Calculation of Cash Conversion Period
The first part of this paper requires the calculation of the cash conversion period (CCP) for the given company for a period of five years (i.e. 2013 to 2017), which is shown below.
Cash Cycle Period
In order to calculate the CCP, the relevant details have been extracted from the financial statements for the respective years. The table below shows the calculation in details.
|
Calculation of Cash Conversion Period |
|||||
|
Particulars |
2013 |
2014 |
2015 |
2016 |
2017 |
|
Revenue from sale of goods |
$45,086 |
$56,247 |
$120,768 |
$164,840 |
$245,873 |
|
Cost of sales |
$22,773 |
$29,387 |
$75,310 |
$97,675 |
$167,772 |
|
Trade and other payables |
$9,977 |
$8,308 |
$29,768 |
$22,373 |
$69,816 |
|
Trade and other receivables |
$18,602 |
$22,350 |
$41,077 |
$41,012 |
$83,392 |
|
Inventories |
$5,180 |
$10,092 |
$20,453 |
$15,655 |
$28,451 |
|
Inventory Turnover Period (A) |
83 |
125 |
99 |
59 |
62 |
|
Debtor Collection Period (B) |
151 |
145 |
124 |
91 |
124 |
|
Creditor Payment Period (C ) |
160 |
103 |
144 |
84 |
152 |
|
Cash Conversion Period (A+B-C) |
74 |
167 |
79 |
66 |
34 |
Table 1: Calculation of Cash Conversion Period
(Source: Created by author)
From the table above, it shows that the CCP of the firm has been inconsistent and decreasing during the period under review.
The trend in Cash Flow
The cash flow of the firm has also been fluctuating which is shown below. It is needless to mention that fluctuating ash flow may adversely affect the liquidity of the firm in the short-run (Drobetz et al., 2017)
|
Particulars |
2013 |
2014 |
2015 |
2016 |
2017 |
|
Cash and cash equivalents |
$16,822 |
$11,559 |
$17,149 |
$17,406 |
$10,269 |
Table 2: Trend in Cash Flow
(Source: Created by author)
Question 2
In the given scenario for Telesmart Ltd, the CEO has received the three offers from different departments of the business for increasing the profitability of the business. However, in this context, it may be wise to assess the implication of each of the proposals in the light of the existing situation and also in the context of the relevant theoretical framework in this regard.
Existing Situation
Presently, the business produces 5,000 units with the selling price of $420 per unit. As per the cost data of the operations, the total variable cost is $180 per unit that makes per unit of the contribution of $240 for the firm and consequently total contribution of $1,200,000. On the other hand, the total fixed cost of the firm for the last year has been $960,000. Based on the given data, the break-even point (BEP) may be calculated to be 4,000 units and margin of Safety (MOS) to be $420,000. BEP is basically a division of fixed cost by per unit contribution (??????????, 2012).
|
Profitability in Existing Situation |
||
|
Particulars |
Amount $ |
Amount $ |
|
Sales (Units) |
|
5,000 |
|
Selling Price/ Unit |
|
420 |
|
Variable Cost/ Unit: |
||
|
– manufacturing |
144 |
|
|
– selling & administrative |
36 |
180 |
|
Contribution/ Unit |
|
240 |
|
Total Contribution |
1,200,000 |
|
|
Fixed Cost |
||
|
– manufacturing |
460,000 |
|
|
– selling & administrative |
500,000 |
960,000 |
|
Net Profit |
|
240,000 |
|
Break Even Point (Unit) |
|
4,000 |
|
Break Even Point (Amount) |
|
1,680,000 |
|
The margin of Safety (MOS) |
|
420,000 |
Table 3: Profitability in Existing Situation
(Source: Created by author)
The above table shows the calculation in details. It also shows that the profit volume ratio (contribution/ sales) is almost 57% in the present cost structure with break-even sales of $1,680,000. The subsequent sections of the report, briefly describe the pros and cons of each alternative as suggested by the production manager, sales manager and marketing director.
