Computation Of Ratios And Budgetary Control In Triton Corporation

Summary of the Revenues and Expenses

Discuss About The Computation Of Ratios And Budgetary Control.

Triton Corporation is a manufacturing division that will be dealt with in the report.  It is located in a country that has received immense economic growth from late 1990 to the early 2000s. However, it moved to an economic recession but after the end of the recession, it made a profit of $15.2 million. Six division of the company operates. The report will shed light on the part of the strategic decision making.  The report will evaluate the product divisions that produce low value-added items and need high working capital. Moreover, the implication of low value-added items is even discussed.

Secondly, a discussion to the long-term viability of the division is put to discussion due to enhanced competition. An evaluation will be done whether to sell the division or not. Thirdly, the factors that influence the payback period are discussed and a critical analysis of the reduction in gearing is being done. Fourthly, an advice is being provided for the dependency on the financial ratios and budgetary controls.

Triton Corporation is having six divisions’ namely Electrical products, Floorboards, Car accessories, Individual services, Bathroom accessories, and Pipes division.

Bathroom accessories and pipes division contribute to only 5% of the total sales revenue each. Hence these two divisions are the low value-added items producing divisions. The overall profit margin of the company is 12% of which the bathroom accessories division and the pipes division are the least contributors. Thus it is evident that these two divisions are the low value-added items producing divisions.

Upon analysis of the statement of financial position, it can be understood that the current assets are $35m while the current liabilities are $20m. The current ratio is thus calculated as under:

Current Ratio = Current Assets / Current liabilities

Current Ratio = 35/20 = 1.75

The company is in a safe zone with reference to the current ratio as it is greater than 1 and so it is having sufficient current assets to cover up or repay and meet its current liabilities.

The working capital of the company is $15m. Apart from this, the company is having a loan capital of $48m.  The share capital of the company is $10m. The debt-equity ratio is thus calculated as under:

Debt Equity Ratio = Debt / Equity

Debt Equity Ratio = 48 / 10 = 4.8:1

Low Value-Added Items Producing Divisions

This ratio of the company is highly risky as the bank loan is 4.8 times higher than the equity capital of the company. The company is not having sufficient assets or capital to cover up its loans and liabilities (Laux, 2014).

An analysis of the profits generated by the various divisions reveals that the individual services division contributes to 53% of the total profits which is clearly the highest contributor. The pipes division contributes only 1% of the total profits and hence it might not be viable to operate and run this division. The reason for the low profitability is the high running and operating costs of the pipes division.

The next low profitable division is the bathroom accessories division. It contributes to 5% overall sales but requires 6% of the total costs and yields 3% of the overall profits of the company. Its performance can be considered to be better than that of the pipes division but from the larger angle, there is not much benefit from the bathroom accessories division as well.

The impact of these two divisions on the overall profitability of the company can be understood such that the company enjoys only 3% market share in the pipes division and 8% market share for the bathroom accessories division. As the working capital gets blocked in these two divisions as well, it leads to lower liquidity available with the company for meeting its other expenses and business requirements (Melville, 2013). As a result, it might not be able to spend on marketing or make other profitable investments, affecting the company’s long-term growth and efficiency. Even if the company takes efforts to increase its sales either by lowering the unit price or by devising strategies, not all of the gains might reach the company. In the long run, it lowers the company’s worth and hence a prospective buyer might ponder over these points before an acquisition or a merger (Leo, 2011).

Businesses are run not just for profits but also for long-term growth and sustainable existence of the company. A business cannot perform with a sole objective of making a profit rather it needs to find out measures that will help it to cater to the long-term growth and existence.

It is true that these two divisions are generating profits, but the gross margins are significantly lower than the industry average and so it is not compensating to the business owner (Greene, 2018). Operating a division just for the sake of operating it is not justifiable as positive returns and rewards have to flow from it. It is important for the business to have a strong profit zone so that it is able to ensure a smooth performance of the business (Melville, 2013).

Impact on the Overall Profitability

The negative cash flows are another sign of the business risk. Negative cash flows can dent the progress of the business and add pressure to it. The pipes division is at a point where a slight drop in the sales could make it a loss-making division. It is at such a peril and hence selling it off is a wise option (Marsh, 2009).

Every business firstly targets for profits after which the long-term sustainability and a healthy growth rate sets in. In case of these two divisions, the long-term viability is purely a question mark.

With a view to increasing the sales, the company might spend on marketing expenses which will ultimately lead to the fixed costs to rise. As the number of products is more, the operations and management become complex and less efficient (Petty et. al, 2012). Thus cutting the low margin items helps in the removing of expenses of a cross-subsidy.

