Topic: Analysing the internal environment

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  • 40 Marks

CSEG – Nov 2018 – L2 – Q1- Analysing the internal environment

Analyzing the internal environment, Strategic management process, Financial planning and forecasting, Liquidity management, Long-term capital raising

GHANA’S FOOTWEAR MANUFACTURING INDUSTRY

Introduction:

The footwear industry has many players including artisanal shoemakers, local and foreign manufacturers, with local representatives, producing a wide range of footwear. In Ghana, the footwear industry is making headway in the local market, with most of the shoes being produced in Kumasi. The Kumasi Shoe Manufacturing Company focuses on making footwear for almost all the security agencies in Ghana, as well as some private security companies. The local market is also filled with individual artisans and small startup companies who make footwear for sale in the country. The other regions in the country such as the Greater Accra Region and the Northern Region also have a few individuals who are into footwear manufacturing but on a smaller scale.

Foreign-produced footwears are of superior quality and attract skimming pricing compared to the locally produced ones. The sector is projected to have high growth potential with most of its forecasted sales to emanate from low-income segments with marginal and flat growth from middle and high-income segments respectively. The growth, among other things, will be fueled by the government’s free school uniform and sandals policy which is expected to be sourced from local manufacturers. In Ghana, luxury shoes are usually European or American brands. The luxury footwear production in Ghana is still a virgin market with a lot of potential once people start to believe in the high quality these Ghanaian brands can offer.

On average, it takes three to five years for local manufacturers to ramp up production significantly enough to drive down average fixed cost and attain utilization of full capacity due to intense competition and difficulty accessing the major wholesale and retail outlets trading in footwears. The foreign as well as a good number of local manufacturers sign 5 to 10 years contract with major outlets in all the major urban centres for exclusive rights to sell their footwears.

The artisanal shoemakers generally produce based on customer orders. In the Footwear industry, customers easily source from many available alternatives. The key customers of foreign and local manufacturers are the various wholesale and retail outlets. There are emerging online shops providing information on prices of goods and services from different manufacturers including footwears free of charge and consumers can easily access that information. The profit margins for the outlets are generally low. There have been recent acquisitions of some local footwear manufacturing companies by some major wholesale and retail distributors in Ghana and the experts are predicting more of such transactions.

In Ghana, there is a cartel of few major importers, controlling approximately 90% of high-quality natural and synthetic leather markets, from whom many local manufacturers and artisanal shoemakers procure their raw materials. These importers source their supplies largely from Europe, which compares favourably, in terms of quality and price, to those available in neighbouring countries. A recent consumer survey indicates that footwear produced with inputs from Europe are durable, of good quality and able to stand high-temperature conditions locally hence consumer preference.

Footwear Ventures Ltd (FVL)

Footwear Ventures Ltd (FVL) was founded by Peter Legubo, who graduated with a bachelor’s degree in Fine Arts, from a public university in Ghana. Prior to starting the company, Peter met one of his schoolmates, who owned a business that specialized in traditional handicrafts including footwear. He was able to convince him to join FVL. The schoolmate’s hands-on experience coupled with Peter’s competence in drawing and designing will be complementary and indispensable to gaining competitive edge. The initial capital for the company was raised from personal savings and severance package received by Peter from his former employment. He was able to acquire requisite tools and machines for the production of footwear.

Based on the determination and ambition of the founder, FVL outdoored its first production line with four different products including shoes and sandals for men, women, children as well as boots for security personnel. The products were well received by the public. The company continued production but it could hardly produce the quantity required by its retailers due to inadequate funding. Peter, therefore, approached some banks for credit facility but due to lack of credit history he was unsuccessful. Peter Legubo decided to turn to his friend, Kingsford Yeboah, who lived in Germany and had earlier expressed interest in investing in the business. Kingsford provided the business with a substantial amount of cash. The capital injection was used to buy more tools and machines in a bid to significantly automate the production process. Additional hands were engaged bringing the total number of employees to 100. Currently, the company produces on average 2,200 pairs of shoes per month.

