Finance论文模板 – Chocolate Delight Profitability and Cash Flow

Task 1

  1. Assessing financial performance

To get the net profit margin, amount of net profit is divided by turnover of the year. The net profit is earnings after deduction of operating expenses, interests and tax.

Net profit margin=net profit/revenue*100

2008=10.3/208.1*100=4.95%

2009=9.7/214.8*100=4.52%

The other ratio is return on capital. It is computed by dividing operating profit with invested capital (PERIASAMY, 2009).

ROCE=operating profit/capital invested*100

2008=10.3/35.1*100=29.34%

2009=9.7/28.7*100=33.79%

Meaning of the profitability results computed

Chocolate Delight net profit margin is not favorable as it is declining. The net profit margin reduced from 4.95% in 2008 to 4.52% in 2009. From the income statement, significant amount of revenue goes to operating expenses as they represent above 40 percent of total revenue for the year 2009. Despite the rise in sales turnover, the firm did not maintain a similar mark-up and cost of sales also rose in 2009, explaining the drop in net profit margin. There was a GBP 0.6m decrease in net profit in the 2008-09 period. Since gross profit did not change, it means that expenses for year 2009 were rising (ROBSON, 1997).

Return on capital employed focuses on profit generated in comparison to the capital invested. ROCE for Chocolate Delight indicates that for every GBP100 invested as capital by investors, they will receive returns of GBP 29.35 in return for 2008 and GBP 33.8 in 2009. Despite the decrease in the net profit figures, there was an increase in return on capital from 29.34% to 33.80%. This is due to the decline in invested capital amounts by 6.4 million from 2008 to 2009. As of 2009, investors received a higher profit of their invested capital hence favorable (PERIASAMY, 2009).

b. Improving profitability

Chocolate Delight has profitability problems. To solve them, they must first try to increase their sales revenue. Sales revenue can be increased by increasing selling price and the volume of sales. It is only possible in markets with high customer confidence where higher prices are applicable due to high demand for products (Hill, and Hill, 2012). Similarly, the firm can bring more new products into the market to have a diversified product portfolio to increase volume of sales. The draw back to increasing selling prices is that it could scare away potential buyers.

Another way is to reduce costs of sales. The annual summary shows that as sales increased, the gross profit remained the same. It shows that cost of goods sold were on the rise. This could be solved by looking for cheaper materials, and cheaper direct labor to incur a lesser cost per unit in sales (Wild et al, 2004).

A more efficient control of expenses is required. Operating expenses take approximately 90 percent of the firm’s gross profit. These expenses could be reduced by relocating its operations low cost centers and reducing costs such as selling, general and administrative (SG&A) (NEEDLES, & POWERS, 2006). This is the most effective strategy as increasing selling prices can affect product demand while lowering material costs could affect quality. The firm should improve its operational efficiency for less operating costs and higher profitability.

Task 2

Chocolate Delight can implement various approaches to improve their cash flow position and not damage profitability

  1. Lowering days’ receivable days

The firm makes sales on credit terms and debtors are allowed a time period to repay their debt. The company should reduce the payment period for debtors so that customers who buy on credit can repay their dues more quickly. For quick payment of debtors, it is achieved through offering incentives such as slightly raising the discount allowed and a rise in their trade discount on the net purchase.  High level of debtors affects cash as the firm wait for customers to repay their dues. Therefore, reducing the days’ receivables period by making debtors repay their debt more rapidly will improve cash flow and also decreases the decrease of bad debts have improving profitability too (Klapper, 2006).

  • Minimizing fixed assets spending

To improve cash flow, capital spending on long term assets should be lowered to keep cash in operations.  There was 1.4M cash used to acquire fixed assets and it reduced cash levels as it was finance by internal funds. Such long term expansions need to be minimized to save the large sums of money usually disbursed. This would free up cash/savings for funding of operations and to improve profitability (JURY, 2012).

  • Leasing fixed assets

Fixed assets should be leased and not bought outright. The large capital expenditure in 2009 would not occur if the firm leased the assets. Capital expenditure involves large sums of cash hence should not be acquired outright using cash but by leasing. Its benefit is the freeing up the vast cash amounts, for short term needs since no large cash outlay occurs as the company will only pay period instalments of interest.  The asset can be utilized and generate returns hence total financing (Miller, and Upton, 1976). The payments can be spread over many years thus offering cash flexibility. The only drawback is that interest payments would lower operating and affect Return for Equity.

