Coventry University Postgraduate Program

Coventry University Postgraduate Program Coventry University Postgraduate Program

Module Title: KPIM05EFA_Financial Analysis and Decision Making –

1819AAA

Current Business Analysis of Global Turbochargers Ltd

for Future Improvements

Emp. No: 133967

Name: P U Divya Darshini
E-mail: P.Darshini@kpit.com

CU Enrolment Number: 9654866

Date of submission: 7th October 2019
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Declaration
The assignment submitted is a result of my own investigation and independent work. All
sections of the text and results, which been obtained from other sources, are fully
referenced. No confidential information of KPIT is included in this assignment. I
understand that cheating and plagiarism constitute a breach of University regulations and
will be dealt with as per prevailing university rules and regulations.

Signed: P U Divya Darshini Date: 7th October 2019

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Introduction
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Table of Contents:
Declaration................................................................................................................................. 2
Introduction ................................................................................................................................ 3
Table of Contents:...................................................................................................................... 4
List of Figures: ........................................................................................................................... 5
List of Tables: ............................................................................................................................ 5
1 Financial Planning ................................................................................................................... 6
1.1 Financial Statements ....................................................................................................... 6
1.2 Analysis of Financial Statements: Ratio Analysis ............................................................. 7
1.3 Calculated Ratios of GTL and Company B ...................................................................... 8
1.4 Analysis of Financial Statements of GTC for future Improvement .................................... 9
2 CAPITAL INVESTMENT DECISIONS ....................................................................................10
2.1 Cash Flow Forecast for Appendix 2 ................................................................................10
2.2 Payback Period of Proposed Investment in Appendix 2 ..................................................10
2.3 Cash Flow Forecast with +20% Sensitivity on Weighted Cost of Capital .........................11
2.4 Analysis of GTC’s Investment Plan .................................................................................11
3 Cost Accounting .....................................................................................................................12
3.1 Direct and Absorption Costing Techniques .....................................................................12
3.2 Absorption Costing Method Applied on Appendix 2 ........................................................13
3.3 How can GTC Optimize Costs to Improve Profitability? ..................................................14
4 Performance Measurement of a Business..............................................................................15
4.1 Financial and Non-Financial Performance Measurement Methods: ................................15
4.2 Proposed financial and non-financial indicators for GTC Ltd. ..........................................17
References ...............................................................................................................................20
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List of Figures:
Figure 1: Components of Balance Sheet .................................................................................... 6
Figure 2: Components of Profit and Loss Account ..................................................................... 7
Figure 3: Methods to Improve Asset Turnover............................................................................ 9
Figure 4:Cost Accounting Techniques (AccountingTools 2019) ................................................13
Figure 5: Financial Performance Measurement Methods ..........................................................15
Figure 6: Balanced Scorecard (Kaplan and Norton 1996:197) ..................................................16
Figure 7: Performance Pyramid (Cross and Lynch 1991) ..........................................................17
Figure 8: Success Determinants and Results (Letza 1996) .......................................................18
Figure 9: BSC of GTC Ltd. (Letza 1996) ...................................................................................18

List of Tables:
Table 1: Comparing Key Financial Values .................................................................................. 6
Table 2: Calculated Financial Ratios .......................................................................................... 8
Table 3: Cash Flow Construct of Investment .............................................................................10
Table 4: Discounted Payback Period ........................................................................................11
Table 5: Discounted Payback Technique with Sensitivity ..........................................................12
Table 6: Labor Rate Per Hour ...................................................................................................14
Table 7: Total Overhead Cost ...................................................................................................14
Table 8: Total Cost Per Product ................................................................................................14
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1 Financial Planning
1.1 Financial Statements
Balance Sheet: Statement of Financial Position
Balance Sheet exhibits the financial status of a business at a point in time (Prasanna
Chandra 2011). Figure 1 explains what a balance sheet mainly comprises of.