The main raw materials for footwear, including natural and synthetic leather, synthetic sole and adhesive, are sourced from local importers. FVL is contemplating diversifying its raw materials. The shoes produced by the company are largely distributed through major retail shops dotted across major urban centres since FVL does not have the required resources to open its own sales outlets. The company also does direct sales to students on campuses of some tertiary institutions in the country.

On strategic approach, Peter believes the company should continue to exclusively rely on the engagement of experienced hands from the industry and should waste no time in formalizing and documenting the company’s strategy. Kingsford Yeboah also believes that the company should institutionalize a strategic approach that should focus on the strategy process, financial planning and forecasting as well as sources of finances.

Financial planning and forecasting

FVL has the potential of becoming a leading producer of footwear in the Ghanaian market. It is however faced with liquidity challenges. The management of FVL has decided to prepare a six-month budget in order to better manage its liquidity needs and avoid any shortages, especially in the light of limited access to bank credit.

Financial data

FVL has planned production and sales for the next nine months as follows:

Month April May June July August September October November December
Production (Units) 700 800 1,000 1,200 1,200 1,400 1,500 1,500 1,500
Sales (Units) 700 800 800 1,000 1,200 1,300 1,400 1,600 1,500

During the period, the business plans to advertise so as to achieve the projected sales. Payments for advertising of GH¢12,000 and GH¢18,000 will be made in June and September respectively. The selling price per unit will be GH¢120 throughout the period. 40% of sales are normally made on two months’ credit. The other 60% are settled within the month of the sale.

Raw materials used for the footwear will be held for one month before they are taken into production. Purchases of raw materials will be on one month’s credit. The cost of raw materials is GH¢60 per unit of production. Other direct production expenses, including labour, are GH¢25 per unit. These will be paid in the month incurred. Various production overheads, which during the period to 30 May had run at GH¢21,600 a month, are expected to rise to GH¢24,000 each month from 1 June to 30 September. These are expected to rise again from 1 October to GH¢28,800 a month and to remain at that level for the foreseeable future. These overheads include a steady GH¢4,800 each month for depreciation. Overheads are planned to be paid 80% in the month of production and 20% in the following month.

To help meet the planned increased production, a new item of plant will be bought and delivered in July. The cost of this item is GH¢79,200; the contract with the supplier will specify that this will be paid in three equal installments in August, September, and October. Raw materials inventories are planned to be 1,000 units on 1 June. The balance at the bank on the same day is planned to be GH¢89,000. The company earns 5% interest on the closing balance, which is paid in the following month.

Required:

a) Analyze the strengths and weaknesses of FVL. (6 marks)

b) Prepare a report to the Director of FVL on the process of strategic management. (8 marks)

c) Prepare a cash budget for the six months ending 30 November based on the financial data of FVL. Show all workings. (12 marks)

d) Recommend to the Directors of FVL FOUR (4) strategies for overcoming the liquidity crisis. (8 marks)

e) Advise the directors of FVL FOUR (4) methods of raising long-term capital. (6 marks)

a) Strengths and Weaknesses of FVL (6 marks)

Strengths:

  • The schoolmate’s hands-on experience coupled with Peter’s competence in drawing and designing are complementary and indispensable to gaining a competitive advantage. They are highly skilled, ambitious, and have a passion for the job. Peter believes the company should continue to exclusively rely on the engagement of experienced hands from the industry.
  • The small size of the workforce allows them to fully dedicate themselves to their tasks to produce high-quality products.
  • Few competitors in the Ghanaian luxury shoemaking industry. The footwear-making industry in Ghana has an influx of local artisans mainly from Kumasi who produce semi and low-quality shoes at very low prices compared to FVL. They therefore do not pose much threat to FVL, taking into consideration the target market of affluent and well-off customers who are willing to spend more than most.
  • FVL has a strong tertiary presence compared to its competitors in Ghana. They do direct sales to students on campuses, and this also helps the company to promote its brand.