The current market conditions are witnessing a general price rise and so the operating expenses are bound to increase. In such a case, even if the current level of sales remains and the costs increase, then the divisions might be making losses. There are chances and signs that these two divisions might become non-performing in the near future (Parrino et. al, 2012). If the company sells off these two units, then it can focus more on the other profitable divisions and increase the profitability from the same.

As the service-oriented industry is gaining more momentum, it would be best if the company can divert its resources to the other most profitable division which is Individual services. This can also be seen as a strategic plan that involves making the company stronger through divestiture (Petty et. al, 2012).

The sale of these two units will help the company raise funds as the cash can be invested into the business for a smoother working capital operating cycle.

It is also seen that a portion of the company might be worth more than the whole company. If the entire company is sold, the proportion of cash generated might be lesser than the sale of individual units. Hence selling off two units at the current stage is an apt decision (Deegan, 2011).

The strategic planning would be to utilize the cash generated from the sale for the growth of the business. Liquidity is created while the major control still remains with the company. This can also increase the earnings per share as the profitability improves. When the company is formed, with a view of diversification, many divisions are created but over the long run, the company might realize that not all the divisions are performing well (Needles & Powers, 2013). A synergy might be created as one plus one equals three. But this might not work out in all cases. Thus the product line that does not fit the overall business might be sold off.

Business Growth and Long-Term Viability

Whether the company is big or small, selling off a portion of a division is a common feature as it can free up cash. Also with the advancement in technology, it might become necessary to divest from some redundant operations and make newer ventures to suit the market needs (Porter & Norton, 2014). The cost of keeping and retaining the division might be higher than the returns generated from the same. The holding costs of inventory, manpower, time and costs are all incurred for very little returns. If the company is facing a financial crunch, then selling off the division provides a solution (Davies & Crawford, 2012).

Thus apart from enhancing shareholder value, this sale can also act as a catalyst for the company to repay its loan to a certain extent. Selling off these two divisions might not bring the company to a situation worse than its current position. It is just a way to de-risk itself and still navigates into the future with the liquidity generated (Porter & Norton, 2014). The business value is likely to increase after the sale of these two divisions also. It is an option to exit which is definitely a smart move.

(i)The company is planning to reduce its loan component and simultaneously plans to make investment in new equipments and replace the old ones and also invest in new products and projects. The payback period of a capital investment project depicts the number of years that will take to recover the amount of capital that has been invested in the project. The lesser the number of years it takes to recover the invested amount, the more profitable venture it is considered (Choi & Meek, 2011). The factors that may influence the length of the payback period of the company Triton Corporation are:

1. Sales- the major factor that shall affect the length of payback period is the revenue or sales from all the divisions. The payback period is that point of time when the total cumulative cash inflows are sufficient to meet out the amount invested in the project (Power, 2017). Hence the sale in different divisions of the company will be a major decisive factor in determination of length of the payback period. The sales must grow in a substantial limit so that the net cash flows also show a substantial growth so that the payback period can be achieved in lesser time period.
2. Material cost and other costs – the costs that are incurred by the company include material, salaries and wages and other costs which include interest on the capital borrowed, etc. The company will need to cut down these costs as more of these costs will result in lesser net cash inflows and thereby will increase the payback period tenure (Power, 2017). The payback period shall be affected by substantial increase in the costs incurred by the company.
3. Other factors that will affect the payback period include availability and payback of the sources of finance for acquiring new projects and equipments, political environment and tax laws, etc.

(ii)The company aims at reducing the gearing to the minimum possible and also to invest in modernisation programmes. For every kind of business, there is always a requirement of working capital or capital for investing in capital assets. Every organisation tries to maintain loans in the business at a minimum possible limit. This loan component is referred to as gearing. There are both advantages and disadvantages of less gearing in the business.

Advantages of lower gearing are:

1. The interest on the borrowed capital is reduced by reducing the loans or gearing. This helps in increasing the net cash flows of the business which can be invested in other profitable ventures and thus increase profitability.
2. There are lesser chances of liquidation of business in case the company is unable to pay off its loans in time.
3. Where there is high gearing in a business, investors consider it as a risky investment. Hence, lowering the loan component from the business shall attract more investment in the business.
4. High gearing increases the risk of rate changes and hence lesser investors would invest in the business fearing hike in the interest rates.
5. A low geared company is more likely to avail loans from its investors as it has a lower risk exposure due to lesser loan payments.

