Jrp Ltd. Management

Case study: JRP Ltd - commentary

To be used in conjunction with the Excel file under week 7 tab.

Sales:

The pattern of changes in sales revenue is best expressed by standard percentages (year 4 = 100). Sales nearly doubled in year 2 but have declined by year 4 to just below what they were in year1. This major change will have an impact on all aspects of the business. The cause of the reduction in year 3 seems to be the downturn in the housing market from which JRP’s demand is derived. But the decline in year 4 may be at least partly due to the reduction in marketing staff numbers and the resulting non-issue of two or three quarterly catalogues.

Profitability:

The most important change in profitability is that the company made its first trading loss in year 4. Although the directors were expecting the results to be worse than the previous year, they had assumed the business would remain profitable. Year 2 had been a good year for JRP with a near doubling of sales revenue and a 50% improvement in ROCE taking it to 27%. This had been achieved with little increase in fixed assets. However, in year 3, there was a significant investment in fixed assets, which, together with the decrease in sales, caused a deterioration in the asset utilization ratio. This deterioration continued in year 4 and may have been partly caused by the staffing cutbacks being accompanied by some selling-off of fixed assets at a loss. If so, this ‘loss on disposal’ of fixed assets may have been erroneously included in the figures showing the negative operating profit margin in year 4.

Whether this was the case or not, it is highly likely that the adverse profit margin was caused by an increase in the direct cost of their purchases. Apparently, early in year 4, one of its main suppliers became very nervous about JRP’s ability to pay for its purchases. The average creditors payment period had increased from 70 to 118 days over year 3 and could have been even higher for this particular supplier who decided that future business must be conducted on a ‘cash only’ basis. JRP refused and sourced its supplies elsewhere but it may have had to accept significant price increases as a result. (This supposition is based on the gross profit margin reducing from 39% to 28% in year 4. This would also explain the negative operating profit

margin in year 4.)

Working capital management:

This illustrates the importance of supply chain management. If the time taken to pay suppliers is continually extended, they may feel that they are being taken advantage of and not being treated ‘fairly’. If the supplier’s terms of trading cannot be adhered to, it should be contacted and some arrangement agreed as to the revised date(s) of payment; communication costs very little and may be vital. The figures show that the payment period had been reduced to 78 days by the end of year 4 (similar to the end of year 2) so JRP may have learned its (very expensive) lesson. Together with the increase in stock turnover days, this has caused the cash cycle to triple from 32 to 93 days – an alarming deterioration.

Cash flow:

The overdraft position is critical and demands immediate management attention. If the amount borrowed is not reduced by more than £20,000 the bank will start to dishonour JRP’s cheques which could easily result in the business going into liquidation. A glance at the stock turnover ratio and debtors collection period shows the possible solution. In year 4, stock days have increased from 55 to 78 days and, over the last two years, the debtors collection period has increased from 73 to 93 days. The liquidity crisis would be solved if management’s performance in these two areas were improved to its former more efficient levels.

Average daily credit purchases = £773,000/365 = £2,118

Improvement in stock management = (78 – 55) × £2,118 = £49,000

Average daily credit sales = £1,040,000/365 = £2,850

Improvement in collection period = (93 – 73) × £2,850 = £57,000

Possible combined improvement in stock and debtors = £106,000.

If these improvements were both achieved in full, the overdraft would be reduced to about £34,000! And the amount of bank interest would reduce commensurately, improving the company’s profitability (after interest) together with the value of shareholders’ funds. Even if only half of the £106,000 were achieved, the overdraft would reduce to about £90,000, well within the limit imposed by the bank. Given competent management, both these improvements should be perfectly possible, as the volume of sales has been falling very significantly over the last two years. Indeed, because of this, the efficiency of management in these two areas is actually much worse than the ratios would indicate.