ABC in the Manufacturing Sector: How to Streamline Your Business Processes

Introduction 

ABC is a company venturing in the manufacturing sector. According to Liozu, Hinterhuber, Boland & Perelli, (2012) , manufacturing firms are involved in the conversion of raw materials into finished products. While undertaking the production, ABC management will be bound to make the overall decision to reduce production cost as well as increasing its output. Therefore, the principal objective of this research paper is to help establish a rational decision as to whether the additional product (cedar dollhouses) by ABC Company will be a profitable or a costly investment. Also, the paper will analyze the risk factors associated with the expansion of the enterprise production line. Further, the research paper will compare the cash flow movements of ABC Company over a two years period. The paper will also focus on providing the appropriate recommendation to the CEO that will help him to make a reasonable decision regarding the company production expansion. 

Risk profile 

The prevailing economic and industry issues in the market may affect the overall production capability of ABC Company. The major economic condition which is likely to influence the expansion of new product is that there may be an increase in the raw materials prices which may adversely affect its production ( Liozu, Hinterhuber, Boland & Perelli, 2012) . Further, the company is likely to face financial problems due to the huge initial cash outlay required to commence the new investment as well as fund the current production. Additionally, the production process of the new product may be affected by the changing economic conditions in the country. Regarding industry overall risk factors, ABC Company is likely to lose its primary production employees to close rivals who may offer them competitive remunerations, thus, affecting ABC production ability ( Liozu, Hinterhuber,Boland & Perelli,(2012) . Further, the existing market for cedar dollhouses which ABC Company wants to start producing may be already saturated. Also, the new product may require being sold to new clients hence causing the company to bear extra selling and marketing costs. 

Cash flow statement 

ABC Company Limited 

Cash flow statement for the year ended 20X2 

Profit for the year before tax	$80,000
Cash-flows from operating activities
Decrease in accounts receivables	$60,000
Increase in accounts payables	$40,000
Depreciation charge	$70,000
Increase in income taxes payable	$30,000
Increase in merchandise inventory	($70,000)
Total cash-inflows from operating activities		$210,000
Cash flows from investing activities
New equipment purchase	($-100,000)
Total cash-outflows from investing activities		($-100,000)
Cash-flows from financing activities
Dividends issued	($100,000)
Total cash-outflows from financing activities		($100,000)
Cash-inflows for the year		$10,000
Add: Opening cash balance		$70,000
Closing cash balance		$80,000

From the cash-flow statement, it is evident that ABC Company utilized the majority of its cash on inventory purchase. In total, the company only gained $10,000 for the whole year. Though the company purchased the equipment at $100,000, it is a capital expenditure and thus will not be incurred every year. The company issued dividends to its equity owners hence reducing the level of cash flows from its financing activities. 

Based on the current cash-flow level, it is my opinion that ABC Company should issue out stocks as a financing option to raise enough capital to fund the cedar dollhouse project. However, the current cash-flow position of the company from its existing production is not sufficient to fund the new project since the project will require additional capital to finance other activities as the project is being undertaken. 

In the event ABC Company needs additional financing, I would suggest that they obtain debt financing. The advantage of obtaining debt finance as opposed to issuing out equity shares is because there will be no dilution in the company ownership by introducing new shareholders to the company. Further, the interest on loan finance will reduce ABC Company taxable income for the year since it an allowable expense against tax. 

5. Product cost. 

1. Product cost for the expansion product using absorption method 

Direct materials cost per product unit	$5.60
Direct labor dollars needed per product unit	$4.00
Variable Factory Overhead per machine hours	$ 1.00
Fixed variable factory overheads	$4.40
Total product cost per unit	$ 15.00

Product cost for the expansion product using variable costing method 

Direct materials cost per product unit	$5.60
Direct labor dollars needed per product unit	$4.00
Variable Factory Overhead per machine hours	$ 1.00
Total product cost per unit	$10.60

2. How much cheaper does this expansion make the existing product. 

Existing product’s Fixed factory overheads per unit	$ 2.475
Less: Fixed factory overhead after product expansion per unit	($ 2.20)
Price reduction per unit	$ 0.275

3. Price to set for the expansion product to attain a 40% margin. 

Gross margin = Gross profit/sales revenue*100 

Current gross margin = $400,000/$1,200,000*100 = 33.3% 

Therefore, new expansion price = 0.4*$14.50/0.33 = $17.42 

4. Computation of the contribution margins and break-even points of the product 

	Existing product	Expansion product
Units sold	80,000	85,000
Sales value	$1,160,000	$1,480,700
Less: Variable production costs	($408,000)	($901,000)
Contribution margin	$752,000	$579,700

At break-even point, contribution margin- fixed production overheads = 0 

Therefore, for existing product break-even point: 

$752,000- $198,000 =0 

Break-even point = $554,000 

New expansion break-even point 

$579,700-$198,000 =0 

Break-even point = $381,700 

Potential investments to accelerate profit 

The net present value decision rule states that all projects with positive net present value are acceptable whereas those projects with negative net present value should be rejected (Wainwright,2012). 