Weaknesses:

  • The raw materials used to produce FVL’s products are sourced from abroad due to unavailability of such quality in the country. This serves as extra cost for the company due to import, handling, and shipping charges plus extra charge from local importers.
  • Inadequate funding and lack of access to funding from financial institutions due to lack of credit history.
  • Inadequate resources to open its own sales outlets as the shoes produced are largely distributed through major retail shops dotted across the country. This could result in price differentials among the various retail shops.
  • Not a strong brand internationally as compared to international competitors. The brand is not well known amongst the affluent masses in foreign countries as its advertisement does not reach those boundaries.

b) Report on the Process of Strategic Management (8 marks)

Introduction:

The strategic management process means defining the organization’s strategy. It is also defined as the process by which managers make a choice of a set of strategies for the organization that will enable it to achieve better performance.

Strategic management is a continuous process that appraises the business and industries in which the organization is involved; appraises its competitors; and fixes goals to meet all the present and future competitors and then reassesses each strategy.

Strategic Management Process:

  • Environmental Scanning: Environmental scanning refers to a process of collecting, scrutinizing, and providing information for strategic purposes. It helps in analyzing the internal and external factors influencing an organization. After executing the environmental analysis process, management should evaluate it on a continuous basis and strive to improve it.
  • Strategy Formulation: Strategy formulation is the process of deciding the best course of action for accomplishing organizational objectives and hence achieving organizational purpose. After conducting environmental scanning, managers formulate corporate, business, and functional strategies.
  • Strategy Implementation: Strategy implementation implies making the strategy work as intended or putting the organization’s chosen strategy into action. Strategy implementation includes designing the organization’s structure, distributing resources, developing decision-making processes, and managing human resources.
  • Strategy Evaluation: Strategy evaluation is the final step of the strategy management process. The key strategy evaluation activities are: appraising internal and external factors that are the root of present strategies, measuring performance, and taking remedial/corrective actions. Evaluation ensures that the organizational strategy, as well as its implementation, meets the organizational objectives.

Conclusion:

These components are steps that are carried out in chronological order when creating a new strategic management plan. FVL, which is in the process of institutionalizing a strategic approach, will revert to these steps as per the situation’s requirements, so as to make essential changes.

c) Cash Budget for the Six-Month Period (12 marks)

d) Strategies for Overcoming the Liquidity Crisis of FVL (8 marks)

  • Directing FVL’s accounts receivable department to bill its customers in a timely fashion and chase any unpaid invoices as soon as they become past due. Money tied up in unpaid invoices can cause FVL serious liquidity problems. The Directors should consider offering its customers a discount for settling their bills early.
  • Analyzing FVL’s overhead and looking for cost savings. Studying all areas of FVL’s business to see where they can save money and free up funds to bolster its liquidity.
  • Selling off inventory and assets that are tying up FVL’s cash. Stock that’s been sitting in FVL’s storeroom for six months is costing the firm money. Discount any inventory that’s proving hard to shift to get cash flowing back into FVL business. Sell assets it rarely uses.
  • Discussing short-term funding options with FVL’s bank or other lenders. FVL’s bank might be willing to extend FVL’s credit line to help it overcome liquidity problems. If FVL’s bank is unable to help, approach other lenders or sell some of the equity in FVL to an investor to overcome cash flow problems.
  • Negotiating new terms with FVL’s suppliers. Ask for a longer period to settle invoices or discuss the possibility of taking stock on a sale-or-return basis. If FVL has been a good customer in the past, there’s a good chance it can come to an arrangement, especially if any new deal boosts the amount of goods or services it is able to buy.

e) Methods for Raising Long-Term Capital (6 marks)

