Strategic Management and Strategic Financial Management
a) Identify the business plan and strategy used by Lululemon and evaluate its relevance to its vision and mission statements in light of current issues faced.
Importance of strategic planning for an organisation:
According to the view of Bertsch and Williams (2009), strategic planning is the most important function of an organisation. The global managers need to develop the strategies in order to cop up with the highly competitive markets. Strategies are to be developed in every aspects of the business. First of all, the mangers need to develop the strategies to acquire more market share. For an existing brand, the main issue is to maintain the current market share and drive for penetrating more market (Gluck, 2010). In order to penetrate more market, the strategies are required to be developed in such a manner that the products satisfy the basic needs of the customers. Moreover, determining the price of the product is one of the important functions of the strategic planning. In order to promote the brand, the strategies are needed to select the mode of advertising which will be effective and at the same time cost efficient. The strategic managers determine the methods to provide the best after sales services to the customers. Marketing is the part of a business that generates revenue. The strategic managers need to develop proper strategies in every part of marketing. However, the financial managers are responsible to develop the strategies that can improve the financial performance of the company and attract more investors to invest in the company. As stated by Gluck et al. (2009), work force are the most important wealth of an organisation, the human resource management are required to develop strategic planning to select the appropriate candidates for the organisation and provide training for the development of the employees. Therefore, the strategic planning is required for the growth of the organisation, maintain the sustainability of the organisation, procure and manage the financial resources and recruit work forces for the organisation. Strategic planning also helps the organisation to reduce risk in terms of maintain long term growth.
Mission and vision statements of Lululemon in the context of current issues:
As stated by Pearce (2010), to maintain the sustainability an organisation needs to set up strong goals and objectives. Based on the objectives, mission and vision statements of the company are prepared. Mission statements are the guidelines that the company follows to reach the short-term goals, on the other hand, in order to maintain the long term goals, vision statements are prepared. The mission statement of Lululemon is presented in a manifesto format. It states that the company is looking to create such components that can give the customers long lives and help the customers to stay happy in life. On the other hand, the vision statement of the organisation is to elevate the world from mediocrity to greatness. The mission and vision statement is completely relevant with the current activities of the organisation. First of all, the organisation is producing clothing made of Smart fibre that helps the body to synthesize amino acids, vitamin etc. Moreover, the company is managing its waste products in an efficient manner such that it cannot harm the people. The company is constantly engaging in to the corporate social activities. As a part of CSR activities, the company has set up a community legacy. In order to elevate the world in to a better platform to live, Lululemon has taken the green buildings and spaces initiatives. This initiative will reduce the level of emissions of detrimental gases in to zero. The company has participated in to the programme of motivating the community to use the paper less communication. The company has set up the goal of 95% zero waste efficiency operation by 2014. In this manner, the company is trying to build up a healthier and better world and fulfil the mission and vision of the organisation.
b) Identify their goals and value process with reference to ethical, cultural, environmental, social and business objectives and evaluate how the current issue impacts these and the business.
The goals and value process to address the current issues:
The goals and objectives of Lululemon are to improve the standard of living of the people in this planet. The current activities of the organisation are completely going in accordance with the goals and value process of the organisation. As mentioned in the corporate websites of the company, the company has given immense importance to the social responsibility. However, Graves and Moran (2011) has suggested that for the profit organisation it is very difficult to maintain the corporate responsibility. In the case of Lululemon, the Scenario is completely different. The company has committed to be responsible to all the stakeholders including the employees, customers, suppliers, stockholders and the environment. The customers are supplied the best quality of products that can improve the health. On the other hand, the company has given importance to waste management. The overall process of manufacturing and selling of the garments are managed in such a manner that the level of waste is minimal. Moreover, the company has increased the level of communication with the experts and other NGOs to take suggestions to minimise the level of wastes generated through the operational process. The company is maintaining a strong bonding with the suppliers. In order to maintain good relationships with the staffs and help the staffs to understand the core values of the organisation, Lululemon has prepared a code of conducts to all the staffs. As the firm is committed to set up a better world, it is engaged in activities that can reduce the environmental pollution. The firm has participated in programmes like recycling the plastics, using the paperless communication. Moreover, the company is quite aware of reducing the level of emissions of the detrimental gases. The company has taken a five-year planning programme LEED. It has prepared a manual for building the new houses that can reduce the level of pollution.
