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The Bucharest Academy of Economic Studies
Faculty of Business Administration
Entrepreneurship and Business Administration Master’s Program
FINANCIAL MANAGEMENT
Instal Sting – Financial Analysis
Students: Ioana Carmen MECHIS
Alina Alexandra POPA
Andreea Mihaela RAICA
Andreea Georgiana SAVIN
Augustina Ozana SPIRIDON
Group: 2
Year: 1
Bucharest, 2014
INSTAL STING 99 SRL
www.instalsing.ro
1. INTRODUCTION
The project illustrates the application and development of financial principles in Instal
Sting SRL, a Romanian SME that activates in the industry of fire extinguishers, installations and
building materials.
2. BUSINESS DESCRIPTION
2.1. Shareholders’ structure
Social capital
- Subscribed social capital: 5000 RON, fully paid
- Number of social parts: 500
- Value of the social part: 10 RON
Associated natural person
1) Gosoiu M. Constantin
- Capital contribution: 3000 RON
- Number of social parts: 300
- Participation quota to benefits and losses: 60%
2) Rusu Petre
- Capital contribution: 2000 RON
- Number of social parts: 200
- Participation quota to benefits and losses: 40%
Empowered person
Gosoiu M. Constantin
- Quality: administrator
- Power: unlimited2
2.2. History of the company
Organization type: Limited Liability Company – the company capital is divided
into shares, held by shareholders who have limited liability.
Headquarters: Reconstructiei Street no. 1, Bucharest, district 3, postal code 45311
Secondary office/Workstation: Splaiul Unirii no. 162, Bucharest, distrct 4, postal
code 70000
Short history:
o May 1999 – The company is founded by specialists in P.F.F and
installations domain.
o August 1999 – Certificates of quality products and staff competence are
obtained.
o 1999-2000 – The collaboration with all big companies producing P.F.F
products, especially fire extinguishers was set
o first quarter of year 2000 – The production of valves and welding angles
started
o 2001 – The authorized distributors for Instal Sting’s products in the big
cities of the country appeared.
The company has as main activity object other professional, scientific and
technical activities, according to the 7490 CAEN (Classification of Activities from the
National Economy) code.
2.3. Current business
Instal Sting offers a wide range of products and services in the fire protection fields, as
well as in the installations (valves, angles, pipes) and building materials field.
It has as main object of activity, activities of services provided in the installations and
PFF equipments domain, being a company that sells: pressurized portable and transportable fire
extinguishers with powder, mechanical foam and carbon dioxide, pickets and hydrant boxes, PFF
accessories (hoses, fittings, discharge pipes), as well as fire equipments.
The company provides service (repairing, inspection and loading) for all types of
extinguishers and it performs fireproofing works.
3
The products of the company address both to the public sector and to the industrial and
agricultural. The main concern of Instal Sting is represented by identifying and satisfying
customers’ needs and expectations and continuous improvement of technical performance of
products, which relies on specialists with vast experience.
In the protection and fire-fighting domain, Instal Sting earned its reputation through
efficiency and quality. The company provides the transportation and delivery, and for the
extinguishers that need to be checked, it provides the taking and the sending back again to the
beneficiary.
Also, the company has all the necessary authorizations to perform the whole activity in
good conditions. The quality-price ratio of the products and services offered by this company is
the best on the market and the satisfaction of the clients is its priority. All the employees are
focused on results and act decisively to achieve them. Enjoying itself of a strong reputation
among the customers, Instal Sting’s team is sure that all types of fire extinguishers, as well as the
other products and services of the company offers to its clients a guaranteed satisfaction.
2.4. Management team & Human resources
The company has a number of 17 employees distributed as follows:
4
COMPANY DIRECTOR
Gosoiu Constantin Gosoiu Gabriel-Dragos
TECHNICAL MANAGER
Rusu Petre
AUTO-MECHANIC
Anitulesei Petre
MECHANIC LOCKSMITH FOREMAN
Dobre Marin
WELDER
Coravu MariusChirca GheorgheManole George
DRIVER
Tima StelianMedeleanu Gheorghe
CARPENTER
Marian Pavel-Constantin
COMPUTER OPERATOR
Bolda Carmen-Cerasela
MECHANIC LOCKSMITH
Petre Constantin Grigorescu Ionel
Pantazi VictorUdila Ionel-Cristian
Gheorghe Stan
MIDDLE MANAGEMENT
LOW MANAGEMENT
TOP MANAGEMENT
2.5. Services/products
2.5.1. Services
InstalSting offers a wide range of services, in order to meet the most various problems: starting
with the maintenance of systems and equipment, continuing with the manufacture of various
devices and finishing with the transport through the country.
1) Fireproofing services. The company is doing fireproofing services for wood, being
authorized by the military fire-fighter’s body.
Technical details:
- it is done in two coats, applied separately
- it is delaying burning with about 15-20 minutes
- the fireproofing is mandatory for wood constructions
- works done: warehouses, bridges, attics
- it can be done with colorless substances or firerpoof paint
2) Extinguishers services. The entire range of extinguishers requires regular service. The
company is equipped with all the necessary facilities to ensure the following maintenance and
verification services:
- loading the extinguishers with extinguishing agent (powder, foam, CO2)
- checking of the pressure and integrity of the components
- replacement of defective parts (gauges, hoses, handles, etc.)
- painting the fire extinguishers (for those requiring this operation)
3) Installation services. Instal Sting offers complete maintenance and reconditioning services
for all types of valves, as well as for elbows, flanges, pipe itself, etc. These services are made in 5
accordance with standards in force, the company providing quality and warranty certificates for
all the works performed.
4) Manufacturing services. Types of manufacturing works:
a) for film studios:
- wind and rain making machine
- smoke making machine
- complex technical sets
b) dissection and autopsy table
c) pumping groups
d) frame of a presentation stand for shops
5) Consulting services. The company offers free consulting for fire extinguishers and valves,
trying in the same time to help the client decide upon the products and the quantity in case of
acquisition of fire extinguishers and accessories for fire protection. Also, it offers specialized
consulting in site with fee and design of installations, having the entire range of necessary
products, too.
6) Second-hand acquisitions services. The company developed a strong service of acquisition
of used products, reconditioning and checking and then reselling them to a quality very close to
the initial, when the products were new. For big companies, which have a special financial power
and which care about their image, the safety of their employees and the equipment they own,
Instal Sting offers the following services:
- free assistance in order to identify the best solutions and equipments that exist on the
market at a specific moment in time
- the acquisition of existing facilities at a negotiable price depending on the attrition and the
usage time
- free training for the specialized personnel in order to use correctly and efficiently those
products and equipments
- informing periodically the customer regarding the new demands and products that
appeared on the market
7) Transportation services. Instal Sting ensures free transportation for all the products
purchased by its clients and to any destination in the country, depending of course on the
quantity ordered and the delivery time. The company has in its subsidy a strong park of vehicles, 6
consisting of the vans special equipped for the transportation of products, and the drivers can
arrive as quickly as possible to the companies’ customers.
