting: The Basis for Business Decisions. Boston, MA: McGraw-Hill. Print.
