step 7: contribution margins - wordpress.com€¦ · web viewacct11059: accounting, learning...

ACCT11059: Accounting, Learning & Online Communication Assignment 2 Steps 7 - 10

Assignment 2 Steps 7-9Blog post: Contribution Margins, Ratios & Investment Decisions

Step 7: Contribution MarginsBlog post: Contribution Margins

Table 1: McBride Products

Product Surcare Concentrated Non-Bio Laundry Liquid

Wash 630ml

http://www.surcare.co.uk/

Surcare Sensitive Fabric Conditioner

Concentrate 1L


Oven Pride Complete Oven Cleaner 500ml

http://www.ovenpride.com/

Retail Price £2.78 £1.50 £4.00

McBride plc Selling Price

£2.08 £1.12 £3.00

Variable Cost £0.21 £0.21 £0.33

Contribution Margin (£)

£1.87 £0.91 £2.67

Contribution Margin (%)

90% 81% 89%

When completing research of my three chosen products produced by McBride plc I realised that because McBride is a manufacturer as opposed to a retailer I was going to have to search the retailer’s websites to gain an idea of the retail price for these products. I then decided that in order to have a reasonable estimate for the contribution margin for these products I would have to reduce the retail price in order to take into consideration the mark-up the retailers would have placed on these products. My research showed that in most cases the mark-up for products is 50% of the retail price however this varies and can be greater or lesser. I have decided a reasonable mark-up for these products would be 25% as there is very little the retailer needs to do, generally the product is just taking up space on the shelf, it is not as though they had to actively try and sell the product as you would say for example a washing machine or car, it is also not as though their overhead costs of holding the item would increase as would say with milk where you have to keep it refrigerated.

The next step was determining the variable costs, to do this I undertook a bit more research so that I could determine a reasonable estimate of the price per product for what I determine the variable costs to be for these products.

1S0291459 Natasha Hodgson

http://www.ovenpride.com/



https://accountingwithtash.wordpress.com/2017/05/23/contribution-margins/

https://accountingwithtash.wordpress.com/2017/05/21/contribution-margins-ratios-and-investment-decisions/


Some background for my estimated variable cost:£0.04 material for 1 bottle £0.20 oven cleaner £0.04 printing on bottles

£0.04 material for 1 box £0.01 casual wages £0.12 liquid laundry wash/fabric softener

I also came across this interesting read while researching the variable costs, it talks about how the cost of manufacturing laundry detergent is very low as one of the major ingredients used is actually just water, it also included other factors which were not 100% relevant to my research but non the less an interesting read.

https://www.quora.com/What-is-the-cost-of-manufacturing-laundry-detergent

While the contribution margins for these three products look extremely promising (which they are), I believe that for McBride plc their fixed costs will be quite high, meaning that the majority of this contribution margin will be put towards covering fixed costs and only a small percentage of this will actually go towards returning a profit.

What kind of things would be included in McBride’s fixed costs?Administration costs Maintenance costs Full-time manufacturing staff wages

Electricity / Water / Phones Rent on Buildings Rates on Buildings and Land

Why have I classified these as fixed costs and why do I feel that the dollar value associated with these items are high? I might start with the issue of wages, I have included wages in both variable and fixed costs, but why? For variable I have only considered casual wages, whereas for fixed I have considered full-time manufacturing staff, also included in administration and maintenance costs are staff wages. I learnt from my production and operations management unit last term that regardless of the size of the run (i.e. producing just 1 item or producing 100,000 items) the set-up time and costs involved will remain the same. By taking this into consideration I have therefore classified that there should be wages that are fixed which associate to the set-up of the run, and any additional staff which are consequently needed for a large run (during the manufacturing process and after which are needed in the packaging and warehousing department) I would consider as casual wages and allocate to variable costs. Administration wages and maintenance wages I decided were not dependant on the size of the run so therefore should be fixed. Then also included in fixed costs were the general overheads associated with running the manufacturing plants, warehouses and offices, these include rent on buildings not owned, rates on buildings and land and general electricity, water and phones etc.

So considering the large amount of fixed costs associated with manufacturing these products I would consider that even if a product had a positive contribution margin as opposed to a negative contribution margin that this should not automatically determine that this product should be included in the product mix for the company. A small but positive contribution margin will likely cause the company to be non-profitable because it can’t reasonably cover the fixed costs for the company. I am sure McBride has done the math and has worked out what average contribution margin % is needed in order to be profitable.

What jumps out at me about the difference between the contribution margins of the three products chosen? I thought it was quite interesting to note that the fabric softener comes in a 1L bottle and retails for only £1.50 (McBride selling price of £1.12) yet the laundry liquid is only in a 630ml bottle but retails at £2.78 (McBride selling price of £2.08). What this is telling me is that the market demand is higher for laundry liquid than it is for fabric softener, which from my own experience


https://www.quora.com/What-is-the-cost-of-manufacturing-laundry-detergent


would be correct as I don’t even use fabric softener. Yet I considered the variable costs for producing these two products would be much the same as there would be in my opinion more ingredients in laundry liquid as opposed to fabric softener, also I considered that it would cost much the same to make the bottles even though one is larger (just because something is smaller it does not necessarily mean it is cheaper to produce, I often ponder this when buying children’s shoes, are they so expensive because it actually costs a lot to produce them, or is it because the market demand of them is high because children grow so damn fast?). Because I have determined the variable costs to be the same for these two products it therefore makes sense that the one with the higher selling price has the higher contribution margin. I think this contribution margin is purposely higher because they know they could push the selling price of this product up because of the market demand for it.

Resource and Market ConstraintsBecause all three products chosen include plastic bottles I have decided to discuss the production of plastic bottles as one of McBride’s possible resource constraints. As the oven cleaner is the only product which comes in a cardboard box I thought this would also be a good resource constraint to discuss.

