Chicken run

Table of Contents Executive Summary 1 1.0 Introduction 2 2.0 Main issue 3 3.0 Analysis and Discussion 4 3.1 Short-term borrowing 8 3.2 Ethical Analysis 9 3.3 Lack of internal control 10 4.0 Recommendation 11 4.1 Develop different types of chicken products 11 4.2 Change or mixed chicken feed 11 4.3 Proper documentation and segregation of duties 12 4.3 Establish new policies by management 14 Figure 1 Process of Sales Order Entry 14 Figure 2 Process of Cash Collection 15 Table 1 Performance analysis of EPM for the past 3 years from 2006 to 2008 5 Table 2 Percentage of increase/decrease in the account balances 6 Table 3 Increase of price of feed and production cost 6 Table 4 Financial ratio analysis of EPM 7 Table 5 Types of chicken production 12 Executive Summary The purpose of this report is to evaluate and analyse the current position of EPM after the occurrence of the problems in the case study and recommend few suggestion to resolve these issues. First, this report provides an analysis and evaluation of the current and prospective profitability, liquidity and financial stability of EPM. Methods of analysis include horizontal and vertical analyses as well as ratios such as profit margin, inventory turnover ratio, account receivable turnover ratio and days to collect account receivable. Results of data analysed show that all ratios are below industry averages. In particular, comparative performance is poor in the areas of profit margins, credit control and inventory management. Other than that, there are analysis on the issue of short term borrowings by performed the comparative analysis on short term borrowing to long term borrowing. An ethical analysis to the action that perform by En Selamat which show the intention not to fulfill his responsibily and duty of care which lead to the problem of conflict of interest. At the end, the analysis to the internal control of EPM and the results show that the EPM’s internal control is really in a bad state which lead to credit control issue. This report finds that the prospects of the company in its current position are not positive. The major areas of weakness require further investigation and remedial action by management. Recommendations discussed include: Develop more types of chicken products Change or mixed chicken feed with other feed Proper documentation and segregation of duties Establish policies by management to prevent any irregularities actions 1.0 Introduction Encik Selamat, the General Manager of Excel Poultry & Meat Sdn Bhd (EPM) had received a report which indicated that the operating cash flow of EPM was systematically running low. The company had to resort to significant increase in the short-term borrowing in order to meet its operating obligations thus increase the interest payments. The credit limit of its major customer, Cold Gold Sdn Bhd also had gone into its level and yet the marketing department continued to supply products to the company. Another problem faced by this company is Mr Siva, its retail customer complaining that the figures on the statement of accounts sent to him were incorrect. He had no outstanding balance in his account as cash payments had been made to Encik Munir, a former staff at finance department. All of these problems interrelated to each other and became the main issue in this company which is low liquidity of cash flow. This report is prepared to analyze the issues in EPM that put it in this kind of situation. It provides information obtained through ratio analysis, regarding the profitability, liquidity and financial stability of EPM. This report pay particular attention to the earning power, liquidity and credit management, inventory management and debt management, and will highlight major strengths and weaknesses while offering some explanation for observed changes. The report will comment on the prospects of the company and make recommendations that would improve company’s current performance. These observations do have limitations which will be noted. 2.0 Main issue The main issue in this case is the low liquidity of cash flow in Excel Poultry & Meat (EPM). The problem arises from several other issues. Since 2008, the company has been facing the problem of increased chicken feed cost which has risen to RM88 from RM54.50 (an increase in almost 61.5%). The increase in feeding cost has ultimately increased the company’s production cost to about 56.5%. Even though EPM had growing in revenue, it still cannot improve its operating profit. It was mainly pertaining to less significant difference between cost of sales and revenue. In that event, the company resorted to borrowing short-term loans from the bank in order to meet these operating obligations. This in turn increased its financial obligations in terms of interest payments and caused more losses to the company. In addition, the financial position becomes worse as EPM continues to supply products to Cold Gold Sdn Bhd even though their credit limit had already exceeded. This leads to the increasing of trade receivables and trade creditors because EPM did not collect its customers’ debt. It also cannot pay its own debt. The receivable collection in this company is out of control. As example, Mr. Siva (a retailer) complained that the figures on the statement of accounts sent to him were incorrect. He had no outstanding balance in his accounts as cash payments had been made to Encik Munir (one of the former personnel in finance department). This proves that the company’s accounts are not in proper order and there is possibility of misstatements in their accounts. Lack of internal control in EPM leave a loop hole for Encik Munir and Encik Selamat to cause these problems. Other than that, EPM’s credit controller (Ms Choy) discovered that Encik Selamat (General Manager) has close relationship with one of the executive directors of Cold Gold Sdn. Bhd., Encik Azman. This relationship has enabled Cold Gold to extend its credit limit with authorisation from Encik Selamat. This situation may create conflict of interest as Encik Selamat did not disclose it to the Board. 