What three factors would influence your evaluation as to whether a company’s current ratio is good or bad

  1.     What three factors would influence your evaluation as to whether a company’s current ratio is good or bad, why?
  2.     Suggest several reasons why a 2:1 current ratio might not be adequate for a particular company.
  3.     Why is working capital given special attention in the process of analyzing balance sheets?
  4.     What does the number of days’ sales uncollected indicate and who would be interested in these ration?
  5.     What does a relatively high accounts receivable turnover indicate about a company’s short-term liquidity?
  6.     Why is a company’s capital structure, as measured by debt and equity ratios, important to financial statement analysts?
  7.     How does inventory turnover provide information about a company’s short-term liquidity?
  8.  Discuss why there may or may not be  ratios that would be more important in a service vs manufacturing environment and which rations would those be?

 

 

 

           

 

 

  Why is working capital given special attention in the process of analyzing balance sheets?

Working Capital gives us an idea about company’s short term financial health (Investopedia, n.d.).

Working capital = current assets – current liabilities

Working capital is important because it tells us if the company can cover or pay off its current liabilities, which might include rent, loan payment, interest payment, payment to vendor etc.  So a positive working capital or a working capital ratio > 1 (current assets / current liabilities) shows that the company will be able to meet short term liabilities.

Ideally the working capital ratio should be between 1.2 to 2.0 (Investopedia, n.d.).

If the working capital is negative or the working capital ratio is less than 1 that means the company has a problem in hand to pay off current liabilities. If it is too high, then the current assets should be investigated further to see if the company has unsold inventory or too much account receivable that means company is behind in collecting money from the customers. So it is important that for the company the inventory is not too high or not going higher year on year or quarter on quarter. And same with the account receivable. But a lower working capital ratio and shrinking account receivable might show declining sales.

 

 What does the number of days’ sales uncollected indicate and who would be interested in these ration?

It is number of days a company needs to get collect the money back after sale has been made. It is usually derived based on month, quarter or year (Investopedia, n.d.).

Number of days sales uncollected = (Accounts receivable / Total credit sales) * number of days

It is in company’s best interest to keep the number of days sales uncollected low, first of all the sooner they get the cash back the less lose on present value of money and secondly they can put back the cash to work wither on investments or paying off debts.

And I think creditors of the company would be interested to know the number, since a lower number would suggest that the company can collect the cash sooner after making sales and that means less chance of cash flow problem. But one important point is this does not capture any sale made in cash.

While number of day’s sales uncollected can give idea about number of sales a company is making or how well the collection system of the company is functioning and if it has any cash flow problem, but it does not capture the part of sale made in cash.

 

  1.     Suggest several reasons why a 2:1 current ratio might not be adequate for a particular company

Current ratio is a good measure to see if a company has enough assets to pay off current liabilities. And 2:1 current ratio might mean in theory that the company has $2 worth current assets to pay $1 worth current liability. Which should sound pretty good on the surface.

One reason behind higher current assets could be unsold inventory, and that might mean that slowdown in sales, or low demand for the market. Or it might simply mean the company is not being able to better use its cash. But when the company has too much account receivable and unsold inventory causing a higher current assets that might imply that the company does not have enough cash to meet its current liabilities.

 

 

 

 

Retrieved on 3/23/2018. Retrieved from https://www.investopedia.com/terms/w/workingcapital.asp

 

Retrieved on 3/23/2018. Retrieved from https://www.investopedia.com/terms/d/dso.asp

Case Study of Diamond Gem Cleaning and Maintenance Company

Abstract

This paper will provide a financial ratio analysis of the company using: (1) Gross profit margin, (2) Current ratio, and (3) Debt ratio derived from the provided data. This paper will provide a narrative about, and observations of, significant lines from the statements. This paper will provide conclusions that are supported with research, data and logic. And finally this paper will provide a brief discussion of what limitations exist with the informational material provided.

 

Keywords: gross profit margin, current ratio, debt ratio

 

 

 

 

 

 

 

 

 

 

 

Gross Profit Margin – Gross profit Margin is used to measure company’s financial health as it reveals the amount of money left from revenues after the expenses for cost of goods sold (Investopedia, n.d.). The formula to measure gross profit margin is –

Gross profit Margin = (Revenue – Cost of goods sold)/Revenue

In case of “Diamond Gem Cleaning and Maintenance Company”

Contract Revenues – 5,146,862

Contract Cost – 4,532,519

So gross profit margin = (5146862 – 4532519)/5146862 = .12 or 12%

Current Ratio – shows if a company has enough cash or cash equivalent which is included in current asset to cover current debts or liabilities (liabilities to be addressed / paid back in 1 year).

In this case current assets = 893868

Current liabilities = 571697

Current ratio = Current assets / Current liabilities=893868/571697 = 1.56 or 15.6%

 Debt ratio tells us how leveraged a company actually is, higher the debt ratio, higher the outgoing cash flow towards debt interest and principle payment (Investopedia, n.d.).