Table 2: Resource Constraints

Product Surcare Concentrated Non-Bio Laundry

Liquid Wash 630ml


Concentrate 1L


Bottle size 630ml 1L 500ml

Units per 1L bottle size

1.59 1 2

Contribution margin (£) per 1L bottle size

£2.97 £0.91 £5.34

If I were to hypothetically consider that these were the only three products which McBride produced and there was a shortage on the materials needed to make the plastic bottles worldwide and McBride was only allocated enough material to produce 1,000,000 1 litre bottles I could use the information in the above table to make a decision about McBride’s best product mix to achieve the greatest profit (this too is hypothetically considering you could make smaller sizes e.g. two 500ml bottles would require the same amount of material as one 1L bottle).

From the information in the above table you could argue that McBride should cease producing laundry liquid and fabric conditioner and focus solely on producing and selling oven cleaner as this produces the highest contribution margin. However I am also considering there is a shortage on cardboard and I only have enough cardboard to make 1,000,000 boxes. The oven cleaner is only in a 500ml bottle though so 1,000,000 bottles of oven cleaner would only use up half of the plastic material allocated meaning we can look at McBride’s other two products.

This one should seem simple too, however I am going to add another factor. Because laundry liquid and fabric softener are related products I am going to include a condition that for every three bottles of laundry liquid produced one bottle of fabric softener must also be produced. Therefore in order to work out the remaining allocation of plastic material to complete our product mix we need to work out how much plastic material goes into three bottles of laundry liquid and one bottle of fabric softener.



(1 x fabric softener bottle size) + (3 x laundry liquid bottle size) = (1 x 1) + (3 x 0.63) = 2.89 L

By using this number we can then divide the remaining plastic material by this number to give us how many bottles of fabric softener we will have.

500,000 / 2.89 = 173,010 bottles of fabric softener

We then multiply our bottles of fabric softener by 3 to give us how many bottles of laundry liquid we will have.

173,010 x 3 = 519,030 bottles of laundry liquid

Consequently because of these factors McBride’s product mix will look like this:

Table 3: Product Mix

Product Surcare Concentrated Non-Bio Laundry

Liquid Wash 630ml


Concentrate 1L


Number of Units 519,030 173,010 1,000,000

Contribution Margin per Unit (£)

£1.87 £0.91 £2.67

Contribution Margin for Total Units (£)

£970,586.10 £157,439.10 £2,670,000

If there were no such resource constraints placed upon the manufacture of these products then why wouldn’t McBride just produce the product with the highest margin? Looking back to table 1, why wouldn’t McBride just sell oven cleaner as this product returns the highest Contribution Margin (£) per unit. McBride needs to consider other factors, primarily market demand. Let me put this into perspective, McBride’s average revenue is approximately £700million. McBride’s sells globally, however their largest market is Europe with an approximate population of 743million. Now consider that each household had 4 occupants (743/4 = 185.75), that means there are 185.75million ovens. If McBride only had one other competitor in this market they may sell around about (185.75/2 = 92.87) 92.87million bottles of oven cleaner. It isn’t a product that needs to be bought often as cleaning your oven is not generally something that is done daily, weekly or even monthly in many houses. 92.87million bottles of oven cleaner is (92.87 x 3 = 278.61) is a revenue of £278.61million. If McBride were to only sell oven cleaner they would be missing out on a potential revenue of approximately (700 – 278.61 = 421.39) £421.39million. Simply stated no matter how great the contribution margin of a product is, you can’t sell more of that product than there is market demand for it.



Step 8: Ratio Analysis & Economic ProfitBlog post: Just Keep Swimming

Profitability Ratios

2016 2015 2014 2013Profitability RatiosNet Profit Margin Net profit after tax/ sales 2.5% -0.1% -2.6% 0.7%Return on Assets Net profit after tax/ total assets 4.1% -0.2% -4.4% 1.2%

The profitability ratios come as no surprise, it was quite evident from looking at McBride’s annual reports that they had been struggling for some time to be profitable, even though 2013 is a positive it is minimal and McBride was still struggling. In 2015 the board of directors decided that McBride’s profitability was something that needed to be greatly considered and the driving factors behind these poor results had to be addressed. This deeper looking provided McBride with their new strategy of ‘Repair, Prepare, Grow’ with 2016 being the first year of this new strategy being implemented and immediate results being seen I think it is fair to say that McBride plc is on their way back up to a well-run highly efficient manufacturing company.

It was quite interesting to compare McBride’s profitability ratios with those of other companies, it just strengthen the fact the McBride had been really struggling with this area. One of my peers Dana made comment on my blog that it was fascinating the difference between our company’s profitability ratios, Dana’s company Brickworks is a manufacturer of building materials and their Net Profit Margin sits at between 10% – 15% however I found it interesting that their Return of Assets only sits at around 3% - 4%. When comparing these figures with that of McBride in 2016 McBride had a Return on Assets of 4.1% sitting at around the average levels for Brickworks yet McBride’s Net Profit Margin was still only 2.5% nowhere near the average levels for Brickworks.

This difference in figures has come down to two separate areas, first of all Brickworks has a very large number of assets which brings their Return on Assets down while their Net Profit Margin is still high. The second area is within McBride, I commented on my blog in response to Dana that; “Your company seems to be in a much better financial position than my own. For years McBride has had


https://accountingwithtash.wordpress.com/2017/05/27/just-keep-swimming/


very large sales but have struggled with profit because they were trying to be too accommodating to their clients, by offering a large range of products and sizes they were largely increasing their expenses. Meaning some of their products had very small profit margins which were incapable of covering fixed costs. On top of this they had a factory which was running at a loss. By recognising these faults McBride was able to turn themselves around in 2016 with a positive economic profit, this is only the beginning, I am sure they will continue to improve, and hopefully have profitability ratios that look a little more like your own company’s.”

