Financial Analysis of Ex Sport Shoe Company Ltd

By | May 1, 2014

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Table of content

  1.      Assumption list…………………………………………………………………………………………. 2
  2. Introduction of the company………………………………………………………………………. 2
  3. Introduce the financial model……………………………………………………………………… 3

3.1      Cost assignment……………………………………………………………………………….. 3

3.2      CVP analysis……………………………………………………………………………………. 4

  1. Scenario……………………………………………………………………………………………………. 5
  2. Financial model: CVP analysis…………………………………………………………………….. 5
  3. Sensitivity analysis to production volume and profit (loss) generation plus breakeven point movement      8
  4. Recommendation…………………………………………………………………………………….. 11
  5. Conclusion……………………………………………………………………………………………… 12

Reference……………………………………………………………………………………………………… 13

Appendix. Charts and excel data……………………………………………………………………… 14
Case Study of Ex Sport Shoe Company Ltd

1.        Assumption list

 

This assignment is based on four major assumptions: first of all, the Ex Sport Shoe Company Ltd is a Dong Guan (China) based sport shoes manufacturer focusing on the middle end market in China in the sport industry; secondly, the company is currently undergoing a rapid growth in its business in China; thirdly, as the company is a medium size manufacturer with small market share and it is assumed that the increase of production volume would not lead to any market over-supply, or in another word the company’s production volume is not big enough to influence the overall market supply and demand for sport shoes. Fourthly, each shoe produced would be sold finally for convenient calculation of revenue and profit at the appropriate price which is defined by the supply and demand curve.

 

2.        Introduction of the company

 

Ex Sport Shoe Company Ltd is a Dong Guan, China based shoes manufacturing company established in year 1990. With two decades’ dedication to the sport shoe industrial sector, the company has well established itself as a middle end brand in the domestic market within China. There are three major objectives of the company upon the starting of the business and they were pointed out by the founders: the Seah Brothers in year 1990. These objectives are the core company culture inherited today and provide spiritual guidance to the continual development of the business and the company. The three objectives are as following: –

 

First of all, the company aims at maximizing the shareholder benefits. As the shareholders are providing strong financial and capital support the company development of the business, it is a must for the management and each staff of the company to realize that maximizing the shareholder benefits is a must and bottom line that each employee should remember always because without making profits to the shareholders the company would no longer exist with understanding. Secondly, the company aims at provide excellent product and after-sale service to the customers that it serves. Another key stakeholder is the customers who actually purchase and then provide direct support to the business. Without serving them greatly, the company still could not exist for long. Thirdly, the company aims at caring the local community which provides strong labor force support as well as continual support in other form to the company. And also the company feels that as a company operating in the local community, it has responsibility to offer back more to the local community which in return cultivate the customer based in the local market.

 

The company target at the domestic market in the first place. Also, the company’s products are sports shoes for young generation which decides that the products have to be positioned to the young people who would tend to doing sporting activities regularly and thus would be in strong demand in the regular manner. Sports shoes for both male and female are the product that provided the company to the customers country wide and also in addition to this, the company provide country wide after-sale service in any of its outlet in more provinces in China.

 

3.        Introduce the financial model

 

3.1    Cost assignment

 

The cost assignment financial model refers to the model that is proposed for the description of the cost assignment process in which cost objects involved in the business are identified, the cost accumulation is calculated as well as the cost are allocated among the cost objects (Contreras & Wu 2000).

 

There are two key advantages by applying the model in a business activity. On one hand, the financial mode of cost assignment assists the management as well as the shareholder to allocate the cost of business (includes production, marketing, after sale and so on); secondly, because of the good cost assignment, the company would be able to locate the areas where cost could be cut if there is a need to with the purpose to reduce the production cost.

 

In respect of the weakness of the cost assignment, it is known to us that there are no standardized rules that would assist the company to decide how much cost is enough for a specified cost object. For instance, one can not tell that a small sport shoe company needs to invest in the cost of R&D and that amount is considered as needed and sufficient.

 

3.2    CVP analysis

 

The CVP analysis refers to the analysis of the business by looking into the cost, volume and profit and also the co-relation between these three critical factors that co-decide the profitability as well as efficiency of the business (Wang 2007).

 

In the strengths of the CVP analysis, as it is the analysis of the business by looking into the cost, volume and profit and also the co-relation between these three critical factors, the strength that is very obvious is that the model assists the management of the company to decide the best production volume that maximize the company’s profit making with very exact calculations.

 

But the weakness of CVP analysis is that for one hand the CVP analysis is based on an ideal flexible market and demand but neglects the actual market conditions and customer response; secondly the CVP analysis only maximize the profit in the short term but does not take into consideration of the long term based business strategies and intentions.