For this company Total Long term Debt = 172467

Total Short Term Debt = 571697

Total Assets = 1180660

Debt Ratio = (Total Long term Debt + Total Short Term Debt) / Total Assets =744164/1180660

=.63

Let us find out the Common side analysis of balance sheet and income statement –

Common-Size Balance Sheet Analysis
ASSETS        
         
CURRENT ASSETS        
         
Cash   225,971   19.14%
Contracts receivables   505,050   42.78%
Other assets   162,847   13.79%
         
Total current assets   893,868   75.71%
         
LONG TERM ASSETS        
         
Equipment   286,792   24.29%
         
TOTAL ASSETS   1,180,660   100.00%
         
LIABILITIES AND STOCKHOLDERS’ EQUITY        
         
CURRENT LIABILITIES        
         
Accounts payable   257,335   21.80%
Line of credit   85,000   7.20%
Accrued expenses   72,495   6.14%
Income tax payable   46,660   3.95%
Current portion of notes payable   31,747   2.69%
Deferred income taxes   78,460   6.65%
         
Total current liabilities   571,697   48.42%
         
LONG TERM LIABILITIES        
Notes payable (long term)   172,467   14.61%
         
TOTAL LIABILITIES   744,164   0.00%
         
STOCKHOLDERS’ EQUITY        
         
Common stock 62,000     0.00%
Additional paid-in capital 63,862     5.41%
         
Retained Earnings 310,634     26.31%
         
Total stockholders’ equity   436,496   36.97%
         
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY   1,180,660   100.00%
         

 

Common-Size Income Statement Analysis
     
Contract Revenues 5,146,862 100%
     
Contract Costs 4,532,519 88.06%
     
Gross Profit 614,343 11.94%
     
General and Administrative Expenses 322,356 6.26%
     
Operating Income 291,987 5.67%
     
Other Expense 25,770 0.50%
     
Income Before Provision for Income Taxes 266,217 5.17%
     
Provision for Income Taxes 115,450 2.24%
     
Net Income 150,767 2.93%
     
     
Retained Earnings, Beginning Balance 159,867 3.11%
     
Net Income 150,767 2.93%
     
Retained Earnings, Ending Balance 310,634 6.04%

 

From Balance Sheet, the significant line items are the “Total Current Asset” and “Total long term assets” which gives us “total assets”. Current assets are cash or cash equivalent, usually current asset is used to cover current liabilities or short term commitments.

Next are “Total current liabilities”, “Long Term Liabilities” those give us “total liabilities”. Current liability is a commitment to be fulfilled in a year, payment to vendors, or repaying some debt etc. and long term liability is usually long term debt or commitment those have to be paid off in more than a year.

Retained earnings is also important because it shows the amount that was not paid out as dividends (Investopedia, n.d.) and is reported under shareholder equity. And a positive retained earning implies the company made a profit and reinvesting in business to grow the business.

From Income Statement, “Contract Revenues”, “Contract Cost”, “Net income” are important. Contract revenues gives us the amount company has made from sales and contract cost gives us the cost of contract sold.

And another important point we see that “Retained Earnings, Beginning Balance” was 159867 and “Retained Earnings, Ending Balance” is 310,634, so the company is making profit, and of course we can see the net income which is 150,767.

 

 

 

With all the data discussed above we can calculate following too –

Profitability Measures

Gross margin ratio = Gross margin / Net sales = 11.94%

Profit margin ratio = Net income/ Net sales = 2.93%

Profit margin is pretty low, because of high debt.

Return on assets = Net income Average/ total assets = 150,767 /1,180,660 = 12.77%

The company is making $12.77 on every $100 of asset

Return of equity =       Net income / Shareholder’s Equity = 150,767 / 436,496=34.54%

The company is making $34.54 on every $100 of equity.

Short-Term Liquidity Ratios

Current ratio = Current assets / Current liabilities=893868/571697 = 1.56

The company has $1.56 of cash or cash equivalent for every $1 of current liability, so it has enough money to cover in short term.

Long-Term Solvency Ratios

Debt to assets = Total liabilities /Total assets = =744164/1180660 =0 .63

This shows for every $0.63 of debt (including current and long term) the company has $1 of asset

Debt to equity = Total liabilities /Total shareholders’ equity = 744164/436496=1.7

This shows the company has way too much liability than equity. For every $1.7 of liability the company has only $1 of equity.

Conclusion- The Company is leveraged although it has enough asset to cover it’s short term current liabilities. But due to high debt the company’s profit is low. The company is a profit making company and makes money, but if interest rate raises or sales drop in that case it might find it difficult to pay back its long term liabilities.

 

Limitation of the data – The limitation is mainly regarding trend analysis. We have balance sheet and income statement of only one year / quarter. So we do not really know if the company is doing better or worse from previous year / quarter. And due to lack of data we do not know if it is doing better than its peer company or doing worse, we cannot do any comparison.

 

 

 

 

 

 

 

 

References

Retrieved on 3/20/2018. Retrieved from https://www.investopedia.com/terms/r/returnonequity.asp

Retrieved on 3/20/2018. Retrieved from

https://www.investopedia.com/terms/g/gross_profit_margin.asp

Retrieved on 3/20/2018. Retrieved from

https://www.investopedia.com/university/ratios/debt/ratio2.asp

Retrieved on 3/20/2018. Retrieved from

https://www.investopedia.com/terms/r/retainedearnings.asp

Identify four reasons that capital budgeting decisions by managers are risky

  1. Identify four reasons that capital budgeting decisions by managers are risky.
  2. Why is an investment more attractive to management if it has a shorter payback period?
  3. Why should managers set the required rate of return higher than the rate at which money can be borrowed when making a typical capital budgeting decision?
  4. Why does the use of the accelerated depreciation method (instead of straight line) for income tax reporting increase an investment’s value?

 

After you’ve completed the questions above, please provide a brief explanation of how this information is important in managerial decision making.

 

 

When manager does capital budgeting, the manager wants to know few factors – how much the investment would cost, cash flow due to the investment, interest rate to calculate the future value of the cash flow , inflation that impacts the future cash flow but there are other factors often imposes risk on budget allocation process, for example managers often decided based on ethical reasons, being short term focused and ignoring the long term goals etc.

Inflation and tax adjusted future cash flow – is important and a manager can ignore tax or future inflation (which might change anyway without anyone having any control over it) to get a proposal approved.

It is important to remember that income tax has to be paid per the law in the country and the inflation can increase too, and both can impact future cash flow inversely. If tax or inflation goes up the future cash flow will come down. The NPV or IRR should factor in future inflation in cash flows.

