Working Capital Management
Working capital management is a strategy implemented by businesses, which ensures that the company has enough cash to cover its short-term operation costs (Tuovila, 2020). Working capital management is associated with close monitoring of current assets and current liabilities to ensure the efficiency of operations (Tuovila, 2020). Working capital is assessed using several ratios, including the current ratio, which demonstrates if the company has enough money to cover its current debt, acid-test ratio, days of inventory outstanding (DIO), days sales outstanding (DSO), days payables outstanding, and cash conversion cycle (CCC). The trends in ratios of the Tassal Group are demonstrated in Table 1 below.
Table 1. Working capital management trends of Tassal Group.
The current ratio is crucial to determine if the company has enough current assets to cover its current liabilities. The acid-test ratio essentially measures the same thing without taking into consideration the inventories. The analysis of these two ratios demonstrates that the Tassal Group has enough current assets to cover its current debt, as the ratio is above 1. However, according to Tuovila (2020), a current ratio above 2 may be a sign of inefficient use of assets. Thus, Tassal Group may be using its current assets inefficiently to increase its revenues.
The CCC is a metric used to calculate how quickly it can convert its investments in inventories and other resources into cash (Hays, 2020). The metric takes into consideration how much time is needed to turn inventory and receivables into cash using the DIO and DSO ratios. It also takes into consideration the amount of time it takes to pay the bills without penalties using the DPO ratio. The analysis of trends in the CCC demonstrates that the company needs less time to sell its inventory and to collect cash from its customers than to pay to its suppliers, as CCC was negative throughout the three years of analysis. This implies that the Tassal Group has great liquidity. In summary, the company can turn inventory and receivables very quickly; however, it may not be using its current assets effectively to develop the business.
External Financing
External financing is often needed to cover different types of expenses of large companies and SMEs. External financing is primarily used in three major cases. First, external financing may be used for major asset purchases, such as facilities, equipment, or land. Second, external financing may be needed to complement insufficient working capital. Fortunately, it is not the case with Tassal Group, as its current and acid-test ratios are very high. Finally, outside money may be needed to expand business operations. Thus, external financing is a crucial source of money for all the companies.
There are several types of external financing, including asset-based lending, leasing and hire purchases, business loans, debt funds, export finance, start-up loans, and overdrafts. According to the annual report Tassal Group for FY2020, the company utilizes two primary sources of external capital: bank loans as short-turn borrowings and cash advances as long-term borrowings (Tassal, 2020).
The bank loans are secured by assets that exceed the loan liabilities, while the cash advances are secured by mortgages over the consolidated entity’s assets and undertakings, freehold land, and buildings, the current market value of which exceeds the value of mortgages. The company no longer utilizes leasing as a source of capital. Thus, the diversification of the sources of outside capital is limited.
There are several issues Tassal Group should consider when using a combination of short- and long-term financing arrangements. First, when using any kind of external financing, it is crucial to consider the cost of debt. The cost of debt may increase the minimal return rate the company should offer to satisfy its shareholders (Chen, 2020). Thus, it is crucial that the cost of debt does not raise the cost of capital above the current return rate. Second, the company should ensure that it has enough current assets to cover the current portions of long-term debt and short-term debt. Fortunately, Tassal Group has enough working capital to cover additional current liabilities. Finally, it is central to ensure that its debt-to-equity (D/E) ratio is not higher than the industry average to ensure stability (Chen, 2020). Currently, the D/E ratio 0.92, which is considered acceptable (Tassal, 2020).
Home and Gather Budgeted Income Statement
Home and Gather Cash Budget
Considering Removal
When a firm decides to removal an item from the product line, not all of the costs are reduced. While variable production costs are always reduced, fixed costs remain untouched. In the case with Home and Gather’s Reed Diffuser, direct material, direct labor, manufacturing overhead, administration wages, and general office expenses will be reduced. At the same time, costs associated with rent, utilities, production supervisor’s salary, machinery purchase, maintenance, insurance, and indirect costs of manufacturing will not be affected. These costs are either applied to the company in general or to the production of the main product (soy-based candles).
Alternative Product
A firm may decide to switch between suppliers if the new supplier offers significant monetary or other benefits to the company. Among non-monetary benefits, the company may consider compliance with corporate strategy, government regulations, or prestige. Changing suppliers, however, is often associated with various uncertainties, including the quality of products, the stability of payments, and supply chain-associated transformations. In the case of Home and Gather’s electric oil diffusers, the contribution margin and the breakeven points of the two options are insignificant. This implies that the first option is considered preferable, as it helps to avoid all the uncertainties associated with changing suppliers. However, the second option may also be adequate if the local supplier offers non-monetary benefits.
Special Order from Candles Plus
Candles Plus, one of the largest Home and Gather’s customers, has placed a special order for 10,000 candles asking for a significant discount of $5 per unit. The current price of soy-based candles is $25 per unit, which implies that Candles Plus wants to buy 10,000 candles at the price of $20 each. Currently, Home and Gather has excess capacity to fulfill the order; however, it is unclear if the order is still profitable after providing the discount. According to the golden rule, the company should accept a special order only if benefits exceed the costs. Thus, it is crucial to estimate both benefits and costs for the special order placed by Candle Plus.
The first part is to estimate the expected revenues. Assuming the selling price is $20 per unit, and the order is for 10,000 units, the expected revenue can be calculated in the following way:
The second part of the analysis is to estimate the full cost of the order. The job costing method is used to determine the expenses associated with filling the order. According to the method, the formula for a total cost the following:
The expenses associated with direct materials can be calculated by multiplying the variable material cost per unit by the number of units. Thus:
It was estimated that five staff members would be working on the order of 9 weeks with a 40-hour working week and wages of $25 per hour. Therefore:
Since overall overhead for the year was estimated at $300,000 per 180,000 working hours, the applied overhead can be calculated the following way:
After calculating all the components of the formula, the total job cost can be estimated:
The associated costs of $180,000 are lower than the expected revenue of $200,000. Therefore, Home and Gather should accept the order from Candles Plus on the special terms. However, it is crucial that Home and Gather makes it clear that the provided discount is a one-time event, as Candles Plus may want the discount to be permanent for future deals. Such an outcome may reduce the Home and Gather’s profitability.
References
Chen, J. (2020). Debt financing. Investopedia. Web.
Hayes, A. (2020). Cash conversion cycle. Investopedia. Web.
Tassal. (2020). Annual report 2020. Web.
Tassal. (2018). Annual report 2018. Web.
Tuovila, A. (2020). Working capital management. Investopedia. Web.