Watley’s Furniture Company budgeting

Watley’s Furniture Store

Part 1

Liquidity

Current assets minus current liabilities is the current ratio.

The current ratio in 2014 was 300/270 = 1.11, whereas the ratio in 2015 was 480/210 = 2.286.

Activity

Inventory turnover ratio equals cost of goods sold divided by average inventory.

In 2014, the inventory turnover ratio was 1290/90 = 14.33.

2015 ratio = 1500/140 = 10.71

Profitability

ROCE equals operating profit divided by capital employed, where capital employed equals equity plus long-term loan capital.

ROCE in 2014 was 420/ (1080+200) = 0.328; in 2015, it was 320/ (1220+200) = 0.225.

Gearing

Gearing ratio = non-current liabilities/ capital employed

Gearing ratio for 2014 = 200/ (1080+200) = 0.156

Ratio for 2015 = 200/ (1220+200) = 0.141

Part 2

Liquidity

For current ratio, a year-to-year dynamic is increasing what is a positive tendency. Moreover, an absolute value of the ratio is about two that is not too low and not too high, therefore it limit risks for payments and does not have extra assets. As soon as in the calculation used general categories of current assets and liabilities there are many factors that can affect result. In this particular case, both liabilities and assets changed in the direction leading to the growth of liquidity, liabilities diminished and assets growth.

Growth in current assets happens due to changes in all its components, inventory, trade receivables, and cash in the bank. However, in the comprehensive evaluation, it occurs mostly with the evolution of trade receivables (plus 100 £3000), in the relative assessment the most robust growth shown as well category of trade receivables (plus 62.5%).

Current liabilities diminished due to changes in tax and dividends that company should pay; trade payables stayed the same. The absolute maximum difference provided by dividends category (minus 40 £3000), while the maximum percent change by tax category (minus 28.6%).

The structure of current assets and liabilities that company got due to listed changes is liquid and diminish risks of non-payment for the company itself. At the same time, cash gives the lower potential profit, as it does not participate in the process of furniture production. A higher portion of trade receivables bear the risk of non-payment by counterparties and require operations facilitating this debt collection. Also, the loan provided to counterparty does not give any percent to the company. Therefore the periods for trade receivables should be minimized even when the total sum growth. Growing inventory category means, on one hand, more relatively liquid assets and on the other less active usage of inventory in manufacturing process what may signal about the worse market situation.

Trade payables are free sources for the company and allow using efficiently financial sources in the other area while postponing payments to counterparties. However, such manipulation has some limits crossing which the company can lose its reputation or essential partners as well as be forced to pay fees. Decreasing tax and dividend payments may be related to both diminished income and better discipline in payment. In the second case, it is a definite fact as soon as it protects company reputation, exclude fees and tighten its relations with government and shareholders. The general recommendation for the Watley’s in this area is raising the coefficient mostly by changes in liabilities than by assets and keep the current level.

Activity

For inventory turnover ratio the dynamic is decreasing, that is a contrary tendency. With the slower turnover, the business getting less profit from inventories. Therefore, the structure of ratios components requires optimization.

The principal accounting categories affecting this ratio are the cost of sales and inventory. The price has been growing in the 2015 year, while stocks too. Therefore, the change of rate happens from the different speed of growth for two components. An absolute increase of costs is 210 £3000, and for inventories, it is just 50 £3000. However, in percent, the change in prices is about 16% and for stocks 56% that is much higher relative growth. The second parameter has affected the result value of this ratio.

Growing cost of sales itself is a positive fact as soon as it leads to higher sales revenue and potentially to higher profit in total. However, the result does not match this expectation and potential positive effect of growing sales revenue and cost of sales turn to lower total gain. An essential role in this situation played overheads. In particular, salaries and wages and others.