Qualitative factor – Sometimes NPV and IRR can show an investment might not bring in positive cash flow, yet manager can go ahead with the decision of capital budgeting.

And this capital allocation might be important because it might be to comply with some regulations, or use the best technology available and stay ahead of the competition. These are few reasons which will not impact future cash flow positively yet these reasons are important to do well in business.

Ethical Issues – A manager may or may not allocate budget based on the fact how that will impact him personally. Consider a manager gets bonus from profit the company makes, and making any investment would take a part away from the profit, and in that case just because the manager would get a reduced bonus amount, could take a decision not to make the investment. An ethical issue can be just the opposite too, a manager can simply inflate the future cash flow to get an investment proposal approved.

A company should not be just reward managers for meeting goals, or the reward should come in from on equity, so the manager actually sees a benefit in company’s long term growth prospect.

Ignoring long term goals – is similar to the ethical issue in few aspects. Manager might postpone investment decision to meet immediate goals or current goals just to make sure his performance is good per the benchmark. And in this process the company might miss out on an investment window that could have yielded better results in long run. And like I mentioned in the previous section, a manager can inflate numbers to get an investment proposal passed to which might yield negative result for the company in long run. These are all risks when managers do capital budgeting in any company.

 

 

Why is an investment more attractive to management if it has a shorter payback period?

According to Investopedia, Payback period is the time take for a company to regain the original investment amount and when the net cash flow equal to zero. The simple reason is the present value of future cash is worth less. The faster the manager can recoup the investment, the sooner he / she can put that money to work in another investment.

Present value of future cash is always worth less to the manager based on the interest rate and time.

For example, Say in one investment would yield $1000 in 1 year, and annual interest rate is 5%

Present value of that $1000 is = 1000/(1 +.05) = $952.38

If the 2nd year cash flow projection is $1000 too, then the present value of that amount would be  1000/(1+.05)^2 = $907.02

As you can see in this example, the present value of same $1000 in future is going down based on the rate of interest and time. So managers prefer a shorter payback period so that they can put the money back to work in another investment. According to Investopedia, managers should always go for the shorter payback period projects.

 

 

  Why does the use of the accelerated depreciation method (instead of straight line) for income tax reporting increase an investment’s value?

Let us take an example, say one company makes an investment worth $1000 and it will last 5 years. The tax rate is 25% and we will keep the future cash flow fixed that is $5000 for next 5 years. There is no salvage value on the investment.

Let us find out what if the company decides to use accelerated depreciation method and claims depreciation value in 2 years instead of 5 years.

So total present value of the cash flow would be

  year 1 year 2 year 3 year 4 year 5
Post Tax cash flow 3750 3750 3750 3750 3750
Depreciation 1250 1250      
Present value 4545.5 4132 2817.38 2561.25 2328.38 16384.5

 

But if the company decides to go in linear so $1000 over 5 years and depreciation expense is $2000 each year , let us check the present value of the cash flow with that, keeping other data points constant

  year 1 year 2 year 3 year 4 year 5
Post Tax cash flow 3750 3750 3750 3750 3750
Depreciation 500 500 500 500 500
Present value 3863.68 3512.2 3193.03 2902.75 2638.83 16110.48

 

 

We can see in 2nd case the total present value of cash flow is actually lower than when manager uses accelerated depreciation. The reason behind this is, when accelerated depreciation is used, company saves more money, and new cash flow increases, and the future cash is less than the present cash, so having more cash flow in initial helps achieve a better cash flow in present value terms.

Case Study of Wolverine Company of Michigan

Abstract

We have the standard unit data for Wolverine Company of Michigan, and we are going to determine following with the data –

  • Direct materials price variance (based on materials used)
  • Direct materials usage variance
  • Direct labor variance
  • Direct labor efficiency variance

And the data for the company is –

Normal volume per month is 40,000 direct labor hours.  Wolverine’s January 2014 budget was based on normal
Volume.  During January, Wolverine produced 7,800 units with records indicating the data following:
             
Actual:       The Wolverine Company Standards:
Direct materials purchased 25,000 lbs. @ $3.60 Direct Materials (2 lbs. @ $3.50 per lb.) $7.00
Direct materials used 23,100 lbs.   Direct Labor (4 hours @ $6.50 per hour) $26.00
Direct labor   40,100 hours @ $6.30 STANDARD COST PER UNIT $33.00
  (excluding overhead)          

 

With addition to the values of the variances, we will define each variance category and how data for it is commonly collected, try to provide a narrative about how the value was computed and explain its use in evaluating operational results. And finally provide a narrative about which two categories require management’s priority attention and support the view.

Keywords:

Case Study of Wolverine Company of Michigan

Direct materials price variance (based on materials used) –  

We calculate “Direct material price variance” to determine if the procurement is cost effective or price adverse. If the Actual price is lower than standard price then it is favorable, otherwise not. We need actual quantity purchased and the actual price of purchase along with the standard price to calculate direct material price variance (AccountingSimplified, n.d.).

From the data we have we know the company has actually quantity purchased 25,000 lb. at price $3.60 when the standard price was expected to be $3.50 per lb.

But, the company estimated to produce 7800 units, and with the rate 2lb per unit estimated material was (7800*2) = 15600 lb. and the quantity actually use is 23,100 lbs.

Direct Material Price Variance: = Actual Quantity x Actual Price – Actual Quantity x Standard Price

                                                    = Actual Cost – Standard Cost of Actual Quantity

Applying the above state formula –

Direct Material price Variance = (25000*3.60) – (25000* 3.5) = 90000 -87500 = 2500

We can conclude that the “Direct Material price Variance is $2500 and this is unfavorable because actual price is higher than budgeted price and it impacts profit negatively.

