Build your IB Business Management HL Finance and Accounts foundation by interpreting financial evidence and evaluating finance decisions.
Papel
Papel manufactures and sells paper bags. It pays cash for 80 % of its raw materials but, to remain competitive, it must sell on credit to all customers. Many debtors are not paying on time and creditors (suppliers) are increasing. The board of directors is concerned about Papel's liquidity position.
The finance manager has provided information from Papel's accounts.
Table 1: Selected information from Papel's accounts at 31 October 2018
Using information from Table 1:
calculate the current ratio for Papel for the end of October 2018.
Explain one possible strategy, other than elimination of credit sales, for Papel to improve its liquidity position.
Rox and Inclusive Music (IM)
Rox was a music band managed by Michel Mbappe. The band enjoyed considerable commercial success thanks to Michel's autocratic leadership style. He personally made all decisions. Rox had given generously to local schools and other non-profit organizations. The band received many awards for their acts of corporate social responsibility. Their last CD "Action Not Words" had brought them considerable fame.
In June 2010, Michel was asked to help finance the start-up of a new non-profit music school called "Inclusive Music" (IM). IM's aim was to support young musicians from low income families. At first, Michel was very enthusiastic and prepared a business plan. Unfortunately, he realized that Rox could not afford to finance IM fully. External sources of finance other than contributions from Rox would be needed for IM to grow. Until then IM would only have a limited budget for marketing and market research.
In June 2011, IM opened with the mission statement "Action not words". To support its mission, it offered free lessons and allowed students to borrow musical instruments. Michel asked a popular former singer, Louis Marsaud, to be the school's director. Louis adopted a laissez-faire leadership style, hoping it would allow creativity among students. Initial student attendance was lower than expected and quickly worsened. Within three months, many instruments had gone missing and many students were no longer attending music lessons.
IM's finances were deteriorating, and Louis could not attract external sources of finance. Michel took action and organized a concert by Rox to promote IM. He also examined IM's accounts and discovered a significant liquidity problem. Without consulting anyone, he dismissed Louis. In the music media, Michel received much criticism for dismissing Louis. Journalists argued that the two main problems were, IM's vague mission statement and poor marketing. However, Michel aimed to ensure that IM became sustainable in the long term.
Identify two possible causes of a liquidity problem.
He knew that he could increase the scale of his business operations with the UWP Mission without any additional marketing. This would also allow for significant economies of scale, but the logistics would be more complex. He would have to drive and collect produce using dangerous remote unpaved roads outside the protection of the UWP Mission. These remote communities might perceive Kos as collaborating with the UWP troops. He would also have to dedicate all his time to his business and would no longer be able to work in the officers' dining hall. Although that job did not pay particularly well, it was in a safe environment and provided a regular source of income.
To collect larger quantities of produce in remote areas, Kos would need to purchase a large lorry (truck). He discussed potential sources of finance with his bank. The bank manager indicated as a condition for the granting of a loan that the bank would require the lorry as collateral. Secondly, the poor quality of the roads meant that the lorry would lose value quickly.
Kos prepared a business plan and compiled information comparing his current income to his forecast income if he increased his scale of operation (Appendix 5). The income comparison showed that the expansion of his business would be very profitable - as long as the UWP Mission remained in Loyka. However, even after a number of conversations with Colonel Donovan, Kos was still unsure how long the UWP Mission would remain in Loyka.
Consequently Kos drew up three possible options for his produce distribution business:
- Option 1: No change. Keep the same scale of operation and stay working at the UWP Mission.
- Option 2: Increase the scale of operation of his business. Sell more produce to the UWP Mission and to the university or hospital. Kos would need to leave his job at the officers' dining hall and lose his regular source of income.
- Option 3: Maximize the scale of operation. Supply produce not only to the UWP Mission and to the university or hospital, but also to retailers in Beral. In Beral there is no city-wide wholesaler for the produce that Kos distributes. Becoming a wholesaler would require setting up and managing supply chains, employing staff, increasing working capital and adopting a new business structure.
As part of his evaluation of Option 3, Kos Palouk consulted Sami Taibi, who owned and operated a medium-sized grocery store. Sami said that Beral had no reliable produce suppliers and there was a business opportunity if someone could make reliability their unique selling point (USP). However, the deterioration of the situation outside of the U W P-protected area was making reliable purchase and distribution of produce difficult (Item 1).
To ensure reliability, Kos would require a loan of \$ 42000 to:
- Purchase two lorries (2 at \$ 15000=\$ 30000 ). Because of the poor quality of the roads, the lorries would require frequent maintenance. One lorry could still deliver produce while the other was being maintained.
