ABC Company Analysis

Introduction

The below analysis focuses on a manufacturing firm ABC. The two major products made by ABC company are cedar roofing and siding shingles. Currently, ABC annual sales is around $ 1.2 million which represents an increase of 25 % from the previous financial year sales. ABC company sales are projected to reach $ 3 million within the next three years. To be able to attain the targeted sales, the company CEO is exploring alternative product that can be produced through the utilization of their current employee’s skills as well as the existing company facilities. The company CEO plans to utilize scrap shingle materials in the production of cedar dollhouses as the new product. As per the CEO recommendation, the new product line will be worth introducing as it will provide additional raw materials and also requires less time to produce compared to cedar shingles. However, despite the fact that the production of the new product line will add to the ABC expenses, it will play a significant part in attaining the targeted sales growth as well as raising the company overall revenue. 

ABC Risk Profile

Risk is the possibility of the anticipated results differing with the actual results. In this case, as ABC company is trying to diversify its production, the company is likely to be faced with various risk. The expansion strategy being adopted by ABC company of increasing its current sales by 2.5 times within the next three years is a very risky undertaking. This expansion strategy will, thus, be faced with various economic and industry issues. Economic and industry risk in this case are both unsystematic risks meaning that ABC company cannot be able to control them ( Loosemore, et.al 2012) . 

The economic risks likely to affect the expansion strategy of ABC company include: price fluctuation of raw materials necessary for the production of cedar dollhouses as a result of price hiking by suppliers or foreign exchange risks in case the materials will be outsourced from another country; Inflation is another economic risk that may affect the expansion strategy of ABC company as it will cause overall reduction in sales level as a result of increased selling price of the new product; and risk of failing to complete the expansion strategy within the stipulated timeframe as a result of disruption by other adverse economic conditions ( Loosemore, et.al 2012) . On the other hand, the industry risks likely to affect ABC company while trying to diversify its production include: stiff competition from new and existing manufacturers which may lead to low sales level; risk of losing the key manufacturing personnel’s assigned to manufacture the new product to competitors especially in the event where the competitors offers them handsome packages and more good working conditions than they are currently receiving at ABC; another industry risk likely to affect ABC company is the acceptance of their new product by customers especially if customers were already used to similar products from other manufacturers who have been in this industry for long time ( Loosemore, et.al 2012) . 

Cashflow Statement

ABC Company Limited 

Statement of Cash Flow 

	Dec. 31, 20X2
OPERATING ACTIVITIES
Profit before Tax	80,000
ADD: Depreciation charge	70,000
Cash flows before working capital changes	150,000
WORKING CAPITAL CHANGES
ADD: Decrease in accounts receivables	60,000
LESS: Increase in merchandise inventory	(70,000)
ADD: Increase in accounts payables	40,000
ADD: Increase in income tax payable	30,000
Cash flows before taxation	210,000
LESS: Income tax	(30,000)
CASH FLOWS FROM OPERATING ACTIVITIES	180,000
INVESTING ACTIVITIES (A)
Purchase of equipment	(100,000)
CASHFLOWS FROM INVESTING ACTIVITIES (B)	(100,000)
FINANCING ACTIVITIES
Dividends declared and paid	(100,000)
CASHFLOWS FROM FINANCING ACTIVITIES (C)	(100,000)
TOTAL CASH INFLOWS (A+B+C)	(20,000)
ADD: Opening cash balance	70,000
CLOSING CASH BALANCE	50,000

Sources and Uses of ABC Company Funds 

Generally, companies generate their funds from their three major activities which are operating activities, investing activities and financing activities. However, based on the above ABC company statement of cashflow, it is clear that the major sources of its fund was operating activities which was cash received from ABC company customers of $ 180,000. The cash generated by ABC company from its operating activities was used in its financing and investing activities. Specifically, the $ 180,000 generated from operating activities $ 100,000 was used in investing activities to purchase some assets while another $ 100,000 was used in financing activities to pay dividends to the company shareholders. 

Improvement of ABC Cashflows

ABC company can implement the following strategies so as to improve its current cash inflows. Offering discount to cash customers and credit customers settling their debts on time basis; automating its sales system to facilitate card payments; evaluating credit worthiness of its customers before granting credit to them and engaging the services of debt collectors to collect all its overdue debts. On the other hand, in order for ABC company to improve its cash outflows, the firm should capitalize on the various benefits extended by their lending partners and creditors. 

Financing of the New Project

The new expansion project by ABC company cannot be financed fully by its current cash flow level of $ 50,000. This is because, the new expansion project will require investment of more additional funds to finance purchase of raw materials, production labour and product delivery to customers. 