2.5.2. Products
The products of the company are divided into two main categories:
1) PFF Products:
a) fire extinguishers: with powder, with foam, with carbon dioxide
b) portable hydrants – Instal Sting is one of the two companies producing portable
surface hydrants in Romania. They are made of aluminium, meet the international
standards and, especially, are sold at the lowest prices in the country.
c) Hydrant boxes – can be: simple, simple (with seal), with space for extinguisher or for
extinguisher
d) PFF accessories: connecting pipe (fix, mobile, clogged), canvas hose, reductions,
wrenches, foam inductors, extinguishing agents, foam generator
e) hydrants
- for underground – The company sells underground hydrants which are mounted on water
distribution systems and are used together with the portable surface ones.
- for ground – Instal Sting also sells complete hydrants (both for underground and ground).
These have an exceptional quality being produced by the best companies in the field.
They are shocks resistant, due to their flexibility being resistant even to a impact with a
car.
2) Installations
a) angles – Instal Sting is one of the most important producers of pulled black pipe
angles in Romania. It produces high quality angles no matter the diameter.
b) valves – The company collaborates since its foundation with the most importants
valves producers of Romania: the enterprises from Zalau and Bacau and this is why it
offers to clients any type of valves in the quantity needed, made of steel or not.
c) flanges – The company sells connecting flanges and mounting flanges (flat, clogged
or with neck)
d) tees – It sells long-neck tees or drawn tees (empty or reduced)
e) other products: 7
- pipes – Instal Sting sells new or reconditioned pulled black pipe at producer price, no
matter the size and it also offers discounts for important quantities. Even if they are
commercialized at a lower price, the pipe meets all quality conditions required on the
market nowadays.
- building materials – The company collaborates with many producers of building
materials, as well as with warehouses in order to deliver to its customers various building
materials, in any quantity and with lower prices.
3. MARKET ANALYSIS
3.1. The industry
As most of the Romanian industries, the fire protection and the building materials
industries are in continuous change, trying to improve and expand themselves in order to make
possible the entrance of more and more important enterprises on the Romanian market. Even if it
seems to be not very appreciated and it is not so much taken into consideration, the fire
protection industry is a very profitable industry because it has as main target market the big
Romanian companies no matter the domain each of them activates in. It is very important for
everyone to protect its most valuable assets and it is vital for them, especially if they have a big
company in which they invested time and money, to find a way to ensure it in case of unexpected
events as the fires are.
3.2. Clients
Regarding the two categories of products available in this company, we can say that there
are also two categories of clients, who are interested in either P.F.F. products or installations.
Buyers of P.F.F. products:
1) ING Nederlanden Romania Company – The collaboration with this company
consisted in the selling and checking of all the fire extinguishers, both from Bucharest
headquarters and Brasov subsidiary.
2) Romanian Bank for Development – Instal Sting provided fire extinguishers and
equipments for Bucharest headquarters, but also the verification services of the fire
extinguishers.
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3) UCECOM – There is a strong collaboration between UCECOM and Instal
Sting in P.F.F. fileld, the products and services of the company being very appreciated by
the specialized people.
4) Castel Film Studios – Castel Film bought the entire range of fire extinguishers
necessary for its current activities. Also, Instal Sting provides the verification and the
maintenance of these products.
5) Bucharest MALL – The company collaborates with Bucharest MALL since its
construction phase, the entire range of products being part of this hypermarket’s
endowment.
Buyers of installations:
1) Bucharest MALL – The pipe, the angles, the valves and the cocks were
purchased for the realization of the installation system, as well as different building
materials.
2) The Iron Gates 1 – Instal Sting contributed to the renewal of the
installations system of the hydro-electric power station, delivering a vast variety of
specialized products.
As you can see, Instal Sting’s target market is represented mostly by big and important
enterprises. It cannot be said that there is a clearly defined customer profile because we are not
talking about preferences as in the fashion industry, but about security, which is a very important
and vital matter of the whole society. Unfortunately, Instal Sting is not the only one that wants to
ensure the safety of the citizen by offering protection fire-fighting products and equipment,
therefore the bargaining power of the customers is rather high because they have the opportunity
to switch to one of the main competitors of Instal Sting that will be discussed in the following
points of the chapter. But despite the enemies’ presence on the market, the company is enjoying
a strong reputation among the customers, the team being sure that all types of fire extinguishers,
as well as the other products and services of the company offer to its clients a guaranteed
satisfaction.
3.3. Suppliers
The main suppliers the company works with are:
- Ferbat Serv SRL Ploiesti – deals with the en-gros commercialization of
industrial products and building materials.9
- SC Regent SRL Bacau – commercializes industrial cocks and industrial
fittings made of iron and steel for water, heating and gas networks. It provides the entire
range of industrial fittings, underground hydrants and accessorizes (flanges and
assembling parts - screws, studs, nuts) necessary for the mounting of any type of
industrial cock. Also, it can ensure the transportation of the products anywhere in the
country, as well as the technical consultancy for the implementation of the solutions
offered.
- SC WILO ROMANIA SRL - is one of the leading manufacturers of pumps
and pump systems made of copper and brass for heating, cooling and air-conditioning,
for water supply and drainage and sewage.
- INSTAL SERVICE TECHNOLOGY – is specialized in the execution of
the construction works, urban networks and installations, for which equipments of both
small and big mechanization are necessary.
- SC Brico Expert SA – is the only retailer present in Romania with the
biggest geographical spread. They offer to Instal Sting o variety of products such as
building materials, products for the arrangement of warehouses, electrical and hand tools,
hardware products, sanitary objects and accessories, sanitary and thermal installations as
well as professional counselling.
- SC Proges SRL Oradea – has as main object of activity the import and the
distribution of building materials. Proges provides for building firms and companies a
team of consultants who know what advices and solutions to give, the delivering of the
orders in multiple locations, special commercial conditions, personalized price and
deadlines offers.
The primary reasons for choosing these companies to collaborate with are the high
quality, the convenient offers and prices as well as their tradition, all of them being companies
based on seriousness and great implication. These qualities are very important when choosing the
providers in order to be sure that you sign a good partnership and you will receive the products
and services you are expecting. The relationship with these suppliers is a normal one as Instal
Sting buys in quite big quantity, depending of course of the type of products and the clients’
demands. Therefore the price and its variations are not a problem, the bargaining power of the
supplier being quite low.
3.4. Competitors10
The main threats for Instal Sting are represented by its direct competitors:
- AutoPress – entered the fire extinguishers’ market in 1994 and offers a
variety of products made by themselves or in collaboration with bigger Romanian and
foreign manufacture firms.
- Gimar Serpico SRL – started its activity in the preventing and
extinguishing fires domain in 1992 as importer and distributer of Italian fire
extinguishers.
- SC LIDLE – is a Romanian distributer of fire protection materials both
from import and its own production.
Even if this branch of the industry seems to be rather unfamiliar to most of the people, I
can assure you that it is not as empty as I personally expected to be and the number of
participants is quite high and therefore Instal Sting has to face to a quite large number of
competitors. For this reason, the threat of substitutes might seem high, but there should be taken
into account the fact that Instal Sting is a modern company that earned its reputation through
efficiency and quality. Also, the company is continuously trying to satisfy customers’ needs and
expectations by improving the technical performance of products with the help of specialists
with vast experience.
