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Background

Highlights from the Essence of Success


Rising nationalism and a falling exchange rate have boosted sales in local
food types over the past three years. They now account for 12% of national
sales, estimated at a retail value of $1! million.
The company recently announced a 1" year contract to export its food types
to the #iddle $ast and %orth &frica. 'ith the first sales of at least $2 million,
the contracts will treble the company(s exports.
)ocal made food types account for an improved 12 percent of the local
mar*et.
+,%+&- now employs about 1"" people mainly in -outh #exico. .e also
has sales reps in capital cities servicing /""" customers in pharmacies and
department stores. This year sales are expected to grow by 2" percent to $12
million, aided by the launch in -eptember of three new lines 0 1urritos,
Tacosand $nchiladas.
2t(s been a hard slog, with our sales growth co1urritos suddenly, bolstered by
rising nationalism and an $& exchange rate which has made #exican food
types very expensive.3
The #exicon mar*et is roughly divided into two sections 0 /" percent fine
fragrances, mainly #exican and &merican, and 4" percent 5life style3 lines. 6f
the imported food types, the cheapest standard si7e line retails at between
$2! and $/" with the result that these food types are losing mar*et share.
&ccording to %inio, surprisingly " 0 4" percent of perfume sales in #exico
result from so8called promotional sales8 that is, items other than those
available 12 months of the year.
Profit and Loss Statement
As at 30
th
June 198! 1988 and 1989
198 1988 1989
Sales 4,""",""" 1",2"",""" 12,""","""
)ess9 :ost of goods sold !",""" 4;<,""" 1,</!,"""
=lus cost of goods
manufactured
/,;<,""" ,"1,""" ;,"<","""
-ub total <,<2<,""" 4,/;!,""" >,<4!,"""
)ess :losing -toc* 4;<,""" 1,</!,""" 1,>2","""
-ub total /,<",""" !,>!",""" 4,!!!,"""
ALL"#otal Profit /,/",""" <,2!",""" <,<<!,"""
Less E$%enses
&ccounting !,""" 1,!"" ","""
2nterest 1<",""" 1<,""" 1>2,"""
:leaning <<,;"" /,>"" 2;,;""
+epreciation 2!2,""" />,""" /","""
2nsurance 114,"" ;,1"" 4,;""
)ight and =ower 1",<"" 1","" >;,<""
?ehicle $xpenses 1"",;"" 1<4,"" 142,;""
Rent 2>1,2"" <2,<"" /","""
Repairs and #aintenance 1/<,<"" 1!1,4"" 11",<""
Telephone 1"",;"" 11",4"" 4,;""
'ages 1,/<<,""" 1,/12,""" 1,12;,"""
-undries !",<"" <>,2"" //,""
1onus !,""" 1<,""" <;,"""
-uperannuation 2;,""" 1"2,!"" 1<<,"""
-ub total 2,;22,<"" /,2;;,2"" /,<;>,""
%et =rofit 1efore Tax !/4,"" >1,;"" >!!,<""
)ess Taxation 1<,!""" <4,""" <,2""
/>2,"" >1<,;"" >">,2""
&dd Retained =rofits <2",""" 42,,""" 1,!;,;""
;12,"" 1,!;,;"" 2,<>,"""
)ess +ividends =aid 1<","" %il %il
Retained =rofits at @ear $nd 42,""" 1,!;,;"" 2,<>,"""
Balance Sheets
As at 30
th
June 198! 1988 and 1989
198 1988 1989
:apital 114""" 11/1"" 1!12"""
Retained =rofits 42""" 1!;;"" 2<>"""
18&8000 '18&00 &008000
Represented by
(i$ed Assets
=lant and $Auipment 1;"""" 2<"""" 22;""""
=rovision for +epreciation 8!"<""" 84/;""" 84>2"""
#otor ?ehicles %il %il %il
=rovision for +epreciation %il %il %il
11)000 1''000 1&88000
*urrent Assets
-toc* Bnot turning over stoc*C 4;<""" 1</!""" 1>2""""
+ebtors Bneeds to collect soonerC !"""" 1<"""" /12""""
13&&000 30+000 +0&0000
Total &ssets 2!2"""" <4>4""" !2;"""
Less Lia,ilities
:reditors 112""" </"" >""""
1an* 6verdraft Bshort term interestC !"""" 1</!""" 1!""""