Extra Financing Option

In the event of extra financing requirement by ABC company, I would recommend that the company finance its project using debt financing instead of equity. This is because, by obtaining corporate debt ABC company will be in control of its debt repayment. On the other hand, equity financing would liquidate the company ownership as well as forcing the company to declare and pay dividends to equity owners every financial year ( Denis, & McKeon, 2012) . 

Product Cost 

Product Cost Under Absorption and Variable Costing Methods 

	$
Direct materials	28,000
Direct Labour	20,000
Variable factory overhead	5,000
Variable selling expenses	1,000
TOTAL PRODUCT COST	54,000

Therefore, the total product cost for the expansion product is $ 54,000 under both absorption and variable costing techniques which is equivalent to $ 10.8 per unit. This is because, the fixed element of this product is not factored in because ABC company will have to incur fixed cost even if they don’t undertake the expansion strategy. 

Effect of Expansion Product on the Existing Product 

	Existing Product	Expansion Product	Total Cost
Units expected to be produced and sold	80,000	5,000	85,000
Total machine hours	40,000	5,000	45,000
	$	$	$
Direct materials	104,000	28,000
Direct Labour	224,000	20,000
Variable factory overhead	40,000	5,000
Variable selling expenses	16,000	1,000
Fixed factory overheads	198,000		198,000
Fixed selling expenses	191,250		191,250
TOTAL COST	773,250	54,000	54,000
Units expected to be produced and sold	80,000	5,000	85,000
Product unit cost	9.67	10.80	9.73

The expansion product makes the existing product cheaper by $ 9.73-9.67 = $ 0.06 per unit. 

Selling Price for the Expansion Product 

Total cost ($)	54,000
Profit margin on sales (40*54,000/60) ($)	36,000
Total sales ($)	90,000
Selling price per unit ($)	18

Contribution Margin and Break Even Point from the Sales Mix 

	Existing	Expansion	Total
Sales	1,160,000	90,000	1,250,000
Variable Cost	384,000	54,000	438,000
CONTRIBUTION MARGIN	776,000	36,000	812,000
CONTRIBUTION MARGIN RATIO			0.66
LESS: Fixed Cost			389250
Profit			422,750

At break-even point, total sales equals to total cost 

Therefore, Total Sales-Variable Expenses-Fixed Expenses =0 

Break-even point in sales= $ 1,250,000 – 438,000- 389,250 =$ 422,750 

Potential Investment 

Computation of Net Present Value 

Year	Amount ($)	PVIF12%
0	(42,000)	1.0000	(42,000)
1	15,000	0.8929	13,394
2	13,000	0.7972	10,364
3	10,000	0.7118	7,118
4	10,000	0.6355	6,355
5	6,000	0.5674	3,404
NPV			(1,366)

Impact of Depreciation on the Factory Fixed Costs 

Annual depreciation = $ 42,000/5 years = $ 8,400 per year 

Year	1	2	3	4	5
Fixed cost savings	15,000	13,000	10,000	10,000	6,000
LESS : Annual depreciation	(8,400)	(8,400)	(8,400)	(8,400)	(8,400)
Annual Fixed cost savings before taxation	6,600	4,600	1,600	1,600	(2,400)

The straight-line depreciation method will lead to a decrease in the annual fixed costs from year 1 to year 4, but in year 5, it will increase the fixed costs due to less fixed costs savings. However, the annual depreciation will have no effect on the annual cash flows since the tax effect is not been considered in this case. 

Equipment Purchase Decision 

Based on the above computed NPV, ABC company should not purchase the equipment since it has a negative NPV. 

Conclusion 

Major Risk Factors 

The major risk factor in this case is that the expected company sales increase from the current $ 1.2 million to $ 3 million mayn’t be achieved as evident from the computations. Additionally, there is a risk factor in that ABC company is extremely optimistic of using the new products as an expansion strategy without providing any alternative in the event the new product is not accepted in the market by consumers. 

Controller and Management Accountant Responsibility 

As the company controller and management accountant I will be responsible for the various accounting and cost management functions especially in regards to the new product expansion strategy to ensure that the CEO objectives are achieved within the three years’ time. 

Recommendation to the Company CEO 

The recommendation to the CEO is that, he/she should undertake deep analysis of this new expansion strategy. This should include the success probability of the new product, the probability of acceptance of the new product by customers so as to meet the intended sales objectives. This is because, by ignoring such analysis, there maybe some unidentified risks which might inhibit the success of this expansion strategy. 

References 

Loosemore, M., Raftery, J., Reilly, C., & Higgon, D. (2012).  Risk management in projects . Routledge. 

Denis, D. J., & McKeon, S. B. (2012). Debt financing and financial flexibility evidence from proactive leverage increases.  The Review of Financial Studies ,  25 (6), 1897-1929.