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Company X has credit sales of \$144,000 yearly with credit terms of net 30 days, which is also the average collection period. Company X does not offer a discount for early payment, so it's customers take 30 days to pay.

If Company X offered a 2% discount for payment in 10 days and every customer took advantage, (using full sales of \$144,000 to calculate receivables) the new average receivables would be?

Then Company X reduces its bank loan which costs 10% by the cash generated from reduced receivables, please help calculate what the net gain or loss is to the company and should it offer the discount?

Then assume the new trade terms of 2/10, net 30 will increase sales by 15%. If company X earns 20% before discounts, should it offer the discount?

Solution Preview

Question 1:
To handle this question efficiently, we would use the idea of account receivable collection period, which is calculated by the formula

Account receivable collection period = 365 * Daily Account Receivable / Total Net Sales
= Annual Credit Sales / Total Net Sales
Here, the account receivable collection period = 30
annual credit sales = \$144,000, so we get
30 = \$144,000 / Total Net Sales
Total Net ...

Solution Summary

This solution of 316 words calculates the new average of receivables for Company X and provides a recommendation on discounts based on new trade terms. All steps are shown with justifications.

\$2.19

Management from the perspectives of profitability, asset utilization, risk management, and cash flow management.

See attached file for full problem description.

Identify and provide a detailed explanation of which company has been better managed from the perspectives of profitability, asset utilization, risk management, and cash flow management.

http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=pep

http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?symbol=KO

Coca-Cola Company
On May 8th, 1886, Coca-Cola was established in Atlanta, Georgia, by a local pharmacist called Dr. John Stith Pemberton. The newly developed soda fountain beverage consisted of the Coca-Cola syrup and carbonated water to produce a delicious and refreshing soda that was sold at a local fountain shop. During the first year of operation, Coca-Cola was sold for five cents a glass and sales averaged about 9 glasses per day. However, due to steady sales and technological advancements in bottling systems, Coca-Cola's first bottling agreement was signed in 1899. As a result of the bottling agreement and increased consumer demand Coca-Cola expanded across the United States and in turn, to over 200 countries around the world.
Today, Coca-Cola is a worldwide brand and an instantly recognizable household name. Even though the company's original product is soda production, the company has updated its beliefs and product line to offer customized products and services within the communities in which it operates. For example, Coca-Cola now offers about 400 brands of products in over 200 countries, such as "...Inca Kola, a soft drink found in North and South America, and Samurai, an energy drink available in Asia; to Vita, an African juice drink, and BonAqua, a water found on 4 continents" (The Coca-Cola Company, 2007). In addition, in order to ensure organizational and community success, Coca-Cola strives to maintain strong locally based relationships between Coca-Cola bottlers, customers and communities. This is accomplished by becoming "... an investor in local economies and a driver of marketplace innovation, with a responsibility to act as a good steward of our natural environment" (The Coca-Cola Company, 2007).
PepsiCo, Inc.
In 1893, the original Pepsi formula was created by a pharmacist named Caleb Bradham in New Bern, North Carolina. The drink was originally called Brad's Drink and the ingredients consisted of carbonated water, sugar, vanilla, rare oils, pepsin and cola nuts. However, on August 28, 1898, Brad's Drink was later renamed to Pepsi Cola after the ingredients pepsin and cola nuts. Due to the success of the Pepsi-Cola formula, Caleb Bradham officially created the Pepsi-Cola Company in 1902 and the name Pepsi-Cola was trademarked on June 16th, 1903.
Today, PepsiCo, Inc. is the result of increasingly successful product lines, global offerings, and the 1965 merger between Pepsi-Cola and Frito-Lay. "PepsiCo, Inc. is one of the world's largest food and beverage companies. The company's principal businesses include: Frito-Lay snacks, Pepsi-Cola beverages, Gatorade sports drinks, Tropicana juices, Quaker Foods" (PepsiCo, Inc., 2007). As a result, "PepsiCo's success is the result of superior products, high standards of performance, distinctive competitive strategies and the high level of integrity of our people" (PepsiCo, Inc., 2007).
Financial Statements
Ernst and Young, LLP has been the auditors for Coca-Cola Company for many years and has a proven record when it comes to servicing the client.