Figure 1: Components of Balance Sheet

Projected Income Statement (Profit and Loss Account)

A record which provides a synopsis of company’s profit/Losses, costs and earnings. Figure 2
shows the key components of Profit and Loss Account.

Taking the financial statements of Global Turbochargers Ltd and its rival Company B, we can draw
out some initial conclusions by juxtaposing key financial values as shown in Table 1:

Financial Value Global Turbochargers Ltd (GTL) Company B

Net Current Assets = Working Capital 110 289
Retained Profit 1160 1586
Net Profit Margin (Net
Income/Revenue) * 100 17% 19.2%
Intangible Assets 600 350
Table 1: Comparing Key Financial Values
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Figure 2: Components of Profit and Loss Account

a) Working Capital: Difference between current assets and liabilities, indicates the position of a
company in terms of liquidity, short term financial health and operational efficiency. Positive
working capital shows that a company has the capability to invest and grow (Investopedia 2019).
Here both the companies have a positive Working Capital indicating healthy financial position, but
Company B has a higher Working Capital which indicates, it can liquidate cash in a short term,
invest for future ventures or it could also mean that the company has excess of inventory and is not
utilizing the cash for investment.

b) Retained Profit and Net Profit Margin: Both these values have a correlation, there is higher
accumulated retained profit if net profit margin is high which is clear from the data above. Net profit
margin indicates how much money is made from every dollar spent (Small Business Development
Corporation n.d). Lower net profit margin of GTL could be an indication that the company’s
expenses are more.

c) Intangible Assets: These assets do not have a physical value, which makes it difficult to exactly
evaluate the benefits of these assets quantitatively. However, it can be valuable and play an
important role for the company in the long term. GTL has more intangible assets which means it
immediately cannot contribute towards company’s profit.

1.2 Analysis of Financial Statements: Ratio Analysis

Financial Ratios which are quantitative help you to understand a firm’s financial health. A ratio is
just a comparison of one element with respect to another element in the financial statements. These ratios
are clustered into groups, each indicating a specific aspect of financial performance or position (Atrill 2012).
Following are the different categories:

a) Profitability: Businesses aim to create wealth for their owners. These ratios give an
understanding on to which level a company can achieve that. Profit made is compared to other key
figures in the financial statements.
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b) Gearing: This is a relationship which compares the money financed by the owners of the business
and amount received by others as a loan. This is an indication of how much a business relies on its
borrowing (Atrill 2012). This helps investors to understand the amount of risk involved.

c) Liquidity: This refers to the potential of a company, in a short term (usually one-year) to meet its
obligations by its liquid resources. These ratios are generally a comparison between liquid
resources (current assets) and creditors due for payment soon (Current Liabilities) (Chandra 2011;
Coventry University 2019).

d) Efficiency: These ratios help to examine how a company can manage its resources and how it
can be employed efficiently. These ratios are relationship between cost of goods sold and different
assets (Atrill 2012; Chandra 2011).

e) Investment: These ratios are used to assess the returns and performance a firm gets from its
investment held in a business. A shareholder can assess the return from an investment with the
help of these ratios.

1.3 Calculated Ratios of GTL and Company B

Table 2 below shows the various ratios calculated for Global Turbochargers Ltd and Company B.
This data will help us analyze the financial situation of GTC, which will help the company to improve its
financial performance in the future.

Sl No. Ratio Analyis GTC Company B

Profit Before Tax and Interest (Operating Profit) 2,200 3000
Total Assets 11800 13334
ROCE - Return on Capital Employed = (Profit Before
i) Tax and Interest/Total Assets)*100 18.6441% 22.49888%
Current Liabilities + Long-term Liabilities 4100 3000
Fixed Assets + Current Assets 11800 13334
Debt Ratio = (Current Liabilities + Long-term
ii) Liabilities)/(Fixed Assets + Current Assets) 35% 22%
Current Assets - Inventory (Stock) 2200 2000
Current Liabilities 4090 4695
Acid Test = (Current Assets-Inventory)/Current
iii) Liabilities 0.5378973 0.5503727
Profit Before Tax and Interest 2,200 3000
Sales 10,000 12500
ROS (Return on Sales) = (Profit Before Tax and
iv) Interest/Sales)*100 22% 24%
Sales 10,000 12500
Total Assets 11800 13334
v) Asset Turnover = (Sales/Total Assets)*100 84.746% 93.745%
Table 2: Calculated Financial Ratios
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1.4 Analysis of Financial Statements of GTC for future Improvement

