Analysis of ABC Company

1
Introduction
ABC Company is a manufacturing company that concentrates in
building cedar roofing and siding shingles. The current annual sales of the
company are around $1.2 million, a 25% rise from the last year. The
company has a violent growth target of achieving $3 million annual sales in
next 3 years. The Chief Executive Officer of the company is keen to search
additional goods that can influence the present employee skillset of ABC as
well as the production facilities. The Chief Executive Officer is working on a
new opportunity. The Chief Executive Officer is planning to use some of the
shingle scrap materials to construct cedar dollhouses. This new product line
would increase additional raw materials and will take lesser time to produce
in comparison to cedar shingles. Although this product line will need extra
expenses, it will generate extra revenue and gross profit and will assist in
achieving the growth targets.
Risk Profile
Risk can be called as the ambiguity involved in a given thing or event.
Risk is observed in every part of life. Two types of the risks are faced by
business enterprise as well namely, Systematic Risk and Unsystematic Risk.
The Systematic Risk is in-built to the whole market known as un-diversifiable
risk or market risk. It cannot be diminished by using diversification
instruments and influences all the business enterprises. Unsystematic Risk
can be called as the risk related to a given business and it can be certainly
diminished. Another name for unsystematic risk is diversifiable risk.

Analysis of ABC Company

2
Therefore, it can be said that identification of the risk involved is very
necessary and diminish it by implementing variety of instruments. Examples
of systematic risk are economic conditions, governmental law, policies,
natural

calamities

etc.

Examples

of

unsystematic

risk

are

strike,

governmental regulation for a particular type of manufacturer, poor relation

with suppliers etc.
Systematic Risk can be controlled by the management of this company
as well; instead they should pay some attention in managing the
unsystematic risk.

The possible unsystematic risk faced by the company

includes expected price of product, manufacturing of new goods, whether

there will be enough demand for new goods, choosing of supplier for extra
requirement of raw material, whether current facilities will be able to manage
the new production, method of financing i.e. debt or equity.

ABC COMPANY
Cash Flow Statement
For the year ended 31st Dec, 19x2

Cash from Operating Activities:

Cash Received from customers (Note - 1)
Cash Paid to Suppliers and Employees (Note - 2)
Cash Generated From Operations
Less: Income Tax Paid
Cash Flow before Extra-ordinary Items

$1,260,000
$1,080,000
$180,000
$180,000

Cash Flow from Investing Activities:

Purchases of Equipment

$(100,000)

Cash Flow from Financing Activities:

Dividend Declared

$(100,000)

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Net Increase/Decrease in Cash and Cash Equivalents:
Cash and Cash Equivalents As at beginning of the year
Cash and Cash Equivalents As at End of the year
Note - 1: Calculation of cash received
Total sales
Less: Opening Balance of Debtors
Add: Closing Balance of Debtors
Note 2: Calculation of cash Paid to Suppliers
Cost Of goods sold
Less: Opening Stock
Add: Closing Stock
Total Purchase
Add: Opening Balance of Creditors
Less: Closing Balance of Creditors
Total Cash Paid
Add: Selling and Distribution Expenses

$(20,000)
$70,000
$50,000

$1200000
$180000
$120000
$1260000
$800000
$280000
$350000
$870000
$210000
$250000
$830000
$250000
$1080000

Sources & Uses of Funds

Sources:
1. Operating: Cash received from debtors
2. Investing: None
3. Financing: None
Uses:
1. Operating: Payment to suppliers
2. Investing: Purchase of equipment
3. Financing: Payment of dividend
Steps for improvement of cash flows
Implementation of following techniques will assist in improving the
cash inflows from debtors:
1. Providing discount on early payments.

Analysis of ABC Company

4
2. Regular reminders for payment.
3. Discount on immediate cash payments.
4. Automated system for accepting payment like credit card, debit
card.
5. Implementation of debt factoring.
6. Evaluating credit worthiness of the client before granting debt.
Similarly, to improve the cash outflows, the company shall try to avail the
benefits offered by the creditor or the lending institutions.
Financing Options
Any new investment or project or expansion of existing project can be
made by two ways namely, by taking money from lenders or owners. These
are known as debt financing and equity financing.
Advantages of Debt Financing:
1.
2.
3.
4.

Control over ownership

Interest paid is tax deductible
Flexibility
Less complicated in terms of paper work

Disadvantages of Debt Financing:

1. Principal borrowed is to be repaid and creates an obligation on
borrower.
2. Excessive debt increases the riskiness and affects the reputation of
the company.
Advantages of Equity Financing:
1. Money taken is not required to be repaid.
2. No obligation of regular interest payments.

