Financial Report for Furniture Company

Financial Report Scenario: Must Have Furnishers

TABLE OF CONTENTS (JUMP TO)
INTRODUCTION
TASK ONE: Effect of Policies on Company Performance
TASK TWO: Effect of Product Diversification and Promotions
TASK THREE: Risk Analysis
TASK FOUR: Production and Profitability
TASK FIVE: Buying Out and Merging
CONCLUSION
REFERENCES
APPENDICES A-E
TABLE 1. CASH FLOWS
TABLE 2. SIMPLIFIED PROFIT AND LOSS
TABLE 3. SIMPLIFIED BALANCE SHEET
TABLE 4. PROFIT AND LOSS FOR MARCH 2001 THROUGH MARCH 2002
TABLE 5. BALANCE SHEETS FOR MARCH 2002 AND MARCH 2003 FOR COMPARISION
INTRODUCTION
A company with staying power within the marketplace will have a keen understanding of ebb and flow, be able to communicate change and put into practice strategies that also reflect flexibility and values for growth situations. The relationship between values and culture, leaders and teams of employees must maintain a healthy balance in order for the status quo of everyday operations to remain but also for the strategies to remain in place and augmenting in flux with market variables.

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This paper presents an interesting scenario of five tasks for you as the management trainee to explore and devise a financial report based on the company’s financial statements such as Profit and Loss, Year End results and other balance sheets. There is a new sales manager, who has promoted new policies toward change to increase sales and production but in other words created growing pains toward an organisation that will require investment, acquiring equipment and employees. It is part of your job to remain focused and subjective to the task at hand and evaluate each of the five tasks with the future of the organisation in mind but also the validity of such growth and the future investments needed. While outside investment is warranted at times, with a growing successful venture, it is assumed that some capital can come from within. However it is curious if her “tried and true” scheme will work for the present economic state. So many consumers purchase ticket items on instalment credit but will this happen when consumer confidence is down and what will this mean for the organisation?
TASK ONE: Effect of Policies on Company Performance
There is concern that the company cannot keep up with production for this new promotion scheme set into place by the new sales manager who has promoted credit related sales. The director is concerned and has asked you to compile a report elaborating on whether the performance of the company and it’s financial position at the year-end has improved because of the new policies put into place. What is your opinion and rationale?
According to the end year statements, operation costs are down which means the factory has reached a new level of efficiency. This indicates that something is going right at the shop room floor when compared with the prior year. It can be expected that the future productivity will be even higher with that rate of growth and profitability in consideration. However part of the scheme has been to introduce a line of credit to the consumer as a way of purchasing high ticket items and furnishing their homes. The main concern here when looking at the year-end statements comparatively should be cause of alarm on the point of the director. The prior year 2002 there were 166 debt accounts to the company. This year 2003 there are 1166 debt accounts and this is at a growth rate of a thousand new accounts or a rate 14 percent for this segment. The main concern here is the rate of repayment that needs to be established over time with these debtors. How quickly are they paying off their accounts and at what rate of interest? This could become a problem should some of them fall behind because then the company needs to implement a debt collection service, which will be an additional expense to the company. Sometimes it is impossible to collect on such merchandise. While the promotion may have spawned a tremendous amount of growth, it has also opened up the company for increased risk in the future for profit and loss. The year 2003 was a good one but one must also consider should the present promotion continue for 204, what are the long-term benefits and risks to having extended credit lines to consumers?
TASK TWO: Effect of Product Diversification and Promotions
Pricing strategies usually change as the product passes through its life cycle. There are a number of different methods of determining price depending on the product. In today’s game, diversification of products and product add-ons is the key to success especially in a saturated market like furniture. There is much competition. It is with this in mind that companies usually develop multiple promotions as opposed to just one. This way, the company has a promotion that can be priced for every budget. For your organisation, this may mean running ad campaigns, for instance a two for the price one during the winter season or provide extra perks for the customer who buys package deal. Right now free delivery seems to be a front runner of what the consumer is concerned about when shopping for furniture. As well as the credit offer, which may not drive many to purchase right away, have a sweepstakes drawing or a movie night that features your most comfortable display model. In a saturated market, it is important for the prices to remain competitive, even reduced at certain times of year. By employing another marketing scheme, it is quite possible that you may see a reduction in credit accounts and more people spending cash especially if the price is right. Still one must be careful to get a return on the product as a profit because also one must consider the cost of acquiring the product, keeping it in stock and delivering to the customer. It is important to always keep in mind the cost of keeping the unit per unit in inventory. This goes beyond what it just costs to produce the unit. Still with the introduction of a counter promotion with reduced price, you will see more inventories out of the warehouse and less debtor credit involved in the transactions.
TASK THREE: Risk Analysis
