Qatar Oil and Gas - Assignment Example

Qatar Oil and Gas [Name] [Professor Name] [Course] [Date] Executive Summary This assignment conducts the financial ratio analysis of United Development Company for the 2011 and 2012 financial years. It is concluded that the company had a stronger financial base in the year 2012 compared to 2011. The term marginal cost and the opportunities it might bring to RasGas Company LTD are also explored. Further, a cost model is developed for mining of natural gas. Also examined include a list of issues to be discussed with a contractor who charges unfair price. Lastly, a range of techniques to be explored in a collaborative relationship with a supplier are explored. Table of Contents Executive Summary 1 Table of Contents 2 Question 1: Financial Ratio Analysis 3 Gross profit margin 3 Current Ratio 4 Quick Ratio (Acid Test Ratio) 5 Fixes Assets Turnover 5 Stock turnover 6 Return on sales 6 Operating Profit Ratio 7 Interest cover ratio 7 Question 2: Marginal costing 8 Marginal Costing Opportunities 10 Purchase Category 10 Question 3: Cost Modelling 12 Example: Natural Gas Production 12 Largest Cost drivers and the basis of the estimates 13 14 Question 4: Unfair pricing by a contractor 15 Question 5: Difference between competition and collaboration with a supplier 17 Conclusion 18 References 19 Appendices 21 Question 1: Financial Ratio Analysis Gross profit margin Measuring gross profit margin is for the purposes of measuring how a business sets prices, as well as how it controls its cost of production (See Appendices Fig 1 & Fig 2). It is important for a company as it is used to determine whether a company generates more revenue from sales. The gross profit margin for UDC is calculated below (Patnia). Gross profit margin = Sales - Cost of goods sold/ Sales 2012 2011 Sales - Cost of goods sold  Sales 2,730,925 - 1,077,942 / 2,730,925 1,906,678 – 1123070 / 1,906,678 0.6 0.4 As indicated in the table, the gross margin for 2012 id 0.6, or 60%. This implies that for every Riyal that was generated in sales, 0.6 was retained in the company. In 2011, the gross margin is 0.4, or40 percent. This indicates that for every one Riyal that UDC generated in sales, 0.4 remained in the company. This shows that the company generated less revenue from sales in 2011 than in 2013, by up to 20 percent. Current Ratio Current ratio shows the degree in which assets cover claims of short-term creditors expected to be converted into cash within a period that corresponds to maturity of the liabilities. 2011 2012 Current Ratio = Current Assets / Current Liabilities 19,055,759 / 10,203,788 19,466,172 / 8,216,473 1.9 2.4 The current ratio for 2011 is 1.9:1. This shows that the current assets are greater than current liabilities. The current ration for 2012 is 2.4: 1. This also shows there is working capital. However, when both years are compared, it is clear that the year 2012 had a stronger working capital than the year 2011. Quick Ratio (Acid Test Ratio) Quick ratio measures UDC’s ability to pay off its short term obligations without having to depend on selling its inventories. Quick Ratio = (Current Assets – Inventories) / Current Liabilities 2011 2012 Quick Ratio = (Current Assets - Inventories) / Current Liabilities (19,055,759 - 2,803,570) / 10,203,788 (19,466,172 - 2,342,024) / 8,216,473 1.6:1 2.1:1 The quick ratio shows that that the amount of assets that can be quickly converted into cash versus the amount of current liabilities in 2011 and 2012 is 1.6:1 and 2.1:1. This shows that in the year 2012, UDC had a greater ability to pay off its short term obligations without having to depend on selling its inventories than in 2011. Fixes Assets Turnover Fix assets turnover measures the sales productivity and use of equipment. A higher ratio shows that the fixed assets are being used efficiently to generate revenue (Patnia). Fixed Assets Turnover Ratio = Sales / Fixed Assets 2011 2012 Fixed Assets Turnover Ratio = Sales / Fixed Assets 1,906,678 / 11,446,823 2,730,925 / 11,408,513 0.7: 1 0.2: 1 The fixed asset turnover rate for 2011 and 2012 is 0.7: 1 and 0.2:1 respectively. The ratio shows that in both years, there was inefficient use of fixed assets to generate revenue. Stock turnover Stock turnover measures the relationship between the costs of goods sold and the cost of average inventory. 