Some of the services used are:

? accessing global resources
? reduce the complexity of legislation
? align tax strategies with Coca-Cola's business needs
? meeting compliance obligations
Ernst and Young national tax practices are worldwide in more than 130 countries and provide a network of tax professionals in the cities and countries where Coca-Cola does business.
These global specialty services provide consistent high quality clientele services to include:
? Human Capital
? Indirect Tax
? International Tax Services
? Tax Accounting and Risk Advisory Services
? Transaction Tax
Strategic growth is an important element to the Coca-Cola Company. Ernst and Young provides consulting services to assist management in the decisions-making process as it relates to programs that will increase sales. Some areas of focus are jobs design, performance management programs, and sales compensation plans. Ernst and Young is passionate about assisting the clients' use of these programs effectively so they can grow profitably, serve customers wisely, and reward employees appropriately for achieving business objectives.
According to Fortune Magazine, KPMG, LLP is named among the 100 best companies to work for in 2007. KMPG, LLP is dedicated to developing long standing relationships with its clients. This has proven to be so as they have been the auditors for Pepsi for over 10 years. Some of KPMG's other lines of business include:
? Financial Services - Banking and Finance, Insurance, and Building, Construction and Real Estate
? Industrial Markets - Industrial and Automotive Products, Transport, Chemicals and Pharmaceuticals, and Energy and Natural Resources
? Consumer Markets - Retail, Food and Drink, and Consumer Products
? Information, Communications and Entertainment, Communications, Electronics, Media, and Software and Business Services
? Government - Federal, State and Local, and Higher Education, Research, and Not-for-Profit
? Healthcare - Providers, Payers, Products
KPMG, LLP has a proven track record for servicing their clients and provides continued insight of professional services for the continuing growth of Pepsi. Another example of KPMG's dedication to its client is its understanding of how legislation policy can affect business today. KPMG produces a monthly report called the Washington Report, which provides information relating to the effects of regulatory agencies, the Administration, or Congress.
Financial Data
Using the services of MSN Money Central, an even comparison of Pepsi Co. and Coca-Cola's financial documents can be obtained. "Financial statements are prepared in this standard format to allow direct comparisons of all companies and industries across multiple time frames" (MSNmoney, 2007, pg. 1). According to Pepsi Co.'s balance sheet, between the end of 2005 and 2006, total assets fell from \$31,727.0 million to \$29,930 mil. However, during this period liabilities also dropped from \$17,476.0 mil. to \$14,562.0 mil. The same period yielded an increase in retained earnings of \$3,721 mil. arriving at a total of \$24,837.0 mil. in retained earnings for 2006. Total revenue for 2006 was its highest in five years at \$35,137.0 mil. resulting in an after tax income of \$5,642 mil, \$1,564 mil. more than in 2005. The statement of cash flow shows cash from operating activities to be \$6,084.0 mil. in 2006. In 2006, \$194.0 mil. was used to finance investing activities and \$5,983.0 mil. was used toward financing activities. The result was a reduction in cash of \$65.0 mil.
In comparison, The Coca-Cola Company experienced a small increase in total assets from \$29,427 mil. in 2005 to \$29,963.0 mil. in 2006. The total liabilities for Coca-Cola remained nearly the same dropping \$29.0 mil. to a total of \$13,043.0 mil. for 2006. Retained earning also showed an increase from \$31,299.0 mil. in 2005 to \$33,468.0 mil. in 2006. Total revenue in 2006 was \$24,088.0 mil. resulting in an after tax income of \$5,080.0 mil., \$208.0 mil. more than in 2005. During 2006, Coca-Cola posts cash from operating activities at \$5,957.0 mil. Investing activities consumed \$1,700.0 mil and financing activities consumed \$6,583.0 mil. for 2006. The result reflects a reduction in cash of \$2,261.0 mil.
Asset Utilization
In the two most recent years of 2005 and 2006, both Coca-Cola and Pepsi Co. have experienced differences in the ability to utilize assets effectively and generate profits. Analyzing each company's ability to efficiently use its assets incorporates the use of financial ratios containing the financial information provided by the financial statements of both companies. For Coca-Cola, an asset turnover of 0.81 has been calculated along with a fixed asset turnover of 3.78. This indicates that each dollar of assets held by Coca-Cola produces \$0.81 in sales and each dollar in fixed assets produces \$3.78 in sales. Compared to Pepsi Co., an asset turnover ratio of 1.14 has been calculated for total assets and 3.83 for fixed assets. While the turnover rates for fixed assets are very similar, relying on the total asset turnover rate indicates that Pepsi Co. is using its assets more efficiently to generate profits.
The inventory turnover rate is another asset related ratio used as an indication of how quickly a company is able to move its inventory. Coca Cola's inventory turnover rate is 5.41 while Pepsi co. has a rate of 8.71. While both companies have similar average inventories, PepsiCo's being higher at 1,809.5 mil. compared to Coca Cola's 1,510 mil., Pepsi Co. sold nearly double the cost of inventory for the fiscal year of 2006. Another financial ratio, which can serve as an indicator of asset utilization, is the day's sales in inventories. This ratio is used to identify the average daily amount of sales inventory, which is warehoused throughout the year. Coca Cola's averaged 67.5 days worth of inventory kept on-hand throughout 2005 and 2006, while Pepsi Co. averaged 41.9 days of inventory within the same timeframe. This indicates that Coca-Cola is utilizing a higher percentage of its assets to increase its inventories, which may be limiting the company's ability to capitalize on investments in other areas.