The manager has asked you to assess the validity of two projects that are independent of each other and require proper recommendation. You will need to run a risk analysis as well as a net present value analysis in order to determine which project to recommend as both will reduce the handling cost and warehouse stock levels as a means to better manage inventory. We use different pricing models as a framework to aid in the analysis. Such models as CAPM and APT aid in figuring out the levels of risk involved with both projects.
For financial professionals it is of utmost importance to assess risk as accurately as possible in order to sell in this case the project. Companies are more than often risk adverse and do not want to take a loss with the money invested. In this respect most companies enjoy a conservative approach, which means the less risk involved the better. Because APT builds upon CAPM and takes the theory to a new level, it requires further analysis to prove the point. Still first in order to understand APT, one must first have a grasp of CAPM works.
CAPM can only work to assess risk in the long run scenario. CAPM also assumes the investor does not have inside knowledge and that the Beta is known. This is the only way an expected return can be determined with CAPM. Mark McCracken defines Beta as “equals 1.0000. 1 exactly. Each company also has a beta. A company’s beta is that company’s risk compared to the risk of the overall market. If the company has a beta of 3.0, then it is said to be 3 times more risky than the overall market” (par. 1). For this scenario each project has a beta. The amount of risk and the type of risk can be determined by diversification. Systematic risk, which is market risk or undiversified risk, is the portion of an asset’s risk that cannot be eliminated via diversification. The systematic risk indicates how including a particular asset in a diversified portfolio will contribute to the risky nature of the portfolio. Unsystematic risk, which is firm-specific or diversifiable risk, is the portion of an asset’s total risk that can be eliminated by including the security as part of a diversifiable portfolio (Mathis, par. 1). So obviously there are some projects that will not be included in a diverse portfolio because of its defined risk under this theory. CAPM digs deeper to assess for an expression, which relates the expected return on an asset to its systematic risk. This in turn gives the financial professional better idea of the project’s risk behaviour.
The equation used is as follows:
(Mathis, par. 3)
The measure of systematic risk is considered Beta or bi while E[Ri] is equal to the expected return on asset I and Rf is the risk-free rate. E[Rm] is the expected return on the project and E[Rm] – Rf is the market risk premium for the company stock. Once the Beta is known then the risk and rate of return can be found.
APT is different because not only can forecast for the long term, it can also work for the short-term scenario. This fact makes it the better of the two theories because it gives the financial professional more tools to assess risk and the rate of return. APT does this by using a model that captures all the data. Other things this model can perform for risk assessment take into account company needs. Risk Estimates such as Tracking Error, Value-at-Risk (VaR), forecast volatility, systematic active risk, beta to benchmark, correlation with benchmark. APT carries out these calculations in a linear framework with a number of different variables. This is how different time frames can be used.
For the APT model there are several outside factors to take into account. The ‘Now’ asset is defined by a number of beta possibilities, each of them representing asset sensitivity to a particular factor and characterizing systematic risk associated with this factor, and, as before, residual yield E. In this respect the risk allotted to this particular venture is less. This multi-factored model brings up many questions for the finance assistant. One thing to keep in mind is that not all factors carryover to risk in this area. There are factors that remain assets to an organisation faced with such decisions. This is one reason why periods of growth need solid leadership. This effectively assesses the risk involved for the furniture company’s returns.
The NPV is assumed as the present value of the project’s cash inflows minus the present value of the project’s cash outflows (Mathis, par. 2). This relationship is expressed by the following formula:
(Mathis, par. 2)
TASK FOUR: Production and Profitability
Your company is considering purchasing another machine due to the increase of production of furniture products and advanced sales of select models featured in the current marketing scheme. You are faced with figuring out if purchase of the machine is a profitable idea and if so what is the long-term cost? And how should it be funded? There are factors one is aware of when purchasing a new piece of equipment. Revenues will not change if the machine is purchased. Both the present machine and the new machine will last 5 years and will have no disposal value in five years. The new machine will cost £400,000. The old machine can be disposed of right now for a disposal value of £10,000. The new machine will reduce operating costs by $£100,000 per year (assume cash flows at the end of the years). Assume a required rate of return or discount rate of 9%. Is it feasible for the company and cost effective? From the standpoint of long-term investment, it seems the new machine will be a valued addition to the team and allow production to not only run at current levels but also maintain new levels of efficiency. Also because it is considered a long-term investment, the company should also consider it an investment and possibly obtain a credit line for the local bank to cover this asset. In this way, the company can also apply for extended warranties to cover any maintenance or break down of the machine over the life of the loan. If the company has prime credit, a low interest rate of 6% is guaranteed and look into possible incentives with the local bank as a regular customer who pays on time, it may be possible to reduce the interest if there is not a pre-payment penalty. Suffice it say, there is cash flow that could be allocated for the purchase but also used for reinvestment in other areas of the company. Traditionalists will want to pay as much upfront as one can but if the long-range benefit outweighs the short-term loan, then by all means allow the company a little space to get ahead with the new machine. Like above the net present value for the machine can be determined with the following equation. The NPV is assumed as the present value of the project’s cash inflows minus the present value of the project’s cash outflows (Mathis, par. 2). This relationship is expressed by the following formula:
(Mathis, par. 2)
TASK FIVE: Buying Out and Merging
Every business needs planning or a defined strategy in place for future growth and control of known issues. There is a certain amount of power that comes from knowing what’s next. Smaller firms are vital to the economic health and stimulus of the world, mainly western nations like the United States and those found in Europe. Much of the success of these firms falls into the hands of leaders involved with everyday management but also the planning for future generations. Sir Adrian Cadbury writes, “Firms form the basic building block for businesses throughout the world. The economic and social importance of regional family enterprises has now become more widely recognized” (p. 5). In fact, it has been found that many firms do not survive the transition a generational business can represent. Many do not see life after the transition, which leads to decreased economic mobility and health. With this in mind, it is very important to have a transition strategy in place. This requires proactive information sharing with all members even if some are not directly involved with day-to-day operations. This will ease the burden of conflict that may arise later. As with any organisation, knowledge management is key to good communication but with a small firm also instrumental for a successful future. This leads one to wonder how the structure of a smaller firm may differ from larger corporations? Is there a chain of command? How does leadership work?
It seems recently the trend of one company buying out another or merging to become one larger company is on the rise. It is in the news everyday, only drawing minimal concern from the public as regulators call into question the legality of such actions. Do mergers and acquisitions make the world a better place for consumers or do they just offer less for the consumer to choose from in the marketplace. It seems that most large companies see this practice as a means of redefining the marketplace by getting rid of the competition and making the competition work for them. In this respect, governments are able to make the rules of the merger and acquisition, setting the standard by which products of both companies can continue to compete with each other in a given market. This in turn, fuels the fire for increased advantage, working toward the goal of ultimately feeding off each other’s energy until it is exhausted. One finds this type of government control more in telecommunications and banking than other industries. For the retail industry, it seems a foregone conclusion that eventually opportunities will present themselves. From the looks of their balance sheets of Furniture Concepts there is a reason the company seeks a merger with another company. There seems to be a large amount of sales but not enough profit being generated. Within the last year their expenses have tripled but the production has not. They look to be in trouble. Another concern is founded within their name it self. Why call them selves a Furniture Concepts store when they sell carpet? It should be Carpet Concept. It may be that they have diversified their production schemes so far that this amounts to the increase of expenses? The recommendation would be to acquire the company, keep high performing employees on board and cut the lard. Expenses may also be attributed to bad debts acquired to maintain production or inflated management salaries? This would be a good move for the organisation and also allow our furniture store to diversify without much overhead or inventory issues.
CONCLUSION
An organisation needs a clear picture of financial health in order to maintain operations and continue a path of growth toward market share. Many things go into deciphering this financial status. Part of what has happened here is a need for new tactics that are tried and true but without great risk affiliation like the credit offer. This strategy while well meaning for the short term has caused long-term ramifications for the organisation starting with growing pains.
Lastly, research shows that the greatest obstacle to accepting new policies is fear of change. Therefore, this makes the transition period crucial and should be handled with kid gloves by management. Communication should be open and clear.
REFERENCES
2003, ‘Capital budgeting needs vision’, Business Line, Islamabad, 21 July.
Allen, G 1999, Introduction to Marketing, Mountain View College, Mountain View.
Anonymous 1991, ‘Risk and Return’, The Economist, p. 1-2.
Brozik, D 2006, Time Value of Money, Marshall University, Huntington, West Virginia.
Cadbury, S A 2000, Smaller Firms and their Governance Creating Tomorrow’s Company from Today’s, Egon Zehnder International, London.
Colli, A 2001, Knowledge and Leadership Succession in Small and Medium Family Firms. Evidence and Generalization From the Italian Experience, Bocconi University, Milan.
Lefley, F 1997, ‘Management Accounting’, Journal of Accounting, vol. 75, iss. 1, p. 64.
Mathis, R 2004, ‘Corporate Finance Live: Capital Asset Pricing Model’, viewed 10 September 2008, http://www.swlearning.com/web-resources/CAPM.htm.>
Mathis, R 2004, ‘Corporate Finance Live: Present Value’, viewed 10 September 2008, http://www.swlearning.com/web-resources/timevalue.htm.>
Mathis, R 2004, ‘Corporate Finance Live: Risk and Return’, viewed 10 September 2008, http://www.swlearning.com/web-resources/riskandreturn.htm.>.
McCracken, M 2004, ‘CAPM’, viewed 10 September 2008, http://www.teachmefinance.com/capm.html>.
Miller, D & Whitney, J 1999, ‘Beyond Strategy: Configuration as a Pillar of Competitive Advantage’, Business Horizons, vol. 42, no. 3.
Wignaraja, G 2004, ‘Building Business Competitiveness,’ International Trade Forum, 1 April.
APPENDICES
APPENDIX A
Table 1. Cash Flows