I had also decided to compare McBride plc with that of Britvic plc (Sarah Zillmann’s company), I thought that Britvic would provide a relative comparison as Britvic is also a UK company and has similar financial statements reported in £million. Britvic produces soft drinks, which while not the same as McBride with their cleaning and personal care products, they do sell for around about a similar price, making Britvic (in my eyes) the perfect company to compare with.

By displaying the Net Profit Margin figures for both McBride and Britvic it was easier to see the trends for each of the company’s over the years, while McBride has struggled with profitability and have quite variable percentages (both above and below the 0% line) Britvic seems to be steadily increasing their profitability. I would imagine in the years to come (2017 – 2020) McBride’s profitability would look much like that of Britvic, which got me wondering whether previously (pre 2013) Britvic was profitable or whether they had similar struggles like McBride has had recently.

Efficiency Ratios2016 2015 2014 2013

Efficiency (or Asset Management) RatiosDays of Inventory Inventory/ av.daily cost of goods sold 63.2 52.9 49.1 60.7Total Asset Turnover Ratio Sales/ total assets 1.63 1.78 1.73 1.71

I will first make note on the Total Asset Turnover, while you would expect that as the profitability of a company would increase so too would their total asset turnover this isn’t necessarily the case, as you can see for McBride plc. However I can explain that for McBride the reduction in their Total Asset Turnover isn’t bad it is in fact part of their ‘Repair, Prepare, Grow’ strategy. As part of prepare which was implemented in 2016 McBride actually reduced their product range that they offered their customers. McBride was previously sacrificing profitability in order to provide flexibility for



their customers by offering a large range of products in a large range of sizes. By simplifying their range McBride was able to reduce costs incurred for producing the products. How did this work, well it goes back partially to the set-up time and costs which I mentioned in step 7 that regardless of the size of the run (i.e. producing just 1 item or producing 100,000 items) the set-up time and costs involved will remain the same. So for McBride their set-up costs were huge because of the many different runs involved in providing such an array of products and sizes. Because McBride has reduced their range their sales have also reduced (which was to be expected) which is why the Asset Turnover has decreased, however this isn’t a negative impact in the case of McBride as despite this profits are increasing.

Remember: Sales do not directly relate to profit!

Days of Inventory; one of my peers Danielle Bradley made comment to me that it was interesting that although McBride’s profitability had increased their days of inventory had actually gotten worse. I agree this is an interesting point so I set about trying to understand why. Days of inventory is also something I learnt about last term in production and operations management, inventory is necessary for the daily running of a business however learning to balance the amount of inventory is essential. It is important to not run out of inventory as you consequently lose sales if the inventory is not in place, and risk losing customers to competitors. However on the other hand too much inventory will lose the business money too as inventory is essentially money which is tidied up in goods, on top of that there is also the cost involved in storing the excess inventory. So why has McBride’s days of inventory increased, as their profitability has increased? My thoughts on this is that because McBride is reducing costs associated with production they may have increased the size of their production runs, this would make sense as it reduces the costs of set-up for the runs and McBride could probably reduce the costs of materials if they are buying in larger volumes. This would explain the increase in inventory, so I wonder if this is the case.

Remember: Days of Inventory do not directly relate to profit!

Liquidity Ratios2016 2015 2014 2013

Liquidity Ratios Current Ratio Current assets/ current liabilities 1.09 1.03 1.07 0.94

In 2013 McBride had current liabilities greater than current assets, this meant that in the case of all current creditors requiring payment at the same time McBride could not cover the costs. This is a direct result of McBride having no cash / cash equivalent in 2013. Thankfully their current ratio has improved in the years after.

Remember: Cash is King!



Financial Structure Ratios

2016 2015 2014 2013Financial Structure RatiosDebt/ Equity Ratio Debt/ equity 505.9% 589.4% 526.4% 317.8%Equity Ratio Equity/ total assets 16.5% 14.5% 16.0% 23.9%

The Debt/Equity Ratio was one that I initially looked at and was puzzled as 2013 had the smallest Debt/Equity Ratio. I would have thought that the percentage for 2013 would have been higher than what it was, considering their current assets didn’t cover their current debts. Then I remembered the reason behind their current ratio being below 1 was because McBride did not have cash in 2013, cash comes under assets, hence, their assets were a lot lower than other years whereas debt was only slightly larger. Also the financial structure ratios take into consideration total debt and assets not just current, when looking at the non-current debt for 2013 that was actually much lower for 2013 than in the years following.



When comparing McBride’s Debt/Equity Ratio to Britvic the first question that crossed my mind was; “Why does Britvic have such large ratios for 2013 and 2014?” It peaked my interest to uncover why this was the case, as in 2015 and 2016 McBride and Britvic have very similar Debt/Equity Ratios. Was this because Britvic had made large investments in 2013 (or even 2012) which were funded by debt investors rather than equity investors? If so was this a strategic debt that they took on in order to produce future gains? Is this why their profitability ratios have steadily increased? So many questions which I had to look into. However upon investigating these I found that my initial thoughts were incorrect, Britvic’s debt wasn’t higher in 2013 and 2014, actually the debt over the four years has been quite consistent with a small increase in 2016, so why such a large difference in the figures?

Finally I looked at equity, equity for McBride was a lot higher in 2013 than in the years following, this information helped explain why the percentage for McBride was a lot lower in 2013. I wanted to understand why in the years following 2013 McBride’s equity had reduced, I discovered that the main contributing factor for this was the accumulated losses which McBride was carrying, this amount dramatically increased in 2014 when McBride made a huge loss. Therefore this loss was also carried forward to 2015 and 2016 meaning the equity remained quite a lot lower than the equity in 2013. When I checked the equity for Britvic my questions about the variance in Britvic’s Debt/Equity Ratios was also answered. Britvic’s equity was a lot lower in 2013 due to losses carried forward, as time has gone on the equity for Britvic has increased as they realise some of these losses in the years going forward as they continue to make a profit. Isn’t it interesting how a company’s Debt/Equity Ratio can change so dramatically without actually changing the amount of debt they are carrying. Maybe my earlier thoughts that Britvic may have been struggling pre 2013 with profitability is likely considering the large amount of losses that were carried forward in 2013.