4. FINANCIAL SITUATION FOR 2008-2012
4.1. Balance sheet analysis
Ratio/Year 2008 2009 2010 2011 2012Current assets 2,790,325 3,255,682 3,529,851 2,607,349 2,384,796Inventories 1,331,944 1485124 1,531,675 1,215,806 1,027,819Accounts receivable 1,214,287 1,630,097 1,666,221 1,180,351 1,253,575Short term investment - - - - -Cash and cash at bank 244,094 140,461 331,955 211,192 103,402Fixed assets 713,508 825,391 892,285 1,204,208 1,252,811Tangible assets 713,508 825,391 892,285 1,204,208 1,252,811Financial assets - - - - -Total assets 3,503,833 4,081,073 4,422,136 3,811,557 3,637,607Current liabilities 1,634,220 1,898,694 2,173,096 1,432,823 1,258,873Accrued expenses (785) - - - -Long term debt 17,186 8,819 - - -Owners’ equity 1,853,212 2,173,560 2,249,040 2,378,734 2,378,734
11
Subscribed and paid in share capital 5,000 5,000 5,000 5,000 5,000
Re-evaluation reserve 398,909 398,909 398,909 398,909 398,909Legal reserve 894,573 1,214,922 1,214,922 1,214,922 1,214,922Retained earnings 554,730 554,730 554,730 630,209 759,903Profit-Loss for the period 453,356 320,348 75,479 129,694 177,113
Sharing of profit (453,356) (320,349) - - (177,113)Total Liabilities + OE 3,503,833 4,081,073 4,422,136 3,811,557 3,637,607
Current assets are important to businesses because they are the assets that are used to
fund day-to-day operations and pay ongoing expenses. In 2010, the company reached the highest
amount of current assets which was 3,529,851. In this year, the company doubled its cash as in
2009 it was 140,461.
Accounts receivable are a legally enforceable claim for payment to a business by its
customer/ clients for goods supplied and/or services rendered in execution of the customer’s
order. These are generally in the form of invoices raised by the business and delivered to the
customer for payment within an agreed time frame. The company encountered some problems in
collecting debts from its clients 2 years in a row, 2009 and 2010, but in the next year they
managed to improve the relation with them, in this way the company decreased considerably its
accounts receivable. In 2011, the company reached its minimum regarding the accounts
receivable and maintained a small level also in 2012.
Fixed asset is a long-term tangible piece of property that a firm owns and uses in the
production of its income and is not expected to be consumed or converted into cash any sooner
than at least one year's time. Regarding the fixed assets, the company followed an increasing
trend, so from 713.508 in 2008 went to 1,252,811 in 2012 which means that investments were
made during these years.
Current liabilities are essentially, bills that are due to creditors and suppliers within a
short period of time. Normally, companies withdraw or cash current assets in order to pay their
current liabilities. In 2010, the company registered the highest value of the 5 years which was
2,173,096, also during this year the cash reached its highest value which means that the company
preferred to keep cash and not to pay its debts.
Long-term debts are loans and financial obligations lasting over one year. Long-term
debt for a company would include any financing or leasing obligations that are to come due in a
greater than 12-month period. Such obligations would include company bond issues or long-term
leases that have been capitalized on a firm's balance sheet. The company registered long term
debts only during the first 2 years 2008 and 2009, in 2008 the value of long term debt was 12
17,186 while in 2009 they managed to reduce it to almost half of 2008, the value for 2009 being
8,819. For the next 3 years, 2010, 2011, 2012, the company had no long term debts,
Accrued expenses are the opposite of prepaid expenses. Firms will typically incur
periodic expenses such as wages, interest and taxes. Even though they are to be paid at some
future date, they are indicated on the firm's balance sheet from when the firm can reasonably
expect their payment, until the time they are paid. The only year in which the company registered
accrued expenses was in 2008 and its value was of 785, which is a very small amount.
Retained earnings refers to the portion of net income of a corporation that is retained by
the corporation rather than distributed to shareholders as dividends. For the period of time 2008-
2010, the company maintained a constants retained earnings level which was 554,730, and
starting with 2011 increased to 630,209 and reached in 2012 the highest value which was
759,903.
Profit sharing refers to various incentive plans introduced by businesses that provide
direct or indirect payments to employees that depend on company's profitability in addition to
employees' regular salary and bonuses. The company shared its registered profit in 2008, 2009
and in 2012, while for the other 2 years, 2010 and 2011, the company didn’t share its profit.
4.2. Income Statement analysis
Ratio/Year 2008 2009 2010 2011 2012Sales revenues 4170902 4109517 3017662 3025426 2678226Other operating revenues - - 35601 1038 565200
Raw materials and consumables expenses 434029 1091119 1028706 832158 1100618
Other expenses with materials 76441 32245 28164 47025 39636
Other expenses with services (water and energy)
33168 43903 38971 38383 39452
Expenses with goods of resale 1972272 1746160 1232647 1227588 1165031
Salaries expenses 110958 125834 143158 160872 163078
Company's contributions to social security and welfare
31205 34796 39917 44764 44981
Other operating expenses 844572 592839 348925 415122 381254
Depreciation and amortization 71237 53325 90715 97581 92754
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Operating income 597020 389296 102060 162971 216622Other revenues (financial revenues) 307 4507 1319 3184 845
Other expenses (financial expenses) 6562 4814 3668 194 247
EBIT 590765 388989 99711 165961 217220
Interest payment - - - - -
EBT 590765 388989 99711 165961 217220
Income tax and other taxes 137409 68641 24232 36267 40107
Net Income 453356 320348 75479 129694 177113
The income statement is a financial report used to provide information on the revenues,
expenses, and the profitability of a company.
It also contains the numbers most often discussed when a company announces its results-
numbers such as earnings and earnings per share. Basically, the income statement shows how
much money the company generated (revenue), how much it spent (expenses) and the difference
between the two (profit) over a certain time period.
14
When it comes to analyzing fundamentals, the income statement lets investors know how
well the company's business is performing - or, basically, whether or not the company is making
money. Generally speaking, companies ought to be able to bring in more money than they spend
or they don't stay in business for long. Those companies with low expenses relative to revenue -
or high profits relative to revenue - signal strong fundamentals to investors.
Comparing all 5 years we can observe a fluctuation in sales revenues, decreasing in 2012
to almost half of the sales revenue from 2008. A sales decline could reflect a decrease in sales
activity (number of units sold) or a decrease in unit selling prices. Either of these causes have
adverse effects on profitability as we will see later on with the net profit.
On the other hand, there was a big increase in other operating revenues in 2012, which
are actually 0 in 2008. These revenues were generated in the course of non-regular business
operations. The operating income is decreasing as well due to a decrease in sales and an increase
in some expenses. The smallest values for operating income, EBIT , EBT and net income are in
2010 when the costs of production were too big compared with sales revenues. The reminder of
the decrease in EBIT was attributable to lower gross profit resulting primarily from higher input
costs and higher selling and administrative expenses. The decrease in operating income during
2010 is an indicator of management’s failure in operating the firm.
The biggest values for EBIT, EBT, operating income and net income were recorded in
2008 when the company had a big amount of revenues from sales and the operating costs and
costs of goods sold were small enough. The small value in raw materials expenses in 2008 is due
to the increase sales and also from buying in bulk to obtain a better price.
