ADM Denim is a Premium Denim Producer. The company is public listed and started production in 1993. Current capacity is three Million yards of Fabric and one million pairs of jeans per month. ADM is a complete vertical unit converting Cotton to Finished Garments. It is an environment friendly company with water treatment and effluent treatment facilities meeting toughest international standards.
ADM is not just a manufacturer of fabric and garments, but also a complete development facility to provide 'speed to the market' capability required by customers.
FINANCIAL REPORTS
PROFIT AND LOSS ACCOUNT
For the year ended June 30, 2009
BALANCE SHEET
As at June 30 2009
FINANCIAL ANALYSIS
Profitability analysis of ADM limited is as fallows:
PROFITABILITY RATIOS
The net result of a number of policies and decisions is known as profitability. The profitability ratios shows the collective effects of debt, liquidity and asset management on operating results.
"A group of ratios that shows the combined effects of liquidity; asset management and debt on operating results".
Gross Profit Margin:
Gros profit margin can be showed by the following formula i.e
Gross profit = net sales - cost of goods sold
Gross profit margin is computed as gross profit/net sales.
the basic cost structure of the firm is indicated by this ratio.
This margin can also be impacted by a change in the firm's product mix towards higher or lower profit margin items.
Operating Profit Margin:
Operating profit is defined as gross profit minus sales, general and administrative expenses. It is referred to as earnings before interest and taxes.
The variability of the operating profit margin over time is a prime indicator of the business risk for o firm.
Overall ADM's profit has been decreased as compare to the previous year's profits. It is observed that Grass profit margin has decreased by 18% from previous year, one reason for this could be high reduction charge in year 2009 as the company bought new non current assets whose contribution to profit might not have started yet. Operating margin has been reduced by almost 16% over the previous year this is largely and the reason for this is the distribution costs, which are increased by 22.4% over previous year.
Return on Capital Employed (ROCE):
This ratio indicates the firm's return on all the invested capital.
ROCE of about 19% compared to 16.5% for last year. Management has been very efficient to keep the operating costs down in relation to its sales this year. ROCE has been increased by more than 2% over previous year which is may be because of better non current asset utilization by ADM in 09 despite increase in depreciation charge And it could also be because of decrease in debt finance in 09, which has been decreased by almost 50%.
LIQUIDITY:
Ratios that show the relationship of a firm's cash and other current assets to its current liabilities.
Current Ratio:
This ratio is calculated by dividing the current assets by current liabilities. It indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future.
It is the most commonly used measure of short-term solvency.
ADM's Current ratio has been distorted as compared to previous year, which is a cause of concern especially because of the fact balance sheet shows that short-term borrowings have been increased by 37% from previous year. It seems that ADM may have replaced some of its long-term loans with short term borrowings to finance fixed assets if this is the case than it will affect future profits because of high interest charge and hence may affect liquidity, gearing ratio has been considerably reduced but it could be meaningless because of this very reason.
Quick Ratio:
A more stringent test of liquidity uses the acid test (quick) ratio. This ratio includes those assets most quickly convertible to cash and is computed by dividing Cash+Cash equivalents+ Market Securities +Accounts Receivable by Current liabilities. Inventories are often the least liquid assets and are not included in the acid test ratio.
Quick ratio of ADM is also little lowered than previous year. We cant say anything on its on unless we have industry average which will make these figures more meaningful and commentable.interest cover has been decreased slightly but it may not have the effect of increased interest charge on new short term borrowings which will distort these figures considerably.
ASSET MANAGEMENT RATIOS:
The second group of ratios, the asset management measures how effectively the firm is managing its assets. If a firm has too many assets its cost of capital will be too high, hence its profit will be depressed. On the other hand if assets are too low, profitable sales will be lost. Ratios that analyse the different types of assets are as follows:
Total Assets turnover ratios:
This ratio measures the turnover of the entire firm's assets; it is calculated by dividing sales by total assets.
