Micro Tiles Limited In June of 2014, Bill Madden considered expanding his micro tiles business. He planned to invest $2.0 million in 2016 to produce more and better-quality plaster or metal tiles and lithographs. These silver and golden ornate tiles can be hung individually or displayed as a collection of various themes (i.e., sports, outdoors, wildlife, music, actors, religion) on living, dining, bedrooms or family room walls. Although Bill had ten years of experience as an artist in designing and developing these products, he had little experience in managing a business. He realized that this was his greatest weakness and was preventing his business from growing to its full potential. Therefore, he asked his son, Robert, who had graduated from Engineering and held a Master's Degree in Business Administration, to join his firm. Robert had six years of experience with a major consumer products company. Management's Background Prior to starting his business, Bill Madden had worked for twenty-five years in communications services for several federal government departments. When he took an early retirement in 2003 at the age of 50, and he decided to realize his dream of starting his own business. At the time of incorporation in 2008, sales began to accelerate, and the company moved from a hobby business to a full-time operating entity. That year, he decided to move the operating facilities from the basement of his house to a small space that he rented in an industrial park. Bill enjoyed the artistic side of the business. He liked to draw images. His friend, Harry Freeman, also a former federal public servant joined him in 2008. He was responsible for sales and general administration. When Bill started his business, he sold his reproductions through small independent kiosk operators and even rented some kiosks himself on a short-term basis. He also advertised his products in catalogues to a wide range of retail outlets particularly in the giftware business. As revenue continued to soar in 2014, he realized that he needed to invest money into his business and authomate his production operations. Both Bill and Harry believed that they needed professional help since they had no qualifications and experience in managing a business that required skills in the field of marketing, human resources, production, and finance. For that reason, they asked Robert, Bill's 31-year-old son to join the business and become president of Micro Tiles. Bill would be responsible for the product design a key factor in the success of the business. Harry would be responsible for sales and marketing activities, and Robert, as president, would be responsible for general administration. Micra Tiles Limited Micro Tiles Limited In 2014, Micro Tiles Limited was showing substantial growth. Revenue went from $1.0 million in 2011 to $2.0 million in 2014 (see appendix A). This huge gain was a result of sales agreements that Bill had signed with several giftware retailers. His catalogues also helped his business to gain recognition. A wide variety of retail outlets and consumers were becoming acquainted with Micro Tiles products. Even some major retailers began to show an interest in carrying his product lines. Bill signed a sales agreement during March 2014 with a major retailer. The retailer would market Bill's products on a trial basis in several stores across Canada. After several months, the consumer response appeared to be positive and Micro Tiles was becoming recognized as a leading monthly sales consignment supplier. This helped generate a 48% sales increase in 2013 (from $1,058,000 to $1,564,000). As the relationship with retailers matured, Micro Tiles introduced several changes in the way products were manufactured and marketed. In the past, the company designed a tile first and then created the promotional plan. Now, the development of new products would be based on consumer research and social trends. For example, the company would develop new product lines as a tribute to successful sports heroes. Retailers and consumers both showed considerable interest in this marketing scheme and this was considered the cornerstone of Micro Tiles" success. Marketing Strategy Based on the data published by various industry sources, the memorabilia market was in a growth phase. The size of the market and the demand for products regarding "themes" or "celebrities" encouraged some medium-sized retailers to buy these types of products. Smaller retailers such as gift shops and even major department stores started to carry this product line described as "commemorative" items. When Bill talked to store managers, they all showed an interest in tiles with NASCAR, basketball, Olympics, sport fishing, and other specialized baseball and hockey themes Since 2003, Bill was responsible for all activities in his business, a sort of jack-of-all-trades. He designed, produced, and sold the products enhancing his knowledge regarding the market, the retailers, and consumer tastes. Bill leamed that: Each product has its own shelf life (i.e., 6 months) and a lot depended on the location before it reached full maturity Products that did not meet sales objectives within a prescribed time frame were considered a "flop and removed from the store shelves. Floor store location was considered vital to a product's