This report deals with the case of Dolphins Ltd. which is engaged in the business of supply of bakery business and other kinds of confectionary business. Currently, the firm is operating its business with the national boundaries. But, looking to the tough competition in its market, it is now proposing a plan of expanding its business by reaching the markets of neighbouring countries. The expansion is being aimed at further growth of its business so as to generate higher revenues and profitability from the bakery business. However, the business cannot grow if the firm has lack of funds to invest in its growth. Further investment in the all types of assets whether it be current assets, fixed assets and intangible assets will have to be made to generate overseas earnings from the business. Also, the firm will have to hire more employees to manage the business at the large scale. But, before entering into the new markets the firm must critically analyse the worthiness of its new venture of expansion. It must apply various capital budgeting techniques to identify the risk and rewards of the international business. Further, when the business is operated at a large scale, it requires adoption of advanced cost management approaches to manage the cost involved in the business. Therefore, Activity Based Costing methodology will be applied to determine the accurate cost of business. Before commencing the foreign business operations the firm must also apply breakeven analysis to identify the level beyond which the business must be operated to generate returns without incurring losses. As investing in the foreign trade will involve huge amount of funds, these decisions demand significant consideration and evaluation processes before initiating such operations.
The life blood of any kind of business is finance, in the absence of which business cannot grow and prosper (Fraser, Bhaumik & Wright, 2015). Generally, there is certain time lag between the time the money is invested in the business and the time when business actually starts generating revenues and profits. Therefore, the business requires funds before it commences its new operations such as expansion. There are various sources of finance from where funds can be raised to operate and expand the current business. The sources of funds required for expansion are generally the same sources from where monies are arranged at the start-up stage of business. It is usually found that generating funds for the existing business is more convenient than funding for a new start-up (Rioja & Valev, 2004). These sources are usually bifurcated into two categories i.e. internal sources and external sources. Internal sources of finance are those sources through which the funds are arranged internally whereas external sources are the sources from where funding is done though external mediums (Evbuomwan, Ikpi, Okoruwa, Akinyosoye, 2013). There are many sources to seek finance for the existing business but the managers have to identify those sources that are appropriate for its business, given the purpose of financing and type of business for which funds are required (Carlin & Mayer, 2003). Each type of finance source has its own pros and cons. So the firm must analyse each option and then select the best suitable sources of finance. Also, it is not mandatory to generate funds from only one source; rather the firm can use varied sources so that its risk can be diversified (Cetorelli & Strahan, 2006).
If funding is done through the internal sources following are the sources that will be best suitable for the purpose of expansion:
This is one of the most effective sources where funds can be raised for new business by using the earnings of its existing business that were retained in the business only. The only cost of using retained earnings of its existing business is to lose the interest income that could have earned if such money is kept in bank accounts. However, as the financing requirement in the present case of Dolphins Ltd is quite large because of proposal of business expansion to foreign market, retained earnings may fall short for the purpose. Therefore, the firm must evaluate other sources of finance also (Beck, Levine & Loayza, 2000).
IPOs are the great source of finance as they enable the companies to generate pool of funds from the public in general through the issuance of shares such us equity shares and preference shares. If Dolphins Ltd has already entered into its IPO it can consider bringing Further Public Offerings (FPO) in the market to finance its business expansion programme. However, if the company has not already gone for IPO, it must check its eligibility as it is not possible for every firm to opt for IPO (Beck, Levine, Loayza, 2000). Dolphins Ltd. must ensure that it has a sound past track record of profitability and revenue earnings and it operates in such industry that is significantly recognised in the market. The requirements of opting for IPO are quite stringent and involve high cost at the initial stage. IPOs are best suitable for the companies who are seeking large sums of funds. As Dolphins Ltd. is considering the proposal of entering into foreign trade market for the purpose of growth and expansion of its business, it may find IPO as the suitable option (Gait & Worthington, 2007).
Apart from internal sources of project funding there are external sources also available with Dolphins Ltd such as venture capital funding, issuance of bonds and debentures, loans from banks and financial institution (Rioja & Valev, 2004).
The venture capitalists can offer huge sums of money and also they provide the financial advice to their clients. The businesses that are backed by venture capitalists are generally considered to be potential for quick growth and profitability. But the loans made by VCs are generally expensive as they charge relatively higher rate of interest (Beck & Demirguc-Kunt ,2006).