The difference between the strategic planning between the profit and non –profit organisation:
As mentioned by Hamel and Prahalad (2009), the strategic planning of the organisation depends on the goals and objectives of the organisation. The main purpose of the strategic planning of the organisation is to provide competitive advantage to the organisation and help the firm to maintain sustainability. However, the goals and objectives of the profit and non-profit organisation is different. The purpose of the profit organisation is to achieve the maximum profit with in a time frame. The profit can be achieved from revenue generation by penetrating the market. Therefore, for the profit organisation, the managers prepare the strategies to design the best quality product at an affordable price. However, the managers need to reduce the operational costs also to maximise the profit. In order to achieve more profits sometimes the managers sacrifice the quality of the products. Aggressive promotion and sales strategies are the main purpose of the strategic planning for the profit organisation. On the other hand, the non-profit organisation looks in to provide the best quality of services to the client. Making profits are the secondary issues for non-profit organisation. Therefore, the managers of the non-profit organisations are much more aware of improving the quality of services for the clients. Moreover, for the non-profit organisation procuring finds to maintain the operational activities are the main issue. These organisations do not get help from the Governments all the time, Therefore, the strategic managers need to aware their activities to the investors to procure he funds. Basically, based on the objectives of the organisation, the managers determine strategies for the organisation.
c) Evaluate efficiencies in resource allocation in relation to current organisation objectives, strategies and goals.
The range of resources required for an organisation:
According to the view of Paine (2010), in order to maintain the sustainability of an organisation, the availability and allocation of the best quality of resources are very much needed. The five most important resources for an organisation are: Financial resources, Human resources, Educational resources, Physical resources and emotional resources.
Financial resources: As suggested by Reynolds (2009), funds are the most vital part of any business. Funds are required to procure raw materials, promotional purposes and all the other aspects of the business. Procuring the right amount of funds at the right time is the major issue. The financial resources can be procured from personal financing, bank loan, financing from the business angels etc.
Human resources: Human resources the workforce for an organisation. Skilled labours are required for an organisation to get the best quality of products. The manpower can be generated by the proper selection procedure of the management.
Educational resources: Educational resources provide the managers knowledge to improve the profitability of the organisation. The managers can take help from the consultancies to acquire the knowledge about the market.
Physical resources: Physical resources include the machineries, buildings, systems etc. The quality of production is highly dependent on the quality of physical resources. The owners can acquire the physical resources by providing advertisements.
Emotional resources: Emotional resources are the moral support of the friends, relatives of the owners. The emotional resources provide the suggestions to the owners to improve the productivity of the organisation.
Tools and techniques of resource allocation:
According to the view of Ireland et al. (2011), resources are the factor of production for any organisation. Resource allocation is a process and strategy that guides a company where the scarce resources may be used in the production of goods and services. In order to maintain the sustainability of an organisation, resources are to be used optimally. The cost of production depends on the quality of the resources. Efficient production includes the maximum output with the utilisation of minimum resources (Noe, 2009). It allows an organisation to utilise the resources for further production. There are several processes by which resources can be allocated in the efficient way. They are discussed as follows:
Strategic Planning: At the first stage of operation, the management of the company needs to formulate the strategies in accordance with the goals and vision of the company. The objectives of the company can be accomplished by achieving the goals (David, 2009). Based on the goals of the company the requirements of the resources can be understood.
Budgeting: After the goals are set up by the organisation, the resources are estimated. Resources are needed in every aspect of the business. First of all, the funds required at the initial stages of operation are estimated. As soon as the funds are managed, the physical resources liker land, labour, machineries are estimated. Based up on the requirements, resources are allocated properly.
Measurement of efficiencies of the resources: After the allocation of the resources, management needs to measure the performance of the resources. Firstly, the organisation needs the measure the performance of the work force of an organisation. The performance of an organisation is directly related to the efficiencies and commitment of the workers (Search.hefce.ac.uk, 2014). The performances of the employees can be measured through performance appraisal of the human resource management team of the organisation.
However, an organisation can also take help from the various resource management software tools available in the market, in order to manage and allocate the resources optimally (Sba.gov, 2014).