The decrease in costs of production beginning with 2009 is attributable to two other
reasons: the company was able to find less expensive sources of raw materials, and it improved
the efficiency of its manufacturing operations.
As we can observe, the company costs with salaries didn’t modify too much in 5 years
due to the fact that either they didn’t hire too much extra personal or didn’t increase their salaries
with a big value.
Also, there was a fluctuation in Financial revenues, the biggest value being in 2009,
revenues coming from interests, rents, and other such income earned in owning or renting an
asset or property. The biggest value in Financial expenses is recorded in 2008, when probably
the company had to rent a place and paid for it.
Higher amortization and depreciation expense from 2008 to 2009 means nothing more
than the business's assets are losing value faster in the business's estimation. The most common
15
reason is that the business simply has more assets from which value can be lost, since
depreciation is usually aggregated into one single expense on the income statement.
4.3. Cash-flow analysis
CASH FLOW FROM OPERATING ACTIVITIES
2008 2009 2010 2011 2012
Net income 453,356 320,348 75,479 129,694 177,113
Depreciation and amortization
71,237 53,325 90,715 97,581 92,754
Changes in assets and liabilities
Inventories 346,605 (153,180) (46,551) 315,869 187,987
Accounts receivable 214,727 (415,810) (36,124) 485,870 (73,224)
Current liabilities 642,812 264,474 274,402 (740,273) (173,950)
Accrued expenses (2,382) - - - -
TOTAL FLOW FROM OPERATING ACTIVITIES
1,726,355 69,157 357,921 288,741 210,680
CASH FLOW FROM INVESTING ACTIVITIES
2008 2009 2010 2011 2012
Acquisition of fixed assets
- (111,883) (66,894) (311,923) (48,603)
Sales of fixed assets 26,112 - - - -
Acquisition of financial - - - - -
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assets
Sales of financial assets - - - - -
TOTAL FLOW FROM INVESTING ACTIVITIES 26,112 (111,883) (66,894) (311,923) (48,603)
CASH FLOW FROM FINANCING ACTIVITIES
2008 2009 2010 2011 2012
Long-term or short-term debt repaid
642,812 (8,367) (8,819) - -
Newly issued long-term or short-term debt
- - - -
Dividends paid (453,356) (320,348) (75,479) (54,215) (177,113)
Repurchase of stock - - - - -
New stock issued - - - - -
TOTAL FLOW FROM FINANCING ACTIVITIES 189,456 (328,715) (84,298) (54,215) (177,113)
2008 2009 2010 2011 2012
OPERATING ACTIVITIES 1,726,355 69,157 357,921 288,741 210,680
INVESTING ACTIVITIES 26,112 (111,883) (66,894) (311,923) (48,603)
FINANCING ACTIVITIES 189,456 (328,715) (84,298) (54,215) (177,113)
Total Cash Flow
1,941,923 285,989 206,729 -77,397 -15,036
Cash flow basically represents the money that are entering into the company and the
money which is going outside the company – the amount of cash that a company generates and
uses in a determined period of time. Generally speaking, incoming money are those represented
by revenues, while out coming money are represented by expenses or investments. These cash 17
movements can result from various activities; therefore, the cash flow is divided into financing
activities, operational activities and investing activities. Along with this activities, the cash flow
can suffer modifications through received donations or gifts, as we as from personal finance.
In order to find out if a company is solvable or not, the cash flow statement represents an
important document, since it is essential in observing the solvency level. This cash flow
statement is actually a recorded document which attests something that happened in the past,
with the associated future effects. For instance, if in the past there was registered a sale of a
particular good, the cash flow statement will show what future implication that specific activity
had on the company’s cash.
In there is the case of the unfortunate situation in which the company is unable to support
its own operation with its cash, then the company is considered to be insolvent, which can
eventually lead to bankruptcy.
In a company’s cash flow, there is registered the inflow and the outflow of cash. In terms
of operating activities, the inflow of cash is consisted of any activity that produces money, such
as sale of goods, accounts receivable, cash interest or cash dividends received. On the other
hand, there is the outflow produced by operating activities, such as payments for purchased
goods, fees, fines, interests paid to creditors and other operating activities that imply cash going
out of the company. These fluctuations in the operating cash flow are best reflected in the change
in net income, the modification in assets and liabilities, while the change in depreciation and
amortization is not that eloquent.
In short, the operating activities show the amount of cash was produced and used in
everyday operations, such as selling or delivering the goods.
In the case of Instal Sting, it can be easily observed that in the case of operating activities,
the company 2009 was the year in which the cash flow was modest, as compared to the other
years analyzed, since it registered the smallest value of all the years, meaning 69,157 RON. The
year in which the company registered the highest value of cash flow based on operating activities
was 2008, where the total amount of cash flow was 1,726,355. The reason behind the small
amount of operating cash flow in 2009 may be explained by observing the fact that in that
particular year, the company’s accounts receivables figure is considerably higher than the other
years; this means that the company hasn’t yet received the money which was due for the goods
sold.
Moving on the cash flow concerning investing activities, this particular type of cash flow
registers and shows the change it a company’s financial situation due to the fluctuation of
18
money, by gain or loss, made from investments of any kind, whether it is an financial
investment, or an investment in plant or equipment.
If the cash flow shows negative figures, it means that the company has made great
investment expenditure, which can represent a positive and beneficial move. This is the case of
Instal Sting, which during the period between 2008 and 2012 made several investments, which
resulted in negative figures in every single year. The highest sum invested was registered in
2011, as a consequence of the acquisition of fixed assets, which can also be observed in the table
concerning cash flow from operating activities, where the inventory account is considerably
higher than any other year. The company hasn’t made any financial investment in the determined
period, and it neither sold any of its fixed assets.
As for the cash flow from financial activities, it represents the part of the total cash flow
statement in which there are registered the changes in cash based on activities such as issuing
cash dividends, paying or changing loans, issuing or selling stock. In other words, it measures
the flow of cash between its owners and its creditors. By observing the table containing cash
flow from financing operations, the first thing to notice would be the fact that Instal Sting had no
debt to pay in 2011, as well as in 2012, which means that it had already paid its debts the
previous years, without making new ones. Also, in every single year, the company was able to
pay cash dividends; the highest rate of dividend was registered in 2008. The fact that this
particular part of the cash flow statement has negative numbers is a proof of the fact that the
company is paying dividends, which can represent a plus for its portfolio, if there is an investor
interested in collaborating with the company.
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5. Financial ratios analysis
5.1. Cash conversion cycle analysis
Through the normal course of business, companies acquire inventory on credit, which
they in turn use to create products. These products are then sold, oftentimes on credit. These
actions generate accounts payable and accounts receivable, with no cash exchanged until the
company collects accounts receivable and settles the accounts payable.
20
The cash conversion cycle (CCC) measures the time - in days - that it takes for a
company to convert resource inputs into cash flows. In other words, the cash conversion cycle
reflects the length of time it takes a company to sell inventory, collect receivables and pay its
bills. As a rule, the lower the number, the better. This is because, as the cash conversion cycle
shortens, cash becomes free for a company to invest in new equipment or infrastructure or other
activities to boost investment return. Also, the cash conversion cycle can be useful in comparing
the company with its industry’s trend and assessing management efficiency.
