Executive Summary First Farms Corporation started as a small animal feeds manufacturing in 1950s.
The company has expanded to other agribusiness products and set up nationwide facilities. Though the company has performed well, it has a dilemma – a huge deficit in the operating cash flows of Php 719 million despite increasing revenues. Also, return on equity (ROE) is decreasing. In analyzing the case, the group is taking the point of view of the Vice President for Finance – addressing the main issue of the source of the decrease in ROE.To determine the causes of the decrease, we looked into the different financial ratios and did trending using common size analysis.
Discussion of relevant issues revealed that the decrease in ROE is caused by the decreased efficiency in the utilization of current assets – especially accounts receivable. The group therefore recommends the further investigation of the increase in accounts receivable and inventory. I. Point of View This group is on the point of view of a Vice President – Finance II. Case Context The First Farms Corporation (FFC) started as a small animal feeds manufacturing plant in the 1950s.Since then, the company’s operation has expanded into fresh and frozen chicken, processed meat, and animal health product and feeds.
FFC went public in February 1995. Proceeds were used to expand operations, additional working capital and to retire part of the corporation’s long-term debt. In 1995, FFC posted a 44% increase in sales, and an 89% increase in net income, wresting industry leadership from Marigold. New product lines – like feeds contributed to the profitability of the company. The year also marked its entry into the fast-food business. With these developments, the ompany is proposing expansion in its chicken dressing plants, with the ultimate goal of doubling the capacity. This proposal of expansion is to be financed by short-term notes.
The industry is currently facing increasing costs of production and the possible impact of entry of imported chicken in 1998 when trade barriers are liberalized. III. Problem Definition • What could have caused the decline in ROE even with the sales growth and increasing net profit margin? IV. Framework of Analysis To investigate on the cause of the decline in ROE, we made use of the following financial ratios: Liquidity ratio • Net Profit Margin • Return on Asset • Operating Leverage So that we can easily identify unusual relationship of across time, we made use of the common size analysis. V. Discussion of Important Steps This group focused its attention on the decline of ROE. To further investigate on what could have caused this decline, the group checked the components on how the ROE is computed.
ROE (Return on Equity) is a product of the net profit margin, return on assets and operating leverage. When this group looked into the net profit margin, the group noticed that it is increasing.However, its operating profit says otherwise. This is caused by higher cost of input goods, such as corn, soybean meal, and fishmeal coupled with lower selling prices on chicken business due to stiff competition.
(Refer to Exhibit 1 for illustration) The group checked on the ROA. ROA (Return on Assets) would tell us the efficiency of the utilization of company’s assets. It’s ratio of sales over fixed assets has increased. This leads us to check on the components of its current assets.
From the common size analysis, accounts receivables and inventories have increased over the years.This has caused a negative operating cash flow for that year. The decreased in the proportion of assets, financed by debt, through its Initial Public Offering (IPO) of its outstanding common stock in1995, would reduce the operating leverage. These three combined would explain why the ROE dropped.
VI. Decision The group decides to examine further the reason behind the increase in Account Receivables and Inventories over the year. VII. Justification of Decision Further examination on the problem will lead this group in determining the cause of the High Inventory and increasing the Accounts Receivables.VIII.
Operationalize the Decision 1. Set up a meeting with the operations manager and the purchasing manager to explain their decision on stocking up inventories. 2. Conduct warehouse audit. These inventory figures found in the books might not be factual.
3. Push the purchasing manager to source out alternative sources of inputs that might offer lower cost or extended credit term. 4.
Meet with the Sales and Credit and Collection Dep’t. Heads to review customers’ accounts: whether they have extended terms to selected customers; or whether these customers have the capacity to pay back the company.