Faculty Of Business And Law: Performance Management 201

Faculty Of Business And Law381acc Performance Management 2016 November

Prepare a cash-flow budget and a profit budget for Sehat Ltd based on Strategy A, including quarterly forecasts. Similarly, prepare a cash-flow budget and a profit budget for Sehat Ltd based on Strategy B, also split into quarterly intervals. Compare and contrast the two sets of budgets to analyze their implications. Finally, advise Sehat Ltd's management on the relative merits of the two strategies, recommending which to adopt and providing justification.

Paper For Above instruction

Introduction

Effective financial planning is fundamental for any business seeking to optimize operations and maximize profitability. In the context of Sehat Ltd, a company specializing in health-promoting products like the KleenAir air purifier, strategic choices concerning investment, inventory, credit policy, and sales significantly influence financial outcomes. This paper aims to develop comprehensive quarterly cash-flow and profit budgets under two contrasting strategies—aggressive (Strategy A) and conservative (Strategy B)—and to analyze their impacts. Finally, a reasoned recommendation is provided based on the comparative analysis, considering operational risks, liquidity, profitability, and strategic positioning.

Methodology and Assumptions

This analysis employs the data provided, including projected sales, production costs, inventory valuation, capital expenditure, credit policies, and other financial details for 2017. Key assumptions include constant sales and production rates per quarter, standardized inventory valuation at $320 per unit, and strict adherence to specified credit terms for each strategy. Depreciation, interest expenses, and tax considerations are incorporated following the company's accounting policies. Cash flows are adapted to reflect payments on credit and expenses, with the overdraft utilized for cash shortfalls. The budgets are constructed sequentially for each quarter, considering opening balances, inflows, outflows, and closing balances.

Strategy A: Aggressive Growth Approach

Capital Investment and Production

In January 2017, Sehat Ltd invests $720,000 in new production equipment (cash outflow). Production is scheduled at 1,800 units/month in quarters 1 and 2, decreasing slightly to 1,650 units/month in quarters 3 and 4. Sales are projected at 1,350 units/month (quarters 1 and 2) and 1,650 units/month (quarters 3 and 4), with a higher inventory level expected due to increased sales and production capacity. The company offers 70% credit sales, extending two months' credit, leading to significant receivables arriving in subsequent periods. Bad debt expense is forecasted at $128,000 for quarter 4, reflecting aggressive credit extension.

Financial Flows and Profit Calculation

Initial cash flows include the capital expenditure and operational expenses, along with variable production costs based on units produced. Income from sales is recognized when units are sold, with revenues calculated at the forecasted market price of $440 per unit. Accounts receivable and payable are adjusted quarterly considering credit terms. Depreciation of new equipment is calculated at 4% per quarter on the reducing balance, influencing profit figures. The net profit is derived by subtracting expenses from revenues, including depreciation, interest on the loan, and taxes.

Strategy B: Conservative Approach

Operational Framework

This strategy maintains existing credit policies, with 30% of customers granted credit for one month. Sales volumes are slightly lower, at 1,200 units/month (quarters 1 and 2), increasing to 1,500 units/month (quarter 3) and 1,650 units/month (quarter 4). Production is slightly below or aligned with sales to keep inventory levels minimized. Accounts receivable and payable reflect the tighter credit policy, with smaller balances and lower bad debt expenses of $20,000 for quarter 4. No new capital investment is made, which improves cash flow in early periods but may limit growth opportunities.

Financial Flows and Profit Calculation

Revenue, costs, and cash payments are calculated similarly, with attention to streamlined credit policies reducing receivables and bad debts. Inventory valuation remains at $320 per unit, but with lower inventories owing to more conservative stock management. Profit calculation accounts for lower sales volume but also lower expenses associated with inventory carrying and credit risk. Interest on borrowed funds, if any, is calculated based on the overdraft levels, which are likely to be lower due to conservative planning.

Comparison of the Two Strategies

Each strategy presents distinct financial and operational profiles. Strategy A's aggressive investment in equipment and higher production capacity aim at capturing larger market share but carry higher risks due to significant capital expenditure, higher inventory levels, and increased receivables with extended credit terms. The forecasted bad debts of $128,000 further impact profitability. Conversely, Strategy B emphasizes risk mitigation through minimal investment, lower inventories, and stricter credit policies, resulting in lower sales volumes but more predictable cash flows and lower bad debts ($20,000 forecast). The impact on cash flow, profitability, and liquidity will differ significantly under each approach.

Analysis of Budgets and Financial Implications

The cash-flow budgets under Strategy A are likely to show substantial outflows in January due to equipment purchase, with inflows delayed due to credit sales extending over two months. The higher inventory levels and receivables may also cause temporary cash shortages, necessitating overdraft utilization. Although profit margins may be higher because of increased sales and capacity utilization, the risk of cash flow shortages and bad debts could undermine financial stability.

Strategy B's budgets are expected to be more stable, with lower initial cash outflows, consistent sales, and smaller receivable and payable balances. This conservative approach ensures more predictable cash flows, reducing reliance on overdraft facilities. Profit margins may be slightly lower due to reduced sales volume and no significant capital expenditure, but overall financial risk is minimized.

Strategic Recommendations

Based on the comparative analysis, the choice between the two strategies depends on Sehat Ltd's risk appetite and long-term goals. Strategy A favors aggressive growth, potentially leading to higher profits but requiring careful cash flow management and risk mitigation strategies. Strategy B offers stability and lower risk but might limit growth potential. If Sehat Ltd prioritizes market expansion, investing in capacity, and is able to manage the associated cash flow risks, Strategy A could be advantageous. However, if the company prefers stability and risk minimization, Strategy B is more appropriate.

Given the current financial position and market conditions, a balanced approach could be considered—adopting elements of both strategies or opting for Strategy A with enhanced risk controls. A detailed sensitivity analysis and cash flow monitoring would be essential to support whichever strategy is chosen.

Conclusion

In conclusion, the budgets highlight the trade-offs between growth and risk. Strategy A, with its higher investments and sales targets, has the potential for increased profitability but requires vigilant cash flow management and risk control measures. Strategy B offers financial stability with lower risk but may limit growth opportunities. Management should adopt a strategic approach aligned with their risk appetite, financial capacity, and market ambitions, with ongoing monitoring and flexibility to adapt as circumstances evolve.

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