  • Issue of Shares: Involves the public issue of equity and preference shares in the Ghana stock exchange. Issuing shares is the most common method of raising long-term capital because there are various investors who are ready to invest in the capital market. Therefore, shares are used to finance projects having long gestation periods.
  • Issue of Debentures: Involves the collection of funds by issuing debentures. When FVL issues debentures, it needs to pay a fixed rate of interest to debenture holders.
  • Term Loans: Refers to the funds that are raised from financial institutions for financing long-term projects. The rate of interest on term loans is higher than the rate of interest on debentures.
  • Fund from Operations: Refers to the fund raised by FVL’s own operations. It is the accumulated profit of FVL and can be used to finance various short-term and long-term projects.
  • Sale of Fixed Assets: Helps in generating funds by selling fixed assets, such as land, buildings, plants, and machinery to finance short-term and long-term projects. However, the usage of this method may hamper the goodwill and creditworthiness of FVL.
  • 40 Marks

CSEG – May 2019 – L2 – Q1 – Analysing the external environment | Analysing the internal environment

Analyze the waste management sector in Ghana, recommend an organizational structure for Omega Group Ltd, conduct portfolio analysis, calculate NPV for a recycling project, and suggest waste management measures.

Waste Management in Ghana

Ghana has been battling with domestic and industrial waste for many years and successive governments made it one of the topmost priorities to address the menace. However, all the well-intended measures adopted in the past have not yielded significant result in addressing the waste menace. The current government which assumed office in January 2017 created a new ministry, Ministry of Sanitation and Water Resources, in a bid to give new impetus to the waste management agenda. Two years on, the general public verdict is that much has not changed as heaps of waste can be seen in every nook and cranny of the major cities in the country. The President has the vision to make Accra, the nation’s capital city, the cleanest within the sub-region but the vision is deemed to be far from realisation. It is estimated that Ghana generates 1.7 million tonnes of waste per year and Accra alone generates 3000 tonnes of waste per day.

It also appears that the state has lost the battle on the desecration of the country’s major beaches with litter and open defecation in abundance. The other national monuments such as colonial forts and castles along the coastal belts have not been spared. These areas are major tourist attraction centers and the negative financial consequences cannot be overemphasized. A popular river, River Odorna, which runs through the national capital has been silted with plastic and organic waste, displacing the water which runs through it and terminate in South Atlantic Ocean. The nation has not recovered from the twin disaster of flood and fire which claimed over 100 lives when River Odorna was overflooded. This resulted in nearby petrol filling station being flooded and with oil displaced fire from unknown source that triggered massive fire killing all the people who had taken refuge there.

The current national policy on waste management is based on decentralisation to the various Metropolitan, Municipal and District Assemblies (MMDAs) who are the sub-national organs responsible for administration of various urban, peri-urban and towns in the country. The MMDAs manage waste within their jurisdiction by signing contracts with various privately-owned waste management companies and to some limited extent MMDAs-owned trucks which has proven to be less effective with frequent break downs of those trucks. The waste so collected is disposed at various landfill sites constructed by the MMDAs but most of those sites are now full and are turning into mountains of waste. The hosting communities of landfill sites are up in arms for their closure as health and environmental negative impact takes a heavy toll on the residents. There is currently pending a plethora of law suits by affected residents to get the courts to force MMDAs to shut down the landfill sites.

The citizens engage in indiscriminate disposal of waste everywhere in the country. The culverts, drainage systems and streets are suffocating under the pressure of waste especially that of plastic. Rubbish are thrown onto the streets from moving commercial and private vehicles alike. At various lorry stations where dustbins are provided, drivers’ mates dispose waste to the floor where cars are parked. Citizens build up wastes in front of their houses day time and by the following morning those waste have vanished. It has been established that a number of residents are beginning to dispose waste into gutters and shoulders of major roads at night. Although, all MMDAs have punitive fines and sanctions in their bye-laws nobody seems to suffer any consequences engaging in littering.

Waste Management Sector

The waste management sector has a number of actors including a few large companies with large concessions and a lot of trucks for waste collection and disposal, MMDAs with their internal waste collection units, small companies with few trucks and hence limited concessions, and recently individuals with tricycles, without concessions, have emerged to cater for unserved new residential areas springing up at the outskirts of the cities. The large companies have a fleet of garbage trucks with capacity to collect huge tonnes of waste within their concession areas. Thus, the large companies are better resourced and able to do mass collection of waste. Many small companies with few garbage trucks are actively involved in waste management effort and are generally granted concession over smaller areas. Despite the collective effort by large and small companies as well as MMDAs, large amount of waste remains uncollected and in fact the amount of waste generated is on the rise. This situation has led to individuals using tricycles to collect waste from households for a fee.

