Introduction
The ABC Corporation is a manufacturing company specializing in siding shingles and cedar roofing with yearly sales presently at approximately $1.2 million. A few months ago, the company’s chief executive officer has had the notion to utilize some of the shingle scrap materials to construct cedar dollhouses anticipating attaining a target growth of $3 million in years disposals in a span of three years. A newly hired controller of the corporation should provide a recommendation to the company’s manager to assist determine if the profit margin can be attained with the addition of dollhouses to the manufacturing line ( Cho & Doblas-Madrid, 2013). The determination of this entails preparing reports to provide the CEO portraying details about the approximated product costs, what is required to breakeven on the scheme, the possible risk factors, and the project’s level of return. The recommendation will address such factors as how the changes will impact the cash flow, potential investments, as well as financing options.
ABC Company Risk Profile
When one considers the products the organization is currently supplying to clients, an addition of the cedar dollhouses may not be taken as a tricky investment to expand the firm’s territories. Such products will be using materials that would typically be disposed of and adding worker wages and hours. All of such factors depict that the organization should be in possession of a green light to carry on with the new product line regardless of the many risks associated with the new venture ( Beatty & Liao, 2014). Among the top most risks ABD Company should consider is the present economical state. It is critical to note that whereas the current economy is booming, the normal American is not, unemployment level is still high, the same case applies to household debt, and the gross domestic product is typically flat ( Principles of Accounting , 2012). Regarding this information, ABC Company will have to determine the principal demographic they are providing their new product and if the market is willing to spend their finances on such goods. These are economic conditions that can affect the organization’s production in major ways. For a manufacturing company of ABC’s status, many industry and economic factors can curtail operations ( Cho & Doblas-Madrid, 2013). The factors may include new or existing competitors in the market, the plummet of the economy, in addition to additional cost of production of a new product.
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The management of the company needs to find experienced dollhouse builders to manufacture the desired outcomes. New materials in the industry are in many cases viewed with some standard of skepticism, as customers are rarely able to accept ready changes, an instance that is bound to cause a slow commencement of the new commodity ( Kanagaretnam, Lim & Lobo, 2013). Inflation can lead to uncalled for fluctuations in market prices, which in most cases render managerial accountants helpless.
CASH FLOW STATEMENT FOR ABC COMPANY (DIRECT METHOD)
ABC COMPANY
Cash Flow Statement
December 31, 2012
Particulars Amount ($) Amount ($)
Received from customers 1,260,000
Paid for expenses (250,000)
Paid for taxes 0
Paid to suppliers (830,000)
Cash flow from operating activities 180,000
Purchase of fixed assets (100,000)
Cash flow from investing activities (100,000)
Dividend paid (100,000)
Cash flow from financing activities (100,000)
Total change in cash flow (20,000)
Cash balance at the beginning of the year 70,000
Cash balance at the end of the year 50,000
Sources of funds for the organization
Cash flow statements are one of the highly essential financial statements for a company, as they identify the financial position of the organization. This is a statement that describes the outflow and influx and outflow finance for ABC Corporation, alongside how the finance is utilized within the company. Cash flow statements entail cash items, with non-monetary transactions not included in its purview. Finance for operating activities was $180,000, money the company has used to procure additional inventory ( Beatty & Liao, 2014). Additional long term assets of $100,000 were acquired by ABC Corporation to widen operations. The board of the company proposed a dividend payment of $100,000 as part of an agreement to investors. Additional finances of $70,000, which was invested in expanding the business allowed the organization $50,000 cash flow at the closure of the financial term ( Cho & Doblas-Madrid, 2013).
Cash flow improvement
Increased sales resulted from $50,000 positive cash flow, money utilized to expand production and operation, in addition to purchasing fixed assets. Profits permitted the corporation pay dividends, maintaining the demands generated by the broadening of the company in the form of cash flow and dividends required to finance the project (( Principles of Accounting , 2012).
Financing of project
The company generates sufficient funds to meet the wants of the proposed scheme, with enough cash on hand to finance all corporation needs. The company plans to maintain future cash at present levels to be able to preserve all its obligations, as well as carrying on with the production of dollhouses ( Cho & Doblas-Madrid, 2013). ABC Company in addition has the capability to debt finance, lessening its discount rate, as well as generating extra funds, a feat that will enable the management attain the capital structure at its ideal levels.
Additional Financing
To further enhance the cash flow, the company should heavily invest in other organization’s securities, such as common debts or stocks to earn additional cash proceeds in return. More common debts or stocks might also be issued to gather funds to invest on more lucrative sectors or to involve more manufacture activities by increasing its production activities. Nonetheless, full financing of this scheme will entail additional monetary support for raw materials to produce with more time ( Beatty & Liao, 2014). This means that additional funds will be required in the dollhouse project to be capitalized in and increased labor force to manufacture effectively to supply in time. Internal financing can also be acquired by corporate debt or issuing equity. The selection of which security to dispose at a specific time is contingent on a number of matters, for instance, firms capital structure, present market conditions impact on taxes and the hazard to the company of extra debt levels ( Kanagaretnam, Lim & Lobo, 2013).