success and turnover. Slow-moving products lost their premier" floor location. . -2- Micro Tiles Limited Slow-moving products significantly tied up cash flow. Distributors were considered too expensive. They required a 100% mark-up. With this background knowledge, Bill adjusted his marketing strategies. Distribution Strategy In order to ensure effective and efficient service, Micro Tiles distributed its products through a courier company. The process was simple: Individual department stores placed orders directly with Micro Tiles. Micro Tiles would keep sufficient inventory on hand to meet product demand for the more popular tiles. The courier accepted a total of 10 tiles per case. The courier picked up the packages and delivered them directly to the retail stores. The company was able to ship the products for less than any department store's distribution and warehousing facilities. Micro Tiles adopted this distribution strategy since it was considered the most cost-effective method. Products and Pricing Strategy Micro Tiles had a "standard" product line that was offered through its catalogue; a total of 25 images. These 12" 15" images were considered standard size and made of either plaster or metal. All products had original designs. Once a model was created, it went into production Each item was hand-finished with appropriate solutions before shipment. Over the years, this process was perfected, and the quality of cach reproduction was considered flawless" or using conventional business terminology, "zero-defects". The per-unit cost (including shipping and packaging) was in the $20.00 range and sold for $59.95 less commission, Micro Titles developed its first premium" products with several hockey, golf and baseball idols. Although the production process of these items was the same as the standard products, incremental costs associated with marketing each piece had to be considered. For instance, the licensing cost for producing the image of a hockey idol was $5 per unit A list of product lines such as Canadian hockey images, NASCAR images, golf images, basketball images, etc. was designed and presented to several retailers, who were very interested. These images would be considered imperative for the company's sales efforts and future success. The traditional product line would be marketed jointly with the new images. These niche products were considered to have exceptional marketability and expected to boost sales volume. Micro Tiles Limited Robert's Vision and Plans Robert spent several weeks listening to his father's objectives and plans and was encouraged by what he heard. However, after looking at the company's 2011 to 2013 actual financial statements, he had some reservations about the financial strength of the business. Robert was currently working as a product manager for an international consumer products company and was eaming a good salary. He liked the financial stability. He was married and had two children. Robert decided that before he "leaped" into his father's business, he would closely examine the profile of each financial statement to determine whether or not it was possible to make Micro Tiles a profitable venture. There was nothing much that he could do about the 2014 estimated year-end financial results. The company was already in its fourth quarter and based on some rough estimates, Robert estimated that it would end the year with a $47.000 profit, just $6,000 more than the previous year. Robert had little reservations about the sales estimates. He believed that revenue would continue to increase in view of the excellent quality product lines and the good working relationships Bill had nurtured over the years. However, he believed the operating costs were a big obstacle for the company's success. Robert made the following statement in a meeting with his father Bill and friend Harry Freeman: "I'm very interested in joining the company. However, I need to be assured that I will be given "carte blanche regarding how this business is managed. We have to make some major changes in our cost structure. I'm glad that a more automated production process was installed in 2014. If we use that production process effectively, we could considerably improve the company's bottom line. I have calculated some financial projections for the year 2015 and would like to review them with you. If you agree with these plans, I think that we have a good chance of producing healthy financial statements. The challenge is changing the way we do things. These changes need to take place immediately. If we are patient and succeed, I firmly believe that Micro Tiles will become a leader in the giftware and memorabilia industry. My intention is to increase our return on sales for 2015 and plan for a major $2.0 million investment in 2016." Micro Tiles Limited REQUIRED: In preparation of Robert's meeting with his father, Bill and partner Harry Freeman, Robert has prepared a report outlining his analysis on how to improve the financial health of the company, improve return on sales for 2015 and be well positioned for the planned $2.0 million investment in 2016. In your role as Robert, your group is required to prepare this report and should include (but not be limited to the following: A financial analysis of Micro Tile's performance for 2013, 2014 and 