The waste management companies get paid in two ways – directly by households and companies that have been provided waste bins and containers and indirectly by MMDAs for the picking of waste containers provided at vantage points for use by market centres, lorry stations and households that may not subscribe to direct service. Payments to waste companies are persistently in several months of arears with serious implications on their financial positions. This situation has resulted in irregular collection of pool waste containers with attendant consequence of mounting waste in urban centres.

The Group and Company

One of the major large companies operating in the waste sector is Waste Tiger Ltd and is part of Omega Group Ltd (OGL) of Companies. The other subsidiaries under OGL include Sewerage Systems and Medical Waste Treatment Ltd, GCD Diamond Ltd, JB Plant Pool Ltd, ACB Bank Ltd and Recycling & Compost Plant. A brief description of the business of each of the subsidiaries follows:

Waste Tiger Ltd (WTL) – is involved in collection of solid domestic and commercial waste in various MMDAs across the country.

Sewerage Systems and Medical Waste Treatment Ltd (SSMWT) – handle liquid and medical related waste across the major cities.

GCD Diamond Ltd (GDL) – a mining company involved in extraction and processing of raw diamond which was added to the group 4 years ago.

JB Plant Pool Ltd (JPPL) – leading supplier of heavy duty and earth moving plant and equipment, buses and renders total service support for all products sold in case of faults or breakdowns.

ACB Bank Ltd (ABL) – is an indigenous financial institution providing retail, corporate and treasury services to diverse clients.

Recycling & Compost Plant (RCP) Ltd – is involve in recycling of waste, export of waste and production of fertilizer for local market.

The Group CEO, Mr. Joseph Quainoo is not enthused at the rising cost of the group and its subsidiaries due to duplication of functional areas within each subsidiary. He wants to reconfigure the existing organisational structure in which there will be dual line of reporting and responsibilities. The CEO wants a structure that combines functional specialisms (marketing, finance, Human resource and Information technology) and the subsidiaries and by so doing eliminates subsidiary-specific functional areas. Again, the structure should result in keeping subsidiaries largely independent but with necessary intervention with respect to functional activities.

The Group CEO wants to do performance analysis of the various subsidiaries based on the extent of cash generated and used by respective subsidiaries. The group Chief Finance Officer (CFO) was tasked and has generated a summary of cash inflows and cash outflows for each subsidiary. The cash flow information is summarised in Exhibit 1 below:

The Group CEO wants a portfolio matrix constructed to analyse the various subsidiaries and advice on strategic option to pursue for each subsidiary so as to inform resource allocation within the group.

Recycling & Compost Plant (RCP) Ltd

RCP Ltd is the latest subsidiary incorporated and commenced business/operations in January 2018. The idea to start RCP Ltd followed from a waste management conference Mr. Joseph Quainoo attended in China and his encounter with the CEO, Chun Juan, of the largest waste management company in China. At the said private meeting Chun shared the idea of how lucrative recycling of waste is becoming, the fact that China is importing waste and how fertilizer is being produced from waste. Armed with this information and the absence of waste recycling in Ghana, Mr. Quainoo decided to venture into that segment of waste management.

RCP Ltd has three major lines of business – production of organic fertilizer from organic waste, plastic from plastic waste to be sold to plastic processing companies and finally process some organic and plastic waste for export to China. The establishment of RCP Ltd is the first significant intervention to change traditional use of landfill sites in waste management to waste recycling which is more sustainable and also generate economic activities. Although, various governments have always proposed to set up a recycling plant but that never materialised. Perhaps, the inertia and apparent lack of commitment by governments to build recycling plant is because it is capital intensive. The company has a combined permanent and contract workforce of 570 and as business picks up, more hands would be engaged. Kindly refer to exhibit 2 for the data that was used in performing investment appraisal. The current capacity of the company only allows it to process 30% of total waste generated in the capital city. The vision of Mr. Quainoo to is to expand to all the major cities in the country.