ADM's Asset turnover has been higher than last year and is the reason of increase in ROCE. That means that management has done well in using its assets to generate returns even though profit margins are down than last year.
Days Sales Outstanding:
It's also called "Average collection period" it is used to appraise accounts receivables and is calculated by average daily sales to find the number of day's sales that are tied up in receivables. Thus the DSO represents the average length of time that the firm must wait after making a sale before receiving cash.
Days Purchase in Accounts Payable:
A measure of the extent to which companies "lean on the Trade" is the average payable days outstanding. The average payable days outstanding provides an indication of the average time the company takes in paying its obligations to suppliers. Longer the period the greater the use of supplier's capital.
Days Sales in Inventory:
This ratio tells us the number of days required to sell ending inventory assuming a given rate of sales. It's useful for assessing a company's purchasing and production policy.
ADM is paying its suppliers 4 days later as compare to previous year while customers are paying 6 days earlier to ADM as compared to previous year. This is favourable situation for the ADM as they are doing business on others money for 10 more days from previous year as this will improve liquidity but this could offend suppliers they could stop supplies in future for late payment. Stock days have been reduced considerably by 65%. Stock holding days for the previous year were close to 6 months which is very long so management's achievement in reducing this period by almost 65% is a good effort however company should try to cut this as much as possible without risking stock-outs.
DEBT MANAGEMENT RATIOS
Gearing Ratio Or Total Debt to total equity Ratio:
The debt to Equity Ratio is computed by Total long Term Debt/Total Equity.
Time Interest Earned Ratio:
A measure of the firm's ability to meet its annual interest payments.
ADM's Cash balances have significantly reduced, that can be partially explained by short-term investment & repayment of long term financing but company's short-term borrowings have increased. Replacing long-term debt with short-term debt can be a risky strategy and company may run into problems in future to repay these short-term obligations. Interest cover of about three times of operating profit means although company can pay its finance costs this figure is getting lower indicating increase in borrowing costs. ADM needs to evaluate its financing strategy. Although gearing ratios indicates debt level has decreased, gearing ratio goes from 18% to 56% when short-term borrowings are taken into account.
INVESTORS INTERESTS
Earning Per Share (EPS)
Earnings per share has decreased from (4.48 to 4.16) rupees per share. As there is no increase in share capital and sales profitability is lowered which adversely affects the clients confidence they are disinclined to invest more money in the company which leads to borrow more money on short term by the company. moreover return on equity is also decreased from (14.14% to 14.04%) this will not only discourage existing shareholders as well as the prospective shareholders from investing.
Conclusion
Artistic Denim Mills Ltd has had a good year with increase in profits but company's cost of sales are increasing putting a squeeze on profit margins and it may not be possible to keep similar profitability level without an increase in price. Management should see if some of the costs can be passed on to its customers without affecting sales levels. At the same time good cost control is very important, however it is important to keep an ethical policy towards payments to local cotton farmers and excessive pressure to keep purchase prices down should not be an option.
With further investment in assets, company should be able to expand and generate profits in future however current finance policy of reliance on short-term borrowings needs to be re-evaluated & with company generating steady profits it might be possible to issue share capital to fund long-term investment in assets than using short-term finance.
FINANCIAL RATIOS
Ratio
Formula
2008
2009
Gross profit ratio
638014/2436268
26.19%
697984/3125384
22.33%
Operating profit ratio
538905/2436268
22.12%
596616/3125384
19.09%
Asset turnover ratio
2436268/(2472836+799889)
0.74:1
3125384/(2681257+471430)
0.99:1
Return on capital employed
538905/(2472836+799889)
16.47%
596616/(2681257+471430)
18.92%
Current ratio
1316858/1251698
1.05:1
1220207/1479389
0.82:1
Acid test ratio
(1316858-796552)/1251698
0.42:1
(1220207-654557)/1479389
0.38:1
Gearing ratio
799889/2472836
32.35%
471430/2681257
17.58%
Interest cover
538905/165183
3.26 times
596616/186278
3.20 times
Payable days
174349/1798254 x 365
35 days
257118/2427400 x 365
39 days
Receivable days
368877/2436268 x 365
55 days
416740/3125384 x 365
49 days
Stock days
796552/1798254 x 365
162 days
654557/2427400 x 365
98 days
EPS
4.48 per share
4.16 Rupees per share
Return on equity
349584/2472836
14.14%
376421/2681257
14.04%
The balanced scorecard
The balanced scorecard approach emphasis on set of information covering all areas of performance provided to the management for improvement.