Evaluation of Alternative 1 (Production)
The option suggests the quality enhancement which may cause an additional variable manufacturing cost burden of $28 per unit and an implication of fixed selling cost of $30,000 for advertisement. It is needless to mention that the alternative cost structure will be different as there have been increases in both costs (Kulchania, 2016). However, the initiative, as advocated by the production manager, will boost up sales by 30%.
|
Profitability in Alternative 1 (Production) |
||
|
Particulars |
Amount $ |
Amount $ |
|
Sales (Units) |
|
6,500 |
|
Selling Price/ Unit |
|
420 |
|
Variable Cost/ Unit: |
||
|
– manufacturing |
172 |
|
|
– selling & administrative |
36 |
208 |
|
Contribution/ Unit |
|
212 |
|
Total Contribution |
1,378,000 |
|
|
Fixed Cost |
||
|
– manufacturing |
460,000 |
|
|
– selling & administrative |
530,000 |
990,000 |
|
Net Profit |
|
388,000 |
|
Break Even Point (Unit) |
|
4,670 |
|
Break Even Point (Amount) |
|
1,961,321 |
|
The margin of Safety (MOS) |
|
768,679 |
Table 4: Profitability in Alternative 1 (Production)
(Source: Created by author)
The calculation above in the table shows that the increase in sales has contributed towards an increase in the contribution, in spite of per unit fall in contribution from $240 to $212. Consequently, net profit has also increased significantly though there has been a simultaneous increase in BEP also by almost 670 units. In other words, the operation under this alternative approach may not be able to achieve cash flow so quick the way the business is presently recovering its cash from the operations.
Trend in Cash Flow
Evaluation of Alternative 2 (Sales)
The second option is presented by sales manager through an advice of ad-hoc increase in sales price and assumed fall of sales volume by 10% along with $50,000 investment in an advertising campaign. However, the profit position in such scenario will be $340,000 more than the present situation of $240,000.
|
Profitability in Alternative 2 (Sales) |
||
|
Particulars |
Amount $ |
Amount $ |
|
Sales (Units) |
|
4,500 |
|
Selling Price/ Unit |
|
480 |
|
Variable Cost/ Unit: |
||
|
– manufacturing |
144 |
|
|
– selling & administrative |
36 |
180 |
|
Contribution/ Unit |
|
300 |
|
Total Contribution |
1,350,000 |
|
|
Fixed Cost |
||
|
– manufacturing |
460,000 |
|
|
– selling & administrative |
550,000 |
1,010,000 |
|
Net Profit |
|
340,000 |
|
Break Even Point (Unit) |
|
3,367 |
|
Break Even Point (Amount) |
|
1,616,000 |
|
The margin of Safety (MOS) |
|
544,000 |
Table 5: Profitability in Alternative 2 (Sales)
(Source: Created by author)
However, the break-even point will be reduced to 3,367 which is surely a positive indication for the business as the management will be able to recoup cash much before then the present scenario.
Evaluation of Alternative 3 (Marketing)
On the other hand, the third option is presented by the marketing director which intends to boost up sales by offering a rebate in the first 1,500 units. Such a proposition would involve an investment towards advertising as well.
|
Profitability in Alternative 3 (Marketing) |
||
|
Particulars |
Amount $ |
Amount $ |
|
Sales (Units) |
|
6,000 |
|
Selling Price/ Unit |
|
413 |
|
Variable Cost/ Unit: |
||
|
– manufacturing |
144 |
|
|
– selling & administrative |
36 |
180 |
|
Contribution/ Unit |
|
233 |
|
Total Contribution |
1,395,000 |
|
|
Fixed Cost |
||
|
– manufacturing |
460,000 |
|
|
– selling & administrative |
560,000 |
1,020,000 |
|
Net Profit |
|
375,000 |
|
Break Even Point (Unit) |
|
4,387 |
|
Break Even Point (Amount) |
|
1,809,677 |
|
The margin of Safety (MOS) |
|
665,323 |
Profitability in Alternative 3 (Marketing)
(Source: Created by author)
The calculation shows that the net profit stands at $375,000 with MOS of $665,323, much higher than the existing MOS of $420,000. However, the BEP increases by almost 387 units, which may not be a positive sign for the operations.
Question 3
In the case of Free Wheels Ltd, the company maintains a specific cost structure and more than 60% profit volume ratio. All the fixed overheads are apportioned on the basis of monthly budgeted production of 6,000 units. However, the given scenario requires the evaluation of two alternative proposals taking into consideration the overall production capacity of 100,000 units (Situation 1) and 90,000 units (Situation 2).
