ABCCompany Financial Analysis
Tableof Contents
Introduction 3
Risk Profile of ABC Company 4
The Cash Flow Statements 5
Product Cost 6
Potential Investments to Accelerate Profit 9
Conclusion 9
ABCCompany Financial Analysis
Introduction
Inthe current context of financial management, there is need to carryout a profound investigation on a business adventure before doing theactual investment. In this prospect, the cost benefit analysis isvery critical as it helps in giving more attention to the levels ofrisks in relation to the returns that are expected from theinvestment. The main aim of every investor is to maximize theirwealth while reducing every advent of risks. According to ModiglianiMiller Model, those investments with high risks usually have highreturns. The high returns are deemed to compensate the high risksinvolved in the investment (Robison,Barry, & Myers, 2015).Investors and financial experts have therefore the mandate to strikea balance between the risks and returns on every investment anddecide on the best venture to pursue. Some of the recommended capitalbudgeting techniques used to measure the viability of an investmentproject are such as the cost volume profit analysis, the net presentvalue, the payback period analysis and the accounting rate of returnanalysis among others (Dhavale,& Sarkis, 2015).Firms also utilize both the marginal and absorption costing todiscern the most proper way to deal and represent costs in theaccounting system. This research paper looks into the investmentanalysis of ABC company with keen interest in making a recommendationon whether it should invest in the new cedar dollhouses. Itinvestigates in the viability and sustainability of the inception ofthe product into the system. Additionally, it analyzes on whether thedesired income level can be reached using the existing resources andthe best alternative source of finance that can be used if theexisting resources are not enough.
Risk Profile of ABCCompany
ABCcompany is currently having annual sales of $1.2 million for which itintends to make grow by 25% each year. By forecasting this growth,the company risks having a high level of operational costs tied withit. With its projection of $3 million in sales by the end of thethird year, the company has a high risk of loss due to thefluctuation of prices of its products. Currently, the firm isinterested in opening a new line of production to boost its sales. Inthe event that the current resources will not suffice, it would onlymean that the company would want to source finances externally(Faulkender,& Petersen, 2012).It might do this through use of selling of its stock which has a riskof reducing the level of control of the existing shareholders of thisfirm. On the other hand, when it decides to utilize the corporatedebt financing, the cost of debt should be lower than the return onthe investment.
Dueto the fluctuations in the prices of these costs of debts, it onlymeans that the firm would risk losing the investment if the cost ifdebt escalates beyond the rate of return (Paquin,Charbonneau, & Tessier, 2015).High level of competition is also expected in this industry ofroofing materials since there are variety of roofing materials in themarket. The entry of a new company into the industry has the effectof reducing the market share for ABC Company hence it poses a threatof reduction in sales for the coming years. Due to the distances andthe raising of taxes by the local government, the cost of rawmaterials is expected to increase. This notion in turn would increaseoperational costs of ABC Company which has the effect of reducing theprofits of the company as well (Kaplan,& Atkinson, 2015).All these risks are analyzed in the subsequent sections in order tocome up with an informed decision on how to invest in the company.
The Cash FlowStatements
Thecash flow statement for ABC Company is as shown below
Fromthe above cashflow statement, the main source of funds is from theretained earnings which the company has used to finance some of itsprojects like the purchase of the new equipment. The cash ratio forthe company is still very low as connoted by less amount of availablecash at hand of $50,000. It should also be noted that the company hasincurred a loss of $ 50,000 which is quite detrimental for itsgrowth. Additionally, ABC gets its source of funding from the commonequity which has stood at $ 240,000. The company has no long-termdebt. One of the ways that this company can improve its cashflows isthrough the inception of a long term corporate debt as a source offund. This source of fund is deemed to be quite substantialespecially if its cost is less than the return on investment(Gambetta,Zorio-Grima, & García-Benau, 2015).This new project cannot be funded by the existing resources fullysince this will reduce the liquidity of the company at that point intime. the main reason why ABC should use corporate debt as a sourceof finance is because it will not interfere with the shareholdercontrol of the company.
Product Cost
Thecalculation of the costs of both the new and existing product aredone in the excel sheet attached to this research paper. An extractfrom the calculations is as shown below.
|
NEW PRODUCT |
EXISTING PRODUCT |
||||
|
Unit product cost |
Unit product cost |
||||
|
Variable costing |
Absorption costing |
Variable costing |
Absorption costing |
||
|
Direct materials |
$ 5.600 |
$ 5.600 |
$ 1.30 |
$ 1.30 |
|
|
Direct labor |
$ 4.000 |
$ 4.000 |
$ 2.80 |
$ 2.80 |
|
|
Variable overhead |
$ 1.000 |
$ 1.000 |
$ 1.00 |
$ 1.00 |
|
|
Fixed overhead per unit |
$ 2.33 |
$ 2.33 |
|||
|
Per unit cost |
$ 10.600 |
$ 12.93 |
$ 5.10 |
$ 7.43 |
|
Fromthe above calculations, it is evident that the cost of the newproduct under all the two conditions is higher than the existingproduct. It should be noted that the company would incur higher costsif it implements this project of the manufacturing the new product(Drury,2013).A closer look at the comparison between the absorption and themarginal (variable) costing, it is evident that the cost per productunit is higher under absorption costing that when the variablecosting is used (Ball,Gerakos, Linnainmaa, & Nikolaev, 2016).The main reason for this is that fact that under absorption costing,all the fixed cost has been absorbed into the current sales and hencethey are charged as and when they are incurred and not carriedforward to the next period. In variable(marginal) costing only thevariable costs are absorbed into the sales of the current period toaccentuate the cost of the product. The fixed selling cost is notabsorbed into the sales of the current period (Dhavale,& Sarkis, 2015).