It focuses on four different perspectives and uses financial and non-financial indicators.
The four perspectives are:
Customer:
A Customer is used to refer to a current potentail buyer or use of the product of an organization.
ADM Specializes in fabrics with Ring x Ring, multi count/ T-400 and coloure weft yarns.ADM fabrics are available in differnet finishes like Resin, 3 Dimensional etc.
It attracts customers as different customers have different needs and requirements like about colours stuff and style. ADM value its customers and retain them by fulfilling their needs and desires.
Internal:
The advertising and promotional activities have direct impact on increase in-group sales and enhanced the brand recognition. ADM should more focus on it. It's the matter of concern for marketing department. Quailty control and customer satisfaction is ADM primary focus.
Innovation and learning
Quality of ADM's fabric and garments is very critical for the success and customer satisfaction. There are risks of lost revenue and market share if quality does not fulfils the customer's satisfaction. That's why group focuses on the quality of material, cotton used in its garments. All of the fabric is delivered on contract basis and all garments are prepared on order, which has enhanced customer satisfaction, sale growth competitiveness and customer loyalty. For restaurants operator's innovation in terms of new products and delicious recipes are key to competiveness and success. It is necessary for garment industries to operators to introduce new designs and quality in control observation and under consideration in order to stabilized sales. DMN continually strive not only to expand but also to improve and develop their unique styles.
Financial
BY offering more share in profit ADM value its shareholders too. Shareholders are satisfied with company's progress and they take more interest in its development.
Appraisal
Part A:
T0
T1
T2
T3
T4
T5
Price (£)
(15x1.03)
15.45
(15x1.032)
15.91
(15x1.033)
16.39
(15x1.034)
16.88
Cost (£)
(8.9x1.04)
(9.26)
(8.9x1.042)
(9.63)
(8.9x1.043)
(10.01)
(8.9x1.044)
(10.41)
Contribution per unit (£)
6.19
6.28
6.38
6.47
Demand in units ('000)
35
40
50
25
Contribution per year (£)
216650
251200
319000
161750
Overheads (£)
(30000x1.06)
(31800)
(30000x1.062)
(33708)
(30000x1.063)
(35731)
(30000x1.064)
(37874)
Revenue (£)
184850
217492
283269
123876
Tax (30%) (£)
(55455)
(65248)
(84981)
(37163)
Tax saving (£) (W1)
19500
14625
10969
30506
Initial investment
(260000)
Residual value
8000
Free cash flows (£)
(260000)
148895
166869
209257
117219
8000
W1. Tax savings
Time
Tax saving (30%)
Period
T0
Initial investment
260000
WDA-25%
(65000)
19500
1
195000
WDA-25%
(48750)
14625
2
146250
WDA-25%
(36563)
10969
3
109687
BA
101687
30506
4
8000
(1) NPV
Free cash flows (£)
(260000)
148895
166869
209257
117219
8000
DF (7%)
1
.935
.873
.816
.763
.713
PV
(260000)
139217
145677
170754
89438
5704
NPV = +290790 ïœ Project should be accepted
(2) IRR
Free cash flows
(260000)
148895
166869
209257
117219
8000
Discount Factor (20%)
1
.833
.694
.579
.482
.402
PV
(260000)
124029
115807
121160
56500
3216
NPV = + 160712
IRR = 7% + 290790/(290790 - 160712) x (20%-7%) = 36%
ïœ Project should be accepted as project return is higher than cost of capital.
