Question
Over the last few days I have posted questions for a large group assignment. The last question worth 20% of the mark - Give your
Over the last few days I have posted questions for a large group assignment. The last question worth 20% of the mark - Give your comments on the cash and inventory management of this company. Provide a suggestion how to improve the financial performance of this company.
This is what I have so far, but not sure on the wording, also its hard to accurately answer the question (the assignment is new and my tutor has told me the course conveniour still hasn't written the solutions and just 'made up the group assignment based off an old individual assignment and added more data' the problems with the company aren't really the cash flow or inventory management. WE have decided to focus on the second part of the question and answer 'How to improve the financial performance of the company.
Fantastic LTD is projecting heavy losses over the coming 6 months. Sales are only just covering COGS so losses equal Selling, Admin & Bad Debts.
From our scenarios, we see the most effective ways to reduce losses are;
Raise prices (option b) - despite the resulting drop in sales, this still increases Gross Profit ($70k profit improvement, if implemented from Jan instead of the recommended May)
Increase sales commissions (option d) - extra revenue generated by increased sales, far out-weighs the additional cost of commissions, and provides a further boost to profitability
On its own, increasing sales commission is a loss-making measure for the simple reason that the selling price is less than COGS (negative Gross Margin). We would be paying sales staff more to sell more of a loss-making product. However, if we raise prices and achieve a positive Gross Margin, then increasing commission to get more sales may make sense.
Discounting, while it improves the speed of cash collection (Cash Balance), also reduces revenue and pushes Fantastic further into the red, and is therefore not recommended. On the other hand, negotiating extended credit terms does improve our Cash Balance without affecting profitability, so fantastic should proceed with this.
The current inventory policy results in an average of 120k of inventory over the 6 months. While this has a modest effect on the Balance Sheet compared to the $2,000,000 being budgeted for CAPEX, it is worth halving all of the inventory percentages policy to gain an additional 60k of cash available month to month.
Small improvements in cash position could be made by offering discounts to get paid in cash and reduce unrecoverable AR, delaying payments to suppliers and reducing inventory, however these are dwarfed by the massive problem that$850,000 is going out the door through on-going losses. It is therefore crucial that Fantastic preserves its cash to cover those losses while it looks for way to get back to profitability. We should be mindful that the bank may withdraw Fantastic's LOC facility if it continues to make such heavy losses, and this would result in insolvency according to the budget.
We should ensure that the proposed investment of $400,000 in Machinery is justified by a decrease in input labour for producing each table, but there is no evidence of this in the projections. Similarly, it would be expected that proposed $300,000 investment in Software in June will help reduce administration costs, and again there is no evidence for this. So, the factory and admin managers need to justify their proposed capital expenditures.
There is also no evidence of the need for investing $600,000 in land at a time when losses are draining the company's cash. It is suggested that land purchases, if they are justified for strategic reasons, be delayed until profitability is restored.
Similarly, the 700k Pretty Chair investment is questionable while Fantastic's are making huge losses. However this may be justified if Pretty Chair is particularly profitable. It is suggested a good benchmark would be if Pretty Chair can earn profits at the same rate as Fantastic's cost of debt, i.e. 18% interest.
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