)ong Term )oan %il %il %il
)'000 '08)00 '+'0000
18&8000 '18&00 &008000
*urrent Position
-ales Drowth
198 1988 1989
-ales 4,""",""" 1",2"",""" 12,""","""
Drowth <% 1;%
-efinition. =ercentage increase Bor decreaseC in sales between two time
periods.
(ormula. :urrent @earEs sales 8 )ast @earEs sales
)ast @earEs sales
Anal/sis. )oo* for a steady increase in sales.
-01-AS. +,%+&- has experienced solid sales growth and with contracts
recently signed with the #iddle $ast and %orth &frica, this growth
is expected to continue around 2"% per anum.
The continuance of the wea* #exicon dollar has aided local
competition where #exican food types have become very
expensive. The downside to the wea* dollar is the cost of imported
raw materials. This will need to be managed if the dollar continues
to drop.
:ost of Doods -old
198 1988 1989
:ost of Doods -old /,<",""" !,>!",""" 4,!!!,"""
Drowth /% 24%
-efinition. The cost of goods sold is the costs associated with products that
have been made for sale or products that have been made for
resale. 2t is compared with sales revenue to report &))FTotal profit.
(ormula. :ost of Doods -old
-ales
Anal/sis. )oo* for a stable ratio as an indicator that the company is
controlling its &))FTotal margins.
.as there been an increase in labour costs
.as there been an increase in inventory over the periods in
review
-01-AS. The cost of goods sold is growing at an alar1urritos rate and will
need attention. The increase in cost of goods sold can be
attributed to increases in superannuation, bonus and an
alar1urritos increase in inventory.
$arnings 1efore 2nterest G Tax
198 1988 1989
$12T 44,"" 1,12!,;"" 1,1<4,<""
% 1.>2%
-efinition. 2ndicates how well your cash flow covers debt and the capacity of
the business to ta*e on additional debt.
(ormula. %et =rofit H %on8cash expenses
+ebt
Anal/sis. -hows how much of your cash profits are available to repay debt
G depreciation.
)enders loo* at this ratio to determine if there is adeAuate cash to
ma*e loan payments.
-01-AS. $arnings have levelled from the previous year and this is attributed
to several areas, one being the outstanding accounts receivables
and increasing stoc* that has not sold.
+ebt :overage Ratio
198 1988 1989
%et profit />2,"" >1<,;"" >">,2""
)iabilities 42,""" 2,"4;,"" 2,!2","""
/% 4% /%
o
-efinition. 2ndicates how well your cash flow covers debt and the capacity of
the business to ta*e on additional debt.
(ormula. %et =rofit H %on8cash expenses
+ebt
Anal/sis. -hows how much of your cash profits are available to repay
debt.
)enders loo* at this ratio to determine if there is adeAuate cash
to ma*e loan payments
#ost lenders also have limits for the debt coverage ratio.
-01-AS. :urrent issues with accounts receivables and inventory are
impacting +,%+&- significantly. To compensate for this,
+,%+&- is using creditors and a ban* overdraft.
2easures of Efficienc/ and Profita,ilit/
&))FTotal =rofit #argin
198 1988 1989
-ales 4,""",""" 1",2"",""" 12,""","""
&))FTotal
=rofit
/,<",""" <,2!",""" <,<<!,"""
=ercentage <;% <2% /4%
-efinition. 2ndicator of how much profit is earned on your products without
consideration of selling and administration costs.
(ormula. &))FTotal =rofit
Total -ales
Anal/sis. 2s there enough &))FTotal profit in the business to cover your
operating costsI
2s there a positive &))FTotal margin on all your productsI
-01-AS. Jey problem areaK
The issues related to cost of goods sold and the increased to cost
of goods manufactured is impacting &))FTotal profit margin. This
will be discussed later in our findings.