I can now appreciate why Cheryl Haupt’s company Funtastic has a negative equity, as they have been running at a huge loss for years, and with these losses being carried forward and accumulating each year it was just a matter of time until their equity became a negative. It is also interesting to note that Funtastic’s shares are no longer listed, to me this just confirms the financial difficulty the company is facing and are probably putting procedures in place to cease business.

Similarly this information helps to explain the Equity Ratio, for McBride the Equity Ratio is higher in 2013 because of the higher equity (not necessarily a change in assets). The same can be seen with Cheryl’s company Funtastic, as the years progress and their equity becomes worse because of the accumulated losses each year you can see that the Equity Ratio also dramatically decreases. Things do not look good for Funtastic.



Here is a quick look at Funtastic and how the negative equity has effected the ratios.

So what does it mean when you have such a large Debt/Equity Ratio? Is it good or bad? This is something I discussed with others who had large Debt/Equity Ratios on Facebook. For McBride the Debt/Equity ratio shows that on average McBride has 5 times as much debt as they have equity, so their firm is majority funded through debt investors. Is this good or not, well I think that depends on the company. Having a high Debt/Equity Ratio means that the company is higher risk, however if they are using that debt to create a higher return than it is costing them then it is obvious that it is a smart debt, if the company hasn’t managed to do this then it is probably not a good idea to have such high levels of debt. I think of it like this, high debt is high risk, however a lot of the time high risk can lead to a higher gain, doesn’t it all depends on how you make that money work for you?



Market RatiosMarket Ratios Pence Pence Pence PenceEarnings per Share (EPS) Net profit after tax/ nos of issued ordinary shares 9.3 (0.4) (10.5) 3.0Dividends per Share (DPS) Dividends(paid during financial year)/ number of issued ordinary shares 3.1 5.0 5.0 4.7Dividends per Share (DPS) Dividends(relating to the financial year)/ number of issued ordinary shares 3.6 3.6 5.0 5.0Price Earnings Ratio Market price per share/ earnings per share 15.97 (231.65) (10.59) 42.12

Market Ratios, this one I decided I needed to do a little extra playing around with, because the EPS and DPS totals are in pence I decided it made sense to multiply my total by 100 so they could be shown in pence on my spreadsheet. This was logically the correct decision for me as in the case of 2015 having such a low figure if this were shown in pounds it would be (0.004) a little ridiculous and quite a lot harder to try and derive meaning from a figure such as this. The market price per share was also in pence so it made the calculations for the Price Earnings Ratio easier to calculate too. I was quite happy to find that when I compared the figures I had calculated for EPS and DPS to the figures shown in the annual report that they matched. It is interesting to note that the EPS doesn’t relate to the DPS, the DPS is decided by the board of directors in their dividend policy. As you can see in 2013 and 2014 McBride paid out 5 pence per share however in 2015 & 2016 it was only 3.6 pence per share, this is because of a change in their dividend policy in order to keep more cash in the company to be used to increase their profitability and financial position. For shareholders this may have been disappointing, however in the long run this should increase the value for shareholders.

While providing feedback for Ros I did actually notice that the dividends were linked back to the statement of movements in equity (cue panic stations as I thought my assignment was complete). This meant I needed to do some more research into the dividends for McBride as the dividends in the changes in equity (item called ‘issue of B shares’) did not match that of the dividend information provided in the annual report at note 12. The inconsistency between the two figures I found was the fact that the final dividend for each financial year is not finalised and paid until the following financial year. The effect of this is when the interim and final dividend payments change year to year that the dividends paid during each year do not accurately reflect the dividends associated with that year. Hence each year the final dividend is being paid for the previous financial year and the interim dividend for the current year. Therefore I felt as though I should not remove my original calculations for DPS as I feel they are a more accurate representation. I instead have still included them in the spreadsheet within a box just below the calculation for DPS from dividends paid during the financial year. By having them next to each other it clearly reflects how when the dividends are paid and what years they are in relation to can change the total DPS for the year (panic stations averted).

I have included below the difference between the two figures for dividends.

From the 2016 annual report:



From the 2014 annual report:

Paid during the financial year:

Price Earnings Ratio, for me this was a little more difficult to derive meaning from. I guess for me on first look I thought it showed how many years it would take of receiving dividends before you have recovered your cost of buying the shares in the first place, a kind of payback period I guess. But on closer inspection this is not the case, this would have been market price per share / dividends per share, we are instead looking at market price per share / earnings per share. So a little more research was needed for me to determine what McBride’s Price Earnings Ratio was telling me.

I found great understanding by reading about Price Earnings Ratio on Investopedia http://www.investopedia.com/terms/p/price-earningsratio.asp

Tips to remember about Price Earnings Ratio from Investopedia:

Generally a high P/E ratio means that investors are anticipating higher growth in the future. The average market P/E ratio is 20-25 times earnings. The P/E ratio can use estimated earnings to get the forward looking P/E ratio. Companies that are losing money do not have a P/E ratio.