 

4.        Scenario

 

There are fixed costs that include rental of machines and management costs and etc, for this year the fixed costs in total reach 10; the marginal cost would be 5 which is the variable cost to the company. The marginal revenue could be calculated as MR = 25 – 2*(sale volume). The company would like to determine the production volume so as to maximize the overall profitability.

 

5.        Financial model: CVP analysis

 

As for Ex Sport Shoe Company Ltd, the following information is given:

x = sale volume (same as production volume according to assumption);

Total cost = 10 + 5x

Marginal Revenue = 65 – 2x

 

First we look at the marginal cost as shown in the chart below:

Then we look at the marginal revenue by checking different production volume and the respondent marginal revenue by production of an additional product.

 

Chart 1.0 MR=MC=10

 

Therefore at the production volume of 11 when MC=MR, the total revenue is maximized. And this could be understood by the following total cost and total revenue relationship.

 

Total cost = fixed cost + various cost

= 10 + 5x

Total revenue = ∑ MR

= 23 + 21 +19 +17…+ (25 – 2*x)

 

 

Chart 2.0 Total profit maximization

 

And when we put together these two charts, we can see from the below that when MR = MC, the profit would be maximized as after reaching the MR=MC, producing an additional item could involve more cost than the revenue that it manages to bring.

Chart 3.0 MR=MC, profit maximization

 

As marginal cost together with marginal revenue decides the volume maximize the company profit, we can see that fixed cost does not contribute to the calculation of volume which is optimized.

 

6.        Sensitivity analysis to production volume and profit (loss) generation plus breakeven point movement

 

Sensitivity analysis is the effect a (small) change of an exogenous variable has upon another variable (Floudas & Pardalos 2008). Here we talk about the sensitivity analysis regarding the relationship between production volume and profit (loss) generation. As per the above chart, one may see several key numbers. For the production ranging from 1 to 11, the revenue increases in a faster speed than the cost increase. And at the point of 11, the profit (total revenue – total cost) reaches a maximized volume and anyhow between 1 and 11, the profit is still positive provided that the company could achieve at least the production / sale volume of 1. And when the production volume continues to grow from 12 to 18, in contrast the revenue increases slower than that of the cost and therefore the profit starts to fall since production volume of 12. After the production volume of 18, the increase of the production volume would lead to loss as the production cost exceeds the sale volume and obvious that loss generation would not be acceptable to the company.

 

But actually in the real scenarios, the situation could be different. When the production volume reach a certain volume, say 20, the company may need to invest more in the fixed (such as machine and equipment) and various cost (such as advertisement), and such investment on one hand may increase the some cost in term of both various and fixed costs but on another hand would lead to lowered production cost per each product made resulting in reduced variable cost. And therefore the marginal cost and marginal revenue curves would be changed accordingly. And within this changed situation, the most direct impact would be on the breakeven point.

 

The original breakeven point as mentioned is 1 as the revenue does exceed the cost while the sale is 1 from the very beginning.

 

Chart 3.0 Breakeven point = 1

 

But as when the fixed cost is increased and the various costs are reduced the breakeven point would be moved up as shown in the following chart.

 

 

On one hand, the breakeven in term of production quantity increases to 4; on the other hand, the optimized production volume is increased from 11 to 12 indicating that investment in the fixed cost to boost the production efficiency though means such as technology innovation, the company could expand the business scale and market share if this is its desire.

Chart 4. MR=MC, x=12

Chart 5.0 Breakeven point = 4

 

7.        Recommendation

 

There are two major recommendations for the company to better identify the sale production other than the sole CVP analysis: first of all, the company needs to survey the customer behaviors changes to identify the trend of customer preference to the sport shoes; secondly, the company needs to confirm whether investment in the new machine would be needed to assist to lower the production cost given the calculated production volume of 11.

 

8.        Conclusion

 

From the analysis above, we can conclude that the company could use CVP finance model to assist the define the optimized production volume and in another word, large volume does not necessarily lead to the increase of profit and the company has to do more research to double confirm that this sale volume is achievable and the marketing efforts and sale channels could make this sale volume possible in this financial year.

 

 

Reference

 

Contreras, J. & Wu, F. 2000. A Kernel-Oriented Coalition Algorithm for Transmission Expansion Planning, IEEE Tractions on Power System, VOl. 15 N  November 2000, pp. 919-915

 

Floudas, C. A. & Pardalos, P. M. 2008. Encyclopedia of Optimization. Germany: Springer.

 

Wang, X. Y. 2007. Applying Excel to Establish CVP Analysis Model. CNKI: SUN: GXSY. 0. 2007 – 06 – 012

 

 

Appendix. Charts and excel data

 

Chart 1.0 MR=MC=10

 

Chart 2.0 Total profit maximization

 

Chart 3.0 Breakeven point = 1

 

Chart 4. MR=MC, x=12

 

Chart 5.0 Breakeven point = 4