Net present value = Present value of cash-inflows-Present value of cash outflows 

Years	Cash-inflows	Present value of Cash-inflows  [1/(1+r) n ]
0	$ (42,000)	$(42,000)
1	$ 15,000	$13,393
2	$ 13,000	$ 10,364
3	$ 10,000	$7,118
4	$10,000	$6,355
5	$ 6,000	$ 3,405

Net present value = $40,635 - $ 42,000 = $ 1,365 

Annual depreciation for the newly purchased equipment using straight line method 

Depreciation = Cost – Residual value/ Useful life in years 

Annual depreciation = $ 42,000 – 0/5 years 

Annual depreciation = $8,400 

In the event of equipment depreciation, the annual depreciation charge will increase the company fixed cost by $ 8,400 for each of the five useful years of the equipment. However, the annual depreciation charge on the equipment will not have any effect on the company cash flows since there are no tax effects on the equipment which would otherwise cause a change on the company cash-flows (Wainwright,2012). 

The equipment purchase cost will reduce the cash flows from investing activities by a total of $42,000. However, the company should not consider purchasing the equipment since its overall net present value is negative (-$1,365). 

Conclusion 

According to Cinquini,& Tenucci, (2010), risk factor refers to uncertain events or conditions that may affect the way a particular project was planned. Risk factors are very common even in the most carefully planned projects. In the case of ABC Company, the targeted sale value in three years’ time is expected to be around $3 million from the current $1.2 million. To attain the goal, the company CEO must devise appropriate measures to increase the sales value by more than twice which is an aggressive strategy. 

Therefore, ABC Company strategy to successfully improve their sales volume may be affected by the following risk factors. 

1. There is a risk that ABC Company Cedar dollhouse which is a new product expected to be introduced in the market will not meet the demand and expectations of the customers. It may, therefore, result in a greater loss since the new product will eventually struggle in the market as its demand will be very low (Cinquini,& Tenucci, 2010). 

2. There may be a risk factor that the company CEO is not very familiar with the new product he/ she plan to launch which may cause some parts of the project to be missing. 

3. The new project may be faced with a risk of conflict between the company employees and the top management, particularly when they were not involved in the initial project plans. 

4. The leading team members assigned to work on the new project may resign from their job before the completion of the project, hence, posing a significant risk factor regarding project completion deadline (Cinquini,& Tenucci, 2010). 

5. The new project may also be faced with financial difficulties causing the project work to progress at a slow rate and not be in a position to complete the project as per the stipulated time frame. 

6. There is also a risk factor that the new project may be requiring the modern technological approaches which may be unavailable or might be very expensive to outsource from outside. 

7. The new project may not result into overheads saving, thus, increasing the overall company expenses which may weaken the company sales volume. 

Therefore, as a project controller and management accountant responsible for the ABC Company project, I will be responsible for the following: 

1. Defining the required management information at the commencement of the project so as to facilitate monitoring based on the project progress. 

2. Management and improvement of the financial processes of the project so as to attain proper financial control information (Cinquini,& Tenucci, 2010). 

3. Performing detailed analysis of the project development costs and revenues generated throughout the project. 

4. Following up the project progress to ensure that laid down procedures are accomplished promptly. 

6. Working closely with the company top management in steering the financial and commercial aspect of the on-going project. 

Since the CEO is in charge of the overall operations of ABC Company. He/she will, therefore, be responsible for any achievement or failure of the company undertakings (Cinquini,& Tenucci, 2010). Therefore, in the event the company CEO plan is to continue with the project, I would, therefore, recommend the following to him: 

I. The CEO should have proper information concerning the market of the new product. 

II. Check to confirm the effects of the new venture on other company’s major projects. 

III. To undertake a cost-benefit analysis of the project before its commencement. 

IV. Analyzing the project fixed cost required ahead of its commencement. 

References 

Cinquini, L., & Tenucci, A. (2010). Strategic management accounting and business strategy: a loose coupling?.    Journal of Accounting & organizational change ,    6 (2), 228-259. 

K Wainwright, S. (Ed.). (2012). Principles of Accounting: Volume II. San Diego, CA: Bridge point Education, Inc. 

Liozu, S. M., Hinterhuber, A., Boland, R., & Perelli, S. (2012). The conceptualization of value-based pricing in industrial firms.    Journal of Revenue and Pricing Management ,    11 (1), 12-34.