Inventories growing faster than costs of sales means higher expenses for stocking and less active application of stockpiles in production processes. This accounting item could play its role in increasing overheads as soon as more inventories need in more security and transportation labor. While stocks are relatively liquid assets, they still lead to spending of cash and money conservation and less convenient in keeping assets in this form (transportation, stocking, and other services).

In general, for optimization of activity parameters the company could change its logistic and chain management principles to just in time methodology or others requiring reserving of less inventory for next operations while providing just enough for supporting current activities and flexible and promising to offer more when it is necessary for operations intensification.

Profitability

For ROCE the tendency is contrary, the value of parameter decreases. The long-term capital of organization gives less profit in 2015 than in 2014. Therefore, ROCE and company profitability require optimization too.

Main components of the ratio are changing in different directions. The operating profit decreases mostly because of growth in sales costs and especially overheads. The other possible reason for the situation is a slowing down the increase in revenue that management expected planning its activities. That correlates with decreasing spending on advertising, saving this item of overheads on the stable level could provide an adequate to cost items dynamic in revenue.

On the other hand, working capital increased mostly in its equity component and stayed stable at the non-current liabilities part. Within the equity component, main growth happens due to changes in shareholder’s funds, while retained profit has diminished. Reasons for the accumulation of such resources are not clear; probably they have a purpose of covering additional financial needs of the company.

The growth of funds, on the other hand, has not lead to a significant increase in the income item. It is logical that sources the management got from the additional resource have been inefficiently allocated within the company. In particular for providing conditions to inventory keeping while saving on advertising. Therefore, the primary recommendation for balancing this ratio is a review of working capital allocation and more intensive financing of items working efficiently, thus, providing a high return on investments into them.

Probably the company could make an optimization of salary and wages item. The possible source of its growth is not only higher spending on inventories support, but the inefficiency of company workers leading to a lower return on every pound of salary or trade unit actions. The reason for lower labor efficiency may be decreased in such items of fixed assets as motor vehicles and machines. At the same time, it may be a source of lower inventory turnover as well. Checking of marginal results by every additional hour of work and labor item in the situation of diminishing capital factor can help with deciding to cut the number of jobs the company provides or its salaries and wages levels per hour/ unit.

Gearing

The gearing ratio in both years is low; it is under 25% and has decreasing values. That means the company has to finance with lower risk. However, it is probably more expensive than potential funds from external sources.

In 2015 in comparison to 2014 within this ratio changed only one component on the part of the working capital, shareholder’s funds. That means an obligation of the company and its dependence on the shareholder’s probably growth. While dividend liabilities are decreasing, it still can significantly limit the freedom of management decisions. As well spending on dividends can increase as soon as yearly income does become higher. In 2014 dividend liabilities have been 35% of profit, in 2015 33% of profit for the period. This dynamic tells the share of stockholders in the benefit to become relatively lower. Nevertheless, their participation in funding getting more active in the 2015 year than in 2014.

Also, as it is clear by previous ratio analysis an allocation of these additional funds is not optimal. Therefore, it could be better not involve them into the baseness at all and reallocate sources that organization already have.

Long-term bank loan could become a cheaper source of funding. However, it is more demanding to regular payments independently of the company financial results. Therefore, first, this organization need in changes in the balance structure making the funding use more efficient and profitable at least by fixing internal issues and then on the positive trend in the profit it can fund by external sources. Otherwise, in the situation of problematic fund allocation and inefficient spending, it is cheaper to use internal sourcing as shareholders are more interested in the long-term development of the company and could allow the Watley’s reinvest the profit or do not pay dividends in the case the financial result of the year is a loss.

Conclusion

In total, the company should revise its structure of the balance and sources of financing. Probable measures of optimization is a preparation of infrastructure both in production (machines and conditions for efficient work) and sales (marketing and advertising support). In this case, additional funding from any source will give a positive result, but mainly by cheap bank loans. Investing in inventory and labor will be reasonable too as there will be potential for efficient work and conversion inventory into goods that will be demanded on the market.