Problems of not having adequate resources in an organisation:
As mentioned by Lee and Peterson (2010), resources are the most integral part of any organisation. Adequate resources are needed in order to maintain sustainability of the organisation. As discussed above for achieving the goals and objectives of any organisation, resources are required. The company may not be able to fulfil its goals and objectives if the resources are not available. Several problems may occur in implementing the projects of an organisation in the absence of sufficient resources. If the financial resources are not available, the organisation cannot procure the other resources and the raw materials. Moreover, in order to set up an organisation, funds are required to bear the initial costs of buying the physical resources, registration of the company etc. However, as mentioned by Reynolds (2009), for a market leader, to remain in the same position and acquire more market in order to cop up with the stiff competition, funds are required to develop innovative products. For the promotional purpose of the business also resources are needed. In the absence of the financial resources the company will remain cash-cow position and may not be able to hold its market share for the longer period of time. In the absence of adequate human resources in an organisation, the productivity will decrease. However, in this context, Mees and Bonham (2009) has argued that quality of the employees are much more important than the quantity of the employees.
a) With the use of relevant tools and frameworks conduct a strategic analysis of its environment to identify the current position of Lululemon.
According to the view of Sachs and Warner (2009), a macroeconomic analysis helps a company to determine the strategies based on the external factors. The PEST analysis is one of the most popular tools for the macroeconomic scan. It helps for understanding the market position of a company. PEST analysis includes a through scan of the Political, Environmental, Social and Technological factors that may affect the overall operation of a company. In the following paragraph, the PEST analysis of Lululemon has been done.
Political: As stated by Porter and Van der (2011), political issues of any nation affect mostly businesses of that nation. With the changes of the political parties, the rules and regulation regarding the operation of any company also changes. However, sometimes the Government relaxes the regulation and help the MNCs to operate. Moreover, the political relation between the two nations also affects the companies. For, Lululemon the NAFTA has made it easier to expand the business across North America. However, most of the Canadian companies got this facility. Lululemon has lots of patents and trademarks over its products and designs.
Economic: The operation of any business is highly dependent on the economy of that country. The economic policies of the country affect the strategies of the global managers. The macroeconomic policies taken by the Central bank of a particular nation, control inflation and encourages the consumers to spend more money to buy the accessories. Therefore, the revenue of any company is dependent on the policies of the Governments and the Central banks. Moreover, the other economic parameters like, exchange rates, interest rate also affects the operation of any organisation. Lululemon’s expansion is affected by the continuous economic struggles within the European Union. During the period of global slowdown and recession the consumers become highly price sensitive, affecting the revenue generation of Lululemon.
Socio-cultural: The company needs to provide the gods to the customers based on the preference . However, the preferences of the customers change based on the cultural point of view. Canadian people are highly health conscious. The number of people participating in the sports and yoga activities are increasing rapidly in North America. As a result of that, the demand for the Lululemon’s product is also increasing. Moreover, the people are highly motivated by the ethical business culture maintained by Lululemon. The market segment of the company is targeted mainly the young generation who are highly conscious about the health. However, the company need to target the large uncaptured market in the women garment.
Technological: Implementation of advanced technology has helps an organisation to increase efficiency and reduce the operational cost. The emergence of online marketing has helped Lululemon to attract the wider range of customers. Moreover, with the help of social media, the company has been enabled to provide advertisements. With the growing technology, the company has been producing a better quality of fibre and that has given the company an competitive edge (Dfo.com.au, 2014).
A microeconomic scan helps an organisation to analyse the internal operation. A detailed analysis of the internal environment helps the company to have an idea about its core competencies. Based on the internal analysis, the managers determine the areas to improve. SWOT analysis is one of the most popular tools to determine the strengths, weakness, opportunities and threats of the company.
SWOT analysis of Lululemon:
Strength: offering high quality products with innovative features and style are the main strength of Lululemon (prezi.com, 2014). Moreover, the company has established itself as the premium brand. Vertical retail strategy with the diversified products has helped the company to earn more revenues.
Weakness: Lululemon is not well famous in the US. The basic operation of the company is limited mainly in the Canada. Moreover, slow growth strategy has been the main hindrance for the company to increase the market share.