Funds can be issued through the issuance of bonds and debentures that may be redeemable or irredeemable, convertible or non-convertible. The funds are raised through these debentures just as shares but the difference lies in the holding of such components. Debenture holders are not the owners of the company and hence they do not get to participate in the internal activities of the company and in return to their holding in the company they are entitled to the interest payments (Caglayan & Demir, 2014).
Dolphin Ltd can raise large amount of funds by borrowing them from various banks and financial institutions. Loans are the most common source of external debt financing. The banks grants loans to only those companies that have sound financial standing in the market and good credit rating as assigned by credit rating agencies. The loans are repaid with the agreed period of time along with the interest on such loan (Caglayan & Demir, 2014).
In order to take business outside the geographical boundaries of its own country, the firm have to set the pricing policies for the items that are to be traded in overseas market. The prices of such products are decided on the basis of the cost involved in their production. Activity based costing model can be implemented to improve the cost management system of the company. This model will help the managers of the company by providing necessary and realistic information that is required by them to formulate various strategies and pricing policies for the products dealt by it. ABC methodology facilitates allocation of overheads to the cost on the most appropriate basis to the products and services by building cause and effect relation for the cost incurred. It works on the fact that it the activities of the organisation that requires incurrence of cost and not the products and it is the products that consume activities. The real nature of cost is identified by ABC methodology and thereby it eliminates the activities that are non-productive or redundant for the production of product. This ultimately leads to reducing the cost of the products. With the implementation of activity based costing model, the managers can control various fixed overhead costs through the exercise of more controls over the activities that have resulted in the incurrence of fixed overheads costs. Further, ABC uses more than one cost drivers. Some of which are based on the volume of the product and others are based on several activities. If ABC is implemented it will take into account all the activities that under are undertaken within or beyond the factory of the company to initiate appropriate overhead allocation (Horngren, Sundem, Stratton, Burgstahler & Schatzberg, 2002). In the absence of ABC model in the company, the cost of the production will be allocated as per the traditional costing approach which suggests the allocation of indirect cost on the basis of predetermined overhead recovery rate. Though the application of traditional method of cost allocation is simple but it does not provide the accurate results and often leads to under-costing or over-costing of the products. The use of ABC in the company will improve the price structure of the company which will ultimately increase its overall profitability (Hansen, Mowen & Guan, 2007). The correct pricing decisions for the confectionary items dealt by Dolphins Ltd will enable to survive and gain more competitive advantage in the global market. ABC approach will not only improve the decision making of the company regarding the accuracy of costs but also it will identify the spare capacity of the machines so that the idle capacity could be used for the further production (Horngren, Bhimani, Datar, Foster & Horngren, 2002).
Though the implementation of ABC model in the business involves considerable time and money but the results from its successful implementation can justify the incurrence of such cost and time. It is quite possible that the employees of the company may resist adopting such an advanced methodology of cost management because of its complexity. They may find comfortable working as per the traditional approach of cost management. Therefore, it is necessary to provide them requisite training to the employees to cope up with the new methodology of cost management. Further the company must hire the professionals who possess required knowledge to successfully implement activity based costing methodology in the company.
As Dolphins Ltd. is proposing to enter into the foreign market, that is completely new for it, to trade its products, it is essential for it to identify the level below which it should not operate in any case as it will cause it the incurrence of losses. Break- even analysis helps the firm to determine the quantum of sales to be made in order to achieve a certain level of profitability (Maloney et. al., 2012). It basically helps in figuring out the point at which the firm will at the position of ‘no profit and no loss’. The phrase no profit no loss implies the sales level which will neither incur any loss neither it will generate profit for the business. Before undertaking the break- even analysis, the company must identify its variable costs and fixed costs separately, that are associated with the overseas business. Fixed costs are the cost that does not change with the change in the level of sales or activities (Drury, 2013). Such costs are: depreciation on various machineries and equipment used for manufacturing bakery products, the cost of consuming power, insurance premium paid to get the insurance of the factory where the operations of company are undertaken. Whereas, variable costs for the bakery business are the costs that keeps on changing with the change in the level of productions of confectionary products. The variable costs of the business will help the company to identify the contribution margin which is required to be calculated to identify the break- even point (Zimmerman & Yahya-Zadeh, 2011).
