- 40 Marks
Question
ICHWARD LIMITED
Background Mr. Kwesi Bonku is the Managing Director of Richward Ltd, a small haulage contracting company, which he founded 15 years ago. Originally, Mr. Bonku was a heavy goods vehicle driver himself, working for other contractors, but he had the intent of establishing his own business. Having received his pension, he acquired an articulator truck and began to work from home. Over time the business expanded and now Richward Ltd operates a fleet of 15 heavy goods vehicles. Five of the current fleet of trucks was acquired in the last financial year, replacing older units which were becoming too expensive to maintain. The Company now employs 20 full-time and varying number of part-time driver mates. The part-time staff work as and when required.
Mr. Bonku acquired two plots of land six years ago and built a house on it, which he and his family occupy. In addition, he built a garage with facilities for minor servicing and repairs on the same site. Living on site has enabled him to offer a 24-hour service to clients. Consequently, movement of the trucks in and out of the site occurs at all times of day and night. There have been objections raised by the residents in the neighbourhood to disturbance and the local Radio Stations has at various times reflected this criticism.
In addition to the haulage business, the company also obtained license and established a driving school. This had proved to be a successful diversification as there is a regular stream of customers. This training takes place mostly in Richward Ltd’s own garage facilities. It became clear to Mr. Bonku that the land on which the garage facility is built was inadequate for the needs of his growing business.
Acquisition of land One year ago, Mr. Bonku entered into negotiations to lease some land which would be more than satisfactorily for the company’s operations. The land is situated on an industrial estate five kilometres from the existing facility. In addition, there is room to build a workshop facility which would be adequate for the needs of the fleet.
Following agreement of a lease arrangement, which was concluded just before the completion of the last financially year, Richward Ltd occupied the land on which there were no building erected or utilities supplied. Since taking possession of the land, a large security fence has been erected and a small portable cabin placed on site. Water and electricity services have been supplied and negotiations are taking place for the installation of a large diesel tank adequate to service other vehicles besides those of Richward Ltd.
Accounting Mr. Bonku recruited Mrs. Efua Dadson, a part-time accountant, four years ago. Prior to Mrs. Dadson’s arrival, Richward Ltd applied a policy of paying all invoices immediately on receiving them. As debtors were frequently taking over and above the credit period (30 days) allowed, Richward Ltd suffered a cash flow shortage, which resulted in a large bank overdraft.
Mrs. Dadson introduced some basic financial accounting procedures into the company. In addition to exercising some control on Richward Ltd expenditure, Mrs. Dadson has reduced the debtors’ collection period to about half its former level. Creditors are now paid when the invoices fall due rather than immediately upon their receipt. Such control had been lacking prior to her arrival at the company.
The company faces strong competition for haulage contract work. Typically, haulage contractors operate on a low-margin basis and smaller companies often sub-contract from large-scale hauliers. Richward Ltd carries haulage for a variety of customers as well as undertaking some subcontracting. Much of the haulage work the company carries out is seasonal.
One of its top clients, Grace Ltd, recently appointed a new transport manager. The new Manager of Grace Ltd. has begun to employ other hauliers besides Richward Ltd. Over the last two months, the haulage work Richward Ltd has received from Grace Ltd has reduced by about a third.
In order to address the competition, Richward Ltd recently diversified into the sale of hydraulic oil. Sales have been running at a steady rate of 50 gallons each month for some time, but the company is dissatisfied with this level of sales and from next month June 2016, the company intends to advertise actively. This is expected to increase sales by 10 gallons per month from June to October inclusive after which it will remain steady at 100 gallons per month.
Each gallon costs GH¢1,500 and sells for GH¢2,000. All purchases are on one month’s credit and sales on two month’s credit. The company feels that, to give a good service to customers, it must have sufficient inventory at the end of each month to meet the whole of the following month’s sales.
Additional non-current assets (a delivery van to help cope with the increased sales) will be bought and paid for in July 2016 at a cost of GH¢15,000. Corporate tax of GH¢25,000 is due for payment on 1st August, 2016. The balance of cash at 31st May, 2016 is planned to be GH¢30,000.
Operating costs will rise to cash payments totaling GH¢10,000 each month. The advertising will cost GH¢20,000 in June and GH¢10,000 for each month from July to September inclusive, payable one month in arrears.
The Accountant has not yet had a cash budget prepared for the rest of the year, but she feels that the sales expansion plans are likely to lead to cash flow problems.
Suggestions have been made that, if her fears are justified, it might be possible to overcome the problem by increasing the creditor payment period to two months and buying inventory as it is used (i.e. zero inventory at month ends).