So when we consider the impact on operational result, because the company had to pay more than it estimated, they estimated to pay $3.50 per lb. but they had to pay $3.60 per lb. Most probably because shortage of material, they had to spend additional money, and that will reduce their potential profit.

Direct materials usage variance –

We determine “direct material usage variance” when actual quantity and standard quantity vary. We can determine, if the material usage is efficient or adverse, based on if we have overpaid or underpaid than estimate (AccountingSimplified, n.d.).

In this case, in the month of January the company’s standard production is 7,800 units, and per Direct material 1 unit requires 2 lb. of materials, hence 7800 units would have required (7800*2) = 15,600 lbs. , this is the standard quantity. And the Actual Quantity used in this case was 23,100 lb.

Direct Material Usage Variance = Actual Quantity x Standard Price – Standard Quantity x Standard Price

                                                            = Standard Cost of Actual Quantity – Standard Cost of Standard Quantity

                                                                = (Actual Quantity – Standard Quantity) x Standard Price

Applying this to our situation –

Direct Material usage Variance = (23100 – 15600) * 3.50 = 26250

So the Direct Material usage variance is $26,250, and this is unfavorable, since actual price of direct material is more than estimated price for direct material, it will impact the profitability negatively. It is evident because they estimated to produce 7800 units with 2lbs per unit estimate, but they actually used 23,100 lbs.

 

 

Direct labor variance –

Direct labor variance is used to calculate if the company has spent more or less than estimated on direct labor.

In hour case, the actual hours worked is 40,100 hrs. With actual rate $6.30 per hr., although the standard per hour rate was $6.50

So here is the equation –

Direct labor variance = (Actual hour * Actual Rate) – (Actual Hours * Standard Rate)

= (40100 * 6.30) – (40100 * 6.50) = 252630 – 260650 = -8020

Clearly the direct labor variance is $(8020), hence it is favorable. The company estimated for $6.50 hourly rate but they had to pay $6.30. The negative number means in direct labor company had to spend less money than estimated, so this will have a positive impact on profit.

Direct labor efficiency variance

The purpose of calculating the direct labor efficiency variance is to measure the performance of production department in utilizing the abilities of the workers. It helps us understand if we used more or less direct labor hours than expected. And we can determine if it is favorable or unfavorable based on the negative or positive outcome respectively (accountingexplained, n.d.).

Direct labor efficiency variance = (Actual hours* standard rate) – (standard hours * standard rate)

Direct labor efficiency variance = (40100 * 6.50) – (40000 * 6.50) = 260650 – 260000 = 650

Direct labor efficiency variance is positive for the company, which is $650 and this is unfavorable. The company had estimated for 40,000 hours but in actual they needed 40,100 hours. So this means they had to work extra, and this should negatively impact profit.

In this case which two categories require management’s attention as a priority?

               This company has purchased and used direct material way more than estimated. For example they estimated to use 15,600 lb to produce 7,800 units, but they purchased 25,000 lbs material and they used 23,100 lbs. It is probable that the material has a poor quality or the wastage of material is high or may be labors are not trained to use the material.

Although the company paid slightly higher price for the material, they anticipated to pay $3.50 per lb but ended up paying $3.60 per lb, but this might be temporary or next time they can estimate better.

The direct labor hours are also higher than estimated, they estimated for 40,000 hrs but ended up working 40,100 hrs. This along with high usage of material gives me the idea that labors are either not trained to use the material or the quality of material is not good. So based on my result of direct materials price variance and direct materials usage variance, my recommendation to the company would be to pay close attention on quantity of actual direct material purchased and quantity of direct material used. These two categories are causing the company to lose more potential profit.

 

References

Retrieved on 3/11/2018. Retrieved from http://accounting-simplified.com/management/variance-analysis/material/price.html

Retrieved on 3/11/2018. Retrieved from http://accounting-simplified.com/management/variance-analysis/material/usage.html

Boyd, K(n.d). HOW TO CALCULATE DIRECT LABOR VARIANCES. Retrieved from  http://www.dummies.com/business/operations-management/how-to-calculate-direct-labor-variances/

Retrieved on 3/11/2018. Retrieved from https://accountingexplained.com/managerial/standard-costing/dl-efficiency-variance

Identify the main purpose of a flexible budget for managers

Identify the main purpose of a flexible budget for managers.

Flexible budget recognizes the relativity of fixed and variable costs and how they change based on the output or turnover, hence flexible budget accommodates the changes in the values. It is also known as variable or dynamic budget (Nayab, 2010).

Purpose of a flexible budget for managers and how this information helps managers to make decisions:

Managers often face situations and opportunity those are not planned for and flexible budget help them plan for the potential changes based on changes in production cost, sales volume etc.

Flexible budgeting is essential for the manager because in the real world the fixed budget does not hold up in most of the cases due to employee unavailability or a waste of material during production. A flexible budget is a tool to accommodate the actual data and get the actual performance then the manager can compare it with budgeted performance.

 

What is a price variance? What is a quantity variance?

Price Variance is the difference between actual and standard prices of one unit multiplied by used input quantity (Businessdictionary, n.d.).

Price variance = (actual price – standard price) x actual quantity

The manager can use price variance to determine the difference between actual and expected input prices. From the equation above if we get the positive result that means the actual price is more than what was anticipated and if the price variance is negative that means actual price lower than anticipated.

 

Quantity variance is the difference between the actual material usage and the budgeted or expected material usage. This can be calculated in terms of actual quantity of material and hence in dollar terms too ( accountingformanagement, n.d.).

Quantity variance = (Actual quantity used × Standard rate) – (Standard quantity expected × Standard rate)

The manager can determine if the quantity variance is positive or negative by applying the formula above. If quantity variance is positive then the manager needs to determine the reason behind the extra cost because of more quantity of material usage. And the reason could be the excessive waste or additional production of units, remain to be found out by the manager.

