Finance for Managers - Essay Example

? Finance for Managers Faisal al Hajri number: 1068926 Mrs. Kay Smith  Word count: 4018 Question Analysis of The Present Position of Jools Furniture Ltd. The table below presents the calculations from the information provided in the case study about furniture business. Then, explanations and justifications of the results are discussed with some suggestions for improvements. Product Division Category Ratio 2009 2008 Result Liquidity Ratios Current Ratio 1.33 1.09 Unfavorable Quick Ratio 0.63 0.47 Unfavorable Stock Turnover 113.84 99.51 Favorable Debtor Days 42.69 27.58 Unfavorable Creditors Days 29.15 51.06 Unfavorable Profitability Ratios Net Profit Margin 3.36% 1.98% Favorable Operating Profit Margin 6.38% 5.71% Favorable Return on Assets 3.56% 1.96% Favorable Return on Equity 10.23% - Critical Analysis:- Liquidity which is defined by Lawrence J. Gitman(2005) in these words “A firm’s ability to satisfy its short term obligations as they come due”(p.58). It is one of the most important financial indicators of a firm. A firm which will not be able to satisfy its short term obligations will neither be able to satisfy its long term obligations/debts nor will be able to satisfy its stockholders. Time series analysis of Jool’s Product division shows unfavorable results, as out of five indicators four are showing negative results. Although current assets have increased in 2009 as compared to 2008 but increase in current liabilities is more as compared to current assets so division’s liquidity has decreased. Increase in inventory turnover shows that division is now more efficient in selling its inventory. While increase in debtor’s days shows that firm making more credit sales now and is inefficient in collecting its receivables and indicates that money is tied up in debtors. Decrease in creditor’s days shows that division’s credibility has decreased and its suppliers are allowing it less time to pay them back. Division should take immediate actions to decrease its current liabilities which will not only increase its liquidity but will also increase its credibility in front of its suppliers and other stakeholders. Moreover firm should adapt any mechanism to quickly collect its receivables. Asset turnover shows that division has ratio of 1.06 in 2009 which is higher than that in 2008 because the assets have increased but sales has also increased by a greater percentage. It shows that division is more quick in concerting its assets into sales now. Profitability analysis of the Jool’s Products division shows very favorable results as all of the profit indicators are showing highly favorable results which are not only good for division but will also contribute in overall profitability of Jools. But although the division is profitable but management should fix the problem of increasing current liabilities and should control operating expenses and receivables as it said by Gibson “ Even a very profitable entity will find itself bankrupt if it fails to meet its obligations to short term creditors”.(p.253) Kitchen Division Category Ratio 2009 2008 Result Liquidity Ratios Current Ratio 2.02 0.4 Favorable Quick Ratio 0.99 0.78 Favorable Stock Turnover 60.74 49.87 Favorable Debtor Days 15.52 18.17 Favorable Creditors Days 10.22 12.01 Unfavorable Efficiency Ratios Asset Turnover 2.20 2.33 Unfavorable Net working Capital Turnover 10.13 13.67 Unfavorable Profitability Ratios Net Profit Margin 3.51% 3.27% Favorable Operating Profit Margin 3.88% 3.61% Favorable Return on Assets 7.71% 7.62% Favorable Return on Equity 11.77% 11.90% Unfavorable Critical Analysis:- Time series analysis of Jool’s Kitchen Division’s liquidity shows favorable results. Division has a healthy short term obligations fulfilling ability. Inventory is efficiently sold, less credit sales are allowed and receivables are quickly collected. But in spite of its good liquidity conditions creditors are still allowing less time to pay back which is a matter of concern for management. Efficiency analysis of the firm shows highly unfavorable results as both of the indicators are showing unfavorable results. Assets and working capital in now less efficiently converted into sales. If see in the depth we can find that actual reason is that sales have decreased significantly in 2009 as compared to 2008 which is a danger alarm. Decrease in sales of kitchen division may be either caused by decrease in quality of products or by entry of any new competitor in market. So management should look into this matter seriously and should fix the problem by improving quality or by increasing marketing campaigns and offering incentives, as per the actual reason. Profitability analysis is showing favorable results. Net profit margin, operating profit margin and return on assets have increased a little bit, which is better as per the situation (i.e. in spite of the declining sales). Here something to appreciate is that management has controlled the situation by decreasing number of employees and reducing other operating expenses and division has not to bear any loss. Bedroom division Category Ratio 2009 2008 Result Liquidity Ratios Current Ratio 1.27 0.65 Favorable Quick Ratio 0.59 0.50 Favorable Stock Turnover 87.77 74.92 Favorable Debtor Days 63.37 46.78 Unfavorable Creditors Days 34.84 56.12 Unfavorable Profitability Ratios Net Profit Margin 3.22% 3.27% Unfavorable Operating Profit Margin 4 % 4.07% Unfavorable Return on Assets 5.09% 5.65% Unfavorable Return on Equity 12.10% 14.41% Unfavorable Critical Analysis:- Time series analysis of Jool’s Bedroom Division’s liquidity shows slightly favorable results as ratios have an increasing trend but are still below the standards. Division has a improving short term obligations fulfilling ability which is caused by decrease in current liabilities. Inventory is very efficiently sold. But ratio of credit sales have significantly increased and receivables are not quickly collected. But in spite of its better liquidity conditions creditors are now allowing less time to pay back as compared to 2008. Efficiency