(3) Payback period
Year
Cash flow
Cumulative cash flow
0
(260000)
(260000)
1
148895
(111105)
2
166869
55764
Payback period is 1 year & 8 months (111105/166869 x 12). Project should be accepted if target payback period is higher than that.
IMPORTANCE OF POST-COMPLETION AUDIT:
A process for assessing the efficiency and effectiveness of a capital budgeting decision is called post completion audit. The analysis focuses on the future projects and future outcome of the project. It analyzez faults, actual position of project ,ways to improve the project returns and the budget .It mainly focuses on the nature of problems and their solutions
It serves as a basis for the identification of the need and implementation of corrective actions.The post completion audit deals with the detrimental future outcomes of the project by accelerating the decision to re-evaluate the project and making changes.
It provides expalanations for over & under performance of the project in provisions of external and internal factors inorder to provide accurate and booming results for future projects.
though it is important that the major costs associated with a project are incurred at start and might not alter the project significantly, so this underscores the importance of the appraisal process before committing to capital outlay.
Methods of finance for company A:
Two important types of finance are short term & long-term finance. Short-term finance is generally used for to fund working capital while long-term finance is used to fund business on long-term basis.
SHORT TERM FINANCE
Leasing
Company can lease its non-current assets instead of purchasing; this can reduce initial capital requirements of setting up a business as well as a flexible way of upgrading non-current assets.
Bank overdraft
This helps company with short-term liquidity but is a risky source as it cab be withdrawn by the bank on demand. It also has a much higher cost and company should not have excessive reliance on overdraft.
Trade credit
Company can purchase its inputs on credit and pay later. This is widely used in business trading and is normally considered free source of finance. Proper use of trade credit should reduce working capital requirements of the company
LONG TERM FINANCE
Ordinary share capital
Equity is the money invested by shareholders who are the ultimate owners of the company. There is less risk with equity issue as there is not contractual obligation to pay shareholders dividends. For new large new projects, company may want to raise equity.
Internally generated funds
Company may not pay all the profits it makes as dividends to shareholders and will normally keep some of these as retained earnings. This is an easy an popular way of raising finance, as there are no issue costs and profits are re-invested to make further profits. However it is important to have a steady dividend policy that shareholders would approve of.
Debt
Loan notes are an important source of finance and provide company with important funds and keep the overall cost of capital down. Interest is payable on loan regardless of profitability so it is riskier than equity.
PART B:
Variable cost (254554-230485)/(14870-12610) = £10.65 per unit
Fixed costs = 254554-(14870 units x £10.65) = £96188
Total costs at production level of 15100 units
= £96188 + (15100 x £10.65)
= £257003
SCATTER GRAPH
A graph used to plot information on two variables related to each other on x-axis and y-axis is called scatter graph. It helps to relate two variables for a set of data .It is essential for trend anlysis and foecasting. Scatter graphs are used to illustrate paired data and give information about it. E.g height and weight, sunshine and rain, sales and price , etc
With a certain confidence interval, scatter graph can give various correlations that might be negative, positive or null. If thedots pattern slopes from upper left to lower right it shows a negative corelation. Usually a trendline is drawn to study the correlation between various variables. By establishing best fit procedures, an equation for the variables correlaton can be obtained. To generate a correct solution in appropriate time using best fit procedure of a linear correlation is known as linear regression.
When it is needed to see how two compareable data sets concur with each other, scatter plot is the best way for it. The vicinity of identify line concentrate when two or more sets of data concur. Moreover if the data is numerically same the scatters exactly fall on identity line.
Another important aspect of scatter graph is its ability to show non-linear relationship between variables,
Benefits.
Helps in decision making by predicting income and expenses in future
Helps to identify trends and establish paterns
Helps for extrapolation and interpolation
Helps to testify the potential relationship and its strength using statistical and visual means.
Helps reveal changes in variables and their relation to others.