2015. This analysis should include a review of, and comments on: o the sources and uses of funds o the cash flow statement o financial ratios (liquidity, debt/coverage, asset/management and profitability) o the sustainable growth rate A determination and analysis of the breakeven points for 2013, 2014 and 2015. What sales revenues levels would Micro Tiles need to achieve to a satisfy a target profit objective of $300,000 before tax, $350,000 before tax and $400,000 before tax? An assessment of the cash budget for 2015 The body of your report should not exceed 3 to 5 pages (this does not include your appendices or title page), written in 12-point Times New Roman font with 1.5 cm margins. Please submit your entire report, including your appendices, as ONE pdf file. Make sure that everything is appropriately formatted, spaced and labelled. To conduct your analysis, you have been provided with three templated Microsoft excel files: 1. "Micro Tiles Analysis Template" - this excel file has 7 worksheets or templates. These worksheets include: a. The Income Statement b. Comprehensive Income and Shareholder Equity Statement C. Statement of Financial Position d. Statement of Sources and Uses of Funds e. Statement of Cash Flows f. Financial Ratios 6. Sustainable Growth Rate -5 Micro Tiles Limited You are required to input data into the greyed our boxes in the first 3 worksheets ONLY. All required data is available in the body of this case and in the additional case data beginning on page 7. Once you have completed this, the remaining 4 worksheets will automatically populate. All formulas have already been programed into the spreadsheets. 2. "Breakeven Analysis Template"- this excel file is only one worksheet. Input the revenue and cost information from the 2013-2015 financial statements into this spreadsheet. You are required to input data into the greyed our boxes ONLY. Once you have completed this, the other cells will automatically populate. All formulas have already been programed into the spreadsheet 3. "Cash Budget Template" - this excel file is only one worksheet. You are required to input data into the greyed our boxes ONLY. All required data is available in the body of this case and in the additional case data beginning on page 7. Once you have completed this, the other cells will automatically populate. All formulas have already been programed into the spreadsheet Micro Tiles Limited Financial Statements Micro Tiles' three financial statements: the statements of income, the statements of changes in equity and the statement of financial position for the years 2011 to 2014 are presented in Appendix A. Although revenue doubled between the years 2011 to 2014, the company's profit for the year remained relatively flat. Bill was able to increase the company's revenue but had problems keeping his costs in line. The statement of financial position indicated that total assets increased substantially from $450,000 in 2011, to $1,132,000 in 2014. In 2011, approximately 67% of the company's assets were financed by debt, a ratio that remained unchanged during the four-year period. This meant that every time assets were purchased, 67% was financed by debt, and the rest, equity. In 2014, Bill decided to invest $300,000 in his business to purchase new production equipment to satisfy product demand and more importantly, improve plant efficiencies. Bill re-mortgaged his house and obtained $100,000 from the bank for the purchase of these assets. Financial Projections When Robert considered joining the company in October of 2014, he realized that his first task was to initiate changes in the business that would have positive effects on both the statement of income and the statement of financial position. If the company wanted to invest $2.0 million to expand its operations in 2016, he knew that some cash would have to be generated internally. He could not continue relying on 67% external funding. This meant going through a cost-reduction program in addition to reducing the level of working capital accounts such as inventories and trade receivables. Statement of Income Planning Assumptions Robert's first objective was to boost operating efficiencies. He wanted to improve the company's return on revenue from 2.3% in 2014 to 9.0% in 2015. He was confident that this could be realized by substantially cutting back on production costs. Based on some preliminary figures, he estimated revenues would increase by 8% in 2015, or reach $2.2 million. In 2014, cost of sales as a peroent of revenue was 76.6% and he wanted to bring it down to 64.0% by 2015. Here are Robert's 2015 cost of sales estimates for individual expense items: Purchases $850,000 Freight in 84,000 Labour 460,000 Depreciation/amortization 25,000 -7- Micro Tiles Limited As far as marketing activities are concerned, Robert wanted to be more aggressive. Distribution costs for 2015 were estimated as follows: Salaries $ 70,000 Commissions 80,000 Travelling 35,000 Advertising 30,000 Depreciation/amortization 10,000 The administrative expense projections for 2015 were to remain flat at 2014 levels. However, as a percentage of revenue, these expenses would demonstrate an improvement in efficiencies. Finance costs would increase substantially as a result of the extensive debt financing obtained from the bank for the purchase