An analysis of the Income statement of Pace Leisurewear co., Ltd does indeed confirm the statement that the company´s profitability is improving from its earlier years. This is supported by the fact that its gross profit margin, operating profit margin and overall profit margin have all increased: 46% to 48%, 15% to 21% and 8.9% to 13% respectively. The improvement in gross margin shows that the firm has a strong control measure over its production costs. In addition, improved operating margin suggests an increase in operational efficiencies. Furthermore, the deductible expense from depreciation mentioned by Mike Greaves is also one of the likely cause of the improvement in the overall profit margin arising from the tax savings.
While profitability figures shown in the income statement seems promising, the fundamental issue faced by Pace Leisurewear co., Ltd is, simply put, its lack of liquidity. Given this, the paper will aim to suggest ways for the company to improve its cash flow figures, consequently, reducing the overdraft pressure instated by the bank (Appendix 1).
Firstly, the company should aim to improve its accounts receivable turnover ratio. This measure is an efficiency ratio that shows how quickly the company is collecting, or turning over, its accounts receivable based on the amount of credit sales it had in the period. The ratio is calculated by dividing the total credit sales by the average trade receivable balance.
Thus, a higher the ratio means higher efficiency leading to fewer liquidity problems. Like most other financial statement ratios, this turnover measure is not relevant when viewed from a single point in time. The relevancy is derived when viewed from different time periods: a comparison can be made to see if the company is improving or declining. If we assume that the ending year receivable data is the average for the year, and that the sales revenue are all sold on credit then the A/C ratio has dropped from 8.7 to 6.0 from the year before last to last year, clearing signifying a reduction in efficiency (Appendix 2).
To increase the A/C turnover, the company should focus on two main agenda: its credit policy and its collection of receivables. Changing the credit policy to allow customers less time to pay can improve cash flow, reducing the overdraft required for other investments. This can be done my incentivising a discount if the customers pay within a certain time. Apart from changing the credit policy, the company should also aim to communicate to its customers to pay their due diligence on time.
Secondly, the company can also aim to improve its accounts payable turnover ratio. This ratio is a short-term liquidity measure used to quantify the rate at which a company pays off its suppliers. It is calculated by taking the total purchases made from suppliers, or cost of sales, and dividing it by the average accounts payable amount during the same period. If we assume that the average accounts payable is the years ending figure, the A/P ratio has reduced from 6.17 to 4.45 from the year before last to last year (Appendix 3).
This reduction, suggests, that the company is taking longer time to pay its obligations to the supplier which is beneficial for its cash flow problem. That being said, to meet the short-term obligations, the company can try to try to bargain even more with its supplier for a longer payment schedule. They can use the large order from Arena as a bargaining tool for future business commitment.
Thirdly, the company should also aim to reduced its unnecessary assets. Since Pace Leisurewear is focused on design-and-marketing led business, it can try to increase cash flow by selling its plants. While the old machines were sold with no salvage value, the paper recommend that the company not focus on production at all. It should not only avoid buying new machinery for production, it should sell the plant altogether. By selling this plant the company will be able to reduce its illiquidity. Apart from this, by focusing on its core strengths, the company will also be able to reduce its inefficient overhead expenses: the lack of experienced members in production indicate that the operations of the facility will most likely be inefficient. Thus, the author recommends that the firm free up cash flow -by selling the plant- to reduce the overdraft and use some of that resources to focus on its core strengths: design and marketing
In addition, the days sales of inventory value (DSI) should also be considered to understand how the company is managing its inventory. This financial measure is important for this case study because it allows investors to get an idea of how long it takes a company to turn its inventory, a source of capital, into sales. The lower the DSI, the faster the inventory is converted. This means there is less liquidity locked up in inventory. It is important to realise that the average DSI will vary across industries so analysts should compare Pace Leisurewear Ltd with the apparel industry average. To improve DSI value, the company can implement just in time delivery strategy. This approach aims to increase efficiency and decrease waste by receiving goods only as they are needed in the production process, thereby reducing inventory costs. To accomplish an effective just in time delivery strategy, Pace Leisurewear is required to have its own manufacturing plant and a strong demand forecast analyst. With the current lack of expertise in this area, as mentioned before, the paper suggests that the company put this objective as its long-term goal.
Lastly, the company can increase liquidity by increasing its profitability. The more profit the company has the more cash flows into the company. This can be accomplished in many ways including continuously improving its product designs to meet its target customer, establishing an effective promotional activity, monitoring competitor prices and ensuring that the product is in the right place and the right time. In addition, the company should also halt dividend payments to the shareholders until the liquidity issue is solved. This will help reduce the overdraft statement.
III. Conclusion and Recommendations
In conclusion, there are many ways in which Pace Leisurewear Ltd can reduce its overdraft positioning. Firstly, it should convince its customers to pay their due diligence on time and/or reduce the credit term payment. That being said, the company must be careful not to pressure customers too much as it could result in lost sales and profitability (which contributes to liquidity). Secondly, the company can try to extend its payment term with its suppliers by using the expected increase in orders from Arena as a leveraging argument to delay cash payment. Thirdly the company should sell off its plants as this is not its core activities. The sale of such unnecessary asset will increase cash and reduce the inefficient overhead costs associated with production. In the long term (once the company has more experience in the industry and a better demand forecast), the company may consider producing its own goods to allow for just in time strategy. This policy will allow the company to reduce inventory holdings which is another source of capital lockup. Lastly, as mentioned before, the company can reduce illiquidity by increasing profitability by improving customers experience. This can be accomplished by improving the 4 main marketing mixes: price, product, place and promotion. In addition, the company should stop dividend payment to the shareholders until the illiquidity problem is solved.
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