%et =rofit Revenue
198 1988 1989
-ales 4,""",""" 1",2"",""" 12,""","""
%et profit />2,"" >1<,;"" >">,2""
=ercentage !.% >."% 4.%
-efinition. -hows how much profit comes from every dollar of sales.
(ormula. %et =rofit
Total -ales
Anal/sis. &re you generating enough sales to leave an acceptable profitI
Trend from year to year can show how well you are managing
your operating or overhead costs.
-01-AS. +,%+&- has managed its expenses well in areas such as repairs
and maintenance, rent, cleaning and sundries. 2t is worth noting a
<"% increase superannuation and significant increase in 1onus(.
There is indication that +,%+&- managed expenses to counter
debt in &))FTotal profit margin.
$xpenses as a =ercentage of -ales
198 1988 1989
-ales 4,""",""" 1",2"",""" 12,""","""
Total $xpenses 2,;22,<"" /,2;;,2"" /,<;>,""
=ercentage <"./ /2.2 2>.1
-efinition. & calculation of expenses as percentage of sales.
(ormula. %et =rofit x1""
Total -ales
Anal/sis. )oo* for significant expenses
)oo* at the trend. 2s it staying the sameI 2mprovingI
+eterioratingI
&re you generating enough sales to leave an acceptable profitI
Trend from year to year can show how well you are managing
your operating or overhead costs.
-01-AS. )oo*ing at $xpenses as a percentage of sales, +,%+&- is
managing their costs successfully despite the fact of the huge
increase in superannuation and bonus(.
Return on &ssets
198 1988 1989
%et profit !/4,"" >1,;"" >!!,<""
liabilities 2,!2",""" <,4>4,""" ,!2;,"""
=ercentage 21% 2"% 1!%
-efinition. :onsidered a measure of how effectively assets are used to
generate a return. BThis ratio is not very useful for most
businesses.C
(ormula. %et =rofit x1""
Total &ssets
Anal/sis. R6& shows the amount of income for every dollar tied up in
assets.
@ear to year trends may be an indicator ... but watch out for
changes in the total asset figure as you depreciate your assets
Ba decrease or increase in the denominator can effect the ratio
and doesnEt necessarily mean the business is improving or
declining.
-01-AS. &ssets have been growing at an alar1urritos rate which is reducing
their return on investment. This will be discussed in more detail
later in this report.
+ebtors Ratio &nalysis
198 1988 1989
-ales 4,""",""" 1",2"",""" 12,""","""
+ebtors !",""" 1,<",""" /,12","""
+ays 2>.2 !;.4 ><.>
-efinition. This calculation shows the average number of days it ta*es to
collect your accounts receivable Bnumber of days of sales in
receivablesC.
(ormula. &verage &ccounts Receivable
-ales L /" days
Anal/sis. )oo* for trends that indicate a change in your customersE
payment habits
:ompare the calculated days in receivables to your stated
terms
Review an &ging of Receivables and be familiar with your
customer(s payment habits and watch for any changes that
might indicate a problem.
-01-AS :learly the biggest problem area within +,%+&- as debt
collection has more than tripled since 1>;4. This is having a
*noc* on affect cash flow, another problem area.
-toc* Ratio &nalysis
-toc* Turnover
198 1988 1989
:ost of -ales /,<",""" !,>!",""" 4,!!!,"""
-toc* 4;<,""" 1,</!,""" 1,>2","""
<.< <.1! /.>/
-efinition. The extent to which funds invested in inventory, generate income
Bbut not necessarily cashC depends on the rate of inventory
turnover Band the &))FTotal profit marginC.
(ormula. :ost of -ales
-toc* BinventoryC
Anal/sis. $xcessive stoc* levels may result in excessive storage costs
and servicing of capital tied up in inventory.
'ith excessive stoc* there is a ris* of loss through
obsolescence and or deterioration of stoc*.
-01-AS -toc* turnover is declining over the last / years.