Opportunities: A wide range of market in Canada is still unexplored. This new market consisting of highly health conscious young and men is one of the major opportunities for Lululemon. The company can build the brand loyalty among the US people and that will help the company to increase sales.
Threats: Lululemon is suffering some of the vital threats from the external markets. The global slowdown and dull economic conditions are affecting the operation of Lululemon. Moreover, the company needs to cop up a high competition from the companies like: Nike, Adidas, Athlrta, Under Armour etc. The scope of earning revenue in Canada is not as high as the Canadian market is much smaller compare to the US market. The weak advertising and promotions are one the major threats of the company (Slideshare.net, 2014).
According to the view of Meltsner (2009), the stakeholders are the most important part of any business. The stake holders of any business include both the internal and external stakeholders. The internal stakeholders are the employees and the management of the organisation. On the hand, the customers, Government, local communities are the external stakeholders. The role of each of the stakeholders is very much important.
Stakeholders of Lululemon:
Non managerial Employees: In Lululemon the employees are highly satisfied and motivated about the jobs. The work environment of the company encourages the employees to perform better. Before starting up the job, employees attain the yoga classes in each morning. It freshens up the minds of the employees. The company gives respect to each of employees (Slideshare.net, 2014).
Managerial Employees: As stated by managerial employees are the brain of the organisation. The managers design the strategies for the best utilisation of the resources. The top level managers of Lululemon incept the production of any new products, the middle managers take care of the research and development and the first-line managers looks after the processing of the products.
Customers: As stated by Thomas (2010), customers are the most powerful stakeholders of an organisation. Lululemon makes sure that each of the employees are satisfied before leaving the shops. The company is providing a very high quality of products at an affordable price. The customers can attain the yoga session in the showroom.
Government: According to the view of Thomas (2010), the main function of the Board of Directors is to maintain the fundamental rights of the shareholders. The Board of Directors of Lululemon Athletica Inc. Sets a very high standars for the company’s employees, officers and the directors. The company is maintaining the corporate governance and ethical practices. The operation of the company is maintained in accordance with the rules and regulations prescribed by the Government.
Suppliers: Lululemon has been maintaining a strong bonding with the suppliers. The suppliers supply the high quality of raw materials and abide by the standards set up by the company. The supplier changes the infrastructure and working environment based on the requirements of the company. The company has stated to all the supplier that the work procedure need to follow the strict regulations prescribed by the Government and the products must be eco –friendly.
Environment: Lululemon ensures that the products sold by the company are not harming any living spices of the environment. A continuous testing has been done by the company while designing the products. Moreover, packaging of the products is done in an efficient manner. The company is producing the products such a manner that waste is very nominal. Moreover, the company is trying to produce products that can be recycled. Based on the goal of the company to improve the health of the customers, the company has produced products that can synthesize amino acids, vitamin in to the body of the customers.
a) Sustainability and risk management are identified as important aspects for better business today. Critically analyse the risks facing Lululemon and the future challenges affecting strategic business management and planning of the organisation.
According to the view of Allen and Gale (2011), the strategic mangers of a company need to be prepared to face the risks at any time of the operation. To maintain the sustainability of the organisation, managers need to design the strategies on a time frame basis. However, the risk may arrive from different parts of the business. In this case, the major risks faced by Lululemon are critically evaluated.
Operational risks: The operational risks can be arrived from the day to day operation of any concern (Gompers and Lerner, 2010). On March 2013, Lululemon has withdrawn the women’s black yoga pants from the stores. Moreover, the pants from the inventories have to be withdrawn by the company. According to the press release by the CEO of the company, the shipment of these pants did not make the standard prescribed by the company. Approximately, 17% of the pants of the inventories were affected due to this. As a result of that, Lululemon’s stock fell to 3.8%. This has impacted on the revenue of the company. Moreover, as the company has established itself as the life style brand, this incident has impacted badly on the reputation of the company. However, as the company has emptied all the products from the stores, the customers have been messaged that the company is supplying only the products that are passing the standard prescribed by the company. This incident has created a huge repercussion among the customers. The customers have shared views in the social websites. However, the company has blamed the suppliers for not maintaining the prescribed standard. The company cannot ignore its responsibility in this matter as proper testing are required to be done by the company before taking any raw materials from the suppliers.