If the sales are made below the break-even point, the firm will not be able to even recover its fixed cost and variable costs and therefore it will have to incur losses. Whereas, if the sales are made at any level above the breakeven point, then the fixed cost and variable cost will be recovered and each additional unit of sale will generate extra profits for the company (Render & Stair, 2006). Break- even analysis is therefore an effective quantitative method that can be used by the managers to under financial planning for the business (Fraser, Bhaumik, Wright, 2015). It will also simplify the budgeting process of the company that is essentially to be carried by the company before taking the final decision of entering into international trade. Break- even charts support the budgetary control system of the company by enabling the managers to know how many exact units are required to be sold in the foreign market to achieve profitability. Therefore, in a way it will establish the target for the company below which the expansion plan will not work positively. The determination of break- even analysis will also help in motivating the employees of the company as they will have a clear idea about after which level their company will start generating returns (Tsorakidis, Papadoulos, Zerres and Zerres, 2011) . The profitable business will only be able to fulfil the return expectations for its employees, so achievement of break-even point will instil confidence in the employees of the company. The said analysis will set the realistic and achievable targets for the company.
Breakeven-analysis shall be undertaken by Dolphins Ltd. to evaluate how practical the proposal of expanding its business to the overseas borders is and its overall worth in financial terms. Even in the existing business that is being carried out in the local territory, break- even analysis will help the company in setting out its pricing policy and cost control management. The analysis will provide an overview of relationship between the cost, profits and revenues involved in products in which the company is dealing.
Capital budgeting decisions are the decisions that involves considering the proposals that involves huge amount of capital investment and therefore they are usually irreversible. Therefore, these decisions are crucial enough and require to be critically evaluated. There are various capital budgeting techniques that can be used to appraise the proposed project such as net present value method (NPV), payback method, accounting rate of return method (ARR), internal rate of return (IRR) etc. these techniques helps the managers to assess the risk and return involved in the projects. Such projects generally generate returns after a certain period of time and there is time lag between the time the monies are investment in such projects and the time when such projects starts generating returns for the business.
Dolphins Ltd in the present case is proposing a plan of expanding its business to the international markets therefore it needs evaluate the proposal using payback period method and annual rate of return. Payback method determines the payback period which is the period within which the project will recover its invested costs. The most significant benefit of the method is that it is simple to calculate and the ranking of the possible alternatives can be done on the basis of its outcomes (Ryan & Ryan, 2002). In the present case of Dolphins Ltd, the company can assess the worthiness of its expansion proposal using the technique of payback period. However, this technique suffers from certain limitations. They are: ignorance of money’s time value and ignorance of cash flows generated after the payback period (Brijlal, 2008). Payback method does not take into account the time value of money and hence the present value of the possible cash flows is not calculated under this method. The consideration of time value of money only enables the managers to accurately assess the project’s worthiness. If the probable cash flows of bakery business operated through foreign market are not identified, the managers may fail to take the correct decision. Further, payback method will not consider the cash flows that will be generated after the initial investments are recovered. It might be possible that the foreign business starts making losses after recovering the cost of initial investments in expansion program.
Accounting rate of return (ARR) is another method of evaluating the project’s worthiness. ARR is also an easy method to appraise a capital investment (Graham & Harvey, 2002). It recognises the ‘net earnings’ of the project concept which is an important factor to assess the appropriate of the investment proposal. In this present case, the company must determine the probable earnings that can be generated from its foreign market business operations. This technique also gives true picture of project’s profitability (Kahraman, 2001). Therefore, if this method is implemented, the managers will be able to evaluate the potential of its proposal of foreign trading to generate profits. The proposal of Dolphins Ltd will not involve a one-time cost or investment, rather the business will operate in long run and hence consideration of time value of money is necessary. However, ARR also does not take into account the time factor and it does not provide realistic results on the basis of which the company should make its economic decisions. The company must rather use other techniques of capital budgeting such as NPV and IRR as these techniques will offer realistic results to base the decision of business expansion (Bierman & Smidt, 2012).
Conclusion
To summarise the above report on evaluation of Dolphin Ltd.’s proposal of expanding its business to the neighbouring countries, it can be said that the expansion program will involve huge costs and time to generate the expected results. Therefore, such decision must be taken after the due consideration of several important factors such as availability of finances to fund the growth of the business, the appropriateness of the decision of capital investment in the new foreign market, the pricing policies to be adopted to create a competitive advantage in the international market etc. The company must also consider adopting the advanced management accounting techniques to improve its cost structures and pricing policies so that maximum profitability can be achieved through the international business.
References
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