Build your IB Business Management SL Finance and Accounts foundation through calculations, accounts interpretation and practical finance decisions.
Hums Athletics (HA)
Hums Athletics (HA) manufactures running shorts, sweat shirts, and sports bras. Operating only in the secondary sector, HA has a head office and three manufacturing facilities, one for each product. These are located in its home country in Europe. Labour costs are high. The quality of labour is excellent.
HA produces goods under its own HA brand, which it sells to wholesalers. HA also manufactures for other sportswear companies. HA puts the other sportswear companies' logos on the running shorts, sweat shirts, and sports bras. Sales to other sportswear companies are an important revenue stream for H A.
HA has many levels of hierarchy. Managers at each level have a narrow span of control, and the company is organized by product. HA's management believe that these features of organizational structure ensure product quality, which they view as essential for brand loyalty.
The sportswear manufacturing industry is becoming more competitive. Some foreign manufacturers have begun using penetration pricing to gain market share. For three years, none of HA's revenue streams have increased, despite increasing unit sales. HA's gross and net profit margins have declined. However, its sales have increased for the last three years. HA has had to raise additional external finance to increase production.
In response to the increasing competition, H A is considering two options:
- Option 1: Outsourcing some of its manufacturing overseas.
- Option 2: Entering the rapidly growing online business-to-consumer (B2C) retail market.
Market research has shown that consumers increasingly expect to buy online.
Explain:
why HA had to raise additional external finance to increase production.
DA has a long-standing social commitment: employees live in Ville d'Ablet with subsidized rent and access to a hospital, school and leisure facilities. The proposed employment package would replace annual salary with low basic wages and profit-related bonuses, charge market rent and fees for facilities, and offer compensation payments to employees who leave. This could reduce employment costs but may damage morale, trust and DA's social values. DA has recently made losses, while its two strategic options have different risks. Option A would move DA from high-end niche markets to the mass market using the DuLow brand and outsourced mass production by SE. Option B would invest €500 million in cellular manufacturing and modular click-and-fix products. The option must be assessed against the cash inflows, finance, product life cycle, brand loyalty, innovation, production costs, environmental concerns and possible future demand.
DA's board must make two major decisions.
Decision 1: DA needs to reduce employment costs. A new system of pay and benefits is under consideration. This includes:
- changing from an annual salary to low basic wages with profit-related bonuses
- reducing social benefits for employees, such as paying market rents for the housing in Ville d'Ablet and having to pay for the use of the leisure facilities
- offering generous compensation payments to employees who are prepared to leave the business.
Decision 2: The three options from DA directors must be considered.
Immediately prior to the board meeting, Mia withdrew her proposal (Option C).
There is now additional information available on the remaining options.
Louise plans to target the mass market and proposes using the brand name DuLow for the redesigned products. She is planning for DA to outsource production to Star Electrics (SE). SE uses mass production together with some customization of products. SE keeps costs low by importing cheap raw materials and paying low wages.
Ben, the human resource management director, is concerned about the impact this change would have on DA's employees.
Salah's plan requires new production lines, one for each product. Salah proposes using cellular manufacturing. The investment cost is estimated to be € 500 million. Salah estimates the following net cash inflows (excluding the initial investment cost).
Table 1: Forecast financial information for Option B (figures in € millions)
Louise thinks the option is expensive. Dodi, the finance director, thinks that the investment is too large and he believes that some shareholders are also concerned about the size of future dividends. Salah believes that shareholders will be pleased about the revenues that this investment will generate. Mia is worried that the products would be expensive to produce and that demand might fall in five to seven years.
Define the term retained profit.
Using Table 1, calculate for Option B:
the average rate of return (ARR) (show all your working).
the payback period (no working required).
Using the case study and additional information from Section B, recommend whether DA should choose Option A or Option B (Decision 2).
Suparman Fish ( SF )
Gepa Suparman owns and operates four fishing boats in Indonesia. There is a growing demand for canned (tinned) food, including cans of fish. Gepa wants to enter the secondary sector by opening a small factory producing cans of fish.
Gepa's business will be called Suparman Fish ( S F ) and will be a private limited company. Gepa will own all of the shares. The factory will be located in a village three miles from the harbour. Because unemployment is high in the village, Gepa should easily find workers for the new factory. In addition to the manager's salary, workers' wages, and the cost of fish, supplies, and cans, S F will have the semi-variable cost of electricity.
Gepa has prepared a four-month cash-flow forecast based on the following information:
- opening balance month 1: .
- month 1 : sales revenue of increasing by 20 % per month.
- manager's salary: per month.
- workers' wages: per worker per month.
- variable costs (fish, supplies, and cans) are equal to 40 % of sales revenue.
- semi-variable cost of electricity: fixed cost of per month, plus a variable cost of per kilowatt hour (kwh). Month 1 usage: 100 kwh , increasing by 10 % each month.
Although S F would create several jobs in the village, many residents are not happy about the new factory. The new factory would use chemicals, which cause pollution. Residents are concerned about the unpleasant smells from the factory. A representative from the local employment office is concerned whether Gepa's factory will provide a safe working environment.
Explain why electricity is a semi-variable cost for S F.
Prepare a monthly cash-flow forecast for S F for the first four months of operation.
Calculate S F 's forecast net profit for the first four months of operation (show all your working).
Calculate S F 's forecast net profit margin for the first four months of operation.
Alejandra’s opening balance in a cash-flow forecast is the cash available at the start of a period; the closing balance is the opening balance plus net cash flow for that period, and the closing balance becomes the next period’s opening balance. As music income grew from copyrights and royalties, Alejandra needed an accountant to prepare final accounts, manage money and pay taxes. Final accounts such as a profit and loss account and balance sheet help owners, managers, shareholders and tax authorities assess performance, financial position, assets, liabilities, profit and obligations. LadyA’s product life cycle began with the 1994 film and first CD, grew through successful albums and a number-one hit, reached maturity and peak popularity by 2000–2001, then faced decline as CD sales fell because of file sharing, MP3 players, smartphones and the economic downturn. Endorsements, social media, perfume and cosmetics and rebranding could extend the life cycle and create new revenue streams.
Describe the relationship between "opening balance" and "closing balance" in a cash-flow forecast.
"Alejandra needed an accountant to help her prepare her final accounts". Explain the importance of final accounts to two different LadyA stakeholders.