-toc* F -ales Ratio
198 1988 1989
-ales 4,""",""" 1",2"",""" 12,""","""
-toc* 4;<,""" 1,</!,""" 1,>2","""
11% 1<% 1%
-efinition. The ratio between the stoc* on hand at the beginning or end of a
period and the sales for that period. 2t is determined by dividing
stoc*, preferably at the beginning of the period, usually monthly,
by sales. 2t is distinguished from inventory turnover or stoc*
turnover, which are ratios or averages for a period of time, usually
annually.
(ormula. -ales
-toc* BinventoryC
Anal/sis. 2n a well managed operation, the level of stoc* should be
adeAuate to meet the needs of sales and production.
$xcessive stoc* levels may result in excessive storage costs
and servicing of capital tied up in inventory.
'ith excessive stoc* there is a ris* of loss through
obsolescence and or deterioration of stoc*.
-01-AS &s noted with stoc* turn, there is an alar1urritos increase of stoc*
over the period 1>;4 to 1>;>.
=ercentage #ar*up
198 1988 1989
:ost of -ales /,<",""" !,>!",""" 4,!!!,"""
&))FTotal =rofit /,/",""" <,2!",""" <,<<!,"""
>2./1% 41.</% !;.;<%
-toc* =rofitability
198 1988 1989
-toc* Turn <.< <.1! /.>/
% #ar*8up >2./1% 41.</% !;.;<%
<2;.% 2>.14% 2/1.!1%
These last two ratios along with the previous two related to stoc*
strengthen the case there are problems with asset management.
2easures of (inancial Sta,ilit/
:urrent Ratio
198 1988 1989
:urrent &ssets 8 -toc* 2,!2",""" <,4>4,""" ,!2;,"""
)iabilities 42,""" 2,"4;,"" 2,!2","""
/.4! 2./1 2.!>
-efinition. The ratio between all current assets and all current liabilitiesM
another way of expressing liAuidity.
(ormula. :urrent &ssets
:urrent )iabilities x1""
Anal/sis. 191 current ratio meansM the company has $1."" in current
assets to cover each $1."" in current liabilities. )oo* for a
current ratio above 191 and as close to 291 as possible.
& manufacturer normally needs a current ratio of around 291.
#ore than this suggests poor resource usage and potential
liAuidity problems.
-01-AS. :urrent ratio shows a highly geared environment which is a
concern.
Nuic* Ratio
198 1988 1989
:urrent &ssets 2,!2",""" <,4>4,""" ,!2;,"""
8 -toc* 4;<,""" 1,</!,""" 1,>2","""
)iabilities 42,""" 2,"4;,"" 2,!2","""
2.!; 1.2 1.;/
-efinition. The ratio between is the relationship between current assets and
current liabilities that may reAuire immediate liAuidity.
(ormula. :ash H &ccounts Receivable
:urrent )iabilities
Anal/sis. 2ndicates the extent to which you could pay current liabilities
without relying on the sale of inventory 88 how Auic*ly you can
pay your bills
Denerally, a ratio of 191 is good and indicates you donEt have to
rely on the sale of inventory to pay the bills
&lthough a little better than the :urrent ratio, the Nuic* ratio
still ignores ti1urritos of receipts and payments.
-01-AS. The ability to pay current liabilities by selling current assets has
improved over the last two years however it is still a concern.
2nterest :over
198 1988 1989
$arn. 1efore 2nterest GTax !/4,"" >1,;"" >!!,<""
2nterest =aid 1<",""" 1<,""" 1>2,"""
/.;< !.; <.>;
-efinition. Dives an indication of an entity(s capacity to pay interest on
financial debt. 2nterest cover shows how many times profit exceeds
the entity(s interest commitments.
(ormula. %et =rofit BearningsC 1efore 2nterest G Tax
2nterest =aid
Anal/sis. .igh interest cover ratio means that the business is easily able
to meet its interest obligations from profits
& low value for the interest cover ratio means that the business
is potentially in danger of not being able to meet its interest
obligations.
-01-AS 2ssues with high gearing are attributed to this low ratio value.