Political risks: As mentioned by Erb et al. (2011), an organisation cannot ignore the political issues while operating in the domestic and the international market. The products sold by Lululemon are of high quality. The company is following the ethical practices. However, as the New York Times has published that company’s Vita Sea fabric consists of 24% seaweed materials, the Canadian Government has completely banned the products. The Competition Bureau of Canada has intervened in to this matter and ask the company not to suggest the customers to buy the Vita Sea products. Moreover, the company has to remove all the information regarding the Vita Sea products from the websites. The company has removed all the tags of Vita Sea from its apparels. However, this has impacted the company in two ways: firstly, as mentioned by Gangemi et al. (2010), customers are the main wealth of an organisation. This incident has created a bad impression on the customers’ mind, resulting declining revenue of the company for the upcoming years. Secondly, the company has lost its good relation with the Canadian Government. This may create problems for the company in future. However, with the change of the political parties in a nation, the rules and regulations also changes, creates a major problem for the companies to operate (Verma and Soydemir, 2009).
Economic risks: Economic conditions influence the performance of the company the most (Saini and Bates, 2011). Lululemon is mainly operating in Canada. However, while expanding the business to the USA, the company need to follow the strict rules and regulations of the USA Government. Moreover, the economic parameters like exchange rates, inflation are affecting the business of Lululemon. Due to the high inflation rate, the customers may not be interested to buy the products, resulting declination of revenue of the company.
Risks of growth: After the inception of the company, the growth rate of the company was very high. The company has enjoyed 61% growth from 2004 to 2011. However, the growth has been declined due to the operational problem as discussed above. Not only the sales of the company has reduced but also the stock prices have fall down due to loss of faith of the investors. Therefore, the company may face problem to maintain the sustainability for the long term.
Risk from competitors: As mentioned by Balkan (2010), the business needs to step up the operation in order to cop up with the competition. Lululemon is facing a very stiff competition from the companies like Nike, Adidas etc. These companies are already established as well known brands. Therefore, in order to penetrate more markets, the company need to struggle. However, according to the view of Cosset and Robert (2010), stiff competition enables a company to perform well in order to maintain the sustainability.
As stated by De Haan et al. (2010), the strategic managers need to determine the strong strategies in order to minimise the risk factors. On the hand, Ghose (2009) has argued that risk management is a techniques by which an organisation anticipates and minimize the adverse outcomes of risks. It involves identifying the risk factors, estimating its impact and taking necessary steps to minimise the risks. From the above discussion it has been shown that Lululemon is facing the operational risks mostly. The impact of operational risks have introduced other kinds of risks that can endanger the sustainability of the company. However, the following strategies can be taken by the company to minimise the risks.
In order to cop up with the operational risk, the company needs to manage its operation more efficiently. However, Kharas (2009) has suggested that quality management is the major issue to reduce the operational risk. In the case it has been seen that Lululemon has been suffering from the product related issue. In order to mitigate the risks, the company needs to tests the quality of all the products. A proper standard chart needs to sent to the suppliers and the suppliers need to follow that strictly. In this case, Lululemon can also follow the sig-sigma to ensure the quality of the product. The company can manage the political risks, by maintaining the rules and regulation prescribed by the Government. First of all, the company has to ensure that the products supplied by them are of the best quality. Moreover, in order to reduce the political risks, the company needs to be transparent in publishing all the financial data to the Government and taxes needs to pay properly. By participating in the CSR activities Lululemon can also create a good brand image to the Government. As the company has already been very much conscious about the waste management, they need to follow the same, in order to maintain a good relation with the Government. However, Yim (2009) has suggested that with the change of political parties the company will face some problems and they have to change the strategies to cop up with the same. The growth of the company can be ensured by penetrating the market of USA. In order to, encourage the shareholders to invest more; the company needs to pay the dividends in proper time and very much transparent in publishing the financial data to the shareholders. Lululemon can attract more customers by improving the quality of the products. The research and development team of the company needs to develop innovative products to catch the attention of the customers. Product diversification is one of the key parameter to cop up with the competitors risk. The company can also follow the competitive pricing by offering the best quality products at a cheaper rate compare to the other brands. The well diversified products in the market may one of the major tools to increase the revenue for Lululemon. The marketing team of the company needs to segregate the target market more effectively to attract the young generation of Canada and USA.
a) You have been requested to provide a report on the financial performance and the position of the company for the year 2008.