analysis of the firm shows highly unfavorable results as both of the indicators are showing unfavorable results. Assets and working capital in now less efficiently converted into sales. If we see in the depth we can find that actual reason is that sales have decreased significantly in 2009 as compared to 2008 which is a danger alarm. Decrease in sales of bedroom division may be either caused by decrease in quality of products or due to new entrants in market. So management should look into this matter seriously and should fix the problem by improving quality or by increasing marketing campaigns and offering incentives, as per the actual reason. Profitability analysis of the bedroom division is showing alarming situation. Net profit margin, operating profit margin and return on assets and equity have decreased, which is highly unfavorable from the point of view of every stakeholder. As per Gibson(2009) “Management uses profit as a performance measure” (p.385) so situation over here shows bad performance of management. Office Division Category Ratio 2009 2008 Result Liquidity Ratios Current Ratio 1.49 0.29 Unfavorable Quick Ratio 0.69 0.71 Unfavorable Stock Turnover 28.83 31.86 Unfavorable Debtor Days 31.09 29.81 Unfavorable Creditors Days 0.08 0.09 Unfavorable Critical Analysis:- Time series analysis of Jool’s Office division shows unfavorable results, as all of the five indicators are showing negative results. Current ratio and quick ratio both have decreased due to increase in current liabilities and decrease in current assets which is highly unfavorable. Decrease in inventory turnover shows that division is now less efficient in selling its inventory. While increase in debtor’s days shows that firm making more credit sales now and is inefficient in collecting its receivables and indicates that money is tied up in debtors. Decrease in creditor’s days shows that division’s credibility has decreased and its suppliers are allowing it less time to pay them back. Efficiency analysis of the division shows favorable results. Assets turnover and networking capital turnover both have moved positively due to increase in sales and show that management is now more effectively using it assets and working capital. Profitability analysis of the division also shows very favorable results for the Jools. Increase in sales have significantly affected division’s profitability and return on assets and equity have also increased. Interest expense has also decreased in current year as compared to 2008. Although overall performance of the division is satisfactory but management should pay special attention towards poor liquidity conditions as it may affect overall credibility of firm and may even lead it to bankruptcy. Brief Description of Results:- The kitchen division has the highest current ratio of 2.02 and the bedroom has the lowest. This means that the kitchen division is best able to cover its short term liabilities using current assets. The office division has the highest quick ratio in 2009 which shows that the division’s most liquid assets have highest ability to meet its short term obligations. Again the bedroom ratio is left behind which tells the company that it should reduce the bedroom furniture inventory because it is a slow selling item and should be stored in lower quantities. The stock turnover for each division kept increasing with the exception of office division. The product division had the highest ratio which means that it can generate the highest profit. The bedroom division has the higher number of debtor days which means it is least efficient in receiving payments from its debtors. All these ratios indicate any liquidity issues within a company and here they depict that Jools furniture needs to make its bedroom division more liquid by maintaining an adequate amount of inventory. Lower liquidity has also caused lower profits for the bedroom division which is the only division with a declining net profit margin in 2009 along with a declining return on assets ratio. Question No.2:- Evaluation of the current role of the Financial Director, how the current system could be improved to aid planning, control and performance management in the future? Finance Director? A finance director is a person in an organization who is responsible for managing the financial operations of the organization. Finance directors are supposed to keep the finances under control and communicate any issues with members of the organization or the general public. Wikipedia describes duties of Finance Director/ CFO in this way “A corporate officer primarily responsible for managing the financial risks of the corporation. This officer is also responsible for financial planning and record-keeping, as well as financial reporting to higher management” Finance Director at Jools:- At Jool’s Furniture, David Green is working as a finance director at holding company. He is a co-director of Julius Brown, the chair person of Jools furniture Ltd and he has played an important role in organizing the financials needed for the product expansion and he has no direct intervention at divisional level. Currently at Jools Furniture Ltd there are no finance directors at the divisional level and financial decisions are made by the divisional managers. But they have to get approval for any 5 year loans from the holding company. They have to make a commitment of maintaining a gearing below 50%. If they can not do that then they will have to face direct intervention by the finance director David Green. All the divisions are required to maintain an ROI of 10% and are paid a bonus according to difference between the actual and target ROI. Importance of Finance Directors:- In order to improve the planning, controlling and performance management a finance director can perform many roles in an organization. He is responsible for cash management, raising capital, maintaining banking relationships, as a custodians finance directors are responsible for having a control on assets and keeping the companies accounts in the correct order. In the contemporary world finance