McBride’s annual report contained a nice compact table showing the Market Price per Share for the last 5 years as shown below:


http://www.investopedia.com/terms/p/price-earningsratio.asp


The first thing to note about McBride is that for 2014 & 2015 the Price Earnings Ratio is not applicable as the company is making a loss in those years (I thought this would be the case as the I couldn’t derive any meaning from those numbers and even if I negated them and turned them into positive numbers the figures were still illogical). Next is that in 2013 for every £1 earned per share the stocks were valued at £42.12 (or I guess I could change that to every 1 pence earned stocks were valued at 42.12 pence, either way they are the same). In 2016 for every £1 earned per share the stocks were valued at £15.97. So what does this tell me? Does that mean that in 2013 because the Price Earnings Ratio was high that investors were anticipating higher growth in the future or does it tell me that the stocks were overvalued?



I found this share price chart on McBride’s website quite interesting, the share price is on the rise, does this show a gained investor confidence in the company due to their increased profitability? It looks to me that their new ‘Repair, Prepare, Grow’ strategy is well and truly working.

Ratios Based on Reformulated Financial Statements2016 2015 2014 2013

Ratios Based on Reformulated Financial StatementsReturn on Equity (ROE) 24.75% -3.65% -42.27% 2.44%Return on Net Operating Assets (RNOA) 20.75% -9.76% -17.61% 5.25%Net Borrowing Cost (NBC) 17.44% -13.68% -0.17% 8.98%Profit Margin (PM) 4.65% -2.04% -3.92% 1.29%Asset Turnover (ATO) 4.46 4.78 4.49 4.07Economic profit (in millions) £16.4 -£29.1 -£45.7 -£8.9 (in millions)

Return on Equity shows how well the company is making use of the equity investors’ interest in the company. The figures are consistent with the facts already identified about McBride that in the years 2013 through to 2015 the company was not performing well, with a huge loss reported in 2014 as reflected in the ROE.

The story is much the same for Return on Net Operating Assets (OI/NOA), this ratio shows how well the company is making use of their assets, looking at 2016 you can see that the RNOA is 20% this means that for every £1 of NOA the company was able to return an OI of £0.20, this isn’t bad if you consider that most of the assets for the company would have an effective life of longer than 5 years.

Net Borrowing Costs, the figures for this in 2014 and 2015 look a little funny, this is because in those years McBride have NFI rather than NFE, which was attributed to gain on cash flow hedges and net investment hedges. It makes sense that they would have a gain on these items in those years because in 2014 and 2015 McBride made a significant loss on currency translation differences from their operations in other companies. These hedges are a mitigation of financial risk for issues such as these. Therefore that NBC for these years are rather meaningless. I guess it is interesting to note again that in 2016 the NBC has increased even though the profitability of the company has increased. I looked into why this was and this was due to losses on the cash flow hedges and net investment hedges. I guess this is because hedges work both ways as a mitigation of risk, when money has been lost there is a gain on hedges to balance it out, when money has been gained there is a loss on hedges to balance it out. I guess if you were confident you were not going to make a loss on currency etc. then you wouldn’t bother with the hedges however it is a form of insurance against this happening (and insurance companies need to make money too).

Economic Profit = (RNOA – cost of capital) x NOA, RNOA is driven by both PM and ATO. This took me back to Chapter 4 (which was probably my favourite). Here are my thoughts on PM, ATO and RNOA from Chapter 4, this gave me a great insight to understanding the driving factors for McBride’s Economic Profit;

Profitability and Efficiency.

Profitability is the relationship between operating income and sales, or how, your profit margin (PM) shows how many cents per dollar of sales is left as profit once deductions for the cost of the sales has been made. It is calculated as:

PM = OI/Sales



Efficiency is the relationship between sales and net operating assets, it is called asset turnover (ATO). It is essentially how well your assets are working for your firm. It is calculated as:

ATO = Sales/NOA

When expressed together profitability and efficiency can provide a picture of the performance of the firm. This is calculated as:

RNOA = PM X ATO

I do believe that this is an effective way to check the viability and health of a firm, it essentially expresses the profit that each dollar of net operating assets can earn. It is essentially the same equation as RNOA = OI/NOA as demonstrated below:

RNOA = Operating Income RNOA = Operating Income x SalesNet Operating Assets Sales Net Operating Assets

So why would we bother using this equation RNOA = PM X ATO when it is the same as RNOA = OI/NOA? Well I believe it allows for the relationships of profitability and efficiency to be easily identified and to provide a deeper understanding into the realities of a firm.

By looking at the figures in the spreadsheet it is glaringly obvious that for McBride the driving factor for the turning point in their Economic Profit is PM. Over the four years ATO has barely changed, this is because NOA has generally stayed quite stable and sales have consistently been high, which has led to very little change year on year for ATO. PM however has varied because of the significant change in OI, therefore you could say the driving force behind McBride’s Economic Profit is PM which stems from increased OI which stems from decreased expenses, which all stems back to McBride’s ‘Repair, Prepare, Grow’ strategy. I think the proof this strategy is working is clearly shown in the figures.



Again I decided to compare McBride’s Economic Profit and driving factors with that of Britvic. Once I viewed both of the charts together for Economic Profit and Profit Margin I was surprised that both charts for McBride followed the same trend. I don’t know why I was so surprised, as mentioned above it was obvious to me that the driving force behind McBride’s Economic Profit was Profit Margin, however I think it was interesting how closely related these two factors were and how strongly the influence of Profit Margin affects the way the Economic Profit behaves. Then when I compare these same factors for Britvic the Economic Profit also follows much the same trend as the Profit Margin.

My thoughts about the driving factors of Economic Profit are confirmed when I look at the chart for Asset Turnover. McBride’s is quite steady and have very little influence over the Economic Profit, Britvic is similar where there is only small change in the Asset Turnover, however it is interesting to note the Asset Turnover for Britvic is actually decreasing, while Profit Margin and Economic Profit have been increasing (with the exception of 2016). Because of this I do wonder whether the Asset Turnover did have some influence over Britvic’s Economic Profit for 2016, however it is hard to provide a definitive answer for this one as the Profit Margin was also decreased for 2016.