1) ROCE, calculated in Table 2 indicates that for GTC to improve its return on capital employed,
operating profit needs to go up, which tells GTC to work on reducing their cost of sales and
operating expenses. Company B has

2) GTC’s acid test ratio is 0.537, which needs to be increased for the company to have a better
liquidity to meet its expenses, creditors and short-term liabilities. It can increase this factor by
increasing sales, converting inventory into sales, reducing creditors collection period and by
clearing off liabilities sooner (FitSmallBusiness 2017).

3) GTC can improve its operational efficiency by increasing its ROS by cutting on labor costs by
automated assembly line and cutting material costs through Mean Time Between Failures (MTBF)
reductions (CAPSTONE n.d).

4) Asset Turnover is 0.8 (85%), which means £1-pound worth of asset generates £0.8 pound of
sales. This clearly indicates that GTC needs to improve their asset management efficiency. Figure
3 shows some of the ways with which GTC could benefit with their asset turnover.

Figure 3: Methods to Improve Asset Turnover

5) GTC’s Debt Ratio is 35%, showing that only 35% of the total assets are from debts.
This ratio indicates that GTC business is safe, has less chance of failure and it has more assets to
sell for paying off debts. However, GTC will have to work towards bringing it down further and not
letting it increase. Debt Ratio can be reduced by issuing new stocks, selling off assets and by
swapping debt by equity.
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2 CAPITAL INVESTMENT DECISIONS

2.1 Cash Flow Forecast for Appendix 2
Table 3 below shows the cash flow for the years 0-6 for the investment for technology upgrade.
Cash flow forecast is done to understand repayment of capital invested and if there is enough cash to meet
financing payments (Flight 2006). Net cash flow is calculated by subtracting total benefits from total costs
for every year.

Cash Flow Forecast for Technology Upgrade Costs of Global Turbochargers Ltd
0 1 2 3 4 5 6
Benefits
1) 20 Manual Assembly Operatives
(20x20,000) 4,00,000 4,00,000 4,00,000 4,00,000 4,00,000 4,00,000
Total Benefits 0 4,00,000 4,00,000 4,00,000 4,00,000 4,00,000 4,00,000

Costs
1) New Cell with 5 Robots(5x200,000) 10,00,000
2) Gripping Device (5x28,000) 1,40,000
3) Roller Tracker and Assembly Fixtures 60,000
4) Maintanence 50,000 50,000 50,000 50,000 50,000 50,000
5) 2 Cell Operatives 60,000 60,000 60,000 60,000 60,000 60,000
Total Costs 12,00,000 1,10,000 1,10,000 1,10,000 1,10,000 1,10,000 1,10,000

Net Cash Flow (12,00,000) 2,90,000 2,90,000 2,90,000 2,90,000 2,90,000 2,90,000
Table 3: Cash Flow Construct of Investment

2.2 Payback Period of Proposed Investment in Appendix 2

To calculate payback period, you need to calculate present value of cash flows by multiplying it
with the discount factor. Table 4 shows the calculated discounted payback period with the calculations
done according to the below data:

 Discount factor = (1+r) ^(-n), where r = rate of interest, n = number or years.