Analysis of ABC Company

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Disadvantages of Debt Financing:
1. Ownership is lost.
2. Requires complex paper work at the time of issuance.
Statement Showing Product Cost for the Expansion Product
Particulars
Calculation
Amount
Units produced and
5000 units
expected to be sold
Machine Hours
5000 Hours
Direct Material
Direct Labor
Factory Overhead
Variable
Fixed
Selling Expenses
Variable
Fixed
Total Cost

5.60 x 5000
4.00 x 5000

28,000
20,000

1.00 x 5000

5,000
-

0.20 x 5000

1,000
54,000

Statement Showing Total Cost of Existing Product,

Expansion Product and overall cost of Products
Particulars
Existing
Expansion
Total
Units produced
80,000 units
5,000 units
85,000 units
and expected to
be sold
Machine Hours
40,000 units
5,000 Hours
45,000 Hours
Direct Material
Direct Labor
Variable Factory
Overhead
Variable Selling
Expenses

104,000
224000
40000

Fixed Factory
Overhead
Fixed Selling
Expenses

198000

198000

191250

191250

Total Cost

773250

Cost per unit

9.67

16000

28,000
20,000
5,000
1,000

54000

54,000

10.80

9.73

Analysis of ABC Company

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The cost of existing product has increased due to the expansion by
$0.06 per unit.
Calculation of Selling Price for the new
Particulars
Calculation
Total Cost
Profit Margin on sales 40% on sales
54000 x 40
60
Total Sales
Selling Price
90,000 / 5,000

Expansion Product
Amount
54000
36000
90000
18 per unit

Sales Mix:
Existing: 80,000 units
Expansion: 5,000 units
Statement Showing Contribution margin and Break Even
Points
Particulars
Existing
Expansion
Sales
1,160,000
90000
Variable Cost
384,000
54000
Contribution
776000
36000
P/V Ratio
66.70%
40%
Total Sales
1250000
Total Contribution
812000
Total P/V Ratio
64.96%
Fixed Cost
389250
Total Profit
422750
Break Even Sales

=
=
=

Fixed Cost
P/V Ratio
389250
64.96%
599,215

Sales Mix Ratio 80:5 or 16: 1

Break Even Sale

:
Existing
Expansion =

=
563,967
35,248

a)
Year

Cash Flows

Outflow

$ 42000

PVF @
12%
1

Product
(42,000)

Analysis of ABC Company

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1
2
3
4
5

Inflows

$15000
$13000
$10,000
$10,000
$6,000
Net Present Value

0.8929
0.7972
0.7118
0.6355
0.5674

13,394
10,364
7,118
6,355
3,404
(1,366)

Net Present Value of the proposed investment = $(1,366)

b) Depreciation =
Year
Savings in
Fixed Overhead
Less:
Depreciation
Savings Before
Tax
Less: Tax
Savings After
Tax
Add:
Depreciation
Cash Flows

42000/ 5

$8,400

1
15000

2
13000

3
10000

4
10000

5
6000

8400

8400

8400

8400

8400

6600

4600

1600

1600

(2400)

6600

4600

1600

1600

(2400)

8400

8400

8400

8400

8400

15000

13000

10000

10000

6000

The straight line method of depreciation will lead to increase in

the fixed cost. There will be no effect on the cash flows because
non-cash item like depreciation is not taken into account while
calculating cash flows.
c) The equipment shall not be purchased because the net present
value from equipment is negative.
Conclusion
The new project does not seem to be going well with the company as
there is increase in the per unit cost of existing product, its manufacturing is
quite time taking, demand for the product cannot be estimated with

Analysis of ABC Company

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certainty. All these lead to doubt regarding the achievement of target profits
and cash flows. The net present value of $1,366 is generated from the new
equipment.
Preparation of detailed budget with fixed and variable cost is the
responsibility of Controller and Management Accountant. He is liable for
maintaining up to date cost records and ensuring effective cost controls. He
is responsible for ensuring that production is carried out with the rules,
regulation, laws laid down by the government. An effective production
process required continuous monitoring, and any imperfections shall be
modified.
The Chief Executive Officer shall work strategically by proper planning,
evaluation of market conditions, analyzing the resources available,
detailing the resources needed. The market for the product shall be
stimulated by implementing promotional instruments. Extensive marketing
will lead to increase in the demand for the goods. Healthy relationships with
stakeholders like customers, suppliers, lending institutions, regulatory
authorities shall be maintained. In production process, the cost can be
decreased by reducing the waste, increasing the efficiency and adequate
training and motivation of employees.

Analysis of ABC Company

9

References
Carl S. Warren, (2009), Survey of Accounting, Fifth Edition
Jan R. Williams, Susan F. Haka, Mark S. Bettner, (2005), Financial and
Managerial Accounting: The Basis for Business Decisions, 13e
Ronald

W.

Hilton,

Michael

W.

Maher,

Frank

H.

Selto,

(2006),

Cost

Management: Strategies for Business Decisions, 3e

Richard A. Brealey, Stewart C. Myers, Alan J. Marcus, (2003), Fundamentals of
Corporate Finance, 4e
Stephen A. Ross, Randolph W. Westerfield, Bradford D. Jordan, (2008),
Fundamentals of Corporate Finance: Standard Edition, Eighth Edition

Analysis of ABC Company

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