of new assets. He estimated administrative expenses and finance costs to be as follows: Salaries $ 120,000 Leasing 40,000 Depreciation amortization 25,000 Other charges 13,000 Financing costs 110,000 Statement of Changes in Equity Planning Assumptions The only two numbers to be inputted in the statement of changes in equity (retained earnings) are: In the Micro Tiles Analysis template under the year 2013: - under common shares, common shares issued: $25,000. - under retained earnings, for the balance at the beginning of the year for retained earnings: $171,000. Statement of Financial Position Planning Assumptions There were two major improvements that Robert wanted to realize in 2015. Reduce the level of inventory and trade receivables. His objective was to increase the inventory turnover (based on cost of sales) from 5.3 times to 8.1 times in 2015. This target was also based on industry averages and benchmarks. He also wanted to reduce the average collection period of accounts receivable from 71.1 days in 2014 to 47 days in 2015. This objective was based on some financial benchmarks that he had obtained from his banker. With these changes in inventories and trade receivables, he believed that he could increase Micro Tiles' internal cash flow, which would then help finance the purchase of the $300,000 non- current assets. Micro Tiles Limited The current asset accounts were estimated as follows: Inventories $ 175,000 Trade receivables 285,000 Prepaid expenses 4.000 Cash and cash equivalents $ 25,000 Short-term deposits 100,000 As previously indicated, Robert expected to invest an additional $300,000 in non-current assets in 2015. As a result, the estimated accumulated depreciation/amortization would increase by $60,000. Goodwill would remain unchanged at a level of $14,000. On the equity and liability side of the statement of financial position, Robert wants to reduce the working capital loan and long-term debts. His strategy was to improve the company's debt-to- total assets ratio in order to have some leverage for obtaining additional financing in 2016 that would be used for the $2.0 million investment. The following are his estimates for the year 2015: Share capital $ 125,000 Non-current liabilities 270,000 Trade and other payables 235.000 Short-term borrowings 120,000 Accruals 36,000 Micro Tiles' weighted average cost of capital for the years 2013 to 2015 is estimated at 10% Break-Even Point Cost Assumptions Robert believed that the company's break-even points for the years 2013 and 2014 were not healthy and by going through a cost reduction program, he was aiming for a significant improvement in 2015. He estimated that 75% of the cost of sales for "labour" to be variable and the other 25%, fixed. -9- Micro Tiles Limited Cash Budget Assumptions for the Year 2015 Robert understood that the only way to realize his 2015 financial objectives would be to follow his monthly expenses like a bawk; therefore, he decided to prepare a cash budget. Instead of waiting for quarterly or year-end results, he wanted to follow every cost item as the year progressed. The monthly revenue and cost breakdown is as follows: $000s January February March April Travel $2 2 3 3 3 Revenue S150 160 170 200 200 200 230 220 190 180 160 156 $2216 May June Purchases S60 60 80 80 80 90 90 70 60 60 60 60 $850 Commissions S6 6 6 7 7 7 8 8 7 Labour $30 32 35 40 50 48 50 45 35 35 30 30 $460 4 4 4 July August September October November December Total 6 3 3 2 6 $ 80 35 As far as revenue is concerned, 20% of the customers paid on a cash basis and 80%, the month after. For purchases, 50% was paid on a cash basis and the rest, the following month. Monthly breakdown for other costs are as follows: Freight in: $7,000 (Jan. to Dec.) Salaries-Distribution: $5,000 (Jan. and Feb.) and $6,000 (March to Dec.) Advertising: $2,000 (Jan. to April and Nov. to Dec.) and $3,000 (May to Oct.) Salaries - Administration: $10,000 (Jan. to Dec.) Leasing: $3,000 (Jan. to Aug.) and $4,000 (Sept. to Dec.) Other - Administration: $1,000 (Jan. to Nov.) and $2,000 (Dec.). Finance costs: $7,000 (Jan. to May), $9,000 (June to Aug.) and $12,000 (Sept. to Dec.) Beginning bank balance: $70,000 - 10- APPENDIX A Micro Tiles Limited Statements of Income 2011 2012 2013 2014 Revenue 1,083 1,058 1,564 2,052 355 369 30 380 Cost of sales Purchases Freight in Labour Depreciation amortization Other charges Total cost of sales Gross profit 630 44 529 4 0 1.207 29 366 4 0 754 825 74 665 8 0 1,572 3 5 787 296 304 357 480 Other income 0 0 D 0 34 33 12 7 2 10 98 37 32 11 9 2 0 91 47 16 10 3 0 117 65 6B 32 20 5 0 190 102 20 Distribution costs Salaries Commissions Travelling Advertising Depreciation amortization Other charges Total distribution costs Administrative expenses Salaries Leasing Depreciation/amortization Other charges Total administrative expenses Financing costs Total expenses les other incon_ Profit before taxes Income tax expense Profit for the year 94 20 13 20 147 107 26 24 16 173 117 31 30 17 11 142 195 3 7 14 34 248 240 304 419 48 64 53 61 10 18 12 14 38 46 41 47 Micro Tiles Limited Statements of Retained Earnings 2011 2012 2013 2014 Retained earnings (beginning of year) Profit for the year Sub-total Dividends Retained earnings (end of year) 87 38 125 0 125 125 46 171 o 171 171 41 212 0 212 212 47 259 0 259 