Financial ratios are used to evaluate the financial performance and position of a company in respect of a particular accounting period. Financial ratio analysis helps in comparing financial performance of an organisation for two different accounting periods (Gebhardt and William, 2011). Financial ratios can be broadly classified into liquidity ratios, profitability ratios, efficiency ratios, and asset utilisation ratios.
Comparison of financial ratios of 2008 to those of 2007:
The financial performance of Lululemon Athletica, Inc has been conducted as under:
Overall, improvement in liquidity position of the company is seen in 2008. Current ratio of Lululemon Athletica, Inc has increased from 1.52 in 2007 to 2.73 in 2008. A current ratio of 2:1 is considered as ideal. In this context, Lululemon Athletica, Inc has been able to achieve a current ratio of 2.73:1 in 2008. Quick ratio of Lululemon Athletica, Inc has also increased from 0.57 in 2007 to 1.61 in 2008. This can be explained by considerable increase in cash balance and trade receivables of the company in 2008 compared to 2007. However, sharp rise in inventories for the financial year 2008 can be considered as a serious concern as excess inventories represents inefficient selling efforts and higher opportunity costs tied-up with inventories.
|Gross profit ratio||53.26||51.03|
|Operating profit ratio||18.25||10.89|
|Net profit ratio||11.23||5.15|
The overall profitability of the company has increased in 2008 compared to 2007. The gross profit margin has increased by 4.36% in 2008. There has been increase in operating profit by 67.58% for the year ending 2008. Sharp rise in net profit ratio by 118.05% is also seen in 2008. This increase in profitability can be attributed to the efficient marketing efforts, sound production strategies, and effective cost optimisation techniques. In addition, the percentage increase in operating profit ratio and net profit ratio is higher than increase in gross profit margin. Sound cost control strategies seem to be the principal reason behind this. There has been considerable decrease in indirect expenses in 2008 compared to 2007. In this context, Chapman (2008) expressed that cost reduction and cost control helps in increasing profitability without raising selling price.
Return on Asset (ROA) of 26.91% is quite impressive for Lululemon Athelica Inc. This indicates efficiency in overall business operations. In other words, effective utilisation of assets is indicated by this ROA achieved by the company. However, small decrease in Return on Equity (ROE) is observed in 2008 compared to that of 2007. ROE has decreased from 41.02% in 2007 to 40.95% in 2008. Return on Investment (Operating) is 66.55% in 2008. This seems pretty good for a retail company but no data is available for 2007 to make a comparison of this ratio. EBITDA margin % has also increased from 13.99% in 2007 to 21.28% in 2008. This can be explained by the increase in gross revenues of the company due to sound advertising and marketing efforts. Cash flow per share has risen from 0.39 in 2007 to 0.57 in 2008. This indicates improvement in the liquidity position of the company. Receivables turnover day of the company is higher than payables turnover days. This is not desirable for a sound working capital position of the company. As mentioned by Langfield (2011), average collection period needs to be lower than the average payment period as this improves the liquidity position of a firm. Inventory turnover day is 8.29 in 2008 but adequate data is unavailable for further analysis of this ratio. In addition, increase in inventory is a key concern.
It can be concluded from the above analysis that increase in inventory level, decrease in ROE, and higher collection period or receivables turnover days are the key issues associated with the financial performance of Lululemon athletic Inc. Rise in inventory level indicates higher cost of funds blocked in inventories. Hence, sound inventory management strategy is required. Decrease in ROE is yet another concern that needs immediate attention before further decrease in the ratio is future. In addition, necessary measures are needed to be taken to reduce the receivables turnover days. The company need to focus on increasing its average payable period. The liquidity and profitability position of the company looks impressive as increase in both current and quick ratio is seen. In addition, increase in gross profit, operating profit margin, and net profit margin is also seen.
Potential strategies have been developed based on analysis of financial performance and position of the company in 2008. These are mentioned below:
Implementation of JIT inventory system:
Lululemon Athletica Inc can implement Just-in-Time (JIT) inventory management system to reduce its overall costs associated with inventories. The strategy would be to maintain minimum inventory level to reduce carrying cost associated with inventories.
