Analysis of ABC Company 8
IntroductionABC 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 ProfileRisk 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 COMPANYCash Flow Statement For the year ended 31st Dec,
19x2
Cash from Operating Activities:Cash Received from customers
(Note - 1)$1,260,000Cash Paid to Suppliers and Employees (Note -
2)$1,080,000Cash Generated From Operations$180,000Less: 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 $70,000Cash and
Cash Equivalents As at End of the year$50,000
Note - 1: Calculation of cash received Total sales $1200000Less:
Opening Balance of Debtors $180000Add: Closing Balance of
Debtors$120000$1260000
Note 2: Calculation of cash Paid to Suppliers Cost Of goods
sold$800000Less: Opening Stock$280000Add: Closing Stock$350000Total
Purchase$870000Add: Opening Balance of Creditors$210000Less:
Closing Balance of Creditors$250000Total Cash Paid$830000Add:
Selling and Distribution Expenses$250000$1080000Sources & Uses
of FundsSources:1. Operating: Cash received from debtors2.
Investing: None3. Financing: NoneUses:1. Operating: Payment to
suppliers2. Investing: Purchase of equipment3. Financing: Payment
of dividendSteps for improvement of cash flowsImplementation 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
OptionsAny 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 ownership2.
Interest paid is tax deductible3. Flexibility 4. Less complicated
in terms of paper workDisadvantages 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
ProductParticularsCalculationAmount
Units produced and expected to be sold5000 units
Machine Hours5000 Hours
Direct Material5.60 x 500028,000
Direct Labor4.00 x 500020,000
Factory Overhead
Variable1.00 x 50005,000
Fixed -
Selling Expenses
Variable0.20 x 50001,000
Fixed -
Total Cost54,000
Statement Showing Total Cost of Existing Product, Expansion
Product and overall cost of
ProductsParticularsExistingExpansionTotal
Units produced and expected to be sold80,000 units5,000
units85,000 units
Machine Hours40,000 units5,000 Hours45,000 Hours
Direct Material104,00028,000
Direct Labor22400020,000
Variable Factory Overhead400005,000
Variable Selling Expenses160001,000
Fixed Factory Overhead198000198000
Fixed Selling Expenses191250191250
Total Cost7732505400054,000
Cost per unit9.6710.809.73
The cost of existing product has increased due to the expansion
by $0.06 per unit.
Calculation of Selling Price for the new Expansion
ProductParticularsCalculationAmount
Total Cost54000
Profit Margin on sales 40% on sales 54000 x 40 6036000
Total Sales90000
Selling Price90,000 / 5,00018 per unit
Sales Mix:Existing: 80,000 unitsExpansion: 5,000 units
Statement Showing Contribution margin and Break Even
PointsParticularsExistingExpansion
Sales1,160,00090000
Variable Cost384,00054000
Contribution 77600036000
P/V Ratio66.70%40%
Total Sales1250000
Total Contribution812000
Total P/V Ratio64.96%
Fixed Cost389250
Total Profit422750
Break Even Sales =Fixed CostP/V Ratio=389250 64.96%=599,215
Sales Mix Ratio 80:5 or 16: 1
Break Even Sale :Existing =563,967Expansion =35,248a) YearCash
FlowsPVF @ 12%Product
0Outflow$ 420001(42,000)
1Inflows $150000.892913,394
2$130000.797210,364
3$10,0000.71187,118
4$10,0000.63556,355
5$6,0000.56743,404
Net Present Value(1,366)
Net Present Value of the proposed investment = $(1,366)
b) Depreciation =42000/ 5 =$8,400
Year12345
Savings in Fixed Overhead150001300010000100006000
Less: Depreciation84008400840084008400
Savings Before Tax6600460016001600(2400)
Less: Tax----
Savings After Tax6600460016001600(2400)
Add: Depreciation84008400840084008400
Cash Flows150001300010000100006000
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.ConclusionThe 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.
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(2006), Cost Management: Strategies for Business Decisions,
3eRichard A. Brealey, Stewart C. Myers, Alan J. Marcus, (2003),
Fundamentals of Corporate Finance, 4eStephen A. Ross, Randolph W.
Westerfield, Bradford D. Jordan, (2008), Fundamentals of Corporate
Finance: Standard Edition, Eighth Edition