Absorption and Variable Costing
Variable Costing income statement
Sales 1,200,000
Cost of goods sold: 800,000
Gross profit 400,000
Less operating expenses
Variable expenses 250,000
Fixed expenses 100,000
Total operating expenses 350,000
Income from operations 50,000
Absorption costing income statement
Sales 1,200,000
Less: cost of goods sold 800,000
Gross profit 400,000
Less variable costs 250,000
Fixed costs 100,000
Operating profit before tax 50,000
Product Expansion
The overall production cost for the expansion good is $60,000, for extra 5,000 unit, in addition to the per unit manufacturing expense for expansion product stands at $12.00 ( Kanagaretnam, Lim & Lobo, 2013). Adding this to the new product assists absorb the sales and fixed factory expenses. The per unit manufacture cost of present product was $9.73, before an addition of the new product was effected. Nonetheless, the cost of the current expansion good was a little higher that the present product. Addition of the new commodity leads to an increase in the total average cost slightly to $10.067 ( Beatty & Liao, 2014). Thus, the total cost per unit of the existing commodity and new expansion product adds up to $20.13. This is a situation that makes the current commodity cost stand at $8.13 per unit. Therefore, the expansion makes the current commodity cheaper by $1.60 rounded up.
Product Margin
If the company requires a 40% gross margin regarding the new commodity, they are to dispose the new commodity for $16.80 per unit. Assuming a similar sales mix of both goods, the contribution margin of the existing manufacture is $7.20 and the contribution margin of the overall desired production (expansion + current) is $7.03 for each unit ( Beatty & Liao, 2014). This situation is portrayed in the graph below:
Particulars Current Per Unit Expected Per Unit
Units disposed 800,000 750,000
Sales 1,050,000 12.5 1,134,000 12.742
Variable expense 462,000 5.5 522,000 5.87
Contribution margin 588,000 7 611,000 6.865
The break-even point takes place when: sales deduct variable expenses deduct fixed expense = zero. $12.742Q - $5.865Q - $355,850 = 0
Therefore Q = 51,734.91
Break-even quantity for ABC Company
This graph indicates that the break-even quantity for ABC Company is 51,375 units.
Net Present Value
NPV of the proposed project, disregarding depreciation and income taxes is negative $1,366.08 as indicated below.
Year Cost Saved Discount cost saved
1 15,000 13392.86
2 13,000 10363.52
3 10,000 7117.802
4 10,000 6355.181
5 6,000 3404.561
PV 40633.92
Prior investment 42000
NPV -1366.08
Cost of capital 0.12
Depreciation impact assuming a five year straight depreciation method
Year cost saved depreciation reduction in fixed costs
1 15000 8400 6600
2 13000 8400 4600
3 10000 8400 1600
4 10000 8400 1600
5 6000 8400 -2400
Considering the time value of money, the company should invest in the project because the new product is cheaper compared to the initial one ( Cho & Doblas-Madrid, 2013). The company should invest in this project but should seek additional financing as the scheme will entail additional cash.
Conclusion
Some important risks factors are visible in the project. For instance, clients’ commitment to the commodity of ABC Company is totally not secured. The organization’s future expansion forecasting is not supported by enough analysis and data. Furthermore, the valuation over the demand condition of both international and domestic is the new expansion commodity and its not effectively cleared by appropriate analysis. This is a project that involves both return potential and higher risks but as ABC is relatively medium or small sized, the gambling of increased risk will escalate the organization’s risk exposure at a comparatively high level. A higher price is imperative for the commodity to earn expected amount of profit, so it involves reduction risk in demand for ABC’s product. There is additionally risk of competition among companies and new entrants to take over the market.
As the management accountant and controller, I have the role for the coordination of management participation and accounting functions in controlling and planning the attainment of goals. Furthermore, one of my roles is to update the management about the scheme’s ability, make project profitability decisions, present details over the estimated commodity costs and revenue for the project.
The company should invest in the project regardless of the negative net present value because that is what defines successful and competitive firms. The chief executive officer should seek other methods to improve the project’s value, for instance, reducing the costs of production on the new commodity and charge a comparatively reduced price to attract a high number of consumers and increase profit.
References
Beatty, A., & Liao, S. (2014). Financial accounting in the banking industry: A review of the
empirical literature. Journal of Accounting and Economics , 58 (2), 339-383.
Cho, D., & Doblas-Madrid, A. (2013). Business cycle accounting east and west: Asian finance
and the investment wedge. Review of Economic Dynamics , 16 (4), 724-744.
Principles of Accounting. Volume II. (2012). San Diego, CA: Bridgepoint Education
Kanagaretnam, K., Lim, C. Y., & Lobo, G. J. (2013). Influence of national culture on accounting
conservatism and risk-taking in the banking industry. The Accounting Review , 89 (3), 1115-1149.