 Present Value = Initial Cash Flow * Discount Factor calculated for each year.
 After the 5th year, we see that cash still to be replayed is £42114.08 (1200000 - 1157885.911).
 Discounted Payback Period = 5.23 years (5 + (42114/182749.1918).
 NPV (Net Present Value) = Sum of present value cash flows = £140635.10
 IRR (Internal Rate of Return) = 11.773%, calculated using the excel function IRR (values, [guess]).
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Discounted Payback Technique

8%
Cash Discount Present
Year Flow (£) Factor Value (£)
-
0 1200000 1.0000 -1200000
1 290000 0.9259 268518.5185
2 290000 0.8573 248628.2579
3 290000 0.7938 230211.3499
4 290000 0.7350 213158.6573
5 290000 0.6806 197369.1271
1157885.911 Amount Remaining to be Payed = £42114.089247
← Discounted Payback = 5.23 Years
6 290000 0.6302 182749.1918
GTC will pay back the initial investment of 1200000 in 5.231 Years
Net Present Value = 1,40,635.10 and Internal Rate of Return = 11.773%
Table 4: Discounted Payback Period

2.3 Cash Flow Forecast with +20% Sensitivity on Weighted Cost of Capital
Table 5 shows how we have calculated the payback period and constructed a cash flow when
sensitivity factor of 20% has been considered in the cost of capital which assumed to be 8%. Calculations
are done according to below data:

 20% of 8% would be 9.6%, which would be our discount factor.

 Rest of the calculations would be as done in section 2.2.
 % of Sensitivity on the Net Present Value (NPV) would be calculated as:

% of Sensitivity = (NPV without sensitivity factor/ NPV with sensitivity factor) *100 = 55%

2.4 Analysis of GTC’s Investment Plan

The following analysis has been done with data in table 4.

1) It is seen that IRR is 11.773% which is greater than the cost of capital, indicating that the NPV will
be positive. Actual interest rate gained on an investment is represented by IRR.

2) NPV for the investment is positive which means that GTC could consider accepting this
investment. Positive NPV is an indication of increase in market value of shareholder’s fund once
the acceptance of the project is recognized by the stock market.

3) From the payback period calculated which is 5.231 years, this could be an indication of risk in the
investment. In this investment, the equipment gets depreciated to zero value in the 6th year.
Considering the payback after 5 years. Investment with longer payback period is more likely to fail
and the company will face constraints with respect to liquidity.
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Discounted Payback Technique

9.600000%
Year Cash Flow Discount Factor Present Value
0 -1200000 1.0000 -1200000
1 290000 0.9124 264598.5401
2 290000 0.8325 241422.0257
3 290000 0.7596 220275.5709
4 290000 0.6930 200981.3603
5 290000 0.6323 183377.1535
1110654.651 Amount Remaining to be Payed = 89345.349460
← Discounted Payback = 5.251704987
6 290000 0.5769 167314.9211
GTC will pay back the initial investment of 1200000 in 5.251 Years
Net Present Value(+20% Sensitivity on Capital) = ₹ 77,969.57
Net Present Value = 1,40,635.10
% of Sensitivity 55%

Table 5: Discounted Payback Technique with Sensitivity

4) From table 5, with a +20% sensitivity on the cost of capital, NPV is reduced by almost half. Even
though NPV is still positive, which means that investment still could be considered with a risk of
failure as the payback period is long.

5) GTC could consider this investment plan but should look for alternative technology upgrade
investment plans which are being proposed in the company with a shorter payback period. This
will ensure that the company does repayment of investment faster and has a good liquidity
position.

3 Cost Accounting
3.1 Direct and Absorption Costing Techniques
Direct/Variable Costing
A technique which considers only variable costs which includes direct labor, direct material and
variable overheads, neglecting fixed overheads for costing for valuation of inventory, crucial management
decisions and product costing (Khan and Jain 2007).

Absorption Costing
Absorption costing is a traditional technique which ‘absorbs’ all the costs to produce a product
which is ready for sale. Along with direct labor, direct material and variable overheads, this method takes
fixed overheads into consideration (Khan and Jain 2007).

Absorption Costing: More Efficient Costing Method Compared to Direct Costing

1) Direct Costing under estimates the cost of a product because of neglecting the fixed overheads.

