Financial Issues and Potential Causes
The report is prepared to evaluate the current financial situation of Gentry Electronics by applying the tool of ratio analysis, corporate governance data and risks. It is observed from the information displayed in the given case study that Gentry has been witnessing a year-on-year increase in their sales growth and despite increasing sales, there are certain concerns that might affect the strategic financial positioning of the company. With the inventory stockout increasing by 40% in the last three years, the future concern is associated with loss in sales. Hence. in this paper, the financial issues are discussed by identifying the potential causes of changes in relevant ratios. The later section of report demonstrates recommendations the organizational strategies that would help in maintaining and creating value for the company.
a)
Erica is concerned about increasing storage cost of inventory and increasing percentage of inventory in the total assets. Erica’s concern about the financial performance of Gentry Electronics is justified as it is well evident from the computed figures of relevant ratios.
b): Problems
- Considerable increase in current ratio of Gentry Electronics- It is observed from the above figure that current ratio has increased significantly over the years. Computed figure shows that current ratio increased from 2 and 2.25 in 2018 and 2019 to 2.41 and 3 in 2020 and 2021 respectively.
- Increase in acid test ratio indicating adequate availability of quick assets- Acid test ratio has also increased year on year from 1 in 2018 to 1.11 in 2019 to 1.13 in 2020 and thereafter to 1.46 in 2021.
- Reduction in gross profit margin- Furthermore, gross profit margin of Gentry Electronics has decreased over the years by significant value from 48% in 2019 to 33% in 2021, indicating that over the period of five years, percentage of gross profit reduced by 15%.
- Significant increase in cost of goods sold- Cost of goods sold has consistently increased at the alarming rate over the years by 78%.
- Increase in inventory turnover days- Apart from the above ratios, it is important to evaluate the inventory turnover in days. As observed from the above table, it is understood that inventory turnover days has increased over the four years period from 42.89 days in 2018 to 49.43 days in 2019 and it increased further to 50.48 days and 53.35 days in 2020 and 2021 respectively.
c): Implications
- Increase in current ratio is considered desirable as it signifies increasing capability of current assets to meet the near-term obligations. Such excessive increase in current ratio is particularly attributable to significant increase in the current assets value over the years by 114%. However, excessive increase in current ratio is not considered desirable because higher value of current ratio indicates that the current assets are not being efficiently utilized by the company (Irman and Purwati 2020).
- It is suggested by the figures of acid test ratio that Gentry electronics has adequate level of cash that can be utilized to support the growth of business. The increase in acid test ratio is associated with an increase in value of current assets significantly (Khalid et al.2018).
- Decrease in gross profit margin indicates that increase in cost of goods sold has been greater than sales growth rate, which indicates operational inefficiency on part of Gentry Electronics in managing its variable cost of production, material and labour (Someh et al. 2019).
- Significant increase in cost of goods sold is indicative of the fact that the profit margin would be adversely impacted.
- Increase in inventory days is not considered desirable for Gentry because higher turnover days is indicative of the fact that the company is not able to effectively convert its inventory into sales. In addition to this, cash flow of the company might be negatively impacted because of holding of excess inventory (Kontuš and Mihanovi? 2019).
d): Potential causes of changing ratios
- Reason for abrupt increase in current ratio is that the amount of current assets in relation to current liabilities has increased significantly leading to higher ratio over the years.
- The increase in acid test ratio is associated with an increase in value of current assets significantly.
- This deterioration in the gross profit percentage can be attributable to a considerable increase in cost of goods sold. Although, sales have increased, gross profit percentage has reduced due to the increasing cost of goods sold.
- The reason for increase in cost of goods sold is due to increase in the storage cost of inventory and renting of the additional warehouse due to diversified inventory possessed by the company.
- Increase in inventory turnover days is due to increase in inventory stockouts because too much of idle inventory is detrimental to the overall financial performance as such inventory eventually becomes unsellable and obsolete.
a): Remedies
In order to improve the performance of Gentry Electronics, the potential remedies to address the problems are outlined in the below section.
- Improving the turnover of inventory by clearing outdated stocks
- Adoption of leaner working capital cycle
- Improving accuracy of demand forecasting
- Efficient restocking
- Lessen inventory diversification and rent lesser warehouse
b) How remedies would alleviate concern of Erica
- It is essential to improve the inventory turnover of Gentry by lowering the inventory cycle period. In the given case, it is observed that inventory of Gentry is burdened by the leftover stock with little demand. In such situation, sales of old stock should be encouraged by giving special discounts and using promotional strategy that would help in moving the inventory out of stock. A remedy that is worth considering is launching special marketing campaign intended to move or clear the unsold and outdated stock (Lin et al.2018).
- The excess of current assets has resulted in undesirable higher current ratio that needs to be addressed for the efficient utilization of resources. Leaner working capital cycle should be adopted which would ensure reduction and help in controlling the current assets (Boisjoly et al. 2020).
- The accuracy of demand forecasting should be improved so as it prevents the unnecessary inventory lying idle in stocks and eventually getting obsolete. It is therefore critical to forecast the demand accurately by identifying the market trend and seasonal demand pattern of the product.
