The five stakeholder groups and their objectives are given below
(i) Government: Private sector organizations are a great source of revenue for the government as it collects taxes from such organizations. Furthermore Government has a responsibility to the citizens so it makes sure that these organizations exhibit acceptable behavior.
(ii) Stockholders: They are the owners of organization. They want compensation for investing in the company in the form of dividends and capital gains.
(iii) Creditors: These are the people to whom the organization owes money. They normally earn interest on the loans they have given and are paid first in case of liquidation. They bear the risk of default by the organization. They’d want to earn more interest on riskier loans that they give. Thus they earn interest based income.
(iv) Trade Unions: They represent the labors of the organization. Employees require compensation for the work they perform in the form of wages. They want to maximize their compensation compared to their work.
(v) Customers: Customers get value in return for the money that they pay to buy an organization’s products/services. Furthermore they are interested in ensuring that the products/services they are buying have been produced in a legal and ethical manner.
Shareholders are the owners of the “for profit” organization. Shareholders require a return on the investments they have made in an organization. If they don’t get the return, they are likely to be dissatisfied from the management of the organization and perhaps sells their shares to another party. This could also result in a hostile takeover. Furthermore they can make changes in the management via the board of directors. This is bad news for the management therefore it is necessary for them to maximize shareholder wealth. Whereas a public sector organization is owned by the government. Most of these organizations are created by the government for the welfare of its citizens. And a Government’s prime source of revenues is the taxes it collects not the income generated by public sector companies. Therefore public sector organizations have the objective of maximizing the value for money of their customers in order to provide welfare to them.
(a) (i) Inventory days = 365/inventory turnover ratio
inventory turnover ratio = Cost of Goods Sold/Average Inventory
Year 2007: inventory turnover ratio = $6,600,000/$1,300,000 = 5.1 times
inventory days = 365/5.1 = 71.89 = 72 Days
Year 2008: inventory turnover ratio = $9,300,000/$3,000,000 = 3.1 times
inventory days = 365/3.1 = 117.74 = 118 days
Average for the industry is 90 days. In year 2007 PPG’s stock turnover was 72 days which means that there is no excess inventory but the company might fail to meet demand in time. In 2008 it takes PPG 118 days to sell the complete stock of its inventory which is higher then the industry average and also higher than its last year number. This is a bad sign. It shows that the demand for company’s products is declining and its finding it difficult to sell its inventory.
(ii) Days receivables = 365/Accounts Receivables turnover ratio
Accounts Receivables turnover ratio = annual credit sales/average receivables
Year 2007: receivables turnover = $11,100,000/$1,850,000 = 6 times
days receivables = 365/6 = 60.833 = 61 days
Year 2008: receivables turnover = $15,600,000/$3,800,000 = 4.1 times
days receivables = 365/4.1 = 88.9 = 89 days
In 2007 PPG’s debtor turnover was 61 days which is very close to the industry average of 60 days. But in 2008 it has become 89 days which is very high. It signifies that company is facing problems in collecting funds and might face liquidity/cash shortage problems in the foreseeable future.
(iii) Days payable = 365/Accounts payable turnover ratio
Accounts payable turnover = total purchases/accounts payable
Year 2007: payables turnover = $6,270,000/$1,600,000 = 3.92 times
days payable = 365/3.92 = 93.14 = 93 days
Year 2008: payables turnover = $8,835,000/$2,870,000 = 3.08 times
days payable = 365/3.02 = 118.56 = 119 days
In 2007 PPG’s creditor turnover was 93 days which is somewhat close to the industry average of 80 days. But in 2008 it has risen to 119 days which is a bad sign. PPG is paying its creditors late. This will affect the company’s credit worthiness in a negative manner.
(b) Working capital cycle = Inventory days + days receivables – days payable
2007 Working capital cycle = 72 + 61 -93 = 40 Days
2008 Working capital cycle = 118 + 89 -119 = 88 Days
Compared with the industry average of 70 days, PPG’s conversion cycle is too high in 2008. PPG is therefore likely to suffer from cash shortages.
(c) We know that working capital is the difference between current assets and current liabilities. Efficient working capital management ensures that business achieves an efficient mix of current liabilities to finance its current assets. Financing current assets with long term debt can be too costly and having to much in short term liabilities can result in liquidity problems. Therefore working capital provides the firm with a buffer. Solvency measures a business’s ability to perform after suffering from a financial loss. If the working capital is too small. That means current assets are financed totally by current liabilities which can prove very difficult for the management. Because short term obligations have to be met even if the firm doesn’t have the necessary financial resources to meet them. Therefore efficient working capital management ensures to a very large extent that the business has a favorable solvency position.