Project A
Cash Flows
£000’s

Project B
Cash Flows
£000’s

Year 0

(1,000)

(10,000)

240

2,300

288

2,640

346

3,040

414

3,500

498

4,020

Cost of Capital

10%

APPENDIX B
Table 2. Must Have Furnishers Ltd.
Simplified Profit and Loss Account for the year ended 30/09/03
2002 2003

£000’s

Sales

1800

5600

Less: Cost of Sales

720

3360

Gross Profit

1080

2240

Expenses

Selling Expenses

300

540

Bad debts

280

Depreciation

416

Interest

384

406

1620

Operating Profit

674

620

APPENDIX C
Table 3. Must Have Furnishers Ltd.
Simplified Balance Sheet for Must Have Furnishers Ltd.
for the year ended 30/09/03

2002

2003

£000’s

Fixed Assets

Factory

900

882

Machinery & Equipment

980

3582

1880

4464

Current Assets

Stock

476

Debtors

166

1166

Bank

250

1642

Less: Current Liabilities

Creditors

350

Bank

372

178

1270

Net Assets

2058

5734

Less: Long term Liabilities

200

3200

Net Worth

1858

2534

Financed by:

Issued Share Capital

600

656

Reserves

1258

1878

1858

2534

APPENDIX D
Table 4.
Furniture Concepts Ltd
Profit and Loss Account for the period March 2001 to March 2002

£000

Sales

9685.5

–

Cost of Goods Sold

8688.9

Gross Profit

996.6

–

Expenses

263.8

Net Profit (before tax)

732.8

Profit and Loss Account for the period March 2002 to March 2003

£000

Sales

10583.2

–

Cost of Goods Sold

9574.5

Gross Profit

1008.7

–

Expenses

639.9

Net Profit (before tax)

368.8

APPENDIX E
Table 5. Balance Sheets for March 2002 and March 2003 for Comparison
Balance Sheet as at 12 March 2002

£000

Fixed Assets

4477.9

Current Assets

Stock

448.2

Debtors

95.3

Cash and Bank

260.5

Creditors: due within one year

Trade Creditors

1524.6

(720.6)

Net Total Assets

3757.3

Creditors: due after one year

(Long Term Loan Capital)

728.6

3028.7

Share Capital

3028.7

Furniture Concepts Ltd
Balance Sheet as at 12 March 2003

£000

Fixed Assets

4659.5

Current Assets

Stock

460.0

Debtors

113.0

Cash and Bank

258.0

Creditors: due within one year

Trade Creditors

1782.9

(951.9)

Net Total Assets

3707.6

Creditors: due after one year

(Long Term Loan Capital)

668.1

3039.5

Share Capital

3039.5

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