- Increase working capital (\$12000) for higher stock levels.
Unfortunately, the bank will loan Kos a maximum of \$ 30000, as they do not wish to loan funds for working capital as well as for the purchase of the lorries (Item 2).
Kos had an idea. He proposed to Sami that they merge his grocery store with Kos' wholesale produce business. The combined operation would be organized as a private limited company and Kos proposed a 50-50 share ownership. It would also have the following advantages:
- It would have two revenue streams: wholesale (from Kos' operations) and retail (from Sami's grocery store).
- The grocery store would acquire produce at wholesale prices.
- The combined operation would always guarantee supply to the grocery store before other customers.
However Sami was reluctant to give up 50 % ownership of his grocery store for an unproven operation. Sami made a different proposal: Kos would merge his wholesale operation into Sami's grocery store in exchange for 25 % of the shares of the new private limited company. The merger would also result in a new contract and management structure (Items 3 and 4).
Calculate:
the annual depreciation expense of one $ 15000 lorry with a useful life of 7 years and a residual value of $ 1000 using the straight line method.
the depreciation expense in the second year of one lorry using the reducing balance method, with a depreciation rate of 32 % (show all your working).
The business grew rapidly over the next four years. Its growth was based on its innovative use of social media and other technologies, the youthful enthusiasm of its owners, its rapid response to customers and the strong word-of-mouth promotion from customers. In 2017, the partners converted MM to a private limited company. They became the majority shareholders, each owning a quarter of the shares, with the remaining quarter owned by their families. MM has strong ethical objectives, including in its choice of customers. It will not accept business from organizations without robust equal opportunities policies or those that do not actively work to reduce their carbon footprint. It will not work with businesses that exploit employees and it considers freedom of expression important. The owners try to reflect their cultural diversity in everything the business does. MM aims to respond to customers more quickly than others in the industry, with customer service at the centre of everything it does. The Bengaluru branch of MM has sales, design and customer care teams serving Asia. There is now the possibility of relocating more of the business to India in 2022. Rachel thinks that the opening of the Bengaluru office has provided an opportunity for a major reorganization of MM. The Indian office has been successful so far, with excellent premises. Some London employees moved to India, with the remainder recruited locally. Recruitment of highly qualified employees was difficult, so MM had to attract new workers with high salaries and generous benefits. The HRM problem concerns Clare, a highly successful marketing manager. Her drive and enthusiasm inspired her team, resulting in a 50 % increase in revenue by the department over the last 12 months. Customer satisfaction is very high and some marketing strategies designed by Clare’s team won awards. Clare consults and delegates but is prepared, where necessary, to be autocratic, particularly when targets must be met. Staff complained about unrealistic deadlines and bullying. Clare was rude to them, blocked their pay rises and threatened them with less interesting work. These employees asked for Clare to be dismissed for harassment. The Bengaluru office is responsible for customers in Asia. In 2021, this region will account for 30 % of MM’s business, but it is expected to account for 60 % by 2025. Rachel would like to move all of MM’s operations to Bengaluru. Bengaluru is a rapidly growing city with high-tech businesses, high-quality education and training facilities, its own film industry and potentially lower rents than in the UK. Javed could see operational difficulties: London has a stronger creative industry, and many creative employees are unlikely to want to relocate to India.
MM's growth has been helped by its unique selling point/proposition (USP) of rapid response to customer needs and by its high-quality customer service. New employees undergo detailed training to become skilled in:
- finding out what a customer's objectives are
- helping the customer work towards a marketing plan
- working closely with the customer as M M develops a marketing strategy for them
- maintaining links with the customer to provide an effective after-sales service.
The business takes a multicultural approach to its customers, employees and other stakeholders. MM's approach to diversity is one of the features that stakeholders say they like about the business. The company also ensures that it accommodates many cultural differences.
According to a business service that provides measures of social behaviour for every country, in British businesses:
- employees are accustomed to working in a competitive, individualistic society
- employees often take individual responsibility for their own actions and decisions
- competition is high between both employees and customers
- customers are accustomed to changing contracts when service is bad or competitors offer a better deal.
In comparison, Indian businesses:
- are based on power structures with a greater focus on teamwork than individuality
- are more likely to be hierarchical
- have greater loyalty from their customers
- have greater formality with their customers
- place importance on building business relationships
- are subject to greater variety in culture between businesses and regions.
Maintaining high levels of customer service is expensive. MM has increasing costs. Rachel is concerned about MM's finances and is examining the latest accounts for the company for 2019 and 2020 (Table 1) to identify problems.
Table 1: Selected financial information for \(\boldsymbol{M
Explain one method M M could use to improve its liquidity.