Introduction
In this paper I will show the financial situation of the ABC company. With all organizations there are various parts that must work together in order to reach a common goal. With the ABC company, the CEO wants to figure out whether or not a new project should be implemented and if it will be profitable or not. ABC is a manufacturing firm who specializes in the production of cedar shingles. However, the company now wants to create doll houses out of the leftover cedar shingles, and they believe that they should be able to generate over $3M in revenue over the next three years. Compared to the $1.2M they make now; this will be a growth of about 150%. A risk profile will tell investors the “Organization’s willingness to take risks, as well as the threats to which the same is exposed (Investopedia, 2015)”. In order to find the financial capacity of the ABC company, we need to first conduct an analysis of the company’s income statements, balance sheets and financial statements. The information that we find in these sheets will assist us in determining if the product will be profitable or not and what decision will need to be made when it comes time to approve or deny the new project.
I. A completed risk summary profile on the ABC company based on the current economic and
industry issues that they may face.
With the ABC company having such a large sales goal to achieve growth of roughly 150%, there may be some risk that they have to accept. The aggressiveness that they show is very risky from that of an entrepreneurial standpoint. The following are some of the factors that should be considered wile implementing the expansion of the new product:
1) The Customers may be anticipating a lot of the new product since the company already puts out a great product. And if the product isn’t what the customers were expecting the company could take some backlash.
2) The company has the ability to use its own resources for the most part as the doll houses will be built from scrap cedar shingles. But if the scrap pieces don’t meet the needs of productivity, then they will have to start producing more shingles from the cedar or venture towards other woods
3) A loss in the market can be one major consequences of the launch of the new product if it is not something the customers want.
4) The company will have to hire skilled doll house builders in order to produce a great product every time. Which will, in turn, raise their overhead cost.
5) Change is hard for many people, so when putting the new product on the market the company will have to be aware of the feedback from the customers and be willing to wait if needed for the product to become a hit.
6) Businesses can often be impacted by inflationary factors. This is the result of the fluctuation in the prices as management teams don’t usually see such factors in the future.
CASH FLOW STATEMENT FOR ABC COMPANY (DIRECT METHOD)
Statement of Cash Flow
December 31, 20X2
20X2
cash flows from operating activities
Net income
120000
plus: Depreciation
70000
total cash receipt
190000
Effect of changes in
Trade receivable
6000
Inventory
-35000
Accounts payable
-250000
Income taxes payable
-30000
total cash payments
-80000
Net cash flows from operating activities
270000
cash flows from investing activities
capital expenditures
-100000
Net cash used in investing activities
-100000
cash flows from financing activities
Issuance of long term debt
70000
payment of dividends
10000
Net cash used in financing activities
-30000
Net Cash Flow from business
140000
add: Beginning of year cash balance
50000
Cash and Cash equivalent at year end
210000
Cash flow statements are vital financial statements for any company as they are used to identify the cash position of the company. The statement above shows the influx and outflow of ABC’s cash and also shows the cash that has been used within the company throughout the year. This Cash flow statement has been broken down into three categories- financing cash, operating cash and investing cash. The calculation shows that ABC generated a flow of cash of roughly $270k in the year 20×2 with an after tax reported income of $30k. Also indicated on the statement was that ABC used more cash to finance activities then the cash that came in from those sources. ABC’s net cash flow was positive at $140k. and with their company, the primary cash flow comes from the net income. This allows ABC to invest in equipment and pay dividends at $200k
In order to improve ABC’s cash flow, they can invest more funds into other organizations debt securities which will return more proceeds to them. The company’s profits also allowed them to pay out dividends, while keeping in mind the demands that were generated by the expansion of the company. To collect more funds to invest in more steady profitable sectors the company will need to issue more common stock.
In order to achieve or receive additional financing the company can allot equity or corporate debt as needed for the extra financing that the company is unable provide. Since the interest outflow of the debt financing is an allowable cost it leads to a low tax expense. In cases like financing through equity, the equity is a form of dividend which doesn’t give them an advantage come tax season. ABC has a very strong position economically so they should use debt financing rather than equity.