Calculating the Cash Conversion Cycle for InstalSting
Year
Ratio2008 2009 2010 2011 2012
ICP 171 180 241 239 164
RCP 97 127 200 172 143
PP 194 225 325 313 196
CCC 75 82 116 98 110
The table above presents data for InstalSting, covering its last five fiscal years. The table
provides the values corresponding to the three activity ratios and, ultimately, the cash conversion
cycle. Analyzing financial ratios on a stand-alone basis doesn’t yield meaningful results. Instead,
tracking trends in an individual company over several years can prove enlightening.
21
Inventory Conversion Period
This measure addresses the question of how long—in days—it takes for a company to
sell its entire inventory. It is computed using the following formula:
ICP = Average Inventory ÷ Cost of goods sold per day
Where:
Average inventory = (beginning inventory + ending inventory) ÷ 2
Cost of goods sold per day = annual cost of goods sold ÷ 365
The principle is simple: the smaller the number, the better. Despite the fact that it appears
that inventory conversion period contributed more than receivables collection period to the rise
of the cash conversion cycle for InstalSting, we observe that it managed to decrease from 171
days in 2008 to 164 days in 2012. Less inventory conversion period is better because in this way
inventory is converted faster into sales, which in turn means that there will be less chance of
obsolescence and paying of over-stocking cost.
Receivables Collection Period
Here we use the below formula in order to calculate the number of days a company needs
to collect on sales.
RCP = Average Accounts Receivable ÷ Sales Revenue per day
Where:
Average accounts receivable = (beginning accounts receivable + ending accounts receivable) ÷ 2
Sales revenue per day = annual sales revenue ÷ 365
22
Cash-only sales have a RCP of zero, but many companies allow customers to buy on
credit. Again, it should follow the same principle as before: the smaller the number, the better,
but unfortunately the receivables collection period ratio has risen from 97 days in 2008 to 143
days in 2012. This may mean that the company is relaxing its collection policies or extending
credit to customers who are having a hard time paying. The easy payment terms may give
InstalSting a competitive advantage in its sales efforts, however, this collection delay may have
adverse such as:
Decreasing its ability to invest in case of increased inventory or other areas of the
business.
Attracting poor customers to buy on credit poses a serious risk of non-payment,
thus InstalSting needs to make sure that it is taking steps to reduce this risk.
Payables Period
Lastly, we measure how long it takes for a company to pay its bills (accounts payable) by
computing:
PP = Average Accounts Payable ÷ Cost of goods sold per day
Where:
Average accounts payable = (beginning accounts payable + ending accounts payable) ÷ 2
Cost of goods sold per day = annual cost of goods sold ÷ 365
The longer a company is able to hold its cash, the better its investment potential. In this
case, a longer PP is better. According to the table, InstalSting’s payables period has risen only
slightly since 2008, from 194 to 196 days, but has seen a sizable increase from 194 days in 2008
to 325 days in 2010. The following period was marked by a sharp fall to 196 days in 2012, which
may be an indication of creditors tightening their terms with InstalSting.
Cash Conversion Cycle (CCC)
Having the three activity ratios used until now to dissect the cash conversion trend, we
can further make up the cash conversion cycle. The cash conversion cycle is actually a collection
of these three “activity ratios” as follows:
Cash Conversion Cycle (CCC) = Inventory Conversion Period (ICP) + Receivables
Collection Period (RCP) – Payables Period (PP)
23
From the data in the table, we see that InstalSting’s cash conversion cycle has risen with
almost 47% since 2008, from 75 days to 110 days. This trend is not favourable for the company,
as money is tied up for longer periods of time before the company is able to convert its own
expenditures back into cash. In other words, the company was not able to pay its suppliers for 75
days in 2008, the period of time rising to 110 days in 2012.
In conclusion, the cash conversion cycle is a useful tool in evaluating a company’s
management. By breaking down the cash conversion cycle into its three component activity
ratios and studying the trends in our company we were able to gain insights in the operating
efficiency of a firm.
5.2. Liquidity ratio analysis
LIQUIDITY RATIOS (2008-2012)
Ratio/Year 2008 2009 2010 2011 2012
Current Ratio 1.707 1.714 1.624 1.819 1.894
Quick Ratio 0.892 0.932 0.919 0.971 1.077
Cash Ratio 0.149 0.073 0.152 0.147 0.082
Curent Ratio = Curent Assets/Curent Liabilities
Quick Ratio = (Cash+Marketable Securities+Accounts Receivable)/Current Liabilities
Cash Ratio = (Cash+Marketable Securities)/Current Liabilities
24
These liquidity ratios represent a method of analyzing whether a company is able to pay
off its short term debts obligations or not. In general, if there is a high value of one of the
liquidity ratios, this means that there is high probability that the company is able to meet its
needs and debts. These ratios are: current ratio, quick ratio and cash flow ratio and they result
from dividing the company’s cash and other liquid assets to its current liabilities. In other words,
these ratios show the number of times in which the company’s short term obligations are fulfilled
by its cash and liquid assets. As a universal rule, if the ratios’ values are greater than 1, the
company is unlikely to have any financial difficulties during that particular year, the company
being able to cover its short term obligations.
The current ratio, like all the liquidity ratios, represents a form of measuring whether
the company can meet its short term obligations; in other words, if it has enough resources to
cover its debts during the next year. This ratio is taken into consideration mostly when asking for
loans, as creditors use it in determining the worthiness of the company to benefit from a short
term loan. Also, the current ratio, also known as the working capital ratio shows if the company
uses its assets efficiently, transforming their products into cash. Just like the general rule, the
bigger the value of the ratio, the more liquid the company is. The accepted healthy value is 2, but
they can vary and can reach even 1,5. Values less than 1 indicate the fact that the company might
have difficulties in covering its short term debts. On the contrary, if the value is way too high,
more than 2, this can indicate the fact that the company is not using its assets efficiently.
Taking the practical case of Instal Sting, the average value of the current ratio is every
single year bigger than 1,5, which indicates a good and efficient use of assets and transformation 25
into liquidity. Like in the case of the quick ratio, the current ratio reaches its highest peak in
2012, when it measures 1,894, the closest value to the healthy value 2. The smallest value of the
current ratio was registered in 2010 (1,624); although it is the smallest value from all 5 years, it
is greater than the average 1,5, which means that even at its lowest and inefficient point, the
company was doing a good job in covering its short term debts.
The quick ratio, also known as the acid-test ratio, is used in order to measure the current
assets of the company, as compared to its current liabilities, thus showing the liquidity of the
company. Following the general rule, if the quick ratio is greater than 1, the company is less
probable of encountering financial problems; on the contrary, if the value is smaller than one,
this shows that there is a problem within the company regarding its financial stability and can be
found in the situation of not being able to cover its current liabilities.
In the case of Instal Sting, during the period between 2008 and 2012, its quick ratios are
fluctuating mostly under the value of 1, with the exception of 2012; this indicates the fact that the
company has small financial problems, having difficulties in meeting its short term obligations.
