Introduction to Decision making
Decision making in the business organization is a mundane activity. Business entities at one point of time make routine decision related to day to day operation of the business and on the other time they draw major decisions for the expansion of business operations. This determination is done by assessing financial performance and position of the company and with this forecasting of cash generation is also undertaken (Suto and et.al., 2007). In order to explain the way financial decisions are taken in the business organization, this report is prepared. The report is made in the context of Clothes for Tots Ltd (CFT), a family run clothing design company which was established in the year 2001 in Northern Ireland.
1. Analyzing the financial performance and position of the business
The Financial performance of CFT Ltd is measured through ratio comparison of last two years. Underneath are the interpretations that can be drawn from each ratios of the firm-
This ratio indicates the availability of liquid funds within the business enterprise. It is computed to analyze the company's ability to meet its short term obligation. Short term obligation refers to the liabilities that business entities owes to its creditors who provided material and cash on credit (Bierman and Smidt, 2003). It is said that the firm must have adequate availability of cash to pay its current liabilities. In liquidity ratio 2 ratios i.e. Current ratio and liquid are most commonly calculated to assess the liquidity available with the entity.
1)Current Ratio- This ratio is usually calculated to analyze the working capital management of the business entity. The working capital management of the firm will be considering being an efficient when it has excess current assets over current liabilities (Ahmed, 2008). This ensures that the firm will meet its short term obligation if it arises at any point of time. In the year 2013, company maintained good current assets against its current liabilities. Usually the ideal current ratio is 2:1, so the company should give more emphasis to increase its current assets.
2)Quick Ratio- It presents the company capability to meets its immediate liability. The quick ratio considers quick assets for computation (Wahlen and et.al., 2011). Quick asset signifies those assets which can be converted into cash at utmost ease. Quick ratio should be equal to 1 but in this case it is lower than one in both the years which indicates the entity doesn’t have enough cash and cash equivalent to meets its immediate liability (Kimmel, Weygandt and Kieso, 2010).
Profitability ratio demonstrates the firm's ability to generate cash from its overall business operation. In this case 3 profitability ratios were calculated to measure the company's performance.
1) Gross Profit margin- It shows the extent of profit mark-up the business entity is making after deducting cost of goods sold from the sales revenue. In the year 2013, the gross profit margin of the firm decreased to 36% from 37% of the previous year. It is giving negative indication (Weil, Schipper, Francis, 2012).
2) Operating Profit Margin- It expresses the profit the CFT Ltd. is making after deducting all operational expenses. Here, the operating profit is increased because of increase in sales revenue and decrease in operational expenses.
3) Net Profit Margin- It considers net profit after tax for computation of financial performance of the firm (Walker, 2009). The net profit of the firm in both the years was more or less same.
It is used to measure the firm's financing method. It shows what extent of debt and equity used in capital structure of the firm.
1)Debt-Equity Ratio- It is said that the firm should have 2 times of equity when it has 1 time of long term borrowed capital (Kinney and Raiborn, 2012). This shows that the firm has adequate equity to meets the long term obligation of the business. Here, the company has high debt and low equity which is wiping out its profit in form of payment of interest.
2)Asset Utilization-This ratio analyzes the effectiveness of company's management in using its assets for the achievement of organizational objectives related to increase in sales revenue. The higher ratio indicates the higher efficiency of management in using company's assets for increase in sales turnover (Lumby and Jones, 2003). Here, Total Asset Turnover and Net Asset Turnover of the firm diminished which means the personnel of CFT Ltd were inefficient in managing business operations. However fixed assets turnover of the entity increased.
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3) Expenses Ratios-It is used to assess the behavior of the operational expenses of the firm. With the help of this ratio the increase or decrease in the expenses can be evaluated (Kastantin, 2005). CFT Ltd able to decrease it's administrative and selling and distribution expenses but it could not able to control the direct cost incurred on the production process.
Profitability In Relation To Investments
These ratios are calculated to determine the relationship between profitability of the firm and investment made for earning required returns.
Return on Gross Capital Employed- It measures the percentage of return earned on gross capital invested (Jonsson, 2008). The firm has made equal amount of return i.e. approximately 4% in the year 2012 and 2013.
Return on Net Capital Employed- In this, the return is evaluated on net capital employed. Net capital employed is determined by deducting current liabilities from the gross capital investment (Deakins, Morrison, and Galloway, 2002). Here, also the business entity has not shown any changes in the last 2 years performance. The performance of CFT Ltd in the year 2013 is same as of year 2012. So this can be said that the company has not added value on its investment in past 2 years.
Return on Shareholders' Capital Employed- With the increase in earnings after tax in the year 2013, the company's return on shareholder's capital employed also shown positive increment. This is a positive sign of CFT Ltd.