Exhibit 2

The plant and equipment and all related cost necessary to make it operational has been pegged at GH¢1,500,000. This recycling plant has an expected life of five years, after which it would have to be replaced and will have no residual value at the end of this period. The plant can produce and process a maximum of 75,000 tonnes of waste per year over five years. The revenue per processed ton is GH¢110. To ensure that the maximum output is achieved, the company will spend GH¢250,000 a year in maintaining the plant over the next five years.

Based on the maximum output of 75,000 tonnes per year, the following expected costs per ton excluding the maintenance costs above are: waste and treatment material GH¢32.5, labour GH¢27.5 and overhead cost GH¢42.5. The following information is also relevant:

The waste and treatment materials figure above include a charge of GH¢10 for treatment (chemicals) materials that is currently being stocked by one of the subsidiaries in the group and can be used for waste treatment. Each ton of waste requires 1,000 liters of the chemicals and the charge is based on the original cost of GH¢5 per 500 liters for the chemicals. It is a material that is currently used in one of the other subsidiary and the cost of replacing the chemical is GH¢7.50 per 500 liters. The chemical could easily be sold at a price of GH¢6.25 per 500 liters.

The labour cost relate to payments made to employees that are directly involved in recycling the waste materials. The labour cost include some employees who have no work at present and if there were no production, they will be made redundant immediately at a cost of GH¢1,150,000. However, if production takes place, the employees are likely to find another work at the end of the five-year period and so no redundancy costs will be incurred.

The overhead cost includes a depreciation charge for the new machinery and equipment. The policy of the business is to depreciate non-current assets in equal instalments over their expected life. All other overheads included in the above figure are incurred in recycling.

The company uses a cost of capital of 20% to assess projects. The management of the company is interested in determining the net present value of the recycling plant and equipment at the end of the five-year period.

Required: a) Assess the legal, economic and social factors in the environment of the waste management sector in Ghana. (6 marks)

b) Recommend appropriate organisational design that will help the group coordinate and control activities among the subsidiaries. Your recommendations should include THREE (3) benefits and THREE (3) demerits associated with that design. Support your answer with appropriate diagram. (10 marks)

c) Using an appropriate portfolio matrix, explain the various categories of businesses within the Omega Group Ltd and advise the CEO of appropriate portfolio strategy (or strategies) to adopt for each subsidiary. Justify your choice of a particular portfolio matrix and categorization of the subsidiaries based on your selected matrix. (8 marks)

d) Using information provided on recycling plant and equipment, determine the net present value of the project after five years. (12 marks)

e) Recommend FOUR (4) practical and tangible measures government can adopt to deal with the waste menace in the country. (4 marks)

a) Assessment of the Legal, Economic, and Social Factors in the Environment of the Waste Management Sector in Ghana

Legal Factors

  • There’s a national policy on waste management based on decentralization to the various metropolitan, municipal, and district assemblies (MMDAs).
  • There’s currently a plethora of lawsuits by affected residents to get the courts to force the MMDAs to shut down the landfill sites.

Economic Factors

  • Littering in major tourist attraction centres could discourage tourists, which could have financial consequences like a reduction in foreign exchange to the country.
  • The hosting communities of landfill sites are up in arms for their closure as health and environmental negative impacts take a heavy toll on the residents. This has economic implications as it increases the cost of living for the citizens.
  • Exportation by Omega Group Ltd. and importation of equipment have foreign exchange implications for the economy.
  • Loss of revenue to the state as a result of a decrease in tourists into the country.
  • Cost to the MMDAs in terms of waste management.

Social Factors

  • The citizens engage in indiscriminate disposal of waste everywhere, which creates a social implication as their culture. There’s a need for punitive fines and sanctions for citizens who engage in indiscriminate disposal of waste.
  • A new Ministry created by the current government in a bid to give new impetus to waste management can be seen as a social intervention by the government to curb the waste management menace in the country.