I wonder if anyone found that Asset Turnover was the driving force behind their company’s Economic Profit rather than Profit Margin, and what the reasons behind this are. My initial thoughts are that for Asset Turnover to be the driving factor it would have to be quite high, which in turn would mean that Net Operating Assets are relatively low in comparison to sales. I think it would be interesting to hear if anyone has found this to be the case for their own company, or whether Profit Margin normally has the greatest influence over Economic Profit?

Something Suzanne Kriedemann mentioned was taking a look at the interim report for 2017, while this isn’t part of the assignment I too thought this would be interesting, especially considering all my assumptions regarding the future of McBride and their ‘Repair, Prepare, Grow’ Strategy.

McBride plc half-year report 2016

I was pleased to see that my thoughts about their future growth were more than just an imagined reality in my mind. McBride is slowly repairing their poor financial status from the years of past, and are slowly climbing their way up the profitability ladder. They are moving onto their prepare phase of their three step plan and are making great progress. They have continued to reduce their revenue (as per their repair plan) on a constant currency basis and increase profits (crazy how this works isn’t it). Mental note to sketch into my brain again and again; increased revenue does not equal increased profit! Well not in McBride’s case anyway.

One thing I can note is that if I were looking to invest in McBride in 2014 the decision would have been an easy “No, stay clear”. However looking at it now in 2016/2017, with the knowledge into how they improved their profitability, and having seen their strategy for the future, the decision may very well be different.

Step 9: Capital Investment Decision

When deciding on a capital investment decision for McBride I decided to take inspiration from their annual report and calculate the NPV, IRR and payback period for capital investments they have already started to implement or they have plans to implement. There was however still a fair amount of estimation involved as none of this included dollar figures. The cost of capital used for both is 10%.

Investment Opportunity – PET Bottle MachinesThis investment decision was inspired from a case study provided in McBride’s 2016 annual report as detailed below:


http://www.mcbride.co.uk/media/140518/mcbride_hy16-report.pdf


Table 4: PET Bottle MachinesThe case study refers to only one of McBride’s sites, therefore the investment decision I have decided to look into is upgrading McBride’s other major PET WUL manufacturing sites with the new machines. The original cost is the estimated price of these new machines for the sites. The estimated cash flows are an estimate of what the benefit of 15% more capacity could look like in terms of increased cash flows. For years one and two I have estimated the cash flows as being significantly lower because of the time taken to implement the new machines at all sites and get them up and running, particularly manufacturing downtime in year one while the upgrades are occurring. The estimated residual value is a negative as it is likely there will be a small cost associated with the removal and rehoming of the machines at the end of their useful life with McBride plc.

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7Cashflows (2,000) 500 2,500 5,000 5,000 5,000 5,000 4,500

NPV 15,928.49


IRR 102.77%


Cumulative Cashflows (2,000) (1,500) 1,000 6,000 11,000 16,000 21,000 25,500Payback Period 1.6 Years

Investment Opportunity - PET Bottle Machines


PET Bottle MachinesOriginal Cost (2017) £’000 2,000Estimated Life 7 YearsResidual Value £’000 -500Estimated Future Cash Flows £’000Year 1 - 2018 500Year 2 - 2019 2,500Year 3 - 2020 5,000Year 4 - 2021 5,000Year 5 - 2022 5,000Year 6 - 2023 5,000Year 7 - 2024 5,000


Investment Opportunity – New Warehousing Facilities Table 5: New Warehousing Facilities

This investment decision also grew from something I read in the 2016 annual report about new warehousing facilities for McBride plc in the future plans. Again this required a great deal of estimation on the original cost of this investment and the possible future cash flows that this would bring. From a little more digging through the annual report I was able to discover that McBride is currently paying rent of £4.4million, I thought it was quite likely that this rent was for such warehousing building etc. so I have decided that this amount would be the maximum yearly future cash flow for this investment. The estimated residual value for the new warehousing facilities is in stark contrast to that for the PET bottle machines. The new warehousing facilities being land and buildings hold their value hence McBride would be able to sell their facilities if they found they no longer had a use for them.

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7Cashflows (16,000) 1,000 4,000 4,400 4,400 4,400 4,400 19,400

NPV 9,696.93


IRR 21.50%


Cumulative Cashflows (16,000) (15,000) (11,000) (6,600) (2,200) 2,200 6,600 26,000Payback Period 4.5 Years

Investment Opportunity - New Warehousing Facilities

Recommendation and LimitationsBy comparing the two decisions, and presuming that only one can be chosen, my recommendation to the board of directors of McBride plc would be to invest their capital in PET bottle machines. The reason behind this is because the risk involved in this investment is extremely minimal. The payback period is 1.6 years, after this point there is no longer a risk of losing money. Not only that, but the NPV and IRR are huge, with £15.9million for NPV and 102.77% for IRR.

Limitations however include the fact that the future estimated cash flow has a higher chance of being incorrect for the PET bottle machines than for the new warehousing facilities. The new warehousing facilities are using a figure that will be saved by not having to pay rent, whereas the PET bottle machine is purely an estimate of how the 15% increased capacity and greater efficiency of the new machines would impact on the future cash flows (so quite a bit of variability there).

Further limitations of the NPV and IRR for both investment decisions include variability in figures if say the NPV and IRR are worked out over a different time frame. I have included a comparison in the


New Warehousing FacilitiesOriginal Cost (2017) £’000 16,000Estimated Life 7 YearsResidual Value £’000 15,000Estimated Future Cash Flows £’000Year 1 - 2018 1,000Year 2 - 2019 4,000Year 3 - 2020 4,400Year 4 - 2021 4,400Year 5 - 2022 4,400Year 6 - 2023 4,400Year 7 - 2024 4,400


table below demonstrating the difference in these figures if the NPV and IRR are worked out over only five years rather than the seven for these investments.