Onthe account of the fixed company selling and factory overhead costs,the new product has made the fixed cost of the existing product toreduce considerably. The following extracts of calculations explainsthe extent at which the company has reduced the cost due to theinception of the new product.
|
Fixed costs |
|
|
Fixed per period (factory) |
$ 11,647.06 |
|
Fixed per period (selling and distribution) |
$ 11,250.00 |
|
Total fixed cost saved |
$ 22,897.06 |
|
The cost per unit saved |
$0.29 |
Fromthe above extract, the total fixed factory overheard for the newproduct stands at $ 11,647.06 while that of the selling anddistribution stands at $ 11,250.00 totaling to $ 22,897.06. Thesefigures are calculated by finding the total number of units that areto be sold for both the new and existing products which stands at85,000. This amount is divided by the total fixed costs under eachcategory to get the fixed cost per unit. The fixed cost per unitunder each category is then multiplied number of units under new andexisting product which is 5,000 and 80,000 units respectively. Thetotal fixed saved due to the introduction of the new product istherefore $22,897.06 (Pratt,2013).The existing product is therefore made cheaper by $0.29 per unit. Forthe company to earn a 40% gross margin on the company has to set theprice of the new product at 21.55 as shown in the calculations below.
Thecalculations above is based on the absorption costing. The price ofthe new product is higher if the company has to meet a gross marginof 40%. This price of $21.55 is deemed to be higher than the currentprice of the existing product which stands at $14.50. On the accountof breakeven analysis, the contribution margin for the new productstands at 49.88% while that of the existing product is 63.45% whichis higher than that of the new product. The breakeven sales for thenew product is $ 45,900.62 while that of existing product is$577,404.09 which is higher than the new product. All thesecalculations have been done in the excel sheet attached to thisdocument.
Potential Investmentsto Accelerate Profit
Thecalculations of the NPV of the project at the rate of return of 12%is as shown below.
|
YEAR |
Cashflows |
|
0 |
$ (42,000.00) |
|
1 |
$ 15,000.00 |
|
2 |
$ 13,000.00 |
|
3 |
$ 10,000.00 |
|
4 |
$ 10,000.00 |
|
5 |
$ 6,000.00 |
|
NPV |
($1,219.71) |
Thenet present value of this project is negative hence the additionalproject is seen to be quite undesirable. The undesirability is basedon the fact that the company is on the verge of making losses and theproject will only increase the amount of losses. The five-yearstraight-line depreciation has the impact of increasing the fixedcosts as the depreciation will be dispensed against the sales of theyear. This depreciation however does not affect the cashflow since ithad already been incurred and now it is only a way of dispensing it(Robison,Barry, & Myers, 2015).According the time value of money on the NPV analysis of the project,I would recommend that project should not be implemented as it willreduce the wealth of the company in the long run.
Conclusion
Inthe view of the introduction of the new product into the company, themajor risk that ABC company faces in this context is lowprofitability on the new product. This is evidenced by the lowcontribution margin. Additionally, the company required a lot ofinput which would increase the cost of operations hence making thecompany have losses. My role as the management accountant is toensure that every investment that the company venture is sustainableand also profitable with less risks. I would therefore recommend thecompany to drop the new venture and stick to the existing product inorder to remain competitive and profitable in the market.
References
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DRURY,C. M. (2013). Managementand cost accounting.Springer.
Faulkender,M., & Petersen, M. (2012). Investment and capital constraints:repatriations under the American Jobs Creation Act. Reviewof Financial Studies,25(11),3351-3388.
Gambetta,N., Zorio-Grima, A., & García-Benau, M. A. (2015). Complaintsmanagement and bank risk profile. Journalof Business Research,68(7),1599-1601.
Kaplan,R. S., & Atkinson, A. A. (2015). Advancedmanagement accounting.PHI Learning.
Paquin,J. P., Charbonneau, A., & Tessier, D. (2015). The derivation ofthe NPV variance of a risky capital investment project withfirst-order autoregressive cash flows and autoregressive conditionalheteroscedastic variances. AppliedEconomics,47(12),1170-1186.
Pratt,J. (2013). Financialaccounting in an economic context.Wiley Global Education.
Robison,L. J., Barry, P. J., & Myers, R. J. (2015). Consistent IRR andNPV rankings. AgriculturalFinance Review,75(4),499-513.
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