In addition to this, EPS on the firm's shares is also increased to .22 from .16 and with this dividend yield on shares is also shown positive increment (Bradbury and Hooks, 2010). It is to be note that the CFT Ltd is distributing more than 50% profits to the shareholders. Company can increase this payout to enhance the perception of the investors on the business entity.
2. Analyzing working capital management faced by the company and presenting recommendations
Working capital problem refers to the shortfall of cash and cash equivalents in the operational activities of the business. In business organization efficient management of working capital is placed on top most priority as any deficit in working capital can restrict the whole operational activity of the business enterprise (Clarke and Tauringana, 2000). There could be many problems in working capital management of CFT Ltd. These issues are very essential to be evaluated as it helps in identifying the roots of the problems and also helps in overcoming from those critical issues. The some of the most common issues which are faced in the organization like CFT Ltd are-
Inadequate availability of cash due to poor sales- It is one of the most common problems which are faced in the business entities. It is truly said the business organization continuous deals with complexities due to uncertain business environment. It is not always necessary that the organization will receive continuous cash flow from its operation and will able to keep sufficient cash for managing its business activities (Galloway and Morrison, 2002). Many of times unheralded and expected situation arises which impede the sales of the firms' like CFT Ltd and this ultimately fetches huge burden related to cash deficiency in the business. Often poor sales are seen due to ineffectiveness of the management and sales personnel in promoting the product among the consumers (Graham and Harvey, 2001). Thanks to the management of CFT Ltd that company able to make higher sales as compared to previous year.
Increase in outstanding expenses- This is also considered to be as the biggest challenge in management of working capital. Many of times it has been seen that business organizations goes for liquidation when they are not able to controlled or pay their past outstanding dues (Ismail and et. al., 2013). It is very essential for efficient working capital management that outstanding expenses are properly paid on time to avoid any unforeseen event related to insolvency of business.
Delay in collection of due receivable- This problem is faced when the organization has poor policy related to debt collection. It is always suggested that the business entity should practice sound collection policy which will helps in continuous flow of cash in the business (Levine and Beck, 2000). This type of situation is also encountered when the management is more emphasized on credit sales rather than cash sales. Usually industry makes benchmarks for the collection of debt this period could vary between 10-30 days. In this case, the debt collection period is very high which will obstruct the business efficiency.
Increase in Bad debts- When more goods are sold on credit then it brings the cases related to bad debts which wipeout the inflow of cash in the business (Theeke and Mitchell, 2008). Bad debts arise due to inability of the debtor to make payment. So it is always preferable to sell goods on cash basis.
Increase in Interest payment due to high borrowed capital- Business entities have to brush with working capital management when the organization pays high interest payment due to huge borrowed capital (Wines, Dagwell, and Windsor, 2007). As in this case, CFT Ltd has taken excess loan and for that it has to pay high interest amount. This interest amount decreased the net profit available with the business.
Increase in Bills Payable- The working capital management of the firm will be imbalance at the time when the firm has huge current liabilities in terms of Bills payable. As in this case, CFT Ltd owes large amount to its creditors.
Improper management of Inventory- Most of the times it has been seen that organization block their money by purchasing inventory in bulk (Suto and et.al., 2007). A business entity requires large amount of funds to purchase in stock in bulk. These issues can be resolved by adopting effective inventory management tools and techniques.
Underneath are the recommendations which the company CFT Ltd can practice to overcome from the issues related to working capital management.
Use of cash flow forecasting techniques- The primarily initiative the CFT Ltd can take to resolve issues related to working capital management is practicing of cash flow forecasting techniques in the operation (Bierman and Smidt, 2003). It involves use of various budgeting techniques which helps in managing and controlling of cash inflow and outflow in the business activities. This technique is widely used in the business because it helps in the meeting future uncertainties.
Implementation of Enterprise resource planning in the business entity- It is considered to be as the best practice to deal with debt collection and payment to creditors. This computer software will keep proper records of the credit sales and credit purchases and also inform the management about the payment need to be made at the particular date (Wahlen and et.al., 2011).
Training and development to the staff- Appropriate training and development to operational staff about how resource can be optimally used for the production will help in reduction in wastage of resources and also helps in reducing the cost of operations.
Forming of sound policy related to debt collection and payment- The business entity CFT Ltd will get advantage by formulating and implementing sound debt collection and payment policy (Ahmed, 2008). This will helps in the regular flow of cash in the business enterprise.
Prioritization of payments- Prioritization of payments will also helps in the efficient management of working capital as the cash will not be outflow from the business before payment due date. This also helps in using cash in the areas where it is urgently required to be used.
Inventory Management by using EOQ method- The entity will ale to rid-off from excess accumulation of inventory by adopting Economic Order Quantity techniques (Kimmel, Weygandt and Kieso, 2010). The method will help in evaluating the number of units required to be purchased, number of orders to be made in the year, and also helps in knowing the minimum stock to be maintained in the business to avoid stock out situation.
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