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Memorandum Case Solution & Answer

Memorandum Case Solution

The organization’s operational performance is evaluated to be poor considering, the organization’s net profit margin, operating profit margin, return on assets and return on equity were significantly below the industry average ratios and last year’s operational performance. The key reason for poor operational performance is the rise of 249 U.S. dollars in the selling and administration costs and the rise of 116 U.S. dollars in interest expense. On the other hand, the total current assets of the organization also declined by 21 percent in 2008 as due to the declining demand of the construction industry, the finished goods reduced to 1200 U.S. dollars as compared to 1700 U.S. dollars in 2007.

Moreover, the poor return on assets suggests that business does not utilize its assets efficiently in order to generate earnings whereas the poor return on equity suggests that the organization is unable to generate profits from its shareholder investments. On the other hand, the organization’s cash conversion cycle of the organization has declined to 128 days in 2008 as compared to 152 days in 2007 and industry average cash conversion cycle days of 137.

The cash conversion cycle of below industry average suggests that Strong tie ltd is solvent, takes less time to generate cash as the organization takes significantly less tie to convert its inventory into sales as compared to other players in the industry. This suggests that the organization manages its inventory efficiently.

Figure 1: Ratio Analysis

Ratio Analysis
Years 2006 2007 2008 Industry average 3 years average
Short term liquidity:
Current Ratio 5.01 4.29 4.29 4               4.53
Cash ratio 2.19 2.07 1.56 0.5               1.94
Solvency:
Debt to equity ratio 32% 33% 38% 35% 34%
Interest cover 9.46 5.68 1.02 2  
Operating efficiency:
Gross Profit Margin: 36% 31% 28% 32% 32%
Operating profit margin 14% 9% 3% 16% 9%
Net profit margin 9% 5% 0.042% 10% 5%
ROA 13% 8% 0.056% 17% 7%
ROE 22% 13% 0.105% 28% 12%
Cash conversion cycle:
Raw Materials Turnover in Days 35.8 41.2 42.6 31 days 39.9
Work in progress Turnover 7.0 4.2 1.3 3 days 4.2
Finished Goods Turnover in Days 71 52 37 51 days 53.2
Accounts Receivable Turnover in Days 73 72 63 63 days 69.5
Accounts Payable Turnover in Days 19 17 15 11 days 16.8
Cash conversion cycle 168.3 152.9 128.4 137 days 149.9

Profitability and Sustainable Growth Model:

A profit model involves steps taken by the organization in order to ensure profitability and business viability. Therefore, the business is advised to employ a production profit model which involves emphasizing on the production and the operating business component. The production component will ensure high-quality services and products are offered to the customers which are manufactured at maximum capacity.

Furthermore, the production component will involve operating at the lowest possible cost by automating the production process as high production cost will make the products expensive for the customers to purchase and will reduce the market share of the organization further considering, the housing prices were at a peak in the year 2006.

The operating component of the profit model will involve using skilled and well-experienced employee which will work efficiently, ensure that the production equipment operates at optimal levels and are upgraded. Furthermore, the profit model of the organization will involve ensuring operational efficiency by employing automated manufacturing processes, cutting the selling and administrative spending,salary paid to the daughters, dividend paid to Katherine, the founder’ sister and hedging the risk associated with the rising metal prices by entering into forwarding contracts.

Recommendation:

In order to ensure the financial viability and sustainability of the business, it will be advised to the business to reduce the cost associated with the health care and pension benefits of the employees in order to reduce operational costs. Furthermore, it will be advised to the business to reduce the selling and administrative spending which includes the salary paid to the daughters in order to increase the net profit margins, return on assets and return on equity.

Moreover, it will be advised to the business to fix the finished goods turnover days to 37 days in order to convert the inventory into sales faster as compared to other players in the industry. Furthermore, it will be advised to the business to reduce the raw material turnover days below industry average by using automated machinery and processes effectively.

The dividends amounting to 500,000 Canadian Dollars paid to the sister of the founder should be cut in order to retain the earnings for future investments in paying short term and long term obligations. The cash saved as a result of implementing a temporary cut in the daughter’s salaries, employee costs and preferred dividends will be added back to the cash which will be utilized for paying expenditures and debts.

Additionally, it will be advised to the business to improve liquidity position by factoring the accounts receivable which will ensure that the organization receives immediate cash from sales as customers tend to pay more quickly to the factors. Employing the provided recommendations, the organization will be able to meet the terms outlined in the revolving credit agreement with the Bank of Nova Scotia and will resolve the bank’s concerns as the business’s profitability and liquidity position will be improved.

In addition, it will be advised to the business to hedge the risk associated with the increase in metal prices by entering into a forward contract which will allow the business to manage the cost of goods sold and continue offering services at the current price in order to create customer value. The organization already sells the products at premium prices as compared to other players therefore, it is advised not to increase the service charges…………………………

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