 

What is the purpose of using standard costs? And how this information helps managers to make decisions:

Before executing the actual plan the standard cost helps manager set the floor of expectations and later based on the standard cost the manager can gain insights into cost, price, profit etc

(acountingexplanation, n.d.).

Standard costs are used primarily to set the budget

Standard cost help managers to measure efficiencies

Managers can use standard cost to identify where cost reduction is possible

Managers use standard costs to expedite cost reporting

With this, it is easy to assign the cost to material and hence finished product

With the standard cost of direct material and direct labor, managers can use the information to draft contracts and set sales price

 

References

 

Retrieved on 3/9/2018. Retrieved from http://accountingexplanation.com/purposes_of_standard_costs.htm

Retrieved on 3/9/2018. Retrieved from https://www.accountingformanagement.org/direct-materials-quantity-variance/

Retrieved on 3/9/2018. Retrieved from http://www.businessdictionary.com/definition/price-variance.html

Nayab, N.( September, 2010). What is a Flexible Budget?. Retrieved from https://www.brighthub.com/office/finance/articles/88382.aspx

 

 

 

 

Statement of cash flows of the Nice Suit Dry Cleaning

Abstract

According to Investopedia “Cash Flow” is cash or cash equivalent moving or out of business. We have a cash flow statement in hand with some of the items missing in it. We will try to find out the value and we will figure out the relationship of those items with other line items. Now let us explore the statement of cash flows of the Nice Suit Dry Cleaning

 

Keywords: cash flow statement

 

 

 

 

 

 

 

 

 

 

 

 

Cash Flow Statement

Cash Flows from Operating Activities      
   
Cash received from customers 3,701,327  
Cash paid out to suppliers and employees [_____A_____]  
Interest paid (28,134)  
Taxes paid (42,046)  
  Net cash provided by operating activities 72,074
   
Cash Flows from Investing Activities  
   
Purchase

 

of equipment

(4,272)  
  Net cash used in investing activities [_____B_____]
   
Cash Flows from Financing Activities  
   
New loans 50,000  
Funds received from lines of credit 26,234  
Repayments on loans [_____C_____]  
Repayments on lines of credit (26,234)  
Repayment of note (38,501)  
  Net cash used in financing activities (38,501)
   
Net Increase in Cash [_____D_____]
   
Cash balances, beginning of year [_____E_____]
   
Cash balances, end of year     130,366

 

 

A = Cash paid out to suppliers and employees

Step 1. Net cash provided by operating activities = Cash received from customers + Cash paid out to suppliers and employees + Interest paid + Taxes paid

Step 2. Cash paid out to suppliers and employees = Net cash provided by operating activities – (Cash received from customers + Interest paid + Taxes paid)

Step 3.  A = 72,074 – (3,701,327 + (28,134) + (42,046))

Step 4. A = 72074 – (3701327 – 28134 -42046) = -3,559,073

Cash paid out to suppliers and employees is included in “operating activities” because it is cost of core business and is part to calculate net cash earned by operating activities.

 

B = Net cash used in investing activities = – 4272

B or Net cash used in investing activities because the amount was spent to purchase long term or noncurrent asset that is equipment.

C = Repayments on loans

Step 1. Net cash used in financing activities = New loans + Funds received from lines of credit + Repayments on loans + Repayments on lines of credit + Repayment of note

Step 2. Repayments on loans = Net cash used in financing activities – (New loans + Funds received from lines of credit + Repayments on lines of credit + Repayment of note)

Step 3. C = -38501 – (50000 + 26234 -26234-38501) = 50000

C or “Repayments on loans” is part of “financing activities” because it is noncurrent liability related activity.

 

D = Net Increase in Cash

D = Net cash provided by operating activities + Net cash used in investing activities + Repayments on loans

Step 2. D = 72,074 + (4272) + (38501) = 29301

So this is pretty much the sum of all activities in the Statement of cash flow and the result is net increase in cash.

E = Cash balances, beginning of year

E = Cash balances, end of year – Net Increase in Cash

Step 2. E = 130366 – 29301 =101065

We have cash balances end of year and we have got the net increase in cash by summing up all activities in cash flow statement. Basically when we add “net increase in cash” with “cash balance, beginning of the year” we get “cash balance end of year” (Business Plan Hut, n.d.).

 

 

 

 

 

 

       
Cash received from customers   3,701,327  
Cash paid out to suppliers and employees   (3,559,073)  
Interest paid   (28,134)  
Taxes paid   (42,046)  
  Net cash provided by operating activities   72,074
       
Cash Flows from Investing Activities      
       
Purchase of equipment   (4,272)  
  Net cash used in investing activities   (4,272)
       
Cash Flows from Financing Activities      
       
New loans   50,000  
Funds received from lines of credit   26,234  
Repayments on loans   (50,000)  
Repayments on lines of credit   (26,234)  
Repayment of note   (38,501)  
  Net cash used in financing activities   (38,501)
       
Net Increase in Cash     29,301
       
Cash balances, beginning of year     101,065
       
Cash balances, end of year     130,366

 

 

 

 

 

References

Retrieved on 3/2/2018, retrieved from https://www.investopedia.com/terms/c/cashflow.asp

Retrieved on 3/3/2018, retrieved from http://businessplanhut.com/how-calculate-ending-cash-balance-forecast

financial statement of a company and speculate on the specific type of activity which would be included in each

Please discuss and differentiate the main categories of a SOCF (Operations, Investment, and Financing.) Find a financial statement of a company and speculate on the specific type of activity which would be included in each.

 

Any statement of cash flow has 3 parts –

Operations activities include cash generated from sales or service those are part of net income.