2) Absorption Costing considers the fixed overhead costs for the all the goods/products produced in
that period which helps to compute cost per unit whereas variable costing treats fixed overhead
costs as one item on balance sheet which is balanced out with net income (Investopedia 2019).
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3) Absorption Costing is an advantage for the company to comply with Generally Accepted
Accounting Principles (GAAP) and International Financing Reporting Standards (IFRS). Variable
costing is generally used for internal financial decisions, but according to law, you need absorption
costing for publishing financial statements (WallStreetMojo n.d).

Figure 4:Cost Accounting Techniques (AccountingTools 2019)

3.2 Absorption Costing Method Applied on Appendix 2

Table 3, 4, 5, 6 ,7 and 8 below shows the detailed calculation determining the total cost and
profitability of the products PL2-A, PL2-B and PL2-C individually.

Calculated Total Allocated Costs and Overhead Per Production Centre

Item of Expenditure Machining Assembly Inspection Packaging
Indirect Wages & Materials 110000 85000 45000 30000
Factory Rental 65000 67500 95000 12500
Depreciation of Plant 52500 37500 15500 5500
Lighting, Heating and Power 15000 15000 5000 5000
Total Allocated 242500 205000 160500 53000
Table 6: Overhead Costs
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Direct Labour Rate for each Production Cost Centre

Machining Assembly Inspection Packaging
Overhead Cost 242500 205000 160500 53000
Direct Labour Hours 35000 20000 3500 3000
Direct Labour Hour Rate (Rs./hr) ₹ 6.93 ₹ 10.25 ₹ 45.86 ₹ 17.67
Table 6: Labor Rate Per Hour

Total Overhead for each Product

Product PL2-A Product PL2-B Product PL2-C
Maching (@6.93/hr) 1.95 1.65 1.45
₹ 13.51 ₹ 11.43 ₹ 10.05
Assembly (@10.25/hr) 0.75 0.3 0.3
₹ 7.69 ₹ 3.08 ₹ 3.08
Inspection (@45.86/hr) 0.3 0.25 0.25
₹ 13.76 ₹ 11.47 ₹ 11.47
Packaging (@17.67/hr) 0.2 0.1 0.1
₹ 3.53 ₹ 1.77 ₹ 1.77
Total Overhead ₹ 38.49 ₹ 27.74 ₹ 26.36
Table 7: Total Overhead Cost

Total Cost Per

Direct Material Costs Direct Labour Costs Manufacturing Overhead Product
Product PL2-A 200 64 38.49 302.49
Product PL2-B 190 41.4 27.74 259.14
Product PL2-C 180 37.8 26.36 244.16
Table 8: Total Cost Per Product

Total Cost Per Product Contracted Selling Price Profit/Loss Profit/Loss %

302.49 295 -7.49 2%
259.14 280 20.86 8%
244.16 260 15.84 6%
Table 9: Profit/Loss Made by Each Product

3.3 How can GTC Optimize Costs to Improve Profitability?

Under absorption costing, net operating profit can be increased in the following ways for GTC:
1) Increasing Production/Inventory: Increasing production will reduce the fixed overhead cost per
product as it does not change and when total overhead cost is divided with a larger volume, cost
will automatically go down. Production can be increased in the emerging markets of South
America and Eastern Europe along with strategies to reduce direct and indirect costs.
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2) Reducing Expenses: GTC could look to reduce its direct and indirect costs by looking for a
cheaper alternative supplier for raw materials, reducing shipping costs, cheaper labor force, cutting
costs on advertising and marketing. All these costs need to be cut down for the Wester Europe
market which is very vulnerable due to the uncertainty of political/legal influences which would
affect the use of gasoline vehicles.

3) Optimization of Processes and Improving Workforce Productivity: In case of GTC,

inspection and packaging processes could be combined to cut down on direct labor costs. This
would require hiring a labor force which has a skill set to do both the jobs or by improving your
current workforce productivity.