2011 2012 Stocks turnover = sales / stock 1,906,678 / 2,803,570 2,342,024 / 2,730,925 0.7:1 0.86:1 The stock turnover rate for the year 2011 and 2012 shows that the management for both years was lower. This shows inefficient management of inventory since the stocks are not sold frequently. Hence, less money is required to finance the inventory. In comparing the two years, it shows that goods moved slower in 2011 than 2012. Additionally, lower profits were realized in 2011 compared to 2012. Return on sales Return on sales ratio is used to measure the extent to which revenues results to profits instead of being diverted to a company’s costs. Operating profit / total sales × 100 = percentage return on sales 2011 2012 Operating profit / total sales × 100 = percentage return on sales (783,608/ 1,906,678) x 100 (1,077,942/ 2,730,925) x 100 41 39 The return on sales for the year 2011 was 41%, this was higher than that of 2012 (39%). This means that the company kept more money for profit before tax in the year 2011 than 2012. Operating Profit Ratio Operating profit ratio measures return on the total investment of the company. Operating profit ratio = Profits after taxes / Total assets 2011 2012 Operating profit ration = Profits after taxes / Total assets 3,702,241/ 19,055,759 849,888 / 19,466,172 0.19: 1 0.04:1 The operating profit ratio for 2011 was 0.19:1, while that of 2012 was 0.04:1. This shows that 2011 had a higher operating profit ratio, meaning that UDC has a good cost control and that sales were increasing faster than costs. Interest cover ratio Interest cover ratio measures the extent to which a company can pay interest on outstanding debts. Interest coverage ratio = PBIT/long-term interest costs x 100 2011 2012 Interest coverage ratio = PBIT/Long-term interest costs x 100 (783,608 / 706,306) x 100 (1,077,942 / 827,149) x 100 110 130 The interest ratio for 2012 was greater than that of 2011 by 20 percent. This means that in the year 2012, the company had become stronger in the sense that it could be able to pay up interest on outstanding debts by up to 20 percent. Generally, UDC had a stronger financial base in 2012 than in 2011, as indicated by the results of the financial ratio analysis. Question 2: Marginal costing Marginal costing refers to an accounting system where variable costs are charged to cost unit and where fixed costs are disregarded against the total contribution. Its real significance is in the recognition of the cost behaviour and therefore assists in decision making. Put differently, it is a technique of decision making and cost accounting essential for internal reporting where only fixed costs are considered as lump sum while marginal costs are charged to the cost units. Here, marginal costs refers to the change in total costs that results when the quantity produced has increased by unit, or the cost of producing an additional unit of good. Hence, marginal costing is the activity of ascertaining marginal costs. When fixed costs are incurred despite the level of internal business activity, the essence of marginal costing is to determine the level of contribution that has been generated. With this regard, the term contribution refers to the differences between marginal cost and sales. Hence: Marginal Cost   =    Variable Cost =    Direct Labour                                                                                        +                                                                           Direct Material                                                                                        +                                                                          Direct Expenses                                                                                        +                                                                       Variable Overheads Contribution    =    Sales   -    Marginal Cost In illustrating marginal costs, if producing 10,000 units of a commodity at RasGas Company LTD is assumed to have a total cost of $50,000, then producing 10,001 units would cost $50,002. This represents the marginal costs, or the costs of producing an additional unit. In this case, the marginal costs would be $2. The reason why marginal costs arose as $2 and not $5, (or the previous average cost that results by dividing $50,000 by 10,000 units) is since some costs are assumed not to have increased when the additional unit was produced. These may include fixed costs such as property taxes or salaries that do not increase once an extra unit of a commodity is produced. Marginal Costing Opportunities First, it differentiates between variable and fixed costs thereby offering appropriate information on costs for decision-making purposes. Once variable and fixed costs are separated, costs can be managed easily as it becomes more apparent to the management on the manner in which costs behave. Therefore, by changing the level of activity, an optimal production level can be chosen by the management. Second, marginal costing takes out the effect of inventory changes on profit. It also reduces the risks of dysfunctional behaviour in workers that may occur when in situations of absorption