Required: a) Assess the nature of competitive forces of Richward Ltd. (8 marks)
b) Present a SWOT Analysis for Richward Ltd. (8 marks)
c) Advise Mr. Bonku on the strategic management accounting information which should be provided to assist future decision making and cost control. (8 marks)
d) Prepare a cash budget for Richward Ltd Limited for the six months ending 30th November 2016, showing the planned cash position at the end of each month; on the basis of the original planned credit and inventory holding periods. (6 marks)
e) Redraft your cash budget to reflect the suggested alterations to these planned periods. (5 marks)
f) Suggest what other aspects Richward Ltd Limited should consider to solve the expected cash flow problem, should the suggested solution be unachievable. (5 marks)
Answer
a) The five competitive forces related to the business of Richward Ltd care:
- Rivalry amongst existing competitors Richward Ltd faces strong competition for haulage contract work and it appears that there are several firms operating in the market. Profit margins are low, which indicates that work is undertaken at low prices. A major customer, Grace Ltd, uses other haulers, which suggests that competition for business is fierce. Richward Ltd is facing strong competition from existing competitors. The strong nature of competition is also exacerbated by low switching costs of customers.
- Threat of a new market entrant The main constraints on setting up a road haulage business will be obtaining a license and having sufficient capital to purchase or lease a tractor unit and trailer. Finance for such an operation will be readily available. The only other significant entry barrier might be low profit margins. It appears that, overall, the road haulage industry has few major entry barriers so this will always be a threat to established business such as Richward Ltd.
Note: Any of the points under barriers to entry that is well explained may considered – capital requirements, low switching costs of customers, degree of differentiation, economies of scale, knowledge requirements, etc.
- The power of customers The customer of Richward Ltd will be primary organisations that employ skilled people who know the road haulage industry and how to negotiate contracts. As there are many competing businesses in the trade, this puts the customers in a strong bargaining position. This is shown by the fact that Richward Ltd’s major customer Grace is using other hauliers and is, no doubt, assessing its supplier’s prices and performance. The power of customers in the market is strong; this poses a serious threat to Richward Ltd.
Note: Other points which may be considered are switching costs, concentration risks (demand), number of competing firms, negotiating skills, profit margin of customers.
- Power of suppliers The main suppliers to Richward Ltd will provide vehicles, other plan and equipment, formal services and labour. It is unlikely that any supplier is in a strong monopolistic situation, except possible providers of capital. Richward Ltd is in an established position and while it remains profitable will probably be able to obtain reasonable amounts of capital. The power of suppliers does not appear to be very strong.
- The threat of a substitute product The main substitute for road haulage services is freight carried by the railway industry. The current dire state of this industry means that rail freight cannot be considered a serious threat to Richward Ltd.
Note: Other points which may be considered are switching costs, concentration risks (demand), number of competing firms, negotiating skills, profit margin of customers.
Overall, Richward Ltd’s competitive position is not strong as it faces a number of competitive threats.
b) SWOT Analysis for Richward Ltd.
Strength
- Richward Ltd is an established business with an experienced management team
- Bonku lives on site enabling Richward Ltd to offer a 24-hour service to customers
- The company acquired a lease on a new site that has quite a lot of potential
- The company has diversified into truck driver training which reduced dependence on read haulage for income.
- Replacement of old trucks and other equipment. This increases the efficiency of operations.
Weaknesses
- Richward Ltd’s existing site is too small, so it will have to locate the new site that requires more capital and will disrupt business operations.
- Richward Ltd currently does not have an effective management accounting system, which means Richward Ltd’s managers make decision without having sufficient information
- The company is too dependent on Grace Ltd, which account for majority of its business
Opportunities
- The enlarged premises will enable the company to attract new business and offer new services e.g. overnight trailer parking and a vehicle repair service.
- Richward Ltd should be able to establish stronger links with existing customers, which should help to retain their business.
- Location of land/business premises.
Threat
- The most serious threat facing Richward Ltd is the loss of Grace Ltd’s custom. In the last two months one third of this business has already been lost.
- There are a large number of competitors working on low profit margins and this forces price down. There appears to be little prospect of Richward Ltd being able to increase its prices.
- Local residents are opposing operations from the current site and the company is receiving bad publicity in the local press.
c) Advice to Mr. Bonku
Competitor Information
- Information about competitors can be very useful as it provides a benchmark against which Richward Ltd’s performance can be compared.
- Budgeting will provide information to forecast patterns and trends. This will be very useful when making decisions and setting objectives and targets e.g. market growth rates.
Financial information
- Investment appraisal Information can be provided to evaluate each capital investment project undertaken by Richward Ltd. This will be very useful when developing the new site.
- Variance analysis This is a very important management accounting control tool. The expected costs and revenues will be forecast and actual costs and revenues compared with them. Variances can then be identified and investigated to find their cause. This will establish some of Richward Ltd’s strengths and weaknesses.
- Customer account profitability Costs incurred by Richward Ltd can be related to each customer and the profit generated by each customer calculated. This will be very important information used by Richward Ltd’s managers to make decisions relating to each customer e.g. Grace Ltd.
- Quoting prices Most of Richward Ltd’s customers will be other organisations. They will expect a price to be agreed before awarding a contract to a supplier. Management accounting can supply the information for quoting competitive and realistic prices when negotiating with customers.
d) RICHWARD LTD: CASH BUDGET FOR SIX MONTHS ENDING NOVEMBER 2016
e)
f) Suggested ways of improving the cash situation of Richward Ltd
- Raising new capital
- Ploughing back profits
- Raising new loans
- Leasing or renting non-current assets instead of buying them
- Raising prices
- Selling for cash
- Asking for a extended period from creditors
- Cutting down costs
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