Table 6: Comparisons

PET Bottle Machines New Warehousing Facilities

NPV £’000 (7 years) 15,928.49 9,696.93NPV £’000 (5 years without residual value) 10,796.91 -2,742.03NPV £’000 (5 years including residual value)

10,486.45 6,571.79

IRR (7 years) 102.77% 21.50%IRR (5 years without residual value) 98.86% 3.90%

If we were to consider that McBride had enough capital to invest in both decisions this variance in calculation between 5 years and 7 years may influence their decision about investing capital in the new warehousing facilities as the NPV is negative (if the residual value is not included at year 5) and IRR is less than the cost of capital. These figures do not reflect the likely future gain that the warehouse facilities may bring, considering that because of the nature of the investment being land and building they could have an effective lifetime value of 20 years plus. Personally I think the New Warehousing Facility is a good investment, however from looking just at these figures PET Bottle Machines on all three areas of payback period, NPV and IRR look to be the superior decision.

However if McBride has the £18million available to invest, my recommendation would be to invest in both the PET bottle machines and the new warehouse facilities. By investing in both the fast returns seen on the PET bottle machine investment would help towards mitigating the risk involved with the warehousing facilities and the longer payback period. I think both investments have the potential to have a useful lifetime of longer than 7 years used to analyse the investment decision and therefore has the potential to provide greater value than that which has been forecast.

Step 10: Feedback

Feedback, oh how I love giving and receiving feedback. I was quite eager to get started on the feedback process as I have found previously that this is a great opportunity to take a critical view of my own work, and come across areas which may have been overlooked. I provided feedback for four of my peers who in turn provided feedback to myself. Normally I find the providing of feedback to be much more beneficial than the receiving, however in this case I found the feedback that I received to be of such high quality that I found both giving and receiving to provide a similar benefit to myself.



From providing feedback I had picked up on a few areas which I had over looked, one of these was the debt ratio, while this wasn’t included in the initial spreadsheet (so I think there is probably no points allocated to it) I am not shy of a little extra work, so I added it into my spreadsheet. I did find it was a useful tool to help confirm my calculations for the equity ratio were correct, as the equity ratio plus the debt ratio should equal 100% this is because equity + debt = assets.

Another error was the fact that I had used the Market price per share at the end of each financial year rather than the average Market price per share which covers the period of each financial year. There was actually a great table included in my annual report covering the last five years showing the low, high, average and at the end of financial year market price per share.

Finally I picked up on the fact that for Dividends per share that most people were linking their dividends back to their statement of movements in equity, whereas I had taken the information from the annual report, I have expanded on this in my step 8.

The feedback I received highlighted that I hadn’t included a residual value for my capital investment decisions. It also made me take a look at the question about contribution margins of ‘why not only sell the product with the highest contribution margin?’ which I had covered when discussing resource constraints but I needed to make it clearer for the person marking that I had actually covered this point.

I have really enjoyed the interactive communication and discussion of concepts and differences between each of our company’s, not only looking at the numbers provided in their annual reports but truly understanding what they mean for each of the company’s. It has come up many times, that each of our companies have different realities and drivers which aren’t always obvious when we first look at the numbers contained within the annual reports. By being able to openly discuss with our peers amongst the many different platforms of online communication, uncovering these realities was and enjoyable task, I am a little sad that this unit is coming to an end, however I just hope I can use my new discussion skills in my future units and keep in touch with my new online study buddies.

The feedback I provided to others can be found below:

PEER FEEDBACK SHEET: ASS#2 Step 10

Feedback From: Natasha Hodgson

Feedback To: Suzanne Kriedemann

My CommentsStep 7

Identify three products or services of

Information MonitoringSelling Price per Unit £1,500Variable Costs per unit (utility costs, sales and £950



your firm

Estimate selling price, variable cost & CM

Commentary – contribution margins

Constraints – identify & commentary

marketing costs, some salaries and wages and printing variable costs as detailed in The House calculations) Contribution Margin = Sales – Variable Costs £750

Contribution Margin Ratio = CM / sales revenue

50%

The figures in this table do not add up.

Love your commentary.

Step 8

Calculation of ratios

Ratios – commentary (blog)

Calculate economic profit

Commentary – drivers of economic profit (blog)

Profitability Ratios:For your net profit after tax you have used CI, I would query whether the figure you should have used should be profit/ (loss).

Days of Inventory:You have worked this out different to me.I used Inventory/ (cost of goods/365), however both equations work and provide the same result, I hadn’t thought of doing it your way.

Earnings Per Share:I think you should have used profit/ (loss) for this calculation rather than CI, as above for profitability ratios.Are your market price per share in pence or in pounds, and if in pence then shouldn’t your EPS also be in pence? (I also had this in mine and have dealt with it a little differently to you, but you will see that when you complete your feedback on mine tomorrow).

Return on Net Operating Assets:I have completed a check on your RNOA, this is just something that I did to check my own figures. You can find this check in yellow at the bottom of your spreadsheet ratios.

Loving your commentary for this step. Just a note on your days of inventory (nothing wrong) that I would suspect that their days of inventory couldn’t really be improved on from their figures for 2016, it looks as though it is a very efficient operation.

No other suggestions for Step 8 as you have included areas in red in your word document of areas you need to expand on already.

Step 9

Develop capital investment decision for your firm

Calculation of payback

Calculate NPV, IRR & Payback Period:If have completed checks on your NPV and IRR and all is perfect. Again these are just checks I had completed on my own spreadsheet to make sure I had used the NPV and IRR function on excel correctly having never used them before. You can see these checks in yellow at the bottom of your spreadsheet NPV & IRR.I just visually checked your payback period and this is perfect too.



period, NPV & IRR

Recommendation & discussion

De Havilland Livingstone & Company

IRR 32% 19%

NPV £22,641 £19,474

Payback Period 2.25 3.75Your NPV in this table does not match your NPV in your spreadsheet.