Evaluation of Situation 1
In the first situation, the overall production capacity of the business is 100,000 units. The offer received from Cycle World Ltd. involves the additional production of 25,000 bikes, which would make the total production of 97,000 units, well within the range of total production capacity.
|
Profitability in Existing Situation |
||
|
Particulars |
Amount $ |
Amount $ |
|
Sales (Units p.a.) |
|
72,000 |
|
Direct Material Cost/ Unit |
75 |
|
|
Direct Labour Cost/ Unit |
35 |
|
|
Variable Factory Overhead/ Unit |
10 |
|
|
Variable Selling and Administrative Cost/ Unit |
25 |
|
|
Total Variable Cost/ Unit |
145 |
|
|
Selling Price/ Unit |
370 |
|
|
Contribution/ Unit |
|
225 |
|
Total Contribution |
16,200,000 |
|
|
Fixed Factory Overhead |
1,440,000 |
|
|
Fixed Selling and Administrative Cost |
1,440,000 |
2,880,000 |
|
Net Profit |
|
13,320,000 |
Table 7: Profitability in Existing Situation
(Source: Created by author)
In the existing cost structure, the net profit of the business stands at $13,320,000. However, the first proposal needs to be checked in the light of contribution and break-even point. Based on the calculation performed in the table below, it shows that the price of $235.20 should be the minimum price that the management of Free Wheels Ld may need to quote to Cycle World Ltd for the given order.
|
Evaluation of Situation 1 |
|
|
Particulars |
Amount $ |
|
Direct Material Cost/ Unit |
75 |
|
Direct Labour Cost/ Unit |
35 |
|
Variable Factory Overhead/ Unit |
10 |
|
Total Variable Cost/ Unit |
120 |
|
Sales (Units) |
25,000 |
|
Total Variable Cost |
3,000,000 |
|
Total Fixed Cost |
2,880,000 |
|
Total Cost |
5,880,000 |
|
Cost/ Unit |
235.20 |
Table 8: Evaluation of Situation 1
(Source: Created by author)
Evaluation of Situation 2
However, if the total production capacity is 90,000, there may be a gap of 7,000 units which may be priced differently. However, since this is a standalone order from Cycle World Ltd, here should be two different prices quoted for this order. Hence, the revised price will be $242.20, which is shown in the table below.
|
Evaluation of Situation 2 |
|
|
Particulars |
Amount $ |
|
Normal Sales (Units) |
18,000 |
|
Additional Sales (Units) |
7,000 |
|
Total Variable Cost/ Unit for Normal Sales |
120 |
|
Total Variable Cost/ Unit for Additional Sales |
145 |
|
Total Variable Cost |
3,175,000 |
|
Total Fixed Cost |
2,880,000 |
|
Total Cost |
6,055,000 |
|
Cost/ Unit |
242.20 |
Table 9: Evaluation of Situation 2
(Source: Created by author)
Assessment of Offer
Based on the discussion and analysis, it seems that the management of Free Wheels Ltd may need to charge a minimum price for the offer of Cycle World Ltd. However, it may be noted that of the production capacity of the firm does not increase and the normal demand of its product gradually grows, the company may not be in a profitable position as far s quoting the lowest price to the offer of Cycle World Ltd. is concerned. This is because the firm does not earn any profit out of the order of 25,000 bikes. However, such a situation is acceptable only if the offer strengthens the business relationship with one of the potentially huge customers (Miettinen and Stenbacka, 2015).
References
Drobetz, W., Haller, R., Meier, I. and Tarhan, V. (2017). The impact of liquidity crises on cash flow sensitivities. The Quarterly Review of Economics and Finance, 66, pp.225-239.
Kulchania, M. (2016). Cost Structure and Payout Policy. Financial Management, 45(4), pp.981-1009.
Miettinen, T. and Stenbacka, R. (2015). Personalized pricing versus history-based pricing: implications for privacy policy. Information Economics and Policy, 33, pp.56-68.
??????????, ?. (2012). Systemic informed break-even point. Technology audit and production reserves, 4(2(6), pp.5-6.
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