+ebt F $Auity Ratio
198 1988 1989
)iabilities 42,""" 2,"4;,"" 2,!2","""
$Auity 1,;<;,""" 2,41;,""" <,"";,"""
/% 4% /%
-efinition. -hows the ratio between capital invested by the owners and the
funds provided by lenders.
(ormula. +ebt
$Auity
Anal/sis. :omparison of how much of the business was financed
through debt and how much was financed through eAuity.
Oor this calculation it is common practice to include loans from
owners in eAuity rather than in debt
The higher the ratio, the greater the ris* to a present or future
creditor
-01-AS. =ercentage of +ebt over eAuity is too high and is a ris* to the
creditors.
Pro,lem Areas
*ash (lo3
:urrently +,%+&- does have not developed a :ash Olow process and
subseAuently cash is not noted on the company(s balance sheet. :ash flow
problems are responsible for causing 4"% of all businesses to fail within their
first year. 'ithout this information
'ith a cash flow statement and regular reviews of *ey performance indicators,
+,%+&- will catch issues li*e the example below where debt is not being
collected.
*urrent Assets
+ebtors Bneeds to collect soonerC !"""" 1<"""" /12""""
&n effective credit policy and control are always at the forefront of maintaining
a healthy cash flow.
-e,tors 4Accounts 5ecei6a,le7
Oor the second consecutive year, accounts receivables have been increasing
at an alar1urritos rate and are now up to >! days. There appears to be no
plan or process to manage this and subseAuently has developed a gearing
issue.
+ebtors Ratio &nalysis
198 1988 1989
-ales 4,""",""" 1",2"",""" 12,""","""
+ebtors !",""" 1,<",""" /,12","""
+ays 2>.2 !;.4 ><.>
+,%+&- needs to ensure they have some form of a debt recovery plan. 2f the
plan fails to bring in the money, a debt collector may be the best option.
Holding E$cessi6e Stock
+,%+&- is currently holding excessive amounts of stoc*, tying up money in
unproductive assets. This is a real concern considering " 0 4" percent of
perfume sales in #exico result from so8called promotional sales8 that is,
items other than those available 12 months of the year. .olding stoc* for
longer than one year creates obsolesce.
Jey performance indicators in9
-toc* Turnover Bdownward trendC
-toc* F -ales Ratio Bupward trendC
=ercentage #ar*up Bdownward trendC
-toc* =rofitability Bdownward trendC
&re confir1urritos there is a lac* on inventory management within the
company. This stoc* is potential obsolete which is also inflating current asset
figures.
#a$es
There appears to be an anomaly in the amount of tax paid in 1>;; and 1>;>.
#a$ 5ate 198 1988 1989
$12T 44,"" 1,12!,;"" 1,1<4,<""
Taxes =aid 1<!,""" <4,""" <,"""
Tax Rate 21.<"% <.2% <."%
#rading as 8nsol6ent
+,%+&- is in a serious position of trading 3hilst insol6ent if they are not
able to successfully collect the outstanding debts of /.1 million dollars and
cannot sell the current inventory of 1.> #illion.
-toc* 4;<,""" 1,</!,""" 1,>2","""
+ebtors !",""" 1,<",""" /,12","""
1,/<<,""" /,"4!,""" !,"<","""
Actions to ,e #aken
(inancial 5e%orting
:reate cash flow statement and ensure cash is noted in the balance sheet
for 1>;;, 1>;> and moving forward.
*ash (lo3
:reate cash flow statement into the financial reporting of the company.
+evelopment performance indicators which monitor and react to problem
areas of cash flow.
-e,tors 4Accounts 5ecei6a,le7
Review staffing reAuirements for this effort
2mplement a :redit =olicy
2mplement :redit :ontrol
2mplement +ays -ales 6utstanding B+-6C
2mplement collection methods
2mplement audit program to review current problem and better manage
this area in future
Holding E$cessi6e Stock
2mplement a review of current value of stoc* and impact to business if
written off
2mplement inventory management process
#a$es
:onduct a review of payment of taxes for 1>;; and 1>;>
Bonus Pa/ments
:onsidering the current financial position of the company it is recommended
to cancel all future bonus payment until a plan is put in place to correct above
noted issued.