MBA9004 Indicative solutions to Sample Exam paper 1

Q1 General Machinery

Important note: These are INDICATIVE answers only. They are written in bullet point form but in answering any similar examination question, you would need to argue your case clearly, showing

• What are the key issues; Your evidence for identifying these as issues; Your reasons as to why the issue is important; Recommendations for improvement

After a decline, the company’s profitability (ROI, ROCE, Operating margin) has improved recently. However, the gross margin has dropped for five consecutive years, suggesting that selling prices are not being increased to pass on purchase (or production) cost increases. This deteriorating margin is a significant risk for the company as profits have only been increased by the large reduction in overhead as a percentage of sales in 2009. If margins continue to erode and if overheads as a percentage of sales cannot be continually cut, profits may be at serious risk. The company needs to continue to increase sales growth, fix its gross margins and continue to manage overheads.

Working capital has been at extremely high levels but has fallen to close to 2:1, an improvement, but with an acid test greater than 1, is probably still too high. This is demonstrated by the relatively high days’ sales outstanding (60 against 30 day terms), which even though it has improved is still too high. Inventory represents the biggest concern to working capital as at 3.3 it represents an average stockholding of 110 days (365/3.3). The company needs to manage its ordering to a just-in-time basis. The cash flow statement shows that most cash has been used in 2009, hence working capital is strained by a lack of cash and slow debtor collections and inventory turnover. The result is too high days’ purchases outstanding of 78, representing over 2.5 months. This is