As seen in the table, 2008 was the year in which the company struggled to remain stable on the
market, since it’s the year with the smallest quick ratio, of 0,892. The reverse situation happened
in 2012, the only year in which the value of the ratio went above 1 (1,077), indicating that the
company overcame its low point and managed to come back afloat, and cover its short term
obligations. In 2008 as compared to 2009, it can be observed that there is an increase in the value
of the ratio, which can mean that the company, in its struggle to meet its obligations, probably
took measures such as selling some of the assets. Then, in 2010 the number dropped slightly, the
company suffering from the loss of assets, followed by an increase in 2011, which continued and
had its peak in 2012.
The final liquidity ratio is represented by the cash ratio, also known as cash asset ratio,
which shows the ratio of the company’s cash and cash equivalent assets to its total liabilities. It
actually represents the extent to which the company can pay its current liabilities with its
available funds. This is also a ratio that is taken into account when making use of creditors, as it
is one of the most stringent of the three liquidity ratios, since it looks at the company’s most
liquid short term assets which can be immediately used in order to meet its obligations. In the
case of this particular ratio, there is no agreed healthy value; however, in some countries, the
ratio must not go below 0,2, otherwise the company can be considered unable to cover its current
liabilities. On the other hand, if the value is too high, the assets are inefficiently used, although
the company holds a large amount of cash in its balance sheet.
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The table shows that Instal Sting does not overcome the 0,2 value, meaning that its
financial situation is instable, having difficulties in paying its short term debts. The lowest point
is registered in 2009, when the value was 0,073, as compared to its peak, which had the value
0,152, which is not a bad figure, but it is smaller than the 0,2 value accepted as healthy in some
countries.
As an overview, by looking at the diagram, it can be observed that the current ratio, as
well as the quick ratio had an ascendant trend, increasing each year in value, meaning that the
company continuously tried to improve its usage of assets and liquidity, in order to be able to
meet its obligation. However, the cash ratio remained rather constant, if not slightly descendant,
showing the fact that the company did not have a large amount of cash in its balance sheet,
which could lead to a potential problem with paying its debts.
5.3. Asset management ratio analysis
2008 2009 2010 2011 2012Inventory turnover 2,142 2,037 1,52 1,533 2,235Accounts receivable
turnover ratio3,768 2,889 1,83 2,126 2,200
Fixed asset turnover 5,845 4,978 3,381 2,512 2,137Total assets turnover 1,190 1,006 0,682 0,793 0,736
Inventory turnover ratio
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Inventory Turnover Ratio measures company's efficiency in turning its inventory into
sales. Its purpose is to measure the liquidity of the inventory. From 2008 until 2011 the inventory
turnover ratio followed a decreasing trend going from 2,142 to 1,533 which is a pretty low ratio.
A low ratio may be the result of maintaining excessive inventories needlessly. Maintaining
excessive inventories unnecessarily indicates poor inventory management because it involves
tiding up funds that could otherwise be used in other business operations. An increased was
registered in 2012 when the inventory turnover ratio was 2,235. This increase shows that the
company managed to have a faster move of their inventory which means that they were selling
faster, in this way they also decreased the storage cost.
Accounts receivable turnover ratio
28
Accounts receivable turnover measures the efficiency of a business in collecting its credit
sales. Generally a high value of accounts receivable turnover is favorable and lower figure may
indicate inefficiency in collecting outstanding sales. Increase in accounts receivable turnover
overtime generally indicates improvement in the process of cash collection on credit sales. The
company had an accounts receivable turnover ratio in 2008 of 3,768, meaning that they were not
very efficient in collecting their credit sales from clients, but a slightly improvement was reached
in 2009 when the ARTR was 2,889. The trend was followed also in 2010 when the company
registered the smallest ARTR of 1,83, so that it could be concluded that during this year they
improved their relationships with their clients and managed to reduce the period of collecting the
credit sales. Unfortunately, this was not the case for the 2011 and 2012 when the company had
difficulties with their accounts receivable.
Fixed asset turnover ratio
Fixed assets turnover ratio is an activity ratio that measures how successfully a company
is utilizing its fixed assets in generating revenue. It calculates the amount of revenue earned per
one unit of investment in fixed assets. The company had a fixed asset turnover ratio of 5.845 in
2008 going downwards to 2,137 in 2012, which means that they utilized their fixed assets to
generate revenue most efficiently in 2008.
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Total assets turnover ratio
Asset turnover ratio is the ratio of a company's sales to its assets. It is an efficiency ratio
which tells how successfully the company is using its assets to generate revenue. If a company
can generate more sales with fewer assets it has a higher turnover ratio which tells it is a good
company because it is using its assets efficiently. In 2008, the company registered the highest
total assets turnover ratio which means that during this year the company used its total assets in a
very efficient way. Unfortunately, the trend was decreasing; in 2010 reaching its lowest limit
which was 0,682 A lower turnover ratio tells that the company is not using its assets optimally.
5.4. Profit margin ratio analysis and Return ratios analysis
PROFITABILITY RATIOS (2008-2012)Ratio/Year 2008 2009 2010 2011 2012Gross margin ratio 0,141 0,094 0,033 0,054 0,081Operating margin ratio 0,141 0,094 0,033 0,054 0,121
Net profit margin ratio 0,108 0,077 0,025 0,042 0,066
Cash flow margin ration 0,413 0,016 0,118 0,095 0,078
ROE 0,244 0,147 0,033 0,054 0,069ROA 0,136 0,054 0,017 0,031 0,047ROIC 0,242 0,146 0,030 0,054 0,069
30
Profitability ratios measure a company’s ability to generate earnings relative to sales,
assets and equity. These ratios assess the ability of a company to generate earnings, profits and
cash flows relative to some metric, often the amount of money invested. They highlight how
effectively the profitability of a company is being managed.
A business's gross profit margin is the percentage of the business's revenue that remains
after the cost of goods is deducted. Between 2008 and 2010 there was a decrease in gross margin
percentage which is an indication that the business is becoming less profitable and the reason is
that in 2009 the company had an increase in manufacturing prices(materials, labour, etc) but the
sales did not increase proportionally. One way to correct a decreasing gross margin percentage is
to look for ways to generate more revenue. Another way to combat a decreasing gross margin
percentage is to explore ways to reduce fixed costs. There was an increase in gross margin ratio
between 2010-2012 because the company raised their prices, lowered the cost of raw materials
and sold more units which translated in an increase in net income The fluctuation in the gross
margin profit ratio can be caused also by the inventory method that is implemented in the
company. The FIFO (first in, first out) inventory method uses inventory that is purchased first
earliest in the production process, causing cheaper materials to be used in the current period.
Inventories that are purchased at earlier dates are typically considered to be purchased at a lower
price due to inflation. LIFO (last in, last out) uses the most recently purchased materials first,
resulting in higher material prices, decreasing gross profit.
Operating margin is used to measure company's pricing strategy and operating
efficiency. It gives an idea of how much a company makes (before interest and taxes) on each
31
dollar of sales. Operating margin ratio shows whether the fixed costs are too high for the
production or sales volume. The increase in operating margin ratio between 2010 and 2012
suggests the company is earning more per dollar of sales. The increase is influenced by a mix of
higher sales revenue and less money spent on materials and labour. The decline however which
can be observed in 2008-2010 due to a reduction in revenue and higher operating costs.