Risk Management
Coca-Cola, the consumer as well as government/public health officials are becoming more health conscience as it relates to obesity; especially among children. It has been reported that if Coca-Cola is unsuccessful in adapting to the changing health environment, the outcome could result in a loss of share sales and the negative effects to volume growth. Although there are other nonalcoholic competitors the primary competitor and potential risk to Coca-Cola is PepsiCo, Inc. Another risk Coca-Cola has is the adverse change in interest rates and exchange of US dollar of which can cause an increase or decrease to the net operating cost against other major currencies.
PepsiCo, long-term growth begins with their products along with the philosophy that humans ("Human Sustainability") should be nourished in multiple dimensions, ranging from simple treats to healthier snacks. In fact, the products PepsiCo refer to as "Smart Spots represents about two thirds of the company's growth in Northern America for 2006. However, although both companies have their individual risks, both are subjected to the following:
? Market risks
? Workforce retention
? Product demand
? Global, economic, environmental and political conditions
? Supply chain
? Information technology
? Company reputation
? Competition
? Raw materials and suppliers
? Maintaining good relationships wit bottling partners and retailers who carry the product
Should either company loose their key customer base or fail to maintain a good relationship with bottling partners and retailers, the financial loss of revenue would be very damaging. This offset would affect the return on the invested capital, operating cash flow/profit growth and earnings per share.
Financial Ratios
Financial Ratios, such as the times interest earned ratio, the net profit margin, and the return on equity, are used to gain an understanding of a company's financial performance. Therefore, it is important that companies like PepsiCo, Inc. and Coca-Cola maintain accurate detailed financial statements to ensure that the correct financial performance is presented to the public. Unfortunately, inaccurate financial statements, such as a company's income statement and balance sheet, can negatively influence potential investors and creditors and even make the company legally liable.
The times interest earned ratio is a measure for determining if a company's earnings are sufficient to cover interest payments. This type of ratio is commonly used by creditors to determine a company's financial advantage. The times interest earned ratio formula applied to PepsiCo, Inc. and the Coca-Cola Company is as follows:
Times Interest Earned Ratio = EBIT / Interest Payments