3.0 Analysis and Discussion Particular/ Year 2006 (RM million) 2007 (RM million) 2008 (RM million) Revenue 54.70 55.01 74.90 Cost of Sales 51.70 54.10 74.09 Operating Profit/ (Loss) 3.00 0.91 0.81 Expenses 0.80 1.10 1.60 Net Profit/ (Loss) 2.20 (0.19) (0.79) Trade Receivables 12.70 16.20 26.00 Stock 3.10 1.50 2.60 Trade Creditor 18.50 30.00 45.00 Table 1 Performance analysis of EPM for the past 3 years from 2006 to 2008 Particular/ Year 2007 2008 Revenue 0.57% 36.16% Cost of Sales 4.64% 36.95% Operating Profit/ (Loss) (69.67%) (10.99%) Expenses 37.5% 45.45% Net Profit/ (Loss) (108.64%) (315.79%) Trade Receivables 27.56% 60.49% Stock (51.61%) 73.33% Trade Creditor 62.16% 50% Table 2 Percentage of increase/decrease in the account balances Particular/ Year 2006 2008 Increment Price of Feed (per bag) RM 54.50 RM 88.00 RM 33.50 Production cost (per kilo) RM 3.22 RM 5.04 RM 1.82 Table 3 Increase of price of feed and production cost In late 2008, the operating cash was running low because of the problems in cash liquidity. From the abstract of account above, we found that the cost of sales was increasing from 2006 to 2008 and it is too close to the revenue amount. However, in 2007, the cost of sales increased while the revenue did not increase much and operating loss was recorded in 2008 as the retail price of chicken was increased from RM 3.22 to RM 5.04 per kilo from 2006 to 2008. Thus, the increment of revenue in 2008 by 36.16% was almost same with the increment in cost, 36.95% in that year. On the other hand, in 2008, the cost of feeding was increased by RM 33.50 from RM 54.50 to RM 88.00 per bag which is an increased of almost 61.5%. Hence, the production cost was also increase from RM 3.22 to RM 5.04 per kilo from 2006 to 2008 by RM 1.82 which is 56.5%. In short, the exorbitant cost of chicken feed resulting the operating loss faced by the company. Particular/Year 2006 2007 2008 Profit Margin 5.48% 1.65% 1.08% Inventory Turnover Ratio 16.68 36.07 28.50 Account Receivable Turnover Ratio 4.31 3.40 2.88 Days to Collect Account Receivable 84days 107days 126days Table 4 Financial ratio analysis of EPM Profit margin is very useful to assess the current financial position and financial performance. The higher the profit margin indicates more profitable company that has better control over the costs compared the years. In this case, EPM have the highest profit margin which is 5.48% in 2006 and decreases gradually in the following years to 1.08% in 2008. This is because the increment of cost of sales, EPM is profiting only 1.08% for every dollar of product sold in 2008. Besides that, the inventory turnover ratio is used to measure the inventory management efficiency of a business. It is an activity/ efficiency ratio and it measures how many times per period, a business sells and replaces its inventory again. In general, a higher value indicates better performance and lower value means inefficiency in controlling inventory levels. For the year 2007 we can see that the value of inventory turnover is higher compare with 2008 may be an indication of overstocking which may pose risk of obsolescence and increased inventory holding costs. EPM was turning over its inventory on average, 3 times per month in 2007 while it reduces to twice per month in 2008. The reason of the low running operating cash was also due to significant increase in the trade receivables, also cash collection. The credit controller, Ms Choy was discovered from the aging analysis of customers that one of the major customers, Cold Gold Sdn Bhd, was exceed the credit limit and the marketing department of EPM still continued to supply products to that particular company. Encik Selamat has personal benefit from the deal with Cold Gold Sdn Bhd. Therefore although Cold Gold Sdn Bhd did not pay within the credit limit, Encik Selamat did not stop the marketing department to continued supply products to the company. EPM has weakeness in their cash collection because of customer selection and depends on the relationship rather than business matter. There is a supported evidence which between General Manager, Encik Selamat and one of the executive directors of Cold Gold Sdn Bhd, Encik Azman, who was the best friend during college days. Besides that, there is two possibilities that the statement of customer account is not tie up with the client records. Firstly, the account receivable is not being maintained properly. There is an assumption that Encik Selamat might use the company’s fund illegally and he instructed the Account Executive, Puan Azura to prepare the accounts in a ways to conceal his acts. It is an illegal transferring of a particular debtor’s balances to another debtor. Secondly, there is theft on cash collections. This might be one of the former staff in finance department; Encik Munir did not record properly and committed fraud on cash skimming. Cash skimming is an illegal practice of taking the money for personal used. And