Financial analysis
ABC Company has been manufacturing roofing and siding shingles its annual sales amount to 1.2 million, which is an average increase of 25% compared to last year. The company wants to increase their sales to 3 million dollars within a period of three years. The CEO of the company has come up with an idea of using shingle scrap materials to make cedar doll houses. This could be a breakthrough for the company to reach its aim of sales amounting to 3 million by the end of the 3 years, in fact, there may be in a position to achieve the target within less time.
However, this is a major step for the company and the company needs to carry out a detailed analysis to identify whether the decision will be for the best of the company. For instance, the company needs to identify the payback period using the total investment the company makes. Some books also need to be kept for follow ups and particularly for the future. Due to the additional expenses, the CEO wants some feedback from financial controller to analyses some financial statement. Before taking the project the CEO will need to know what will be the product cost, and what is needed to break even and in addition, the level of return the product is expected to provide, the level of return should be high than the total investments made.
Risk profile
A risk profile can be defined as an evaluation of a company which is willing to take risks exposing the company to threats. A risk profile assists in the evaluation of a proper investment asset allocation. Risk profile helps in mitigating potential threats and risks. ABC Company will, therefore, use risk profile in mitigating the risk it is likely to suffer from the new product and more importantly it will help the company in determining the level of risk they are likely to accept and how that risk will affect their decision making. A risk profile also assists in determining the threats that ABC will face and the potential cost as well as the whether the project is likely to cause disruption in the normal operations of the company.
The risks that the company will face is that they may end up investing so much yet the product return might turn to be very low than anticipated. This is very risky for the company since they may end up investing so much and even fail to recover the capital investment. Due to high investment, this means that the company may invest their liquid cash and begin struggling to meet their daily expenses (Spekman, 2004).
The company must as well plan for the maintenance cost that is required in maintaining the product. There is a probability that the maintenance cost may be too high compared to the return the product is giving the company. They may as well be required to employ new employees to manage the product which will be an extra cost for the company. The other risk is the product breakdown, I have heard of cases where the machine broke down when it was still new though it is a very rare case. Machine breakdown is a big threat to ABC because this will make the company incur a huge lump sum or may be even forced to buy another product. The company must, therefore, come up with strategies that it will use in mitigating the risks and the threats (Spekman, 2004).
Cash flow statement
ABC COMPANY
STATEMENT OF CASH FLOW
FOR THE YEAR ENDED
Cash flow from operating activities
Cash receipts from customers 60,000
Cash paid to suppliers 40,000
Stock 70,000
Cash generated from operation (100,000)
Net cash from operating activities 70,000
Cash flow from investing activities
Proceed with sale of equipment 100,000
Net cash used in investing activities 100,000
Cash flow from financing activities
Retained earnings (50,000)
Stock and equity 20,000
Sale of assets (20,000)
Depreciation (70,000)
Net increase/ decrease in cash equivalent (120,000)
Cash equivalent at the beginning of the period 50,000
Cash equivalent at the end of the period 70,000
Solutions
- How does our cash flow statement explain the source of funds?
The source of finances in a cash flow includes things like transaction of stock, debt, and dividends transactions. When the company issues stock ownership is changed and cash is received. Shares can also be sold to the general public. In our case, the main source of funds is the stock and equity. The retained earnings have increased in the period of that one year.
- Things ABC Company can do to improve cash flow.
ABC Company can be able to improve its cash flow if it maintains a well smooth flow of cash and this will be done by targeting the account receivables, extend their credit limit in order to manage inventory. The importance of managing the flow of cash is to regulate money in and out of the company. We can use some of the listed ways to curb with cash flow problem; billing schedule organizing, the stretch of payables, incentives of early payment advantage, inventory tightening, leasing instead of buying and much more (Jensen, 1986).
- Can this project be financed with current cash flow from the company? Why or why not?
The current cash available cannot be able to finance this project. The reason is because the cash flow is very tight to accommodate a new project unless we consider external borrowing. The company has sold a quarter of its property and plant this is clear indication the company is not financially stable.
- What is the best external financing and why?
ABC Company is a small company which has no big capital base. I would recommend the company to consider the ordinary share capital as a way of its huge finance plan. The reason why is because ordinary shares give a degree of ownership in the company. The shareholder becomes the owners of the company so they in a case of loss they will carry the burden. The shareholder will be paid last in case of liquidation of a company. As compared with other preference shares and debt which need to be paid interest which is expense to the company, the ordinary shareholder only enjoys divided which are not mandatory as they are calculated when the company makes the profit.
Production cost of adding 5,000 machine hours
Current production Adding 5,000
Sales 1,160,000 1,725,500
Cost of sales
Direct material (104,000) (154,700)
Direct labour (224,000) (333,200)
Variable factory overhead (40,000) (56,000)
Variable selling expenses (16,000) (17,000)
Fixed factory overhead (198,000) (198,000)
Fixed factory selling (191,250) (191,250)
Expected profit 386,750 775,350
Solutions
- The production cost of ABC Company is 773,250
- After the product expansion, it helps us to absorb the fixed factory overhead and sales expense by using same fixed cost to produce more profit(Needles, 2013). It reduces by 7,000 that is additional 40% of 5,000
- The selling price of new product after 40% gross margin
Selling price of current product is 14.50
14.50 – 100%
? -140%
New Selling price will be 20.30
- Assuming the same sales mix of these two products, what are the contribution margins and break-even points by product?
= fixed cost
(Selling price per unit –variable cost per unit)
= 198,000+191,250 = 389250 / (20.30-1.20)
389,250/19.10
B.E.P = 20,380
NPV
Year Expected returns ($)
1 15,000
2 13,000
3 10,000
4 10,000
5 6,000
Initial investment - $42,000
Rate 12%
NPV = 15,000/(1+0.12)^1 + 13,000/(1+0.12)^2 + 10,000/(1+0.12)^3 + 10,000/(1+0.12)^4+ 6,000/(1+0.12)^5- 42,000
Npv = 13,392.86+10,363.52+7,117.80+6,355.18+3,404.56
=40,633.92-42,000 = -1,366.08
Npv = (1,366)
Decision
The ABC Company should not invest in buying additional equipment.
Conclusion
The ABC company cash flow needs to be changed as it has been deteriorating. For example, we have noted that the company net worth of asset has been reducing as the company has been selling most of its fixed asset to finance its operation. The company needs to locate a more fixed source of income to improve its cash flow position.
The company needs to consider adding 5,000 extra hours because the production will be added. The profitability has improved in order to exhaust all the fixed cost available.
In the NPV the company should not invest in the new project as it gives a negative NPV.
References
Jensen, M. C. (1986). Agency cost of free cash flow, corporate finance, and takeovers. American Economic Review.
Needles, B. E. (2013). Principles of accounting. Cengage Learning.
Spekman, R. E. (2004). Risky business: expanding the discussion on risk and the extended enterprise. International Journal of Physical Distribution & Logistics Management, 414-433.