Investing activities include cash activities related to noncurrent assets such as long term investments, purchasing land, equipment etc. Or cash generated from sale of any noncurrent assets. Any cash flow change caused by the result of purchase or sale of investment assets belong to investing activities ( Talliard, n.d)

Financing activities include noncurrent liability and owners’ equity. Noncurrent liability would include principle of long term debt, stock sale or repurchase or both, dividend payment etc.

 

 

 

Here is a financial statement of JCP from https://www.marketwatch.com/investing/stock/jcp/financials/cash-flow

Operating Activities          
Fiscal year is February-January. All values USD millions. 2013 2014 2015 2016 2017
 Net Income before Extraordinaries (985M) (1.39B) (717M) (513M) 1M
Depreciation, Depletion & Amortization 543M 601M 631M 616M 609M
Depreciation and Depletion
Amortization of Intangible Assets
Deferred Taxes & Investment Tax Credit (467M) (164M) 3M 9M
Deferred Taxes (467M) (164M) 3M 9M
Investment Tax Credit
Other Funds 151M (78M) (57M) 198M (62M)
Funds from Operations (758M) (1.03B) (140M) 301M 557M
Extraordinaries
Changes in Working Capital 748M (785M) 379M 139M (223M)
Receivables
Accounts Payable 140M (214M) 49M (72M) 52M
Other Assets/Liabilities (5M) 74M (1M) 19M 11M
 Net Operating Cash Flow (10M) (1.81B) 239M 440M 334M

 

Here are few items for JCP’s operation activities –

JCP got a 9 million tax credit in 20017 , The revenue generated from operations is 557 million

In the year 2017, JCP’s working capital dropped by 232 million and JCP go 52 million as account payable and 11 million from other asset/liabilities

So we can see that the operational activities section tells us how much the company has generated from core business. (Morningstar.com . n.d.)

 

 

Investing Activities          
  2013 2014 2015 2016 2017
 Capital Expenditures (810M) (951M) (252M) (320M) (427M)
Capital Expenditures (Fixed Assets) (810M) (951M) (252M) (320M) (427M)
Capital Expenditures (Other Assets)
Net Assets from Acquisitions (9M)
Sale of Fixed Assets & Businesses 19M 105M 24M 98M
Purchase/Sale of Investments 5M 13M
Purchase of Investments
Sale/Maturity of Investments 5M 13M
Other Uses
Other Sources 526M 143M
 Net Investing Cash Flow (293M) (789M) (142M) (296M) (316M)

 

The investing activities section of the statement of cash flow for JCP tells us that JCP has spent 427 million in capital expenses. JCP has sold fixed asset worth 98 million in 2017 and the have sold another investment worth 13 million.

 

 

Financing Activities          
  2013 2014 2015 2016 2017
Cash Dividends Paid – Total (86M)
Common Dividends (86M)
Preferred Dividends
Change in Capital Stock 71M 793M 2M
Repurchase of Common & Preferred Stk.
Sale of Common & Preferred Stock 71M 793M 2M
Proceeds from Stock Options 786M
Other Proceeds from Sale of Stock 71M 7M 2M
Issuance/Reduction of Debt, Net (254M) 2.4B (260M) (557M) (23M)
Change in Current Debt 650M (650M) 667M
Change in Long-Term Debt (254M) 1.75B 390M (557M) (690M)
Issuance of Long-Term Debt (4M) 2.15B 828M (4M) 2.36B
Reduction in Long-Term Debt (250M) (395M) (438M) (553M) (3.05B)
Other Funds (5M) (9M) (34M) (5M) (10M)
Other Uses (17M) (9M) (34M) (5M) (10M)
Other Sources 12M
 Net Financing Cash Flow (274M) 3.19B (294M) (562M) (31M)
Exchange Rate Effect
Miscellaneous Funds 0
Net Change in Cash (577M) 585M (197M) (418M) (13M)
 Free Cash Flow (820M) (2.77B) (13M) 120M (93M)

 

In the financing activity section of cash flow statement we can see JCP has sold 2 million worth in common stock, taken new debt worth 23 million. Paid of 667 million worth current debt. JCp got 2.36 billions worth long term debt in 2017and paid back 3.05 billion in long term debt.

 

Reference

Taillard, M.  (n.d.). INVESTING ACTIVITIES CASH FLOWS.              Retrieved From

 http://www.dummies.com/business/accounting/investing-activities-cash-flows/

Retrieved on 3/3/2017. Retrieved from http://news.morningstar.com/classroom2/course.asp?docId=145092&page=3

Make-or-Buy Differential Analysis

Abstract

A firm has prepared the following cost estimates for the manufacture of a sub assembly component based on an annual production of 8,000 units.

  Per Unit Total
Direct materials $5 $40,000
Direct labor $4 $32,000
Variable factory overhead applied $4 $32,000
Fixed factory overhead applied (150% of direct labor cost)

Executive Salaries, Rent, Depreciation, and Taxes

 

 

$6

 

 

$48,000

Total Cost $19 $152,000

 

The supplier has offered to provide the subassembly at a price of $16 each.  Two-thirds of fixed factory overhead, which represents executive salaries, rent, depreciation, and taxes, continue regardless of the decision.  Now let us examine if the firm should make the product?

 

Make-or-Buy Differential Analysis

We need to find out the cost differential when the company makes 8000 product units internally and when they buy the same amount of products. We know if the company decides to buy , the variable costs will go away and only 2/3rd of fixed cost will continue, but each unit of product will cost $16.

Differential costs represent the difference in costs among alternative courses of action. In this case making products in house or buying from supplier. Analyzing this difference is called differential analysis. Differential analysis will help us take decision whether making or buying products financially wise (Heisinger, K., & Hoyle, J. B.,2012).