Micro Tiles Limited In June of 2014, Bill Madden considered expanding his micro tiles business. He planned to invest $2.0 million in 2016 to produce more and better-quality plaster or metal tiles and lithographs. These silver and golden ornate tiles can be hung individually or displayed as a collection of various themes (i.e., sports, outdoors, wildlife, music, actors, religion) on living, dining, bedrooms or family room walls. Although Bill had ten years of experience as an artist in designing and developing these products, he had little experience in managing a business. He realized that this was his greatest weakness and was preventing his business from growing to its full potential. Therefore, he asked his son, Robert, who had graduated from Engineering and held a Master's Degree in Business Administration, to join his firm. Robert had six years of experience with a major consumer products company. Management's Background Prior to starting his business, Bill Madden had worked for twenty-five years in communications services for several federal government departments. When he took an early retirement in 2003 at the age of 50, and he decided to realize his dream of starting his own business. At the time of incorporation in 2008, sales began to accelerate, and the company moved from a hobby business to a full-time operating entity. That year, he decided to move the operating facilities from the basement of his house to a small space that he rented in an industrial park. Bill enjoyed the artistic side of the business. He liked to draw images. His friend, Harry Freeman, also a former federal public servant joined him in 2008. He was responsible for sales and general administration. When Bill started his business, he sold his reproductions through small independent kiosk operators and even rented some kiosks himself on a short-term basis. He also advertised his products in catalogues to a wide range of retail outlets particularly in the giftware business. As revenue continued to soar in 2014, he realized that he needed to invest money into his business and authomate his production operations. Both Bill and Harry believed that they needed professional help since they had no qualifications and experience in managing a business that required skills in the field of marketing, human resources, production, and finance. For that reason, they asked Robert, Bill's 31-year-old son to join the business and become president of Micro Tiles. Bill would be responsible for the product design a key factor in the success of the business. Harry would be responsible for sales and marketing activities, and Robert, as president, would be responsible for general administration. Micra Tiles Limited Micro Tiles Limited In 2014, Micro Tiles Limited was showing substantial growth. Revenue went from $1.0 million in 2011 to $2.0 million in 2014 (see appendix A). This huge gain was a result of sales agreements that Bill had signed with several giftware retailers. His catalogues also helped his business to gain recognition. A wide variety of retail outlets and consumers were becoming acquainted with Micro Tiles products. Even some major retailers began to show an interest in carrying his product lines. Bill signed a sales agreement during March 2014 with a major retailer. The retailer would market Bill's products on a trial basis in several stores across Canada. After several months, the consumer response appeared to be positive and Micro Tiles was becoming recognized as a leading monthly sales consignment supplier. This helped generate a 48% sales increase in 2013 (from $1,058,000 to $1,564,000). As the relationship with retailers matured, Micro Tiles introduced several changes in the way products were manufactured and marketed. In the past, the company designed a tile first and then created the promotional plan. Now, the development of new products would be based on consumer research and social trends. For example, the company would develop new product lines as a tribute to successful sports heroes. Retailers and consumers both showed considerable interest in this marketing scheme and this was considered the cornerstone of Micro Tiles" success. Marketing Strategy Based on the data published by various industry sources, the memorabilia market was in a growth phase. The size of the market and the demand for products regarding "themes" or "celebrities" encouraged some medium-sized retailers to buy these types of products. Smaller retailers such as gift shops and even major department stores started to carry this product line described as "commemorative" items. When Bill talked to store managers, they all showed an interest in tiles with NASCAR, basketball, Olympics, sport fishing, and other specialized baseball and hockey themes Since 2003, Bill was responsible for all activities in his business, a sort of jack-of-all-trades. He designed, produced, and sold the products enhancing his knowledge regarding the market, the retailers, and consumer tastes. Bill leamed that: Each product has its own shelf life (i.e., 6 months) and a lot depended on the location before it reached full maturity Products that did not meet sales objectives within a prescribed time frame were considered a "flop and removed from the store shelves. Floor store location was considered vital to a product's