Increased collection efforts:
The company can set up a separate collection department dedicated for the collection functions. Reminder emails and phone calls to debtors prior to the payment due date can help in timely release of dues from receivables. In some cases, the company can also offer cash discounts for early disbursal from debtors.
Increased supplier payment period:
The company needs to focus on increasing the average payment period but this should not affect the relationship with suppliers. Increase in supplier payment date would allow the company to invest the funds in short-run to earn interest thereon.
Focus on online shopping system:
The company can focus on online shopping system due to the rising trend in online shopping in UK. Online shopping system can save considerable cost for the company. Online shopping facility does not require any retail outlet or customer care executives. This can reduce the indirect costs associated with the selling and distribution expenses and thereby increase the profitability of the organisation.
b) Assume that the company is now planning to invest on a new project and they are seeking your advice on this regard as the financial manager. Briefly explain the available investment appraisal techniques for the company to assess the worthiness of the considered project. You are required to evaluate the usefulness of various investment appraisal approaches by highlighting the strengths and weaknesses of each method.
Evaluation of investment appraisal techniques:
Capital budgeting decisions refer to financial decisions in respect of long-term investment made by a firm. Product development, business expansion, infrastructure development, and product diversification are some of the major capital budgeting decisions. Different investment appraisal techniques are available for the evaluation of a concerned investment project. Some of the popular investment appraisal techniques are discussed as under:
No project can start without an initial investment. However, the time required to recover the initial investments made on the project is one of the key concerns for business owners because higher recovery period has a negative impact on the liquidity position of the company. In this context, payback period refers to the time needed to recover the initial investments in respect of a concerned investment project. Shorter payback period implies greater acceptability of a project as it results in quick cash generation.
Payback period is determined as under:
Payback period = Initial investment / Average annual cash flows
In the view of Spanyi (2008), payback period is considered a good investment appraisal tool for organisations facing liquidity problems. Payback period approach is mainly focused on liquidity aspects of a business. In addition, simplicity makes this technique a popular choice among small and medium scale business enterprises. However, Chapman (2008) argued that Payback period does not result in accurate investment decisions as the time value of money is not included in the calculation process. Payback does not consider the time value of money and thus it is often not used for evaluation of big investment projects. Though Payback period is used as a measure of risk factors associated with a project but this method does not consider the net cash flows post completion of the payback period.
Accounting Rate of Return:
Profitability is the principal concern of any entrepreneur while deciding on the investment in respect of a particular project. Profit refers to the excess of cash inflows over the cash outflows from a given project. In this context, Accounting Rate of Return (ARR) is the ratio of expected accounting profit from a given project to the aggregate investments made on the same project. In general, a project with higher ARR is considered suitable compared to a project with lower ARR.
ARR is determined as under:
ARR = Average accounting profit after tax / Average investment on the project
Focus on profitability is a prime benefit associated with ARR method. Long-term sustainability, sustainable competitive advantage, and long-term growth are highly dependent on the profitability of a project. In contrast, Langfield (2011) viewed that inconsistency and ignoring time value of money makes ARR inappropriate for investment decisions. Inconsistency is yet another limitation of ARR because the ARR of two similar projects can be different in spite of having same initial investments. This is due to trend of cash flows occurring from a project. A project that generates higher accounting profits during the later phase of a project would generate a greater ARR compared to a project that generates higher ARR during the initial phase of a project (Hoshi et al. 2009). In addition, there exists different ways of calculating ARR which is a serious concern with this method. However, ARR is easy and simple to calculate.
Internal Rate of Return (IRR):
IRR is the interest rate at which the present value of future cash inflows equalises the present value of future cash outflows. Hence, IRR can be regarded as the break-even point for a concerned project as the NPV is zero at IRR. A project needs to generate an IRR higher than the required rate of return for the same to be acceptable. A project can also be accepted if it produces an IRR that is equal to zero but a project with negative IRR cannot be accepted.
All cash flows from a project is given equal importance under IRR method. This is a key benefit of this method. However, the calculation of IRR is difficult and complicated. As mentioned by Langfield (2011), IRR can be considered as an accurate investment appraisal technique as it considers the time value of money. In addition, IRR represents the return earned on book value of investments which is essential for judging the feasibility of a project. In contrast, Gompers et al. (2007) expressed that multiple IRR is a serious limitation of this technique. Furthermore, it is assumed under IRR that the profit generated by a project is re-invested at the same IRR but this assumption does not seem realistic in nature.
