Suggested answers for General Machinery question Important note: These are INDICATIVE answers only. They are written in bullet point form but in answering any similar examination question, you would need to argue your case clearly, showing What are the key issues Your evidence for identifying these as issues Your reasons as to why the issue is important Recommendations for improvement After a decline, the company’s profitability (ROI, ROCE, Operating margin) has improved recently. However, the gross margin has dropped for five consecutive years, suggesting that selling prices are not being increased to pass on purchase (or production) cost increases. This deteriorating margin is a significant risk for the company as profits have only been increased by the large reduction in overhead in 2009. If margins continue to erode and if overheads cannot be continually cut, profits may be at serious risk. The company needs to continue to increase sales growth, fix its gross margins and continue to manage overheads. Working capital has been at extremely high levels but has fallen to close to 2:1, an improvement, but with an acid test greater than 1, is probably still too high. This is demonstrated by the relatively high days’ sales outstanding (60 against 30 day terms), which even though it has improved is still too high. Inventory represents the biggest concern to working capital as at 3.3 it represents an average stockholding of 110 days (365/3.3). The company needs to manage its ordering to a just-in-time basis. The cash flow statement shows that most cash has been used in 2009, hence working capital is strained by a lack of cash and slow debtor collections and inventory turnover. The result is too high days’ purchases outstanding of 78, representing over 2.5 months. This is likely to give the company bad credit rating and may impact its ability to maintain continuity of supply. Asset turnover has steadily increased, a trend which needs to continue. Gearing at 42% has increased slightly over 5 years but is at acceptable levels (anything in the range 40-60% being very common). However, interest cover has fallen significantly and is less than
Suggested answers for General Machinery questionImportant note:
These are INDICATIVE answers only. They are written in bullet point
form but in answering any similar examination question you woul!
nee! toargue your "ase "learly showing #hat are the $ey issues %our
e&i!en"e for i!entifying these as issues %our reasons as to why
the issue is important 'e"ommen!ations for impro&ementAfter a
!e"line the "ompany(s pro)tability *'+I '+CE +perating margin, has
impro&e! re"ently. -owe&er the gross margin has !roppe! for
)&e "onse"uti&e years suggesting that selling pri"es are
not being in"rease! to pass on pur"hase *or pro!u"tion, "ost
in"reases. This !eteriorating margin is a signi)"ant ris$ for the
"ompany as pro)ts ha&e only been in"rease! by the large
re!u"tion in o&erhea! in .//0. If margins "ontinue to ero!e an!
if o&erhea!s "annot be "ontinually "ut pro)ts may be at serious
ris$. The "ompany nee!s to "ontinue to in"rease sales growth )x its
gross margins an! "ontinue to manage o&erhea!s.#or$ing "apital
has been at extremely high le&els but has fallen to "lose to
.:1 an impro&ement but with an a"i! test greater than 1 is
probably still too high. This is !emonstrate! by the relati&ely
high !ays( sales outstan!ing *2/ against 3/ !ay terms, whi"h
e&en though it has impro&e! is still too high.
In&entory represents the biggest "on"ern to wor$ing "apital as
at 3.3 it represents an a&erage sto"$hol!ing of 11/ !ays
*32453.3,. The "ompany nee!s to manage its or!ering to a
6ust7in7time basis. The "ash 8ow statement shows that most "ash has
been use! in .//0 hen"e wor$ing "apital is straine! by a la"$ of
"ash an! slow !ebtor "olle"tions an! in&entory turno&er.
The result is too high !ays( pur"hases outstan!ing of 9:
representing o&er ..4 months. This is li$ely to gi&e the
"ompany ba! "re!it rating an! may impa"t its ability to maintain
"ontinuity of supply. Asset turno&er has stea!ily in"rease! a
tren! whi"h nee!s to "ontinue.;earing at e"on! a!!itional "ash
woul! enable the "ompany to pay its "re!itors more qui"$ly. It
woul! be better for the "ompany to )x its in&entory problems
an! "olle"t its !ebts on time pay its o&er!ue "re!itors an!
then loo$ to see how mu"h a!!itional borrowing was require!.>o
the "ompany fa"es three ma6or issues it nee!s to a!!ress: Fix the
!e"lining gross margin to maintain pro)tability. Fix the
in&entory an! !ebtors problem to impro&e "ash 8ow. ?ay its
"re!itors on time. #hether or not the "ompany nee!s to borrow
further will only be seen after the eAe"ts of these
impro&ements are ma!e.