(2 marks each for Legal, Economic, and Social Factors = 6 marks)

b) Appropriate Organizational Design for Omega Group Ltd and Its Benefits and Limitations

The structure that is able to achieve the CEO’s requirement of combining functional specialisms with subsidiaries while eliminating duplication is the Matrix Structure. A matrix structure combines different structural dimensions simultaneously, for example, product divisions and geographical territories or product divisions and functional specialisms. A matrix structure is a combination structure in which the organization is organized along two or more dimensions at once (e.g., business, geographic area, value chain function) for the purpose of enhancing cross-unit communication, collaboration, and coordination.

Advantages of Matrix Structure

  1. Knowledge-sharing: It promotes knowledge-sharing across the organization (in this case, Omega Group) because it allows separate areas of knowledge to be integrated across organizational boundaries.
  2. Efficient Resource Utilization: Allows more efficient utilization of resources. Since matrix structure eliminates duplicated functions in the subsidiaries, the group would make some savings in terms of staff costs and other related costs.
  3. Flexibility: Matrix structures are flexible, because they allow different dimensions of the organization to be mixed together, combining subsidiaries with centralized functions/specialisms.
  4. Professional Development: Increases professional development through a broader range of responsibility.

Disadvantages of Matrix Structure

  1. Uncertainty in Accountability: Dual-reporting relationships can result in uncertainty regarding accountability.
  2. Power Struggles: Intense power struggles may lead to increased levels of conflict.
  3. Impeded Decision Making: Excessive reliance on group processes and teamwork may impede timely decision-making.
  4. Violation of Unity of Command: Violates the unity of command principle.

Matrix Structure Diagram:

c) Portfolio Matrix Analysis Using the Boston Consulting Group (BCG) Matrix

The BCG Matrix categorizes businesses into four types based on their market share and market growth: Stars, Cash Cows, Question Marks, and Dogs.

Star:

  • Waste Tiger Ltd and JB Plant Pool Ltd fall under this category, given their high cash inflows and high cash outflows, resulting in neutral to marginal positive or negative net cash flows. The strategic option for these businesses is a Build strategy, focusing on long-term profitability by making heavy investments in them to grow their market shares.

Cash Cow:

  • ACB Bank Ltd is a Cash Cow with very high cash inflows and low cash outflows, resulting in high positive net cash flow. The strategic option for this business is a Hold strategy, making necessary investments to maintain market share while using excess cash to subsidize other businesses within the group.

Question Mark:

  • SSMWT Ltd and Recycling & Compost Plant (RCP) Ltd are Question Marks with negative net cash flows. The strategy options are Build where there are prospects for market share growth or Harvest where growth prospects are low.

Dog:

  • GCD Diamond Ltd falls under this category, with low cash inflows and outflows. The strategic option is to Divest this business from the group.

(8 marks)

d) Net Present Value (NPV) Calculation

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e) Measures for Government to Deal with Waste Menace in Ghana

  1. Complete Ban on Non-biodegradable Plastic: The government should legislate to ban the use of non-biodegradable plastic in packaging applications and criminalize its use with strict penalties.
  2. Strict Enforcement of MMDAs By-laws: The government should enforce existing by-laws related to waste management, ensuring that offenders are prosecuted to set an example.
  3. Building of More Recycling Plants: The government should encourage private sector involvement in building recycling plants by offering tax waivers and holidays.
  4. Active Public Education: The government should intensify public education on the importance of proper waste management through the National Commission for Civic Education (NCCE).
  • 40 Marks

CSEG – May 2016 – L2 – Q1 – Analysing the external environment | Analysing the internal environment

Conduct strategic analysis and prepare cash budget for Richward Ltd, a small haulage contracting company, addressing competitive forces, SWOT, and financial planning.

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)

a) The five competitive forces related to the business of Richward Ltd care:

  1. 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.
  2. 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.

  1. 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.

  1. 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.
  2. 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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