Net profit margin measures how much of each dollar earned by the company is translated
into profits. Net profit margin provides clues to the company's pricing policies, cost structure and
production efficiency. Different strategies and product mix cause the net profit margin to vary
among different companies. The decline in net profit margin in 2008-2010 is due to increasing
operating costs: cost of materials, costs of sales, salaries, depreciation and so on. In order to
improve net profit margin we need to reduce the costs which are involved in creating the
revenue. Cost of sales could be reduced by sourcing cheaper materials/labour. Administrative
Expenses could be reduced by cutting central costs like management. Depreciation can be
reduced by not buying new assets or by selling existing ones. Between 2010 and 2012 there were
higher net profit margin values which means that the company is more efficient at converting
sales into actual profit and it’s more effective at cost control.
While net profit margin shows how much profit comes from sales, gross profit margin
shows the profit a company makes on the cost of the sales. Gross profit margin shows how costs
such as supplies, labor and production affect profits overall and is calculated by deducting the
cost of goods sold from the sales revenue and then dividing the number by sales. Both gross and
net profit margins are important as companies not only need to determine their overall profit, but
how much they are able to spend on business operations and supplies
Operating cash flow relates to cash flows that a company accrues from operations to its
current debt. It measures how liquidity a firm is in the short run since it relates to current debt
and cash flows from operations. The operating Cash Flow Ratio for the company is less than 1.0,
which means that the company is not generating enough cash to pay off its short-term debt which
is a serious situation.
ROE reveals how much profit a company earned in comparison to the money a
shareholder has invested. The company managed to keep a higher ratio percentage in 2008
meaning that the management was more efficient in utilizing its equity base and have better
return to investors. ROE may be based on high operating margins combined with a rather poor
asset turnover and a low indebtedness but it may very well be the combination of low operating
margins capitalized by high productivity of assets and a high financial leverage. It is very vital
for this company to maximize ROE because in the same time it maximizes the Self-Sustainable 32
Growth (SSG), the rate of growth that a company can maintain (can sustain) internally without
changing its financial structure (D/E).
Return on Assets shows how many dollars of earnings result from each dollar of assets
the company controls. Return on Assets ratio gives an idea of how efficient management is at
using its assets to generate profit. The highest return on assets was in 2008 so the company was
earning more money on its assets. The decreasing ratio between 2008 and 2010 indicates
inefficient use of company's assets. The big factor that separates ROE and ROA is financial
leverage, or debt. The balance sheet's fundamental equation shows how this is true: assets =
liabilities + shareholders' equity. This equation tells us that if a company carries no debt, its
shareholders' equity and its total assets will be the same. It follows then that their ROE and ROA
would also be the same. But if that company takes on financial leverage, ROE would rise above
ROA, which is our case here, every year from 2008 to 2012 having this situation.
The return on invested capital (ROIC) is the percentage return that a company makes
over its invested capital. However, the invested capital is measured by the monetary value
needed, instead of the assets that were bought. We can observe a declining ROIC starting with
2008 until 2010 which may be an advanced indicator signalling that the company is having a
hard time dealing with competition. On the other hand, beginning with 2010 there was an
increase ROIC which may indicate that the company is outdistancing its competitors or that it is
being more efficient at deploying capital.
As a conclusion, by looking at all profitability ratios we can observe a decline from 2008
to 2010 due to decrease in revenues or higher operating cost without a proportional increase in
sales. Also the operating Cash Flow Ratio for the company is less than 1.0, which means that the
company is not generating enough cash to pay off its short-term debt which is a serious situation.
The slight increase in ratios from 2010 to 2012 is showing an improvement in managing the
costs and an increase in sales and therefore net income.
5.5. Leverage ratios analysis
YearRatio 2008 2009 2010 2011 2012
Debt Equity Ratio 0.890 0.877 0.966 0.602 0.492
Long Term Debt Ratio 0.009 0.004 0.000 0.000 0.000
Total Debt Ratio 0.471 0.467 0.491 0.376 0.346
33
The table above presents data for InstalSting, covering its last five fiscal years. The table
provides the values corresponding to the three leverage ratios (the debt equity ratio, the long term
debt ratio and the total debt ratio).
The Debt Equity Ratio measures the management’s reliance on creditor financing
compared to the amount invested by its owners. This ratio indicates the amount of liabilities the
business has for every dollar of shareholder’s equity. It is a good indicator of a business’s
capacity to repay its creditors and it is considered very important.
Debt-to-equity ratio is calculated using the following formula:
Debt-to-Equity Ratio = Total Liabilities
Shareholders' Equity
The Debt Equity Ratio for our company is not high, which means that the company has
not been aggressive in financing its growth with debt. All the values are lower than 1.00, which
means that more assets are financed by money of shareholders than those financed by debt.
The ratio increased constantly until 2010 and then it went down to about 0.492 in 2012.
This represented an improvement for the company because the percentage of assets of the
business which were financed by the debt decreased.
The Long Term Debt Ratio is showing the financial leverage of a firm, calculated by
dividing long term debt by the amount of capital available:
34
This value computes the proportion of a company’s long term debt compared to its
available capital.
InstalSting has a lower leverage ratio because it’s financing only a small portion of its
capital via debt. In 2010, the company decides to pay its long term debt and to finance the entire
capital by money of shareholders, which shows how strong the company is financially. The
percentage of the ratio is 0 which means that a proportion of 100% of the investor’s funds is used
for the permanent financing for the firm (equity financing).
The Total Debt Ratio is a financial ratio that measures the extent of a company’s or
consumer’s leverage. The debt ratio is defined as the ratio of total debt to total assets, expressed
in percentage, and can be interpreted as the proportion of a company’s assets that are financed by
debt.
All the ratios are smaller than 1 which means that the company has more assets than debt.
In 2008, 47% of company’s assets have been financed by debt while in 2012, only 34% of the
company’s assets were. InstalSting has in 2012 a lower degree of leverage than in 2008, and
therefore a higher degree of financial flexibility.
The ratio has decreased over time, so the company’s financial risk profile has improved.
6. INVESTMENT PROJECT
In this chapter we’ll analyze what would happen if the company decided to develop an
expansion project in order to expand the earnings of its business.
We’ll assume that InstalSting is planning to add new technology to its current plant.
There are 2 new equipments the company is considering, for which we predict the following
future cash flows:
35
Equipment A
Year 0 1 2 3 4 5 6
Cash Flow -6000 750 1250 1250 1750 2500 1500
Equipment B
Year 0 1 2 3 4 5 6
Cash Flow -3000 1000 2000 2200 2200 2200 2200
Next, we can compute NPV for each equipment and decide which the company should
invest in. In our case, the cost of capital (k) is 10%.
NPVA = -6,000 + 750 + 1,250 + 1,250 + 1,750 + 2,500 + 1,500 = RON 248 (1.1)1 (1.1)2 (1.1)3 (1.1)4 (1.1)5 (1.1)6
NPVB = -3,000 + 1000 + 2,000 + 2,200 + 2,200 + 2,200 + 2,200 = RON 5,325 (1.1)1 (1.1)2 (1.1)3 (1.1)4 (1.1)5 (1.1)6
Given that both equipments have NPV>0, both projects are acceptable. In general, the
decision rule is to invest in the project with the greatest NPV. As equipment B has the greatest
NPV, InstalSting should decide to invest in equipment B.