Net Present Value (NPV):
NPV can be defined as the difference between the present values of future cash inflows and outflows arising from a concerned project. In general, a project is accepted if it generates a positive or at least a zero NPV and a project is considered unacceptable in case of a negative NPV.
NPV is determined as under:
NPV = Present value of future cash inflows – present values of future outflows
The time value of money is given due recognition under NPV method. The principal benefit of NPV technique is that it considers risk factors, profit margin, and time value of money associated with a given project. However, inconsistency is a key weakness of this method. In this context, Lazaridis (2008) argued that NPV can differ due to difference in initial investments or difference in project lifespan. In addition, determination of NPV is not an easy job as discount rate calculation is a difficult task. However, Gebhardt and William (2011) expressed that NPV is helpful in enhancing organisational value.
International aspects of financial risk management:
Investment appraisal is one of the major financial functions and it is directly linked with the financial risk management. Sound investment decisions help in reduction of financial risks arising due to losses incurred from a project. Financial risk management is aimed at identifying, eliminating, and mitigating potential financial risks through the application of various risk management techniques and models. The long-term sustainability and growth of an enterprise is highly dependent on the effectiveness of financial risk management. As mentioned by Choo and Tan (2009), interest rate risk, exchange rate risk, and credit risk are key risk factors to which an organisation is exposed to. Interest rate risk is the risk arising due to change in the general interest rate of an economy. Exchange rate risk arises due to fluctuations in the international exchange rate or devaluation of home currency against the foreign currencies. Credit risk arises due to default in payment by debtors located at foreign locations. Financial risk management helps to identify these risks and adopt suitable strategies to eliminate or mitigate risks.
c) Assume the following details are applicable for the Lululemon Athletica Inc for the current year. You are required to conduct the cost-volume-profit analysis on the production of jackets. Find the Break-even point (BEP) and interpret the findings using suitable theories.
The fixed cost allocated for the production department of Jackets for the year is $7,200,000 and the production volume is 300,000 units.
|BEP formulae||Fixed cost / (Selling price – Variable cost)|
|BEP (sales value)||14,700,000|
|Margin of safety|
|Actual production units||300,000|
|Margin of safety formulae||Actual output – BEP output|
|Margin of safety (units)||150,000.00|
|Margin of safety (sales value)||14,700,000.00|
|Analysis of profit|
|Production level (units)||300,000|
|Total sales value||29,400,000.00|
|Total variable costs||15,000,000.00|
Break-even analysis is a supply side analysis that is used to determine the point at which revenues equalises cost of production. It is also used to calculate the Margin of safety. Margin of safety refers to the sales revenues exceeding the BEP sales revenues. Margin of safety can also be defined as the excess of actual output over the BEP output.
In present context, the BEP has been determined as 150,000 units. It means that at this point, the company neither earns a profit nor incurs a loss. Sales value of 150,000 units is $14,700,000. As mentioned by Choo and Tan (2009), it is important to ensure that the selling price is able to generate positive contribution after covering all variable costs. In this context, the selling price set by the company seems to be correct as the selling price is sufficient enough to cover the variable costs. However, Chapman (2008) expressed that BEP and selling price are inversely related and that increase in selling price reduces the BEP.
The current production level of the company is 300,000 units which is far above the BEP units. A selling price can be considered as effective if it is sufficient enough to generate a contribution that covers the total fixed costs and results in profit. In this context, the selling price of $98 has generated a positive return after covering the fixed costs. At current production level of 300,000 units the firm is expected to earn a profit of $7,200,000, the total sales revenue being $29,400,000.
As regard to the margin of safety, the company is able to maintain a margin of safety of 150,000 units which is quite impressive. In this context, Lazaridis (2008) expressed that higher margin of safety results in lower production risks.
The current selling price seems to be appropriate based on above analysis but it is important to consider the qualitative factors associated with pricing decision. As mentioned by Yan (2008), qualitative factors like market demand, intensity of competition, and availability of substitutes are some of the major factors that needs due consideration for sound pricing decision.
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