success and turnover. Slow-moving products lost their premier" floor location. . -2- Micro Tiles Limited Slow-moving products significantly tied up cash flow. Distributors were considered too expensive. They required a 100% mark-up. With this background knowledge, Bill adjusted his marketing strategies. Distribution Strategy In order to ensure effective and efficient service, Micro Tiles distributed its products through a courier company. The process was simple: Individual department stores placed orders directly with Micro Tiles. Micro Tiles would keep sufficient inventory on hand to meet product demand for the more popular tiles. The courier accepted a total of 10 tiles per case. The courier picked up the packages and delivered them directly to the retail stores. The company was able to ship the products for less than any department store's distribution and warehousing facilities. Micro Tiles adopted this distribution strategy since it was considered the most cost-effective method. Products and Pricing Strategy Micro Tiles had a "standard" product line that was offered through its catalogue; a total of 25 images. These 12" 15" images were considered standard size and made of either plaster or metal. All products had original designs. Once a model was created, it went into production Each item was hand-finished with appropriate solutions before shipment. Over the years, this process was perfected, and the quality of cach reproduction was considered flawless" or using conventional business terminology, "zero-defects". The per-unit cost (including shipping and packaging) was in the $20.00 range and sold for $59.95 less commission, Micro Titles developed its first premium" products with several hockey, golf and baseball idols. Although the production process of these items was the same as the standard products, incremental costs associated with marketing each piece had to be considered. For instance, the licensing cost for producing the image of a hockey idol was $5 per unit A list of product lines such as Canadian hockey images, NASCAR images, golf images, basketball images, etc. was designed and presented to several retailers, who were very interested. These images would be considered imperative for the company's sales efforts and future success. The traditional product line would be marketed jointly with the new images. These niche products were considered to have exceptional marketability and expected to boost sales volume. Micro Tiles Limited Robert's Vision and Plans Robert spent several weeks listening to his father's objectives and plans and was encouraged by what he heard. However, after looking at the company's 2011 to 2013 actual financial statements, he had some reservations about the financial strength of the business. Robert was currently working as a product manager for an international consumer products company and was eaming a good salary. He liked the financial stability. He was married and had two children. Robert decided that before he "leaped" into his father's business, he would closely examine the profile of each financial statement to determine whether or not it was possible to make Micro Tiles a profitable venture. There was nothing much that he could do about the 2014 estimated year-end financial results. The company was already in its fourth quarter and based on some rough estimates, Robert estimated that it would end the year with a $47.000 profit, just $6,000 more than the previous year. Robert had little reservations about the sales estimates. He believed that revenue would continue to increase in view of the excellent quality product lines and the good working relationships Bill had nurtured over the years. However, he believed the operating costs were a big obstacle for the company's success. Robert made the following statement in a meeting with his father Bill and friend Harry Freeman: "I'm very interested in joining the company. However, I need to be assured that I will be given "carte blanche regarding how this business is managed. We have to make some major changes in our cost structure. I'm glad that a more automated production process was installed in 2014. If we use that production process effectively, we could considerably improve the company's bottom line. I have calculated some financial projections for the year 2015 and would like to review them with you. If you agree with these plans, I think that we have a good chance of producing healthy financial statements. The challenge is changing the way we do things. These changes need to take place immediately. If we are patient and succeed, I firmly believe that Micro Tiles will become a leader in the giftware and memorabilia industry. My intention is to increase our return on sales for 2015 and plan for a major $2.0 million investment in 2016." Micro Tiles Limited REQUIRED: In preparation of Robert's meeting with his father, Bill and partner Harry Freeman, Robert has prepared a report outlining his analysis on how to improve the financial health of the company, improve return on sales for 2015 and be well positioned for the planned $2.0 million investment in 2016. In your role as Robert, your group is required to prepare this report and should include (but not be limited to the following: A financial analysis of Micro Tile's performance for 2013, 2014 and 