4) Elimination of Wastes and Non-Value Adding Processes: This will reduce the time required for
each process and work will get the job the done faster.

5) Automation: Automation of processes and technology upgrades will directly reduce labor costs
and time which automatically will reduce the cost of production.

4 Performance Measurement of a Business

4.1 Financial and Non-Financial Performance Measurement Methods:
Financial Performance Indicators:

Figure 5: Financial Performance Measurement Methods

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Non-Financial Performance Indicators

1) Drucker’s views on non-financial measure: Drucker’s measure emphasizes the companies to
collect information/data about their core competencies. He believes that every company differs in
its core competencies and each company should have one core competence as innovation.
Management can add value by asking the right questions, acknowledging critical matters and
providing frameworks to address the issues (Adler 1999).

2) Hall’s four dimensions of performance measurement: This system has 4 assessment

measures which are as follows (Adler 1999):
 Quality: Which could be further divided as external quality, internal quality and quality
improvement processes. External quality is a measure like customer surveys, warranty
rates for the outsiders or the consumers on the product or the service. Internal quality is a
measure of effective operations where the measures include yields, defects and rework.
Company constantly improves quality processes to ensure high standards of internal and
external quality.

 Lead Time is the total time required to make finished products from raw materials.

 Utilization of Resource is a measure to quantify consumption and the associated cost.

This can be done through direct labor, materials, space, machinery and equipment.

 People Development to ensure human resource inventory and give rewards to

employees for their performance.

3) Kaplan and Norton’s Balanced Scorecard: Originally designed with 4 perspectives which are
business, financial, business-process, learning and growth. These perspectives help take strategic
decisions for implementation from a holistic view. Figure 11 shows a framework which could be
used to convert a strategy into operation (Mooraj et.al 1999).

Figure 6: Balanced Scorecard (Kaplan and Norton 1996:197)

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4) Cross and Lynch’s Performance Measurement Hierarchy links financial and non-financial
information and strategic and operational goals which is illustrated as a performance pyramid in
Figure 12. Strategies are cascaded down to develop performance measures.

Figure 7: Performance Pyramid (Cross and Lynch 1991)

4.2 Proposed financial and non-financial indicators for GTC Ltd.

Financial Evaluation of G-TC’s Performance
Return on Investment (ROI) could be used as a measure to understand on how much profits are
being generated on an investment. Since G-TC has divisions of varied sizes and varied product lines, this
measure could help us to understand where to invest more money and where not to based on the returns
generated. Residual income is an absolute measure and cannot really be a measure for divisions with
different sizes. EVA™ and SVA measures are more aimed towards adding value to stakeholders’ value.
Right now, G-TC needs to focus on generating more profits and ROI by investing in the right direction so
that they could continue to have strong hold in the coming years.
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Implementation of Balanced Scorecard (BSC) for GTC To Measure Strategies

GTC could use BSC as a system to plan and manage strategies to communicate goals, efficient
planning of day-to-day work for the employees, measure and monitor progress towards targets and help to
prioritize projects, products and services (BALANCED SCORECARD INSTITUTE n.d). Figure 8 shows
the determinants which could be used to device a scorecard for GTC as shown in Figure 9.

Figure 8: Success Determinants and Results (Letza 1996)

Figure 9: BSC of GTC Ltd. (Letza 1996)

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G-TC has been in a strategically strong position so far, but to continue they would have to work
towards increasing the profitability of their PL2 production line, whose demand has fallen by 15%. Going
ahead, G-TC should invest in their engineering department to come up with new powertrain technologies
as there is soon going to be a paradigm shift towards electric, hybrid and fuel cell vehicles in the automotive
industry. As some of the key customers are driving for lower future prices, reduced planned volumes and
shortened contracts, G-TC needs to ensure a high operating margin by cutting its costs. This could be
done by improving quality processes within the company. The BSC can help G-TC exactly understand all
its current shortcomings and help decide future strategies which will help G-TC take a higher market share.
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