directors are required to be in the center of the decision making process and help the CEO in generating creative ideas and strategies along with providing full financial support and services. Finance directors have to take care first of all of their salutatory responsibilities which pertain to the rules of the organization and the finance directors responsibilities towards the public interest. In order to be successful in fulfilling statutory responsibilities they are required to perform five key roles which include the following: Strong financial management through strong financial controls Corporate management and leadership Giving support and advise to elected members Giving support and advise to operational officers Leading a effective financial service in the organization How Finance directors can help Jool’s ? In Jool’s there is no financial director at divisional level, due to which divisions are facing a lot of problems some of which are also identified in auditor’s report. Below points indicate that how appointment of finance director at divisional level can be helpful for Jool’s any many of its divisional and overall organizational problems can be solved. In the Auditors report it was pointed out that salaries were being paid to retired workers of the bedroom division. The finance director should be able to eradicate this problem by keeping a tight control over the company’s books. As a strategist the finance director will have a future and must be able to motivate employees to works towards the organizations goals. They set standards of performance in the finance department. These standards can be set through management arrangements or by a partnership model. To achieve this the finance directors can arrange proper training for their financial staff and some awareness training for the non financial staff so that everyone in the organization has a knowledge of the financial requirements of the organization. Working Capital Management: The working capital of a company is the measure of its liquidity. It can be positive or negative depending on whether current assets exceed current liabilities or not. It measures the amount of a liquid asset a company has available for its expansion and growth. Good management of working capital can help an organization get the cash necessary for expansion. There are two parts of working capital. The first is one where money is tied up which includes inventory and receivable and the second is one which provide money which include trade payables. If Jools furniture is able to effectively collect money from debtors and decrease inventory against sales then it will have more cash available and will not only have to borrow less from creditors but its liquidity conditions will also be better. But all of this insight can only come through a devoted financial director and only he is the person who can formulate such policies. Inventory management: It is an important aspect of working capital management. A finance director needs to make sure that there is an adequate amount of inventory available and that any surplus or shortages are avoided. The idea is to have the knowledge of how fast stocks are being sold and how long are pieces of inventory sitting idle on shelves. The audit report has discovered that around 20 boxes of flat packed chairs and desks have disappeared from one of the office division’s outlet. Discrepancies have also been found in other divisions as well. It is the responsibility of the finance director to resolve this issue as it can cause a negative working capital to occur for the company. This issue can be resolved by taking the following measures: a) Examine and evaluate the current purchasing and inventory systems. By analyzing the current system, the finance director will get the exact knowledge of the inventory that has been purchased, entered the warehouse, processed and then sold. Any inventory that has not been sold and is not found in the store or warehouse should be investigated. b) Use ratios to analyze the current situation of inventory. By analyzing the stock turn over ratio the finance director can have knowledge of the movement of inventory. If the inventory is moving slow the root cause should be discovered. c) The finance director should implement tight controls over inventory. He should appoint a team that is solely responsible for quality and quantity inspection of inventory stored in the warehouse and outlets. d) The finance director can advise the management to outsource the manufacturing of some items. This will ensure that only finished goods well counted are delivered to the outlets. e) Strict security measures should be implemented in the divisions to ensure that only authorized persons are allowed to enter the inventory store. A proper check on authorized personnel should also be implemented. Performance Management: It is true that some organizations work very hard to keep their budgets, planning, sales and other activities intact to be able to become successful but many of them fail to achieve success. This is because hard work, training and being busy all the time does not lead to success or best performance for organizations. Performance is achieved only when all these activities are performed with the aim of contributing directly to the preferred goals and objectives of an organization. Performance management is achieved by making sure that goals are being achieved in the most effective and efficient manner. Performance management is focused on 1. An Organization 2. A Unit/ Division 3. A major process 4. An individual In Jools furniture a problem has been found with the ‘individual’ aspect of performance management. It was found during the audit there is a problem with the performance appraisal system which may cause a failure in achieving group objective. It is the responsibility of the finance director to ensure that employees are being compensated well in order to improve performance. In order to improve the performance appraisal system the finance director can take measures. Capital Budgeting:- A budget is a document