  • Increasing days’ payable period

This is whereby the firm is allowed more time to pay its credit purchases in a concept referred to as ‘buy now pay later’ (Petersen, and Rajan, 1997). Chocolate Delight must seek maximum possible credit offered by the creditors. Increasing days’ payable period would allow a longer period to repay credit purchases. Consequently, it would free up cash and the later repayment would be financed by cash generated from sale of the same goods earlier purchased on credit. On the downside, it is only a short term measure.

  • Reducing cost of production

There is significant cash going into production. High production costs make the products to be priced highly hence less competitive in the market and reducing cash from operating activities. Cost to be reduced include raw material, along with direct labor (Dedman, and Lennox, 2009). On purchase of raw materials, the firm must utilize supplier discounts through bulk purchases at reasonable prices for minimum cost per unit. Through lean production, production costs would reduce as raw materials would be provided when demanded. This approach would lower cash outflow.

  • Raising selling prices

As earlier discussed, prices can be raised but simultaneously limiting the cost of sales. This approach applies only for highly demanded goods where customers cannot switch to rivals. It is also affected by demand fluctuations and firm must at least promote the products for customers to stay locked in. However, raising selling prices would contribute to higher margin of sales and improve cash flow (Weil et al, 2012).

  • Improving inventory turnover (reducing inventory days)

The annuals summary shows a rise in inventory levels. It means that the inventory days were on the rise hence less conversion of stock into sales (Barth et al, 2001). It also creates cash outflow in inventory holding costs. Improving inventory turner would increase sales in underperforming outlets and reduce costs for holding stock. A Just in Time strategy would allow stock to be availed according to demand hence increase stock turnover. It would improve cash from operations (Pan, and Liao, 1989). This is a short term approach though.

  • External financing

There is a reduction in capital invested and it affected cash available to finance operations. Long term debt is a viable option since the cash can be invested and revenues realized used to make the interest payments. It would also free up cash generated internally. A long term loan can also finance working capital hence improving cash from operations (Vishnani, and Shah, 2007). It also has tax advantages (AHUJA, 2016) while is downside is that it must be repaid within a specific period irrespective of performance.

Recommendation

From the discussed alternatives for improving cash flow, there are two approached that can be combined for maximum gains. The firm must focus on reducing operating expenses. This is a measure to improve cash flow in the short ter. The second approach is recuing capital expenditure or financing it externally. If fixed assets need improvement, it should be using lease or long term debt but not internal funds. This would reduce cash outflow hence improve cash flow position.

References

AHUJA, N. L. (2016). Corporate finance. [Place of publication not identified], Prentice-Hall Of India.

Barth, M.E., Cram, D.P. and Nelson, K.K., 2001. Accruals and the prediction of future cash flows. The Accounting Review, 76(1), pp.27-58.

Dickinson, V., 2011. Cash flow patterns as a proxy for firm life cycle. The Accounting Review, 86(6), pp.1969-1994.

Hill, A. and Hill, T., 2012. Operations management. Palgrave Macmillan.

JURY, T. (2012). Cash Flow Analysis and Forecasting the Definitive Guide to Understanding and Using Published Cash Flow Data. Hoboken, John Wiley & Sons.

Klapper, L., 2006. The role of factoring for financing small and medium enterprises. Journal of Banking & Finance, 30(11), pp.3111-3130.

Miller, M.H. and Upton, C.W., 1976. Leasing, buying, and the cost of capital services. The Journal of Finance, 31(3), pp.761-786.

NEEDLES, B. E., & POWERS, M. (2006). Financial accounting. Boston, MA, Houghton Mifflin Co.

Dedman, E. and Lennox, C., 2009. Perceived competition, profitability and the withholding of information about sales and the cost of sales. Journal of Accounting and Economics, 48(2), pp.210-230.

Pan, A.C. and Liao, C.J., 1989. An inventory model under just-in-time purchasing agreements. Production and Inventory Management Journal, 30(1), pp.49-52.

Petersen, M.A. and Rajan, R.G., 1997. Trade credit: theories and evidence. Review of financial studies, 10(3), pp.661-691.

PERIASAMY, P. (2009). Financial management. New Delhi, Tata McGraw-Hill.

ROBSON, A. P. (1997). Essential accounting for managers. London, Continuum.

Vishnani, S. and Shah, B.K., 2007. Impact of working capital management policies on corporate performance—An empirical study. Global Business Review, 8(2), pp.267-281

Wild, J.J., Bernstein, L.A., Subramanyam, K.R. and Halsey, R.F., 2004. Financial statement analysis. McGraw-Hill.

Weil, R., Schipper, K. and Francis, J., 2012. Financial Accounting: An Introduction to Concepts, Methods and Uses. Cengage Learning.

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