ABC's Product Information
Current Product
Expansion Product (estimate)
Selling Price
14.50
15.12
Units produced and expected to be sold
80,000
5,000
Machine Hours
40,000
5,000
Direct Materials
$1.30 per unit
$5.60 per unit
Direct labor dollars needed per product
$2.80 per unit
$4.00 per unit
Variable Factory Overhead
$1.00 per Machine Hour
$1.00 per Machine Hour
Variable Selling Expense
$0.20 per unit
$0.20 per unit
Total Fixed Costs:
Fixed Factory Overhead
$ 198,000
Fixed Selling expenses
$ 191,250
ABC thinks that before they would have to expand, they would have an additional 5000 machine hours available. They use machine hours in order to allocate for the fixed factory overhead and they allocate the fixed sales price by units sold. With the current research, the total cost of production of the expansion is $54k for 5000 more units. The production cost per unit with the expansion is at $10.80. This is all based off the current production information from ABC.
• The cost per unit before the new product is $4.80.
• The New product will increase per unit cost to $9.73.
• Total per unit with the current and the new expansion is estimated at $19.46 which raises the existing product by $4.93.
In order to get a 40% gross margin with the new product the company should sell the doll house for $15.20 per unit.
Consolidated Product Cost
current + expansion product
total variable cost
438000
fixed factory overhead
198000
fixed selling expenses
191250
Total production cost
827250
Total unit produced
85000
Per unit production cost
9.732352941
With the assumption of having the same sales mix of the two products, the contribution margin for the total expected production will be $7.15 per unit and the break-even quantity will be 55,365 units. Assuming
Particulars
current
per unit
expected
per unit
unit sold
80000
85000
sales
960000
14
1035600
12.18353
variable expense
384000
4.8
438000
5.152941
contribution margin
576000
7.4
597600
7.130588
The company has an option to purchase additional equipment for $42k which is assumed to produce the flowing savings in overhead over a span of 5 years.
Year 1, $15,000 Year 2, $13,000 Year 3, $10,000 Year 4, $10,000 Year 5, $6,000.
The Net Present Value (NPV) of the proposed investment is (-$1366.09).
Year
0
1
2
3
4
5
Cost Saved
15000
13000
10000
10000
6000
Discounted cost saved@ 12%
13392.86
10363.52
7117.802
6355.181
3404.561
Cost of capital
0.12
PV
40633.92195
Initial investment
42000
NPV
-1366.078052
The Straight line depreciation of the new equipment will be $8,400 each year. With the tax rate being ignored and not accounting for the depreciation, it will only be applicable during tax season as it’s a tax allowable expense. The table below shows what the fixed cost will be dropped to with exception to the last year.
Year
cost saved
Depreciation
Reduction in fixed cost
1
15000
8400
6600
2
13000
8400
4600
3
10000
8400
1600
4
10000
8400
1600
5
6000
8400
-2400
Some of the major risk that have been identified in the new project are:
The new product requires a higher sell price to get the 40% profit margin that ABC has set as a goal. However, this higher selling price can very well price the company out of the market and with a failed product the company can be put in a bad situation.
As the controller and a management accountant, what is your responsibility to this project?
The responsibilities that the controller and management accountant on this project are planned and proposed by managers within the organization, where on the other side, the financial information is designed by shareholders and creditors. For this project, the project management accountant has clearly defined the requirement of the project and the sum of the products needed. He will also be responsible for the control and production of documentation that goes with the project. These documents vary in purpose and timeframes. Most information and documentation will be on the paper and its system may not yet look like a conventional document (Simon Wallace, 2007).
What do you recommend that the CEO do?
As the CEO of the company you take responsibility for the success the you have but also the failures of any project. There are many recommendations for the project to be a success. My recommendations are:
• Set a solid vision and strategy to complete the project
• Approve and finalize the budget, partnerships and a solid team to guide the project
• Build a solid working environment with a crew of employees that will accomplish the goal
• Keep your project team motivated and on task
• Keep the all problems in house and do the best to solve them at the source
• Routinely check in with senior project leads to follow the progress of the project and keep the team together to make it happen
• Carefully consider the major expenses that the company will have along the way
• Have additional funds set aside to help the project with any shortfalls and mishaps