that coverts planned activities into funds required by those activities. It is defined as a document that contains management’s plans for a forthcoming year. It includes details of the money that you need to spend on the activities (expenditure) and money that is need to cover the cost (income). In simple terms budget helps a managers to managing the funding of planned activities. Along with preparing simple budgets finance directors help in making capital budgeting decisions “The Financial managers has to help the firm identify promising projects and decide how much to invest in each project” (Brealey, Myers & Marcus, 2007, p.g.4) Question No.3:- Loan as a source of finance for the investment proposal? Loan:- “An arrangement in which a lender gives money or property to a borrower, and the borrower agrees to return the property or repay the money, usually along with interest, at some future point(s) in time.”(InvestorWords) The time for the repayment of loan is predetermined and lender has to bear the risk of non payment which may be mitigated by backing the loan by collateral. Advantages of Loan:- It allows the private sector organizations to retain the control and ownership of the entity. A loan only provides the lender with the rights of the repayment of principle and interest and no claims on how the organization is operated. There are limited obligations when it comes to financing through loan capital because the only major obligations are of meeting the principal and interest repayment deadlines. Apart from that the lenders have no claims on the organization. Loan financing is also simple to administer as compared to equity financing because there are no complex reporting obligations as to how the company is performing and is being administered. It is also very cost-effective for the private sector organizations over the long run because long term loans charge an interest rate which is less than the interest rate charged on the short term borrowing. It so happens because the short term loans usually do not have the requirement for collateral or good credit rating. Loans are a much cheaper way to raise finance. Loans are a very economical and effective way for SMEs to raise finance because some loan schemes offer funds on an unsecured basis. As interest payment on loan is an expense of business and it is made from pretax income so it also entails a tax advantage for business. Disadvantages of Loan capital: Regular payments of principal and interest must be made which tend to be difficult for new ventures because of inadequate cash in hand. In case of non-payment or delayed payment, lenders tend to charge severe penalties. Loan capital is often limited to established and highly reputable entities only. The lenders require some sort of security for their funds and they feel more confident and safe investing in long established entities. This leaves very few funds for the new business ventures. There is a requirement for collateral which is often difficult for the small and new business entities to manufacture. In such cases, these entities may have to pay a guarantee premium to obtain the loan. Jool’s can secure a loan of ?1.8 million in order to expand operations of its kitchen division. Moreover it can also choose any one of the below mentioned sources in order to finance its current needs. Alternative Sources of Finance Equity Capital: “Equity financing is a strategy for obtaining capital that involves selling a partial interest in the company to investors”(RaferenceforBusiness) Capital through equity is raised by issuing common or preferred stocks to investors. Issuance of stock is carried out through either an IPO (initial public offering) or private placements to big investors through an investment bank. The investors in stock get the ownership rights in the company and are considered for annual or interim dividends out of the profits of the company. If the company does not make any profits, it is not liable to pay dividends to the shareholders. Advantages of Equity :- No direct obligation for repayment of funds. Equity investors may also provide managerial assistance to entrepreneurs and rae more committed for success of company. Easily available even at early stages of business. Disadvantages of Equity:- Being part owners they may exercise a part control on how business is run. Expect for a higher rate of return on their investment. Raising equity may also be costlier. Corporate Bonds: It is a debt security issued to the investors to raise funds. The bonds are backed by the company’s financial position and the ability to pay back. In some circumstances, the bonds are backed by the physical assets of the company. The interest paid on the corporate bonds is higher than the interest paid on the government bonds because of the high risk premium; even for the companies with very high credit ratings, the interest rate is always higher than the government bonds. For a company to issue corporate bonds, it must depict a consistent earning potential so that the investors are attracted towards buying the corporate bonds. Suggestion:- As Smith-Brown Owner of the firm wants to keep it private and under local control so firm can not go for equity financing, by going public. Moreover, since issue of corporate bonds is also not feasible for firm due to its costs, complexity and company’s relatively week standing. So, most suitable, simple and appropriate source of financing for this project is by securing loan capital. So, Jool’s Furniture Ltd should secure a loan facility for its Kitchen division’s project. Reference List GITMAN, L. J. (2005). “Principles of Managerial Finance (11th ed.)”. San Diego State University. GIBSON, C. H. (2009). “Financial Statement Analysis (7th Ed.). The University of Toledo. WIKIPEDIA, (no-date) “Chief Financial Officer” Accessed on 03 July 2011. < http://en.wikipedia.org/wiki/Chief_financial_officer> BREALEY, R. A., MYERS, S.C. & MARCUS, A.J. (2007). “Fundamentals of Corporate Finance” (5th ed.). New York: Irwin/McGraw-Hill. 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