First Farms Corporation free essay sample

I. Point of View This group takes the point of view of Mr. Ricardo Sarmiento, Vice President for Finance of First Farms Corporation (FFC for brevity). Mr. Sarmiento will present to the Board the financial performance and financial position of the company from 1993 to 1995. In the process, he will also make recommendations as to the feasibility of the proposed expansion. II. Case Context In 1995, FFC raised P1. 1 billion from its initial public offering. P500 million of the proceeds was used as working capital (livestock inventories and raw materials), P476 million went to expansion of operations and acquisition of properties while P69 million was used to pay part of the corporation’s long term debt. In the face of tight competition, consolidated sales for the year still amounted to P5. 7 billion which is 44% higher than the previous year. P3. 508 billion or 62% of revenue was from chicken sales hence, taking over leadership in the business from Marigold Foods Inc. We will write a custom essay sample on First Farms Corporation or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page Moreover, FFC has outpaced the industry growth on chicken sales volume which is largely attributed to the company’s increased contract growing base. Net income was also up 89% amounting to P280 million despite the increasing costs of production. During the year, FFC launched a new line of extruded aquaculture feeds. It also entered the fast food business thru California Chicken and Gulliver’s Chicken restaurants. Management is proposing for construction of three dressing plants and four new feed mills for the following year (1996) as they believed that sales and profits were held back in 1995 partly by constraints in production capacity. It is expected to be financed by short term notes if approved. It must be noted, that the Industry is bracing for the entry of imported frozen chicken in 1998, when trade barriers in the Philippines are lowered. III. Problem Definition Why is there a deficit amounting to P719 million in operating cash flow in 1995? Why does Return on Equity gone down? Given the financial position and performance of the company, is it feasible for FFC to construct more dressing plants and feed mills? If so, should they use short- term notes to finance the expansion? IV. Framework A breakdown of Cash Flow from Operating Activities will be used in analyzing the deficit mentioned in the previous sections. Ratio analysis (specifically the liquidity, efficiency, leverage and profitability ratios) and the Du Pont Technique will be used to assess the possible reasons for the decrease in ROE and the feasibility of expansion. V. Analysis ILLUSTRATION 1: BREAKDOWN OF CASH FLOW FROM OPERATING ACTIVITIES CASH FLOW FROM OPERATING ACTIVITIES (P’000)19941995 Net Income148,216280,256 Adjustments98,23080,668 Changes in Operating Assets and Liabilities: Trade Receivable(112,420) (180,893) Others(32,527) (212,761) Inventories(118,029) (803,317) Due from affiliated companies17,661(17,650) Deferred income tax (2,037) Prepaid Expenses(25,198) (85,602) Accounts Payable Accrued Expense26,746 163,746 Acceptances Payable109,205 (3,859) Dividends payable9,236 Income tax payable(3,428)61,956 Due to affiliated companies(2,057)10 Net Changes in Operating Assets and Liabilities(130,811)(1,080,407) Net Cash Provided by Operating Activities115,635* (719,483)* *Minor discrepancy in computations because of approximations. Illustration 1 shows that the deficit in the operating cash flow was caused by increase in all the current assets of the company and largely because of bloated inventories. Looking at year 1994, changes in inventories in 1995 was more than 6 times larger. Investment in other current assets was also noticeably augmented in 1995. From a positive P115. 6 M to a negative P719. 5 M operating cash flow, we can see how aggressive the company was in spending for current assets in general in 1995. ILLUSTRATION 2: RATIO ANALYSIS RATIOFORMULA1993199419951993-1994 Trend1994-1995 Trend LIQUIDITY Current ratioCA/CL0. 9990. 9971. 353v^ Quick Asset ratio(Cash+Trade Receivables)/CL0. 2910. 3320. 401^^ LEVERAGE Debt ratioTL/TA0. 6250. 6450. 536^v Debt- Equity ratioTL/SE1. 6841. 8511. 163^v EFFICIENCY Total Asset TurnoverSales/TA1. 7191. 9961. 458^v Receivables TurnoverSales/Trade Receivable15. 98613. 49111. 985vv Days Receivables360/ RTOR22. 52026. 68430. 