Step 10Individual feedback with other students

I know you are completing this tomorrow so N/A at this stage.

Overall ASS#2

Overall Feedback

Additional Notes / Questions

Wow, what an amazing last assignment for ACCT11059. You have communicated well your thoughts and understandings of your company’s ratios. The areas I have picked up on are only very minor and could have been easily missed (however I did say I would go through it with a fine tooth comb).

My question to you.Financial Structure Ratios:I have seen others have included another row below Equity Ratio (as you have too), have I missed something should I have done this too?

Spreadsheet Checks can be found on my blog.



Feedback To: Monal Ghosal

My CommentsStep 7Identify three products or services of your firm




I really like your work for the contribution margins for your company’s three products, I especially like how you have included the averages of the three products, what a great idea, I might have to include this in my own step 7.

Step 8




Days of inventory:I see you have included sales and marketing costs and freight costs in your cost of goods sold. I am not sure if this is correct? However this would make your days of inventory even larger, which I thought was already extremely high.

Earnings Per Share:


https://accountingwithtash.wordpress.com/2017/05/21/contribution-margins-ratios-and-investment-decisions/



I had tiny earnings per share too (pence or 0.4 of a pence), so as my figures looked strange with showing all the extra decimal points I decided to multiply my EPS by 100 so I could show it in pence rather than pounds and I found this much easier and more readable. (This may not be the correct thing to do but it made sense to me)

N/A’s on spreadsheet:I noticed you have a few n/a’s in your spreadsheet, I think you should still show the figure calculated for this and just explain in your word doc that it is not applicable because of reasons a, b or c etc.

Very thorough commentary on your ratios for your company and deriving meaning and understanding from them.

Step 9Develop capital investment decision for your firm

Calculation of payback period, NPV & IRR


Calculations:PERFECT You have completed the same checks I did on my own of manually calculating NPV to make sure the excel NPV was correct.

Step 10

Individual feedback with other students

Unsure whether you have provided feedback at this point, so I will leave this section as N/A

Overall ASS#2

Overall Feedback


Wow Monal, great work, it was very difficult to provide you with constructive feedback as your assignment is very well done. The few things I did pick up may just be a difference in opinion and areas to think about rather than areas which need to be rectified.Well done



Feedback To: Danielle Bradley

My Comments



Step 7Identify three products or services of your firm




Container door taping you have $ in front of 90% for variable costs was this intentional?

I know you have the contribution margin as a dollar figure but I think it would be nice to also show this as a percentage.

Love you commentary for this.

Step 8





Earnings Per Share:You have the number of issued ordinary shares for 2015 and 2016 as well as net profit/ (loss) from your financial statements for these years so why have you decided not to calculate EPS for these years? Is this because on the financial statements it says the earnings per share is 0?

Net Borrowing Cost:I find this one quite interesting for your company LPC, because in 2013 they had both NFE and NFO which is what is used to calculate NBC. However is the years following they had the opposite of NFI and NFA which I guess would essentially calculate Return on Net Financial Assets (RNFA) a bit like RNOA. I wonder if you would show these percentages also as positives and change the labelling of it explaining that for 2014 – 2016 your company had no NFE or NFO and hence you have calculated RNFA for these years. However after reading your in depth explanation of NBC I can see you have justified your figures as they are and they do make sense being shown as a negative NBC, as it says that instead of them paying interest of x % they are actually receiving interest of x %.

Amazing commentary for your ratio analysis and economic profit.

Step 9Develop capital investment decision for your firm

Calculation of payback period, NPV & IRR


Not available at the time of providing feedback.

Step 10Individual feedback with other students

Not available at the time of providing feedback.

Overall ASS#2

Overall Feedback

Always to a very high standard with 110% effort put in. I found it extremely hard to provide constructive feedback because everything had already been completed to such a



Additional Notes / Questionshigh standard.



Feedback To: Ros Jonsson

My CommentsStep 7

Identify three products or services of your firm




It is clear you have done a great deal of research when determining your three products and their variable costs.

I really enjoyed how you have explained what variable cost and contribution margins are and the little graph you have included to demonstrate it.

Your write up and justification of your products and their contribution margins and discussed market constraints are of a very high quality.

I have no suggestions for this step.

Step 8





Number of Issued Ordinary Shares:Row 58Is this shown in thousands? I think it would be good to make a note in your spreadsheet so your marker knows whether this is shown in ones, hundreds, thousands, millions etc.

Dividends:Ros you have really got me thinking now, for your dividends you have used share based payments from the statement of movements in equity. I haven’t used this figure and if I had it would conflict with everything in my company’s annual report. I found dividends paid in the annual report and included this in the working area (just like with the number of issued ordinary shares). I think this is an area within my own assignment I might just need to double check too before submitting.

There is so much information and thought put into your word document. I love it!

Step 9

Develop capital investment decision for your firm

Calculation of payback period, NPV

Calculations:PERFECT I have checked your NPV, IRR and Payback Period and they are all adding up.

Your word document for this step is also well set out and



& IRR


included a great detail on information.

Well done, I have no suggestions for this step.

Step 10

Individual feedback with other students

Thank you very much for the feedback you provided me with. I felt as though you had put a lot of effort into checking my spreadsheet and reading through my word document and it is much appreciated.

I have previously seen your feedback for others for earlier assignment steps and you put the same effort into each and every one that you provide feedback for, it is great to see.

Overall ASS#2

Overall Feedback


Amazing final assignment step for ACCT11059.

Only additional note would be to complete a final proof-read and spell-check before submission.

All the best for the rest of your studies.


step 7: contribution margins - wordpress.com€¦ · web viewacct11059: accounting, learning...

Documents