The firm would purchase 8000 units, so the cost would be 8000 units * $16 per unit = $126000

And if the firm stops making, then the fixed cost (i.e.: $48,000) will go down and would continue with 2/3 rd of it, hence 2/3rd of $48000 = $32,000

  Make Internally Buy from supplier Differential Amount “Make Internally” is
Cost to Buy from outside $0 ( 8000 units * $16)=
$126000
(126000) Lower
Total Direct Material Cost $40,000 $0 40000 Higher
Total Direct Labor cost $32,000 $0 32000 Higher
Total Variable factory overhead applied $32,000 $0 32000 Higher
Fixed factory overhead applied (executive salaries, rent, depreciation, and taxes) $48,000 $32,000 16000 Higher
Total Production costs $152,000 $158,000 ($6,000) Lower

 

If the firm continues making 8000 units, that would cost the firm $152,000

But if the firm decide to buy the 8000 units instead, that would cost them $158,000

The table above with “Differential Analysis” column shows us that if the firm decides to buy that will cost them $6000 more than what they would need to make the 8000 units internally.

Hence the company should make the product.

 

 

 

 

 

 

 

 

 

 

 

 

 

References

Retrieved on Heisinger, K., & Hoyle, J. B.(2012). Accounting for Managers.

Describe Differential analysis to drop/keep customers

Describe Differential analysis to drop/keep customers

Often managers need to decide if dropping a customer is profitable than keeping him. The manager can use differential analysis with variable cost associated with the customer, the fixed cost directly related to the customer along with any other allocated fixed cost that is not directly related to the specific customer.

For example for an online only bank, the variable costs would include customer support cost, interest / dividend payment to the customer etc and fixed cost would be information technology maintenance cost, employee cost etc. But notice, that these fixed costs are not specific to the customer, these costs would continue whether or not any particular customer is retained or dropped. When the customer makes the company make loss, then the manager would perform differential analysis to determine if it is profitable to drop the customer or to keep him so that the total profit does not drop.

Describe Differential analysis regarding product line offerings

Any company that wants to introduce a new product or wants to decide on – whether of not to continue with existing product from their offering can use differential analysis to determine the most profitable decision for the company.

For example, say a Yogurt company wants to determine if dropping one particular flavor of yogurt that basically makes loss, should remain in their product offering or should it be just dropped to increase overall profit.

 

 

Describe Differential analysis regarding Make-or-Buy decisions

Companies making products can determine using differential analysis whether or not manufacturing in house would be profitable or should they just buy that product from a supplier to make a bigger profit.

For example say a café sells cookies, and to make those cookies the café needs the oven, ingredients, baker etc. Differential analysis can help us determine if simply buying those cookies from outside would help them save money or not, provided the café has some fixed costs such as rental of the place, leasing cost of the oven etc and some variable costs such as ingredients, the employees.

 

 

 

Discuss the role qualitative information may have in differential analysis

Differential analysis usually does not focus on qualitative information while making decisions.  For example, when I gave the example of a bank customer who is not profitable for the bank, and bank has to spend too much money on him with customer support. Eventually the customer would require less support and he would deposit larger sum of money and the bank would be able to make good profit out of him. Or in the example where I said, the café can decide to outsource the cookies, but considering qualitative information would make the café manager re-consider his decision – the quality of ingredients for the cookies might not meet the café standards, the supplier can deliver late. Firing the baker might have bad effect on existing employees etc.

So qualitative information which does not relate to exact profit figures but it might play a significant part in determining the decision from differential analysis.

 

Discuss sunk and opportunity costs, why must managers consider these things?

Sunk cost is a cost that had been incurred in past and cannot be recovered in future. Sunk cost should not be considered in differential analysis (Bragg, 2017).

For example, in the previous example where the café manager was deciding whether or not he should buy the cookies from a supplier. Say, the café has already purchase ingredients to bake cookies, and some of them cannot be returned as those have been already used, in this case the cost incurred to obtain these ingredients are sunk cost.

 

Opportunity cost is when business chooses one specific alternative it misses the benefits or profit from then next alternative, and that mossed benefit/ profit is opportunity cost. It in theoretical cost (https://www.myaccountingcourse.com/accounting-dictionary/opportunity-costs).

For example, when the café manager decided to make cookies instead of cupcakes, the café missed of the opportunity to sell cup cups and missed out the potential profit from sell cupcakes. Say the potential profit from selling cupcake was $100 daily, in that case this is the opportunity cost.

 

Provide a brief explanation of why a managerial decision may be made, at times, that doesn’t align with the quantitative recommendations of the analysis.

Quantitative recommendations that is often derived from differential analysis can be superseded at times because of the qualitative factors. Before taking any decision to fire an existing employee, a manager considers the effect on moral of current employee. Then customer has a certain expectation from a business, service or quality wise, and the manager often does not want to compromise on that.

And at time brand value might also at risk, for example, if original coke ever becomes loss making product for the company, before eliminating the product from portfolio the company will have to decide if removing original coke from offering will dampen their brand. Same goes for KFC, these brands were built on a certain product. Amazon Prime promises 2 days delivery, if amazon has to decide if they want to continue 2 days delivery or not, they will have to factor in customer sentiment too.

 

References

 

Bragg, S. (August, 2017). Sunk Cost. Retrieved from https://www.accountingtools.com/articles/what-is-a-sunk-cost.html

Retrieved on 2/24/2018 Retrieved from https://www.myaccountingcourse.com/accounting-dictionary/opportunity-costs

 

Cost Management Consulting

Abstract

In this paper we will try to come up with the solution for the given problem, we will work on finding out the break-even cost. And we will find discuss the purpose of assigning cost categories of fixed and variable costs. We will discuss the relationship of variable costs to contribution margin. After that we will discuss the limitations of the data and finally we will speculate what data is missing from the case.

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost Management Consulting

Here are the important data point we are going to work with

Currently, the chain of operations has $22,500,000 of revenue from 5,000 events that they have serviced.