the person skimming is not reporting the cash as the payment of Mr Siva, one of the retail customers with small account. By calculating the financial ratio analysis, account receivable turnover ratio is indicates how quickly a company is having difficulties collecting sales made on credit. It is an important indicator of a company’s financial and operational performance also. However, the receivables turnover ratio is convert it into days to collect account receivable. The days to collect account receivables is also called Average collection period is the number of days , on average, that it takes a company to collect its account receivables. In 2006 we can see that the company collects its trade receivables in 84 days (around 3 months) compare with the year 2007 and 2008 when their collect the money in 107days and 126 days (around 4 months), where there is the differences about 1 month. It means that a higher value of average collection period is unfavorable whereas a lower value is favorable. So, it is means that EPM takes around 3 months to collect its debt in 2006, while it takes more than 4 months in 2008. 3.1 Short-term borrowing The another reason of the low running operating cash was also due to the company had to resort to significant increase in the short-term borrowing in order to meets its operating obligations. This may in turn increase its financial obligations in terms of interest payments. By increasing short-term borrowing, the company may incur short-term debt; the debt is usually made up of short-term bank loans taken out by the company. The value of the debt is important when determining the company’s financial health. If the debt is larger than the company’s cash and cash equivalents, the company may results in poor financial health and does not have enough cash to pay off its debts. EPM will facing loss if the debts incur could not be clear and the interest payments will keep on increasing. On the other hand, short-term borrowing may in turn increase its financial obligations in terms of interest payments. The interest payments on the short-term bank loans can quickly add up to a major expenses for EPM. Short-term borrowing Long-term borrowing -The borrowing time usually not more than one year. -Unsecured. -High interest rate with additional fees. -Short-term borrowing is good non-regular expenses that come up. -EPM can take longer period of time to start paying of their loans. -Lent over a longer lending term. -Long-term borrowing is good for equipment and other depreciable assets. 3.2 Ethical Analysis Encik Selamat and Encik Azman were best friends during college days. They involve in the issues of conflict of interest during the trading business between both companies. Both of them have personal deal within the company’s interest. Cold Gold Sdn Bhd was one of the major customers in EPM, the relationship between Encik Selamat and Encik Azman may affect the judgment of Encik Selamat as a General Manager of EPM. Fraud was founded in EPM especially the irregularities in the debtor’s account. This is lead to the figures of the debtor’s account does not tie up to the balances in the company’s account, this happened caused by one of the former staff at the finance department Encik Munir who did not record the payment paid from customer in company’s account. One of the retail customers Mr. Siva, with the small account in EPM came to the office and complaining about the figures on the statement of accounts that sent to him were incorrect. He stated that he had no outstanding balance in his account as payments had been made to Encik Munir. This happened was totally unusual in the company’s account, there is some where goes wrong when preparing the account. Moreover, there is another ethical part which is when Ms. Choy realizes this issues was happened, she approached one of the company directors and highlighted the fiasco, only to discover about the “deal” between Encik Selamat with one of the Cold Gold Sdn Bhd’s directors. The director was reluctant to take any action against Encik Selamat, since he was very “well-connected” and had good reputation at the previous company. Encik Selamat’s connections with parent company will results that he can secure his position in EPM and settled the problem that he created without facing any penalize. Encik Selamat will continue make this fraud because he know that nobody will caught him or get any penalize just because of his relationship and “well-connected” with all the related person, he know that they will cover up his fraud. 3.3 Lack of internal control Internal control plays an important role in how management meet its stewardship or agency responsibilities. Management has the responsibility to maintain controls that provide reasonable assurance that adequate control exists over the entity’s assets and records. Proper internal control not only ensures that assets and records are safeguarded, but also creates an environment in which efficiency and effectiveness are encouraged and monitored. Encik Selamat had been the General Manager of EPM, a subsidiary of PCK Holding. He was transferred from another subsidiary of the same group, which dealt in the business of transportation. He was initially reluctant to accept the current position due to his lack of expertise in poultry and meat industry. PCK Holding Company was still transferred him to become General Manager of EPM, PCK was founded lack of internal control that did not consider Encik Selamat was lack of expertise in poultry and meat industry. After Encik Selamat was accepted the offer, the career track had been smooth until the closing of the year 2008 when the company he presently helmed faced operational crises. The “chicken run” saga pictured a case that was familiar in respect of management of small-and-medium sized-industry, at the infant stage when there was a lack of focus on the important considerations for proper running of business operations. Due to Encik Selamat was lack of expertise and don’t have experience in this industry, he was unable to handle when things become more and more serious. 