costing as it encourages managers to create more inventory than the company can sell. Production of goods for stock has the consequence of absorbing fixed production overheads. This reduces the costs of sale. In return, the reduced cost of sale improves the level of profits earned. In any case, it is easy for such stock to bind capital and in some circumstances it may become obsolete. Third, marginal costing avoids capitalization of fixed overheads in stocks that cannot be sold. In this case, all fixed costs are considered as period costs. This means that they are written off during the accounting period they related to. Therefore, the issue of using inventory to suspend fixed costs expenses is eliminated. Purchase Category Marginal costing has several advantages to purchasing category. When a company makes a decision on how much products it should produce, it faces both marginal and average cost. Since decisions are made at the margin, managers will consider marginal cost and the benefits anticipated from an action rather than the average costs and benefits. Such a process is referred as marginal analysis. Marginal analysis can be applied in the purchasing category. With regard to purchasing of commodities, it refers to taking into account the increasing or decreasing costs of buying extra commodities. This is since economies of scale often favours decreased average and marginal cost for additional purchases. For instance, "RasGas Company LTD" will accrue less benefit or utility from buying a second commodity than the first. The company will benefit even less from the third commodity and so forth. This concept is referred as diminishing marginal utility. Therefore, the value of successive purchases decreases in the eyes of the company while the marginal cost (price) remains the same. In this case, the decision to purchase the first commodity is more beneficial since the benefits outweigh the costs. However, buying the second commodity is less beneficial, since the costs will now outweigh the benefits. Marginal costing is also essential for RasGas Company LTD when it wants to purchase additional units of gas cylinders. Suppliers will take advantage of marginal costs by offering deals and sale, for instance in offering discounts for bulk purchases. This will encourage the company to buy multiple units as well as generate income. In conclusion, when "RasGas Company LTD" makes decisions to makes purchases at the margin, it has to consider each new decision independently by considering the marginal benefits and the marginal costs. Question 3: Cost Modelling Cost-modelling is essential when a company needs to finds a balance between competition and cooperation. Darwinian Rivalry model can be used when a company needs to negotiate callously with suppliers. Here, cost models are used particularly when dealing with suppliers (Ask and Leseter). The first principle in cost modelling captures cost drivers rather than just cost elements. The basic ones include overhead, materials and labour. It also captures drivers such as hourly wage rates and other drivers that support “what is” and “what if” analysis. Tradeoffs between the drivers are also documented. For instance, increase of sizes of production-lot can lower the cost of production since fewer setups are required. Rather, it increases cost of inventory since more inventories are held. Because of this, cost models that are based on cost drivers provide more insight into decision-making (Ask and Leseter). Example: Natural Gas Production The estimated cost to produce one cubic metre of natural gas has to be determined in a bid to allow the company to control costs and price the product. Cost to produce natural gas consists of the direct materials that become part of the product. The direct labour applying in producing the product as well as other costs related to the production. Natural gas produced per day is at 800 cubic metres. The total operating costs included supplies and materials, equipment operation, labour, administration and sundry items. The capital costs included equipment, site works, pre-production preparations, building, electrical systems, engineering and management and contingency. Operating Costs NATURAL GAS COST SUMMARY 800 cubic metres per day Production ratio 1:1 Supplies & Materials Per cubic metre $0.73 labour Per cubic metre 1.61 Equipment Operation Per cubic metre 2.16 Administration Per cubic metre 0.36 Sundry Items Per cubic metre 0.49 Total Operating Costs $5.35 Capital Costs Equipment 14,105,100 Site work 2, 410,300 Pre-production preparations 1,660,100 Buildings 7,487,300 Electrical systems 1,843,100 Working capital 9,430,000 Engineering & Mgt. 4,707,500 Contingency 2,522,200 Total Capital Costs $44,165,600 Table 1: Cost modelling