038^^ Inventory TurnoverCost of Sales*/Inventories4. 5595. 1313. 482^v Days Inventory360/ITOR78. 97270. 168103. 397v^ Payable TurnoverCost of Sales*/AP**7. 8329. 8239. 880^^ Days Payable360/PTOR45. 96536. 65036. 438vv PROFITABILITY Return on EquityNI/SE0. 1370. 2140. 156^v Return on AssetsNI+[Int. Expense*(1-tax rate)]/TA0. 0880. 1100. 078^v Operating Profit MarginOperating Income/Sales0. 0790. 0890. 078^v Net Profit MarginNI/Sales0. 0300. 0370. 049^^ *Includes operating expenses **Includes accrued expenses ILLUSTRATION 3: DU PONT TECHNIQUE YearNet Income/ SalesSales/ AssetsAssets/EquityROE ProfitabilityEfficiencyLeverage 19930. 0301. 7192. 6950. 137 19940. 0371. 9962. 8670. 214 19950. 0491. 4582. 1680. 156 Based on Illustration 3, it is observed that in 1995, efficiency and leverage decreased causing the ROE to plunge to 15. % from 21%. Decrease in efficiency was mainly due to low inventory turnover and low receivable turnover (see Illustration 2) while decline in leverage may be accounted to the substantial increase in stockholders’ equity brought about by the IPO proceeds. The company’s profitability in 1994 was excellent, for this reason it was easy for FFC to raise equity in 1995. However, th e management decision to boost inventory has adversely affected its efficiency for the year. Contrary to what management believes, the sales and profits were not held back in 1995 due to production capacity. If this was the case, inventories should have a lower figure and higher inventory turnover. In fact, there was a lot of inventory that was not disposed that it held back the sales and consequently profits. Stocking up large inventories is not advisable for FFC as most are perishable and entails cost like warehouse space, feed consumption and utilities (see Table 1 of Case for Inventories details). Expansion of the contract growing base may have been too much too soon. Notice also that receivables turnover decline even more (see Illustration 2). It now takes 1 month for the company to collect from its creditors. It is alarming because though sales grew by 44% in 1995, trade receivables have increased further by 62% (see FFC’s Consolidated Balance Sheet). It seems that the company is very generous with its credit policy which affected adversely its operating cash flow. If the company continues to expand by constructing new dressing plants and feed mills, it may seriously affect the company’s efficiency and liquidity if sales remain unchanged given tight competition especially with the entry of imported frozen chicken. Net income may also be affected considerably as it brings about expenses like maintenance, employees salary etc. Should the company expand and use short- term notes to finance the expansion, it will significantly affect the cash balance even more upon payment of the debt. VI. Decision FFC was too aggressive in keeping inventories resulting to lower ROE and cash flow from operations. The management may have overlooked the abnormally high inventories and focused mainly on the remarkable performance (sales) of the company. It is recommended that the company postpone its plan to increase production capacity until inventory turnover improves. As soon as the company becomes more efficient, FFC may opt to revamp existing dressing plants and feed mills by installing a more advance technology to increase production capacity. It is also advised that long-term liabilities be used in expanding production capacity instead of short- term notes to make a leeway in building funds for payment. VII. Justifications †¢Inventory turnover and receivables turnover declined resulting to lower asset turnover. †¢It is too optimistic for the company to expect that sales will continue to increase in the next five years especially with the anticipated entry of imports. Construction of dressing plants and feed mills may increase asset but may decline further efficiency of the company if growth in sales is insignificant. †¢Using short- term notes to finance expansion may result to a negative cash flow. VIII. Implementation To initially improve inventory turnover, FFC can lower its price to get a higher market share so it can also di spose its excess inventories. The company may also give sales discounts to increase receivable turnover. Doing these may decrease profit margin but will actually have a better impact since risk of spoil of inventories and default in payments will be lessened.