2015. This analysis should include a review of, and comments on: o the sources and uses of funds o the cash flow statement o financial ratios (liquidity, debt/coverage, asset/management and profitability) o the sustainable growth rate A determination and analysis of the breakeven points for 2013, 2014 and 2015. What sales revenues levels would Micro Tiles need to achieve to a satisfy a target profit objective of $300,000 before tax, $350,000 before tax and $400,000 before tax? An assessment of the cash budget for 2015 The body of your report should not exceed 3 to 5 pages (this does not include your appendices or title page), written in 12-point Times New Roman font with 1.5 cm margins. Please submit your entire report, including your appendices, as ONE pdf file. Make sure that everything is appropriately formatted, spaced and labelled. To conduct your analysis, you have been provided with three templated Microsoft excel files: 1. "Micro Tiles Analysis Template" - this excel file has 7 worksheets or templates. These worksheets include: a. The Income Statement b. Comprehensive Income and Shareholder Equity Statement C. Statement of Financial Position d. Statement of Sources and Uses of Funds e. Statement of Cash Flows f. Financial Ratios 6. Sustainable Growth Rate -5 Micro Tiles Limited You are required to input data into the greyed our boxes in the first 3 worksheets ONLY. All required data is available in the body of this case and in the additional case data beginning on page 7. Once you have completed this, the remaining 4 worksheets will automatically populate. All formulas have already been programed into the spreadsheets. 2. "Breakeven Analysis Template"- this excel file is only one worksheet. Input the revenue and cost information from the 2013-2015 financial statements into this spreadsheet. You are required to input data into the greyed our boxes ONLY. Once you have completed this, the other cells will automatically populate. All formulas have already been programed into the spreadsheet 3. "Cash Budget Template" - this excel file is only one worksheet. You are required to input data into the greyed our boxes ONLY. All required data is available in the body of this case and in the additional case data beginning on page 7. Once you have completed this, the other cells will automatically populate. All formulas have already been programed into the spreadsheet Micro Tiles Limited Financial Statements Micro Tiles' three financial statements: the statements of income, the statements of changes in equity and the statement of financial position for the years 2011 to 2014 are presented in Appendix A. Although revenue doubled between the years 2011 to 2014, the company's profit for the year remained relatively flat. Bill was able to increase the company's revenue but had problems keeping his costs in line. The statement of financial position indicated that total assets increased substantially from $450,000 in 2011, to $1,132,000 in 2014. In 2011, approximately 67% of the company's assets were financed by debt, a ratio that remained unchanged during the four-year period. This meant that every time assets were purchased, 67% was financed by debt, and the rest, equity. In 2014, Bill decided to invest $300,000 in his business to purchase new production equipment to satisfy product demand and more importantly, improve plant efficiencies. Bill re-mortgaged his house and obtained $100,000 from the bank for the purchase of these assets. Financial Projections When Robert considered joining the company in October of 2014, he realized that his first task was to initiate changes in the business that would have positive effects on both the statement of income and the statement of financial position. If the company wanted to invest $2.0 million to expand its operations in 2016, he knew that some cash would have to be generated internally. He could not continue relying on 67% external funding. This meant going through a cost-reduction program in addition to reducing the level of working capital accounts such as inventories and trade receivables. Statement of Income Planning Assumptions Robert's first objective was to boost operating efficiencies. He wanted to improve the company's return on revenue from 2.3% in 2014 to 9.0% in 2015. He was confident that this could be realized by substantially cutting back on production costs. Based on some preliminary figures, he estimated revenues would increase by 8% in 2015, or reach $2.2 million. In 2014, cost of sales as a peroent of revenue was 76.6% and he wanted to bring it down to 64.0% by 2015. Here are Robert's 2015 cost of sales estimates for individual expense items: Purchases $850,000 Freight in 84,000 Labour 460,000 Depreciation/amortization 25,000 -7- Micro Tiles Limited As far as marketing activities are concerned, Robert wanted to be more aggressive. Distribution costs for 2015 were estimated as follows: Salaries $ 70,000 Commissions 80,000 Travelling 35,000 Advertising 30,000 Depreciation/amortization 10,000 The administrative expense projections for 2015 were to remain flat at 2014 levels. However, as a percentage of revenue, these expenses would demonstrate an improvement in efficiencies. Finance costs would increase substantially as a result of the extensive debt financing obtained from the bank for the purchase