Payback period (PP) is the number of years it takes for a company to recover its original
investment in a project, when net cash flow equals zero. In the calculation of the payback period,
the cash flows of the project must first be estimated. The payback period is then a simple
calculation.
Uncovered cost at start Number of years before of full-recovery yearPP = full recovery of + original investment Total cash flow during
full-recovery year
The shorter the payback period of a project, the more attractive the project will be to
management. In addition, management typically establishes a maximum payback period that a
36
potential project must meet. When two projects are compared, the project that meets the
maximum payback period and has the shortest payback period is the project to be accepted. It is
a simplistic measure, not taking into account the time value of money, but it is a good measure of
a project's riskiness.
We’ll compute the payback period for the 2 equipments to see if the equipment B is still
the good choice to make. We’ll also assume that the maximum payback period the company
establishes is five years.
Equipment A
Year 0 1 2 3 4 5
Cash Flow -6000 750 1250 1250 1750 2500
Discounted Cash
Flow-6000 -5250 -4000 -2750 -1000 1500
Equipment B
Year 0 1 2 3 4 5
Cash Flow -3000 1000 2000 2200 2200 2200
Discounted Cash
Flow-3000 -2000 0 2200 4400 6600
Payback period for Equipment A = 4 + 1,000 = 4.4 * 365 days = 4 years and 146 days 2,500
Payback period for Equipment B = 2 + 0 = 2 years 2,200
Both machines meet the company's maximum payback period. Machine B, however, has
the shortest payback period and we have the confirmation that it is the project InstalSting should
accept.
Discounted payback period is similar to payback period and computes the expected
future cash flows discounted by the project’s cost of capital, thus the discounted payback period
37
is defines as the number of years required to recover the investment from discounted net cash
flows.
The discounted cash flow formula is derived from the future value formula for
calculating the time value of money and compounding returns.
Equipment A
Year 0 1 2 3 4 5 6
Cash Flow -6000 750 1250 1250 1750 2500 1500
Discounted Cash
Flow-6000 682 1033 939 1195 1552 847
Cumulative Cash
Flow-6000 -5318 -4285 -3346 -2151 -599 248
Equipment B
Year 0 1 2 3 4 5 6
Cash Flow -3000 1000 2000 2200 2200 2200 2200
Discounted Cash
Flow-3000 909 1653 1652 1503 1366 1242
Cumulative Cash
Flow-3000 -2091 -438 1214 2717 4083 5325
Discounted payback period for Equipment A = 5 + 599 = 5.71 * 365 days = 5 years and 259 days 847
Discounted payback period for Equipemnt B = 2 + 438 = 2.27 * 365 days = 2 years and 99 days 1,652
Even if we take into consideration the cost of capital when computing the number of
years required to recover the investment, there should be no change in the decision-making
process. The company should stick to investing in equipment B due to the fact that DPP for B is
still lower that DPP for A.
38
Profitability index is computed by dividing the present value of forecasted future cash
flows to the initial investment cost. In order for the company to accept an investment, the index
generated should be greater than 1.
NPVPI =
Initial investment
PI for Equipment A = 248 / 6000 = 0.04 < 1
PI for Equipment B = 5,325 / 3000 = 1.77 > 1
The profitability index continues to support our previous findings: as the index for the
equipment B is greater than 1, the company has the confirmation that investing in the second
project is more profitable than investing in the first one, whose index in lower that 1 and should
be rejected.
Internal Rate of Return (IRR) is the discount rate for what the Present Value of a
project’s expected cash flows is equal with the initial cost (NPV = 0).
The principle of internal rate of return, in our case for mutually exclusive projects, is
based on the assumption that the project with the highest IRR (where IRR ≥ k) is the one that
should be selected. As can be seen below, the results follow the same pattern, continuing to
support Instal Sting decision of investing in equipment B:
NPVA = 0 = -6,000 + 750 + 1,250 + 1,250 + 1,750 + 2,500 + 1,500 (1+IRR)1 (1+IRR)2 (1+IRR)3 (1+IRR)4 (1+IRR)5 (1+IRR)6
6,000 = 750 + 1,250 + 1,250 + 1,750 + 2,500 + 1,500 (1+IRR)1 (1+IRR)2 (1+IRR)3 (1+IRR)4 (1+IRR)5 (1+IRR)6
IRRA = 11.213% (Excel function IRR)
NPVB = 0 = -3,000 + 1,000 + 2,000 + 2,200 + 2,200 + 2,200 + 2,200 (1+IRR)1 (1+IRR)2 (1+IRR)3 (1+IRR)4 (1+IRR)5 (1+IRR)6
39
3,000 = 1,000 + 2,000 + 2,200 + 2,200 + 2,200 + 2,200 (1+IRR)1 (1+IRR)2 (1+IRR)3 (1+IRR)4 (1+IRR)5 (1+IRR)6
IRRB = 52.213% (Excel function IRR)
It is worth mentioning the fact that when evaluating the two mutually exclusive projects,
equipment A and B, there were no conflicting results occurring, due to:
- NPVB > NPVA
- IRRB > IRRA
both cases supporting the investment in equipment B.
Conclusions
As a conclusion, we can say that the company is profitable by using efficiently its assets
and transforming them into liquidity.
From 2008 till 2010 the company managed to have a faster move of its inventory which
means that they were selling faster and in this way they also succeeded to decrease the storage
cost. Between 2010 and 2012, the company adopted another strategy in order to increase its net
profit. The company had higher net profit margin values because it become more efficient at
converting sales into actual profit and more effective at cost control.
The slight increase in ratios from 2010 to 2012 is showing an improvement in managing
the costs and an increase in sales and therefore in net income, which on the long-run may provide
the necessary resources for Instal Sting to make new investments.
40
REFERENCES
1. Financial Management lectures and seminars
2. http://www.readyratios.com/reference/liquidity/
3. http://www.investopedia.com/university/ratios/profitability-indicator/ratio1.asp
4. http://www.fool.com/investing/small-cap/2005/12/30/foolish-fundamentals-return-on-
invested-capital.aspx
5. http://www.aaii.com/computerized-investing/article/profit-margin-analysis.mobile
6. http://smallbusiness.chron.com/factors-contribute-change-net-profit-margin-18456.html
7. http://www.money-zine.com/investing/investing/return-on-invested-capital/
8. http://www.wisegeek.com/what-is-an-operating-cash-flow-ratio.htm
9. http://www.investopedia.com/articles/stocks/08/operating-margins.asp
10. http://www.forbes.com/
11. http://www.aaii.com/computerized-investing/article/the-cash-conversion-cycle.mobile
12. http://www.a-systems.net/calculator/cash-conversion-cycle.htm
13. http://www.a-systems.net/calculator/index.htm
41
ANNEXES
Financial situation calculated originally on each financial year
A1. Financial year 2008
42
A2. Financial year 2009
43
44
A3. Financial year 2010
45
A4. Financial year 2011
46
47
A5. Financial year 2012
48
49