- Efficient restocking is also considered critical to address the issue of increasing percentage of inventory in the assets. The sales cycle should be kept on fire by developing robust stock of the desirable items and also such items should be stocked in smaller quantity so that the turnover can be positively affected (Amanda 2019).
- Another concern of increasing cost of goods sold and this is also due to rising storage cost. It is observed that inventory is being written off due to obsolescence. Gentry electronic rent additional warehouse to store diverse inventory which is also increasing the inventory storage cost. In order to address, it is important to lessen the inventory diversification and rent lesser warehouse so that storage cost reduces. In addition to this, wherever possible, lower cost material lower cost material should be substituted as it forms an important component of cost of goods sold. Costs of goods sold can also be improved by eliminating the costly waste and stopping the stockpiling of the products that is no more desirable (Nofiana and Sunarsi 2020).
a) Two possible concerns
Since Erica intends to boost financial position of Gentry Electronics and raising the capital base by proactively trading in the foreign currency despite the fact that they do not have the authority to deal in foreign currency trading. It indicates the desperation of Erica to make the company look attractive to the investors and expand it internationally, even though they intend to do it or not (Marodin et al. 2018). In such situation, doing the things right way can be obstructive for Erica. Some of the concerns can be raised by Erica in view of the above suggestions are as follows.
- The option of restocking might not be so attractive because the inventory already represents 35% of the assets. Hence, clearing off the unsold inventories by offering discount would be better in the current situation rather than restocking. restocking can be the next step after the unsold stocks or stock lying idle have been dealt with.
- Reducing the inventory diversification might not appeal Erica because she intends to attract investors with the objective of increasing the capital base. Lessening the diversification of inventory might not sent good impression for the company intending to expand internationally (Nguyen et al.2020).
b) Two alternative source of finance
In such situation, alternative sources of finances can be offered to Gentry Electronics and they are as follows:
- Increasing short term loans- Raising the short-term loans can be considered apt in the situation where current ratio is unreasonably higher. In such situation, Gentry can raise funds by increasing their current liabilities, that is the proportion of short-term loan against long term loan cab be increased. Such increment in the current liabilities should not be done in association with increase in current assets (Nwude et al.2018).
- Gentry electronics can also opt for venture capital financing where long-term investment is provided to the company in exchange for equity. Active support can be provided to the firm intending to expand internationally by the venture capitalist firm. Finance opted through venture capital would help Gentry electronics with greater success and faster growth (Lin et al.2018).
a): Financial or operating risks
The two operational and financial risks that Gentry would face if the suggestions of Erica and Jeff were adopted are as follows.
- The idea of Erica to build currency base by trading in the foreign currency is associated with the operational risk such as transaction risk, economic risk and translation risk. Any changes in the rate of exchanges between the currencies would impact the financial performance or financial position of the Gentry Electronics. It is because the financial transaction in the international business should be converted into home country currency. Any change in value of one currency against another poses financial risk in term of its impact on the financial position. In addition to this, there also exists operational risks resulting from settlement errors or trade processing and the consequence of managing the wrong position resulting in large loss for the portfolio of firm. In addition to this, operational risk in foreign currency transaction also increases due to the third-party payments (Lubnina et al. 2018).
- Making public offering of the shares can be sometimes risky as such investment is speculative. Risks associated with the financing by issuing of shares could have a significant impact on the operations and performance of the business. The support of underwriter in issuing the shares is only in the initial phase that prevents the share price from falling. Stock price might decline significantly below the offer price once the underwriters support ends. In such situation, Gentry electronics might face great deal of financial risks (Landi and Sciarelli 2018).
b): Ethical or corporate governance issues
From the information given in the case study, it is understood that Gentry Electronics might face issues of corporate governance resulting from idea of Erica to manage the financial position of the company. Some ethical or corporate governance issues that might arise relating to Jeff and Erica business development ideas are as follows.
- Transparency issue- The idea of Erica to make investors just believe that the company is expanding results in compromising trustworthiness and creates transparency problems.It is important for the organization to disclose the process and transactions of doing business to the shareholders and not disclosing the same hampers transparency (Braunack et al. 2020).
- Leadership issue- Leadership character is another corporate governance issue being faced by Gentry electronics because of the fact that its leader does not intend to conduct the business in good faith. The intention of Erica to misrepresent the facts in an effort to facilitate the business growth of Gentry to increase capital base by duping investors questions the character of a leader.It also indicates lack of sense of irresponsibility towards the shareholders and shows that leader lacks integrity (Hughes et al. 2019).
Conclusion
The report demonstrating the overall evaluation of the financial performance and corporate governance of Gentry Electronics using financial data ascertains that in the current scenario, the company is facing issues relating to its financials such as increasing cost of goods and stockpiling due to high stockouts rate. It is important for the company to work on its overall liquid position to improve the financial performance and make it suitable for the international expansion. It is because in the current situation, Gentry Electronic is not operating efficiently that has hampered its liquidity performance and thereby the financial position. Apart from the examination of the financial performance, it has been found that the company is also facing few ethical issues in relation to the ideas put forward by the CEO of the company. Such idea is compromising the corporate governance of the company by misrepresenting the investors and keeping them in delusion about the financial strength of the company.
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