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Whether to continue with apparently unprofitable products, divisions, branches
We see a lot of examples in the press stating that shops are being closed, or various products terminated because they are unprofitable. Before any such action is taken we need to be clear what we mean about being unprofitable. We need to examine and question the figures that are offered to support this decision. This is a simple example where most will automatically choose to terminate product Y, or branch Y.
The decision to make or buy
If you are not involved in a manufacturing environment, you may be tempted to ignore this blog on the grounds that make or buy decisions will be irrelevant to you. Nothing could be further from the truth! This we will demonstrate in the next section, which is concerned with the evaluation of providing internal services against the use of outside contractors, and represents a good illustration of an application of make or buy principles.
The decision to accept/reject a special order - Example
In this example we will first produce a budgeted Income Statement (without the special order); We will then construct a total Income Statement (including the special order); Finally, we will produce an Income Statement - showing incremental income and costs for a special order
The decision to accept/reject a special order - Introduction
One issue likely to be appropriate to all managers at some time in their careers is whether to accept what we will refer to as a special order. By this we mean, 'Are there circumstances in which it might make sense in financial terms to sell products or services at a lower price than normal, or alternatively, to provide a service internally at less than its full cost?'
How to best use available scarce resources
In some production and distribution decisions, management may be confronted with the question of how best to allocate the firm’s limited resources. Where demand for the product is greater than the production or distribution capabilities available, a company should seek to maximise its total contribution margin from these limited resources.
An example of cost-volume-profit (CVP) analysis
This is a fully worked example with comments. It covers the calculation of break-even, minimum selling price and volume required at a fixed selling price. It concludes with the construction of a break-even chart.
Competitive tendering
There are many examples of organisations using competitive tendering in an attempt to obtain savings in the services they provide. These include, local authorities with refuse collection; health authorities with domestic, catering and building maintenance services; and the Royal Navy with ship repair.
An example applying Robertson (1983) ratio model
For this blog I will provide relevant data and show how I combine the figures. I will then show the calculation of the individual ratios which are then combined to give a total score.
Robertson’s 1983 ratio model
For this blog I will describe a ratio model developed by Robertson in 1983. It is a model that has stood the test of time since the ratios included are those that best measure overall changes in financial health
Employee ratios
This blog will introduce five employee ratios and provide comments on each one. I will then attach a table that will show the results using data taken from the Polly Ester case study and conclude by giving an interpretation of each ratio.
Working capital ratios / liquidity ratios
This blog will introduce five working capital ratios and provide comments on each one. I will then attach a table that will show the results using data taken from the Polly Ester case study and conclude by giving an interpretation of each ratio.
Profitability ratios
I will introduce four profitability ratios and provide comments on each one. I will then attach a table that will show the results using data taken from the Polly Ester case study and conclude by giving an interpretation of each ratio.
Cost analysis statement year-on-year
The common size statement shows that there are many significant changes throughout the period. It will now be useful to consider some of the changes that were highlighted, in more detail.
Common size statement base year = 100
This blog will use data taken from the Polly Ester case study. The common size statement takes data from the income statement and the balance sheet and calculates movements from a starting (base) year. It does help to provide useful information that can be used when carrying out an analysis of the financial position of a company.
Diary of events
Corporate reports do in fact contain much useful information but it may not necessarily be (and is not usually) organised in the most appropriate way to permit analysis. All too often the inexperienced analyst will focus attention upon hard forms of analysis like the calculation of ratios without setting the scene appropriately.
Gearing ratios
There are good gearing ratios but there are also gearing ratios that are not sufficiently robust. Quite simply, gearing is the relationship between borrowings (interest bearing debt) and equity (the shareholders interest in the company).
Case Study - Polly Ester Holdings plc
This case study was prepared from published sources. It is intended as a basis for assignment/class discussion and not as an illustration of good or bad management.
Relevant costs
The accounting information used in any decision must relate to the future, not the past. It is essential that only costs and revenues yet to be incurred are used for purposes of decision making.
Net present value (NPV)
To illustrate the application of the net present value (NPV) technique, where for a given rate of interest, future cash flows are discounted using the principle discussed in the The principle of discounting blog. The sum total of these discounted future cash flows is compared with the capital outlay and where it is greater than the outlay, the NPV is said to be positive and the project is acceptable on economic grounds.
The principle of discounting
In order to present the capital appraisal technique of net present value (NPV), it is necessary to explain the principle discounting, or scaling-down, future cash flows. I will do this by comparing discounting with the more familiar but related technique of compounding.
Simple payback
Simple payback is the most widely used technique when it comes to appraising capital projects. The reason for this is that it is used most often by small to medium businesses where their aim is to try to find out how long it will take them to recover their outlay.
What is Gearing?
In this blog I want to cover the important topic of gearing. In accounting it is simply the relationship between debt i.e. the lenders and equity i.e. the owners capital. Should a company increase it debt, then all other things being equal, this will tend to increase the gearing and at some stage the risk. It is similar to an individual or a country borrowing more than they can afford, at some stage there is a tipping point.
Sole trader vs Partnerships
In this blog I want to discuss the two basic types of business. These are the ones that many small business will tend to operate under. The sole trader is owned and run by an individual; it has a simple structure, only requiring key decisions to be made by one person. The partnership is also a common type of business. Often professional firms operate under this system. It will normally have two or more partners and will require an agreement outlining such things are sharing of profits, interest on capital, partners salaries.
Credit control
The main objective of credit control is to minimise bad debts. This requires that a balance is achieved between the risk of granting credit to a customer and, the loss of profits through not trading with that customer.
Inventory control
The financial objective of inventory control is to minimise the overall costs of holding stock while taking into account the various objectives of other functions within a company.
The Ansoff Matrix Higher Education setting
The Ansoff Matrix is a bit easier to prepare than the SWOT but does give some useful information that will allow you to better understand your product/market space.
SWOT analysis Higher Education setting
The preparation of a SWOT gives some useful insights into possible objectives for the coming year. When preparing a SWOT simply do a brainstorm and record the items as a list against each of the four segments. At this stage don't question any of the items in the list. Just keep it going for several minutes.
Whats in this for my business SWOT
A SWOT analysis should be carried out prior to the preparation of the business objectives. The analysis should highlight areas of the business that need attention – therefore change.
Financial ratio analysis
This blog gives a brief introduction to seven basic financial ratios and provide an exercise complete with worksheet.
Years forecast or outturn
Why prepare these years forecasts? The main reason is that an annual budget quickly becomes out of date as key factors in the environment change.
Relationships between Product and Market
The Ansoff Matrix is an important tool to show the relationship between a product (or product group or service) and the existing or potential market.
Profitability measured using Net Assets or Total Assets
In the UK profitability is typically measured using the formula, profit expressed as a percentage of net assets (RONA%). Profit is taken before tax and before the payment of interest while net assets is taken as total assets minus current liabilities. In the USA they use the same profit figure but express it as a percentage to total assets (ROTA%).
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