4.0 Recommendation 4.1 Develop different types of chicken products In order to resolve the main issue of the low liquidity of cash, we recommend that EPM can expand or develop more chicken products to sale. Since the main activity of EPM is supplying the whole chicken to customers, it is advisable to develop more products to increase the sales as below. Types Purpose Eggs EPM can raise the chicken eggs either for consumption or to breed more chicken to sell. Feathers The chicken feathers also can be use to sell to the handicraft makers. Livestock EPM can sell the chickens not only for consumption but also to customers who would like to buy chicken as pet. Table 5 Types of chicken production Another problem that causes the low liquidity of cash flow is the increase in the cost of chicken feed. It is recommended that EPM mix the chicken feed with other cheap ingredients to reduce the chicken feed cost. 4.2 Change or mixed chicken feed The following are the list of other feed that can be use to replace the current chicken feed: Wheat – one of the best grains for poultry feeding should be ground and fed in mashes and less in the scratch feed. Oats – vary considerably in feeding value, due to difference in hull, can be fed whole as part of a scratch feed or in mashes in the crushed, rolled or finely ground form. Barley – work well as part of the scratch feed and in mashes in crushed, rolled or finely ground form. Corn – a very desirable grain that can feed as whole, cracked or ground. Shell corn may be used with other grains as scratch feed and corn chop can be included in any of the dry mash rations. 4.3 Proper documentation and segregation of duties Based on the analysis, we recommend that EPM to manage their cash flow system. EPM allows their customers to purchase their products by credit. Thus, before approving the customers, EPM should conduct a background check on their customer’s credit account and related relationship pertaining to creditors. This is to avoid any personal interest in the company’s management team. EPM should prepare a specific contract that includes the credit term (e.g. 90 days, 120 days or 180 days) in collecting the debt. EPM can send reminders to customers with outstanding balances in respect of their accounts. Therefore, the customer will not have long outstanding and can avoid paying higher debts and pay at time given. In order for EPM to avoid having risk with customers purchase in credits, EPM can find their customers that afford to pay in term of cash. They can be the small-medium sized company or small groceries stores. This will increase directly the income of the company thus higher operating cash flow. Somehow, they can also export their products to other countries. Besides that, EPM can apply for banking facilities and financial assistance in order to meet their financial obligations. For example, Skim Pembiayaan Perniagaan MARA or TEKUN. With the money they received, EPM can use them for improving the cash flow of the company. They also can purchase additional raw materials in order to supply their products to their customers. In term of maintaining their resources, EPM can find other supplier for their product. They can implement the backward integration as one of the way to control their supplier. From the supplier, they can ask to buy in bulk so that EPM can get discount for every purchase. This will reduce their cost and increase the sales. Other than that, since marketing department continued to supply their product even the credit limit of Cold Gold Sdn Bhd had gone into its limit, EPM should take alert on their revenue cycle especially sales order entry. Figure 1 Process of Sales Order Entry In order to solve the problem on cash collection, EPM should maintain their account receivables. Errors in maintaining customer accounts can lead to loss of future sales and may indicate possible theft of cash. EPM can implement the closed-loop verification to ensure that proper account is being credited. A field check onto the numeric values must be done frequently for the payment amounts. It is also important to reconcile the subsidiary account receivables in general which should be done by another person. Figure 2 Process of Cash Collection 4.3 Establish new policies by management In order to resolve this issue, it is recommended to bring the matter internally to the board of directors with sufficient evidences and justifications together with any solutions to boards of directors. For example, EPM should establish policies for clear ethical conducts, job scopes and management of EPM to solve the ethical problems. Other than that, EPM should develop whistle blowing policy to ensure and encourage the members of EPM to disclose any conflict of interest issues or irregularities. In the end, a good communication across levels of management to implement these policies and absorb them into EPM’s corporate culture to be shared within the organization. 14