Financial and Management Accounting Case Study Example | Topics and Well Written Essays - 3750 words

Financial and Management Accounting - Case Study Example The rise in inventory levels is of particular significance and it is suggested that if a proper stock management plan was put in place, the Company would be able to improve its liquidity and cash flow position. It is also suggested that alternate sources of funding for the Company's expansion, such as debt finance and/or leasing of assets as opposed to relying predominantly on equity finance may have a favourable impact on Foster Ltd., in terms of liquidity and otherwise. Foster Ltd. has gone through rapid expansion over the two years that make up the subject matter of this report. This is evident from the financial statements of the Company as seen from the fact that revenue has grown by 43.75% and the investment in machinery has increased by 60% in 2006. The Company has also increased its long term funding by drawing a '1 Million loan as well as making a share issue. This expansion has reaped benefits in terms of profitability; however the liquidity and cash flow position of the Company has deteriorated. The directors themselves have felt the strain and the Cash Flow Statement prepared for 2006 clearly reflects the problem. The financial statements show further signs of the cash shortage and these will be discussed below. Overtrading is a likely cause for the Company's current unfavourable situation. This refers to the fact that the Company has expanded its sales revenue quite rapidly without securing the additional funds necessary to support the expansion. This report looks to find the underlying causes of the liquidity problem by analysing the available financial statements. Any potential causes found will be discussed and possible remedies suggested. In addition, other ways in which the liquidity position of the Company can be improved will also be considered. Foster Ltd.'s Current Profitability &Liquidity/Cash flow Position As mentioned above, the profitability of Foster Ltd. has seen a commendable increase. The Gross Profit Ratio (GP Ratio) of the Company has increased from 21.88% in 2005 to 26.09% in 2006 (see Appendix). This is a significant rise. It must be noted that just because revenue increases, profitability does not increase as the cost of sales would have increased along with the revenue. However, in Foster Ltd.'s case, the cost of sales has increase in a proportion quite considerably less than that of revenue (36% as compared to 47.35%). It is because of this difference in proportions that Foster Ltd. is exhibiting higher profitability levels. A likely reason for cost of sales increasing by a lower percentage is the achievement of economies of scale. As Foster Ltd. expands and increases production, its cost per unit decreases as it begins to enjoy the benefits of bulk discounts in raw material purchases, as well as being able to spread overhead and other fixed costs over a larger number of u nits thereby reducing the fixed cost per unit. Along with its GP Ratio, the Total Profit ratio has also increased from 8.75% to 8.99% (see Appendix). This may not be a sizable increase but is definitely notable. The reason for the increase in the GP Ratio not being followed through to the Total Profit ratio is that the operating expenses, and the finance and tax costs to a lesser