- Introduction
Nectar Sweets Plc is a company with the main shop in Hong Kong. It is experiencing cash flow problems and is seeking an increase in the overdraft facility from the bank. Statements of the company reveal that its operations are profitable, but it is not efficient in collecting debt. The report identifies and analyses the company’s problems and recommends possible solutions. In addition, it uses financial ratios to assess the performance of the firm.
- Problems facing the company
- Nectar Sweets Plc has a problem in collection of its accounts receivables. The company takes a long period to collect money from its debtors. This leads to a reduction in cash inflows to the business thereby causing cash flow problems (Stice and Stice, 2012). In addition, the company suffers from keeping high levels of inventory.
- High inventory levels. As shown in the balance sheet, the amount of stock is so high. This further worsens the problem of cash flow inadequacy as stock ties down capital that could be used for other purposes (Reimers, 2007). In addition, the company incurs expenses in holding the high levels of inventory.
- The company also has a problem of a decline in turnover. The year 2013 saw a decrease in the company’s turnover to £350 million from £450 million in the year 2012. If the fall in sales continues, the company will face a reduction in profitability, and this will further aggravate the cash flow problem.
- The company’s cash flow indicates that a significant proportion of total capital expenditure was financed by cash from operating activities. This may worsen the liquidity problem as benefits from capital investments accrue over a long period.
- Delaying payments to creditors may lead to more cash flow problems in the future. The ratios indicate that creditor days increased from 70 days in 2012 to 126 days in 2013. Nectar may experience liquidity problems if suppliers stop selling to the company on credit.
- Possible solutions
- The company should revise its credit policy to enable rigorous and prompt collection of accounts receivable. This should include proper screening of customers to ensure that only those that are credit worthy are offered credit terms. The company should also introduce cash discounts to encourage prompt settlement of debts by accounts receivables. Aggressive debt collection policy will reduce average collection period thereby improving cash availability in the company.
- The company should reduce its levels of inventory in order to reduce the amount of capital tied down in inventory. This will enable it improve cash availability and reduce its expenditure on inventory maintenance costs. In order to achieve this, the company should introduce Just-In-Time inventory management system. In this case, the company should only order or purchase inventory when it receives an order from a customer. JIT will also improve efficiency in the production process as it reduces the time the company takers to convert raw materials into finished products. In addition, accurate determination of optimal order quantity will enable the firm to reduce its inventory level. The firm should also identify and order inventory from reliable suppliers to avoid inconveniencing the customers.
- The company can reverse the decline in turnover in a number of ways. Firstly, the company should invest in advertising and sales promotion to create awareness of its products. In addition, the company can invest in research and development to find innovative ways of improving the quality of its products. Improved quality will enable it gain a competitive edge over its competitors. Furthermore, improved quality may be used as a justification for premium prices. Diversification of products and markets will also enable the company to expand its revenue base and spread risk.
- The company should use a conservative approach in managing its finances. This implies that it should finance long-term investments using long-term sources of finance (Moles, 2011). The cash flow statement indicates that it incurred £3,000 in capital expenditures, out of which only £1,150 was financed from long-term sources of finance (issuance of shares and proceeds from the sale of non-current assets). It financed about £2,000 of the expenditure using cash from operations. This leads to cash flow problems as it crowds out cash available for operating activities.
- Company performance
- Profitability
Profitability ratios indicate that the company is doing well. The gross profit margin indicates that it earns about 61% of its turnover as gross profit. In addition, it made a net profit of £0.371 from every pound of turnover. The return on capital indicates that investors earned £0.18 from every pound of capital invested in the company (Gibson, 2008, p. 451). The asset turnover ratio of 0.42 indicates that the business is efficient generating revenue from the use of its assets. These ratios indicate that the enterprise is profitable. However, the decline in these ratios in the year 2013 shows a drop in the overall profitability of the company.
- Liquidity
Current ratio indicates that the value of Nectar’s current assets were twice that of current liabilities. In addition, quick ratio is more than one suggesting that quick assets were more than current liabilities (Rich, 2010, p. 640). These ratios indicate that the company is liquid. The increase in liquidity ratios in 2013 shows an increase in the liquidity of the Nectar Sweet Plc.
- Working capital management
Stock turnover ratio indicates that the company replenishes its stock 5.4 times in a year. The increase in stock turnover in 2013 shows an improvement in the efficiency of the company to convert inventory into revenue (Gallagher and Andrew, 2007, p. 97). Debtor day’s ratio shows that the company takes an average of 83 days to collect money from its accounts receivables. The increase in debtor days from 48 in 2012 to 83 days in 2013 suggests a reduction in the efficiency of the company to collect accounts receivables thereby adversely affecting the liquidity of the enterprise. Creditor days indicate that it takes an average of 216 days to pay its creditors. The increase from 170 days in 2012 shows a decline in the company’s ability to pay its payables. Delaying the payment of creditors may worsen the company’s liquidity especially if suppliers lose confidence on the ability of the firm to honour its debt obligations.
- Solvency
The company’s gearing ratio of 31% shows that 31% of its total assets were financed through borrowing (Wahlen and Bradshaw, 2010, p. 374). The company is, therefore, solvent and does not face a high risk of liquidation. The increase in the gearing ratio from 27% in 2012 to 31% in 2013 implies a decline in the solvency of the company. Interest coverage of 17 implies the company’s earnings before interest and tax were 17 times the amount of annual interest expense hence they were adequate to cover the interest obligation hence the likelihood of default is low. The reduction in interest coverage from 20 in 2012 to 17 in 2013 suggests a fall in the ability of the company to honour its interest obligations.
- Market ratios
Dividend coverage of 17 and price earnings of 3.0 indicate that the company is offering value for shareholders’ money invested in the corporation (Besley and Brigham, 2007, p. 60). Dividend coverage shows that the company made adequate earnings in the current period to meet the payment of dividends to shareholders. The price/earnings ratio of 3.0 implies that investors are willing to pay 3 times more for every pound of earnings of the company. This indicates that the company’s stock is doing well in the stock market thus giving good returns to the shareholders. The decline in earnings per share from 51p in 2012 to 33.7p implies a decline in its profitability. The reduction in dividend from 2.67% in 2012 to 2% in 2013 also suggests a fall in the profitability of Nectar.
5. Strengths and weaknesses of the report
The report uses current and past data to analyse the performance if the company in terms of liquidity, profitability and solvency. The use of ratios enables comparison of performance of the Nectar for years 2012 and 2013. The report also identifies problems facing the company and highlights possible solutions. The weakness of this report is that it relies on ratios that are based on past data hence may not be appropriate to predict the future performance (Baker and Powell, 2009, p. 70). In addition, the report relies on quantitative information. Qualitative information such as key customers, key suppliers, market conditions, among other information will improve the quality of the report.
Bibliography
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Gibson, C., 2008. Financial reporting and analysis: Using financial accounting information. 11th ed. Cincinnati, Ohio: South-Western College Pub.
Moles, P., 2011. Corporate finance (European ed.). Hoboken, N.J.: Wiley.
Reimers, J., 2007. Financial accounting. Upper Saddle River, N.J.: Prentice Hall.
Rich, J., 2010. Cornerstones of financial and managerial accounting: Current trends update. Mason, OH: South-Western/Cengage Learning.
Stice, E. and Stice, J., 2012. Intermediate financial accounting. 18th ed. Mason, Ohio: South-Western Cengage Learning.
Wahlen, J. and Bradshaw, M., 2010. Financial reporting, financial statement analysis, and valuation. 6th ed. Mason, Ohio: South-Western.