1. Where there are lesser loan payments, the profits or the net cash inflows are increased and hence the shareholders start expecting higher dividend payments.
2. The low gearing in a business implies more shareholder funds as the capital required for the business will be raised through share capital. There will be higher control of shareholders over the company in such a case.

The company is planning to introduce decentralization programme. The controls will be exercised from the head office by having a regular reporting system using financial ratios and budgets. The ratios analysis is a helpful tool in studying and understanding the financial statements of a company or organization over a period of time and comparison with other years as well. The use and advantage of using financial ratios and budgets for exercising controls can be summed up as under :

1. The financial ratios and budgets are prepared using accurate financial information and the ratios and budgets are prepared consistently over a period of time.
2. The ratios and budgets can be used in comparison to already set goals and benchmarks.
3. The ratios can be used to assess the financial performance of the company in comparison to previous years.
4. The comparison of other company’s financial performance can be done with own company using financial ratios
5. The ratio analysis can be used by managers to find out the weaknesses and strengths of the company and then different strategies can be made.
6. The ratio analysis is also important for investors so that they can compare the financial information with other companies as well (Ross et. al, 2014).

Selling off Low Performing Divisions

Although there are many advantages of ratio analysis and budgets, any decision making should not be made only on the basis of standalone ratios and budgets for the following reasons:

1.    The comparison of ratios with that of other companies may not be used where the companies in comparison use different accounting policies. For example, if a company uses the first-in-first-out basis of stock valuation and other company uses last-in-first-out basis, then a comparison of inventory ratios will not give accurate results (Ross et. al, 2014).
2.    Although the ratios depict that there has been a changing in the financial information but it does not explain the reason for the change in such financial information. Hence it cannot be solely used for making a decision about the changes occurring in financial data of the company over a period of time (Ross et. al, 2014).
3.    The ratios which are calculated using the figures of assets of the company cannot be relied upon as usually the assets are booked at historical costs rather than the current costs. Hence the accuracy of the ratios cannot be relied on for any decision making.
4.    There might be clerical errors in the calculation of ratios and preparation of budgets as the work will be done by

Hence it is advisable for the managers not to solely rely on the financial ratios and budgets prepared and depute personnel for managing control over the functions of the company. Top-level personnel should be deputed for this purpose and proper supervision should be exercised.

In case the company wants to expand its operations to low-cost countries, it should re-organize its working criteria in those countries. Following are some suggestions that can be implemented by the company:

1.    The company should try to raise more share capital through a share issue and try to take lesser loans. At present, the debt-equity ratio of the company is very high which implies that the company is in a high-risk state (Choi & Meek, 2011). When it will move to expand in other countries, it will require investors in those countries. Investors will not like to invest in high-risk companies. Hence the company should raise share capital to reduce the debt-equity ratio.
2.    The main business segment of the company at present is Electrical Goods which means that the company specializes in this segment. It should maintain its expertise in other countries as well and should try to enter into Electrical Goods segment first and other segments later on.
3.    Proper budgets should be made before expanding the operations so that later on variances can be minimized.
4.    The company should study the needs and habits of the customers of those newly entered countries and also the governmental policies so that it can comply with all the statutory requirements as well as respect the sentiments of people of those countries (Choi & Meek, 2011).
5.    As the countries to be entered are low cost, the company will have to introduce its products at a lower price as the price paying capacity of the people over there is already low.

Conclusion

Going by the overall analysis it can be commented that the company should strive to raise more capital through the process of issue of share and rely on less debt. When the level of debt is less, it will lead to lesser loans and hence less payment of interest.  The company needs to reduce the debt-equity ratio as it is high and might create a problem for the company. It is a common parlance that the investors are not willing to invest in companies that are riskier. Moreover, the company is witnessing negative cash flow and hence, a cause of concern for the company. The division will make losses in such a scenario and hence, it is imperative that the company should vouch on a different mechanism that will ensure a strong presence in the market and lead to profit.

References

Choi, R.D. and Meek, G.K. (2011)  International accounting. Pearson .

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Power, T. (2017) Fund choice: Comparing super funds in 8 steps [online].  Available at: https://www.superguide.com.au/boost-your-superannuation/comparing-super-funds-in-8-steps [Accessed 20 June 2018]

Ross, S., Christensen, M., Drew, M., Bianchi, R., Westerfield, R. And Jordan, B.(2014)

Vaitilingam, R. (2014) The Financial Times Guide to Using the Financial Pages. London: FT Prentice Hall.

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