PepsiCo, Inc. Coca-Cola Company

2005 2006 2005 2006

6,382 / 460 6,989 / 550 6,690 / 675 6,578 / 75
= 13.87 = 12.71 = 9.911 = 87.71

The net profit margin is a profitability ratio that focuses on a firm's earnings. This ratio helps to highlight a company's ability at controlling costs by determining how efficiently revenues are converted into profit. Basically, the net profit margin ratio is used when "...you want to know the proportion of revenue that finds its way into profits..." (Brealey, Myers, & Marcus, 2003, p. 457) For example, if a company obtains a high net profit margin then it is usually successful at generating a profit. The net profit margin applied to PepsiCo, Inc. and the Coca-Cola Company is as follows:
Net Profit Margin = Net income / Sales

PepsiCo, Inc. Coca-Cola Company

2005 2006 2005 2006

4,078 / 32,562 5,642/ 35,137 4,872/23,104 5,080/24,088
= 0.16 = 9.911 = 0.21 =0.21

Return on Equity (ROE) is used to measure a company's profitability by focusing "...on the return on the shareholders' equity." (Brealey, Myers, & Marcus, 2003, p. 458) Basically, the ROE measures the profitability of company stock by determining the return of each invested dollar. The return on equity ratio applied to PepsiCo, Inc. and the Coca-Cola Company is as follows:
Net Income / Average Equity = Return on Equity

PepsiCo, Inc.

2005 2006

4,078 / ((14,251 + 15,368)/2) 5,642 / ((14,251 + 15,368)/2)
= 4,078 / (29619 / 2) = 5,642 / (29619 / 2)
= 4,078 / 14809.5 = 5,642 / 14809.5
= 0.275 = 0.381

Coca-Cola Company

2005 2006

4,872 / ((16,355 + 16,920) / 2) 5,080 / ((16,355 + 16,920) / 2)
= 4,872 / (33275 / 2) = 5,080 / (33275 / 2)
= 4,872 / 16637.5 = 5,080 / 16637.5
= 0.29 = 0.305

PepsiCo

2006 2005
Total Current Assets \$ 9,130.00 Total Current Assets \$10,454.00
Total Current Liabilities \$ 6,860.00 Total Current Liabilities \$ 9,406.00
Current Ratio 1.33 Current Ratio 1.11

2006 2005
Total Liabilities \$14,562.00 Total Liabilities \$17,476.00
Total Equity \$15,368.00 Total Equity \$14,251.00
Debt to Equity Ratio 0.95 Debt to Equity Ratio 1.23

2006 2005
Net Income from Operations \$ 6,439.00 Net Income from Operations \$ 5,922.00
Revenues \$35,137.00 Revenues \$32,562.00
Operating Profit Margin 0.18 Operating Profit Margin 0.18

Coca-Cola

2006 2005
Total Current Assets \$ 8,441.00 Total Current Assets \$10,205.00
Total Current Liabilities \$ 8,890.00 Total Current Liabilities \$ 9,836.00
Current Ratio 0.95 Current Ratio 1.04

2006 2005
Total Liabilities \$13,043.00 Total Liabilities \$13,072.00
Total Equity \$16,920.00 Total Equity \$16,355.00
Debt to Equity Ratio 0.77 Debt to Equity Ratio 0.80

2006 2005
Net Income from Operations \$ 6,308.00 Net Income from Operations \$ 6,085.00
Revenues \$24,088.00 Revenues \$23,104.00
Operating Profit Margin 0.26 Operating Profit Margin 0.26

Both Coca-Cola and Pepsi so are two of the biggest and most profitable companies in their industry. With both companies posting gross profits in excess of \$15 billion for 2006, it is no wonder other manufacturers have yet to come close to each company's performance. Comparing the two companies with the help of the various financial ratios does give a better indication of how these companies compare financially. While Pepsi Co. posts revenues over \$10 billion above Coca-Cola, both companies have posted nearly identical net incomes for the fiscal year of 2006; the result is a higher profit margin for the Coca-Cola Company. Similarly, both companies closely resemble each other in terms of assets, liabilities, and owners' equity amounts. A thorough analysis including the use of financial ratios is essential in the process of comparing and analyzing the financial performance of an organization. With the help of these ratios, a careful analysis of a company's performance can be obtained; such analyses can be of significant importance when trying to accurately determine the financial performance of an organization.

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