The cost data I have:

  • Floral costs, $200 per event,
  • Table arrangements, $100 per event,
  • Soft drinks and children snacks, $500 per event,
  • Annual allocated costs of tents and other structures, $500,000,
  • Annual allocated costs of trucks and vehicles, $2,000,000,
  • Annual costs related to maintaining permanent staff, $3,500,000,
  • Wage for temporary staff (paid per event), $1,800 per event.

Now let us find out the variable costs –

We know amount for temporary staff per unit, floral cost per unit, soft drinks and snacks cost per unit and table arrangement cost. So the total variable cost per unit is ($200 + $100 +$500 $1800) = $2600

Fixed cost includes –

Annual allocated costs of tents and other structures, $500,000,

Annual allocated costs of trucks and vehicles, $2,000,000,

Annual costs related to maintaining permanent staff, $3,500,000,

  • So total fixed cost – $6,000,000
  Total Per Unit
Sales (5000*$4500) $22,500,000 $4,500
Variable Costs (5000 *$2600) $13,000,000 $2,600
Contribution Margin $9,500,000 $1,900
Fixed Costs $6,000,000  $1200
Net Income $3,500,000  $700

 

Solution to the question how far she can lower her prices without losing money?

Breakeven results if – Sales = Total Variable Costs + Total Fixed costs

Step 1. (Number of events * $4500) = (Number of events * $2600) + $6,000,000

Step 2. (Number of event * $4500) – (Number of events* $2600) = $6,000,000

Step 3. Number of Events * $1900 = $6,000,000

Step 4. Number of events = $6000000 / $1900 = 3150.78 ~ 3151

My client can come down to 3151 events every year if she wants to keep charging $4500 per event.

But her specific query was, she wanted to reduce her price keeping the number of events constant

So let us find out the breakeven cost:

Per unit cost = $4500 and Per unit net income = $700

Now, if she wants to reduce cost without losing money she should be able to go down as low as ($4500 – $700) = $3500 per event

Here is another way to find out the breakeven cost – let us quickly find out how much she has to spend on each even, considering her revenue s $22,500,000 from 5000 events

So cost breakdown for each event would be –

Floral costs – $200

Table arrangements – $100

Soft drinks and snacks – $500

Other structures – ($500000 / 5000) = $100

Trucks and vehicles – ($2000000/5000) =$400

Permanent staff cost = $3500000 /5000) = $700

Temp staff= $1800

So total cost for each event $3800

Currently she is charging $22,500,000 /5000 = $4500 per event

This is one way to find out the breakeven point which is $3800, so she should be able to give a discount of ($4500-$3800) = $700 on each event without losing any money

 

 

 

 

 

Purpose of assigning cost categories of fixed and variable costs

What is a ‘Variable Cost’

A variable cost is a corporate expense that changes in proportion with production output. Variable costs increase or decrease depending on a company’s production volume; they rise as production increases and fall as production decreases. ( Investopedia,2018)    

We know following costs per unit, and we understand the total cost ( for following items) may go down or come up based on number of units going down from 5000 or going up from 5000. –

  • Floral costs, $200 per event,
  • Table arrangements, $100 per event,
  • Soft drinks and children snacks, $500 per event,
  • Wage for temporary staff (paid per event), $1,800 per event.

Following costs are fixed in a year, regardless how many events my client serves to, be it 1 or 10000 she has allocated following –

  • Annual allocated costs of tents and other structures, $500,000,
  • Annual allocated costs of trucks and vehicles, $2,000,000,
  • Annual costs related to maintaining permanent staff, $3,500,000,

Since the above line item costs are fixed and do not depend on number of events , these are considered as fixed cost items.

 

 

Relationship of variable costs to contribution margin

  Total Per Unit
Sales (5000*$4500) $22,500,000 $4,500
Variable Costs (5000 *$2600) $13,000,000 $2,600
Contribution Margin $9,500,000 $1,900
Fixed Costs $6,000,000  $1200
Net Income $3,500,000  $700

 

What is ‘Contribution Margin’

Contribution margin is a cost accounting concept that allows a company to determine the profitability of individual products. (Investopedia, 2018)

Per the table above, Per unit cost = Variable costs + Fixed Cost + Net Income

            And Contribution Margin = Per unit cost – Variable Costs

So one way to look at it is Variable costs = Per unit Cost – Contribution Margin

Or, Variable costs = Per unit cost – (Fixed cost + Net Income)

Limitations of the data and what data is missing from the case

Floral costs – We do not know if it can change based on event or not, can a client order some special flower that would cost more than $200 or can someone request for no flower? So we do not exactly know if $200 figure can change based on event

Table arrangements, $100 per event – We do not know if this can go higher or lower based on number of tables ordered

Soft drinks and children snacks, $500 per event – we do not know if this amount would go up or down based on number of children present in the event

Annual allocated costs of tents and other structures, $500,000 – We do not know if the cost could be less than total allocated amount or if it could go beyond allocated amount.

Annual allocated costs of trucks and vehicles, $2,000,000 – We do not know if the cost could be less than total allocated amount or if it could go beyond allocated amount based on certain circumstances

Annual costs related to maintaining permanent staff, $3,500,000 – We do not know if the cost could be less than total allocated amount or if it could go beyond allocated amount. If someone leaves the job, does the cost go down? Do the employees get raise resulting in more expenses?

Wage for temporary staff (paid per event), $1,800 per event – We do not know if the cost could be less than total allocated amount or if it could go beyond allocated amount. Do we need same amount of temporary stuffs in every even or can it vary based on event size and how would that impact cost?

So these are the areas we do not need enough information on.

 

 

 

 

 

 

References

Retrieved on 2/19/2018. Retrieved from https://www.investopedia.com/terms/c/contributionmargin.asp

 

Retrieved on 2/19/2018.  Retrieved from https://www.investopedia.com/terms/v/variablecost