for natural gas production Largest Cost drivers and the basis of the estimates Table 2: Model costing % Equipment was the largest cost driver estimated at 14,105,100 at 31.9% (Table 2). The high cost is attributed to the cost of tendering for a contractor, installation of the equipment as well as maintenance. The cost of equipment is also high due to the transport cost. Working capital is the second largest cost driver (21.4%). This is since the cost of funding the day to day activities must be sufficient enough to enable smooth running of the business. Buildings are the third largest cost drivers (17%). The cost of buying the materials for building and tendering a contractor are expected to be high hence the estimation. Other high cost drivers are engineering and management and site work in that order (10.6% and 5.4% respectivel). In conclusion, the first principle of cost modelling creates a more accurate cost model for purchasing goods. The first principle entails the capture cost drivers rather than cost elements. The fundamental inputs to a cost model are the cost elements that can be captured. These include materials, direct labour, hourly wage rates, and overhead (Kovak and Michaels 2). Question 4: Unfair pricing by a contractor In cases where the cost model suggests that the supplier may have been charging for supplies than justified, certain issues can be discussed. Detailed material and labour breakdown A detailed labour and material breakdown can enable a company to detect whether a contractor is overcharging. Having a detailed material and labour breakdown is the first step towards determining how much the contractor spent or should be spending on materials and labour. On the sheet, items to be discussed should include the number of items the contractor purchased for the job and the price the contractor is charging (ACQ). For instance, with regard to building, one charge may read “22 pine studs, $8 per item, total $176.” The contractor’s material handling markup The contractor’s material handling markup can also be helpful in detecting whether the contractor is overcharging. This refers to the fraction of materials charged by contractor for ordering, determining or delivery of materials. Typically, contractors charge a markup of between 10 and 20 percent, although certain contractors may charge differently. This should be discussed with the contractor. For instance, if the markup is not clear in the invoice, the contractor should be asked what they charge. Price list of items The price list of the materials from the supplier enables the company to compare with the price of the items on the contractor’s invoice. Any disparity in the listing provided will present a subject for discussion with the contractor. In any case, the company can add the cost of the items and the contractor’s markup cost to determine whether there is a disparity in the total cost (ACQ). Receipts of purchases The receipts of the materials that were bought by the contractor present data for analysis to determine whether the contractor charged fairly. Unfair or dishonest contractors may charge the company for high-quality materials before funnelling the less expensive ones into the project. The copy of a receipt enables the company to discuss the disparities in the items listed and those used in the project (Kovak and Michaels 2). Fair market value The contract deliverables market value can be fair if the company expects to pay the fair market value because of the prices of market transactions between the sellers and the informed buyers under the same competitive market conditions for the deliverables that have the same product quality and quantity. This can be discussed with the seller, to ensure that the pricing is fair. Things not to be listed Rate-of Return Pricing Although this instrument can be used to determine whether there is fair pricing, it cannot be listed by the contract for discussion with the contractor. This kind of pricing is similar to markup pricing since profits are added to the approximated costs. The only difference is that the profits are not calculated on account of the cost of materials and labour. Rather, profit is determined based on the financial investment needed to provide the service (Kovak and Michaels 2). Question 5: Difference between competition and collaboration with a supplier The supply chain relationship can be divided into collaborative partnership and adversarial competitive. Most price management techniques can be applied when the competition is the key driver of supplier value (Rickert 13). This refers to adversarial competitive that uses price-based criteria. However, the range of techniques differs when a company is in a truly collaborative relationship with the supplier (Fig 3). In the collaborative relationship, rather than RasGas Company Ltd considering a price-based criterion, it can focus on the performance criteria such as quality rather than cost. Table 3: Difference between adversarial competition and collaborative partnership (Choi 2010) Further, there is a shift towards cooperation where the companies exchanges nuggets of vital information and get to engaging one or two suppliers in long-term contracts (Table 3). (Spekeman 634) This is different from adversarial competitive where there is no exchange of information, and where the supplier-and buyer engagements are in short-term contracts (Bhardwaj 241). In collaborative relationship, there is a consensus between the buyer and the supplier that trust will contribute significantly to long-term business relationship. Here, trust is showed through reliance, loyalty and confidence in the supplier partner as basis for preventing opportunistic behaviour. This is different from adversarial relationship that is characterized by opportunistic behaviour between the buyer and the supplier (Benavides et al). In collaborative relationship, the suppliers may be engaged in joint planning of the purchases. For instance, the buyer and the supplier assume that the procurement function transcends its conventional role of contributing to cost leadership and can therefore support strategic initiatives that are revenue-enhanced such as development of a new product (Choi 29-32). In conclusion, in adversarial competitive, RasGas Company maintains a large number of suppliers and focuses on making short-term contacts in a bid to have a higher bargaining power. This means that the company does not make use of the total resources like in collaborative relationship. Therefore, suppliers have less potential to provide value-added services or technology-based services compared to situations in collaborative relationship. Conclusion In Question 1, financial ratio analysis indicates that UDC had a stronger financial base in 2012 than in 2011. In Question 2, when "RasGas Company LTD" makes decisions to makes purchases at the margin, it has to consider each new decision independently by considering the marginal benefits and the marginal costs. In Question 3, the first principle of cost modelling creates a more accurate cost model for purchasing goods as it captures cost drivers rather than cost elements. The largest cost drivers are equipments, working capital and building in that order. In question 4, the list of items to be included in discussion with a contract who charges unfair prices include detailed material and labour breakdown, contractor’s material handling markup, price list of items, receipts of purchases and fair market value. In question 5, when RasGas Company Ltd is involved in collaborative relationship with a supplier, it focuses on performance criterion such as quality of goods, rather than on a price-based criterion. References ACQ. Contract Pricing Finance Guide, nd. 12 Nov. 2013, http://www.acq.osd.mil/dpap/cpf/docs/contract_pricing_finance_guide/vol1_intro.pdf Ask, Julie & Timothy, Leseter. "Cost Modeling: A Foundation Purchasing Skill." First Quarter 10 (1998). 12 Nov 2013, http://www.strategy-business.com/article/9625?gko=ba075 Benavides, Luis, Verda De Eskinazis and Daniel Swan. "Six steps to successful supply chain collaboration." Supply Chain Quarterly 2 (2012). 12 Nov 2013, http://www.supplychainquarterly.com/topics/Strategy/20120622-six-steps-to-successful-supply-chain-collaboration/ Bhardwaj, W. Glossary of Purchasing and Supply Chain Management. Excel Books India, 2007. Choi, Sunkyung. Key success factors of supply chain relationships: Multiple-case studies in China from buyer’s and supplier’s perspective. University of Gavle, 2010. pp29-32 Kovak, Brian & Michaels, Ryan. Price dispersion and price dynamics when it is costly to switch suppliers: A quantitative example.11 Nov 2012, http://www.upjohn.org/MEG/papers/Kovak_Michaels_Price.pdf Patnia, Alok."How to Calculate Key Financial Ratios?" Your Story, 2012. 13 Nov 2013, http://yourstory.com/2012/03/how-to-calculate-key-financial-ratios/ Rickert, Jeffrey, Rogers Joel, Darya, Vassina, Josh Whitford & Jonathan Zeitlin. Common Problems & Collaborative Solutions: OEM-Supplier Relationships and the Wisconsin Manufacturing Partnership’s Supplier Training Consortium. University of Wisconsin-Madison, Madison, 2000. pp13 Spekeman, Robert, John Wamauff & Niklas Myhr, "An empirical investigation into supply chain management: A perspective on partnerships." International Journal of Physical Distribution & Logistics Management, 28.8 (1998): 630-650 Appendices Figure 1: Consolidated financial statement for UDC end of year 2012 Figure 2: UDC financial position 2012 Read More