of new assets. He estimated administrative expenses and finance costs to be as follows: Salaries $ 120,000 Leasing 40,000 Depreciation amortization 25,000 Other charges 13,000 Financing costs 110,000 Statement of Changes in Equity Planning Assumptions The only two numbers to be inputted in the statement of changes in equity (retained earnings) are: In the Micro Tiles Analysis template under the year 2013: - under common shares, common shares issued: $25,000. - under retained earnings, for the balance at the beginning of the year for retained earnings: $171,000. Statement of Financial Position Planning Assumptions There were two major improvements that Robert wanted to realize in 2015. Reduce the level of inventory and trade receivables. His objective was to increase the inventory turnover (based on cost of sales) from 5.3 times to 8.1 times in 2015. This target was also based on industry averages and benchmarks. He also wanted to reduce the average collection period of accounts receivable from 71.1 days in 2014 to 47 days in 2015. This objective was based on some financial benchmarks that he had obtained from his banker. With these changes in inventories and trade receivables, he believed that he could increase Micro Tiles' internal cash flow, which would then help finance the purchase of the $300,000 non- current assets. Micro Tiles Limited The current asset accounts were estimated as follows: Inventories $ 175,000 Trade receivables 285,000 Prepaid expenses 4.000 Cash and cash equivalents $ 25,000 Short-term deposits 100,000 As previously indicated, Robert expected to invest an additional $300,000 in non-current assets in 2015. As a result, the estimated accumulated depreciation/amortization would increase by $60,000. Goodwill would remain unchanged at a level of $14,000. On the equity and liability side of the statement of financial position, Robert wants to reduce the working capital loan and long-term debts. His strategy was to improve the company's debt-to- total assets ratio in order to have some leverage for obtaining additional financing in 2016 that would be used for the $2.0 million investment. The following are his estimates for the year 2015: Share capital $ 125,000 Non-current liabilities 270,000 Trade and other payables 235.000 Short-term borrowings 120,000 Accruals 36,000 Micro Tiles' weighted average cost of capital for the years 2013 to 2015 is estimated at 10% Break-Even Point Cost Assumptions Robert believed that the company's break-even points for the years 2013 and 2014 were not healthy and by going through a cost reduction program, he was aiming for a significant improvement in 2015. He estimated that 75% of the cost of sales for "labour" to be variable and the other 25%, fixed. -9- Micro Tiles Limited Cash Budget Assumptions for the Year 2015 Robert understood that the only way to realize his 2015 financial objectives would be to follow his monthly expenses like a bawk; therefore, he decided to prepare a cash budget. Instead of waiting for quarterly or year-end results, he wanted to follow every cost item as the year progressed. The monthly revenue and cost breakdown is as follows: $000s January February March April Travel $2 2 3 3 3 Revenue S150 160 170 200 200 200 230 220 190 180 160 156 $2216 May June Purchases S60 60 80 80 80 90 90 70 60 60 60 60 $850 Commissions S6 6 6 7 7 7 8 8 7 Labour $30 32 35 40 50 48 50 45 35 35 30 30 $460 4 4 4 July August September October November December Total 6 3 3 2 6 $ 80 35 As far as revenue is concerned, 20% of the customers paid on a cash basis and 80%, the month after. For purchases, 50% was paid on a cash basis and the rest, the following month. Monthly breakdown for other costs are as follows: Freight in: $7,000 (Jan. to Dec.) Salaries-Distribution: $5,000 (Jan. and Feb.) and $6,000 (March to Dec.) Advertising: $2,000 (Jan. to April and Nov. to Dec.) and $3,000 (May to Oct.) Salaries - Administration: $10,000 (Jan. to Dec.) Leasing: $3,000 (Jan. to Aug.) and $4,000 (Sept. to Dec.) Other - Administration: $1,000 (Jan. to Nov.) and $2,000 (Dec.). Finance costs: $7,000 (Jan. to May), $9,000 (June to Aug.) and $12,000 (Sept. to Dec.) Beginning bank balance: $70,000 - 10- APPENDIX A Micro Tiles Limited Statements of Income 2011 2012 2013 2014 Revenue 1,083 1,058 1,564 2,052 355 369 30 380 Cost of sales Purchases Freight in Labour Depreciation amortization Other charges Total cost of sales Gross profit 630 44 529 4 0 1.207 29 366 4 0 754 825 74 665 8 0 1,572 3 5 787 296 304 357 480 Other income 0 0 D 0 34 33 12 7 2 10 98 37 32 11 9 2 0 91 47 16 10 3 0 117 65 6B 32 20 5 0 190 102 20 Distribution costs Salaries Commissions Travelling Advertising Depreciation amortization Other charges Total distribution costs Administrative expenses Salaries Leasing Depreciation/amortization Other charges Total administrative expenses Financing costs Total expenses les other incon_ Profit before taxes Income tax expense Profit for the year 94 20 13 20 147 107 26 24 16 173 117 31 30 17 11 142 195 3 7 14 34 248 240 304 419 48 64 53 61 10 18 12 14 38 46 41 47 Micro Tiles Limited Statements of Retained Earnings 2011 2012 2013 2014 Retained earnings (beginning of year) Profit for the year Sub-total Dividends Retained earnings (end of year) 87 38 125 0 125 125 46 171 o 171 171 41 212 0 212 212 47 259 0 259