There are many factors that could influence the optimal cash level for a firm i.e. its interest expense, the kind of business the firm and the overall strategy of the firm. The optimal cash level for each firm is different based on all these factors.
Cash budget for Perth Medical Supplies Ltd. Is given below
Cash Added During Month
(a) Vision Group (VG) is involved in providing healthcare services in the field of ophthalmology.
(b) Current Ratio = Currents Assets/Current Liabilities
Year 2008: $24,128/$19,091 = 1.26384
Year 2009: $27,893/$129,997 = 0.21457
Current ratio of more than 1 signifies a good liquidity position. VG’s current ratio declined from 1.26 in 2008 to 0.21 in 2009 which is a sharp decline. VG’s liquidity position is really alarming. It doesn’t have enough current assets to meet its current obligations in case of a financial adversity.
Acid Test Ratio = (Cash + Accounts Receivables + Short term investments)/Current Liabilities
Year 2008: $23,171/$19,091 = 1.21371
Year 2009: $26,863/$129,997 = 0.20664
Acid test ratio is a better measure of liquidity of a firm’s assets because it excludes inventory. The findings of acid test ratio are similar to the ones we found in our analysis of current ratio. VG’s liquidity condition is very alarming in the year 2009 while it was good in year 2008. This makes the company very risky.
Gearing Ratio = Total Equity/Total Assets
Year 2008: $118,060/$247,944 = 0.47616
Year 2009: $128,276/$258,522 = 0.49619
VG’s percentage of equity in its capital structure is increasing which implies that the firm’s long-term solvency is moving into a more positive direction.
Percentage Change in Income = (Income 2009 – Income 2008)/Income 2008
= ($12,587 – $16,915)/$16,915 = -$4,328/$16,915
There is 25.58% decline in VG’s net income in the year 2009. Gross profit of the firm has shown an increase therefore we can attribute this decline to an increase in operating expenses. VG needs to cut down on its operating and administrative expenses.
Operating Margin = Operating Revenues – Operating Expenses
Year 2008: $110,273 – $54,707 – $30,573 = $24,993
Year 2009: $113,380 – $58,777 – $37,414 = $17,189
The operating margin has declined for VG because the rise operating expenses is greater than the rise in operating revenues. This shows declining operational and managerial efficiency.
Interest Coverage Ratio = EBIT/Interest Expense
Year 2008: ($24,993 + $8620)/$8620 = 3.899
Year 2009: ($17,189 + $9583)/$9583 = 2.794
VG’s ability to meet its interest payment obligation has declined in the year 2009 but it is still at reasonably good levels. But if it continues to decline in the coming years, this could be a very alarming situation for the firm.
Cash Dividend Coverage = Cash Flows from Operations/Dividends
Year 2008: $24,993/(79,128 x 0.13) = 2.43
Year 2009: $17,189/(82,457 x 0.05) = 4.169
Although the cash dividend coverage ratio for VG seems to have improved but this is just one side of the picture. The main reason why there is an increase in this ratio is because DPS has declined considerably from 13 cents in 2008 to 05 cents in 2009. So the firm is able to improve this ratio only by giving smaller dividends which gives a negative signal to the investors. This ratio should be viewed with extreme caution because it could be very misleading.
Return on Capital Employed = EBIT/(Total Assets – Current Liabilities)
Year 2008: $33,613/($247,944 – $19,091) = 0.14688
Year 2009: $26,772/($258,522 – $129,997) = 0.20830
VG’s ROCE is increasing in year 2009 which shows that more efficient usage of capital investments is being made by the management. But this increase can be explained in another way. Since we already know that increase in current liabilities is greater than increase in current assets for the year 2009, ROCE has increased because long term debt is now a smaller percentage of overall liabilities of the firm.
Return on Assets = Net Income/Total Assets
Year 2008: $16,915/$247,944 = 0.06822
Year 2009: $12,587/$258,522 = 0.04869
ROA for VG has declined from 6.8% to 4.8% which is again a bad sign for investors. This shows that the efficiency in utilization of assets is declining.
(c) VG is a company with declining profitability, worsening liquidity and increasing inefficiencies in asset utilization, operations etc. Based on all the financial analysis given above, as an investor I don’t consider it an attractive option at all.
The chief executive officer (CEO) is the head of the management and accordingly is a part of it. CEOs are not elected by the shareholders; they are normally selected by their predecessors. The board of directors is an elected body which is usually voted into office by the shareholders. The chairperson of the board of directors ensures that the board reaches consensus and is working in the right direction. Furthermore he is also responsible for approving key managerial decisions and allocation of resources.
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