Thai-Lay Fashion Company Ltd.
The Thai-Lay Fashion Company Ltd. started in 1991 is a garment manufacturing company situated in Hong Kong. It is a medium-sized company with an annual turnover of HK$ 10 million and employees nearly 200 people. It has locations in two places and has a capacity to produce nearly 60,000 units per month. Its production units are housed in a 3500 sq meter factory and produce a variety of materials like T-Shirts, sweaters, denim, knitwear, sportswear etc for adults and children of both sexes. Its revenues are mainly through exports and its market is found mainly in Europe.
Financial management
Financial management is an important area of business essential for any organization whether it is in the private or public sector. “In short, Financial Management deals with procurement of funds and their effective utilization in the business.” (Meaning of Financial Management. 2006). This definition shows that financial management is concerned with both the acquisition and management of funds required for an organization. It is just not enough to see that money is available for its long, medium and short-term objectives. It is equally important that the funds so acquired be managed properly. So, financial management has three main objectives which are:
Financial Planning
This involves planning for the short, medium and long term. Short term planning is to see that funds are available to buy stock and raw materials, pay salaries, expenditure for running day to day operations and funding credit sales. Medium and long term planning involves seeing that funds are available for its bigger investment like machinery, expansion plans etc.
Financial control
Organizations must ensure that the funds available are utilized properly according to planned expenditure and investments so that they may achieve their financial goals. The finance manager should ensure that the assets of the organization are being utilized efficiently, that the business and its assets are secure and that the management acts in the best interests of the company and its shareholders.
Decision making
Decisions have to be made as to which alternative be taken in case more options are available for investments and expenditures and revenues. For example, the management may have to decide as to whether funds for the acquisition of machinery be taken from company reserves or by taking a loan. Another example would be to decide how much of profits be retained and how much of it be distributed to shareholders.
The Thai-Lay Fashion Company has a finance department headed by a qualified finance manager. At present all the above objectives are being controlled by the finance manager with assistance and advice from its top management.
Financial management strategies at Thai-Lay Fashion Company Ltd.
Such strategies are related to two major areas, capital investment and financing.
Capital Investment Decisions
Thai-Lay Fashion is embarking on an expansion plan and is in the process of investing in additional plants and machinery for this purpose. The reason for the expansion is due to new markets in Asia being available for the company. Before going into the process it would be worthwhile to see how the earlier capital investment decisions were made in the company. To help make such decisions, the following tools are available to finance managers namely Accounting Rate of Return (ARR), Payback Period (PP), Net Present Value (NPV) and Internal Rate of Return (IRR).
The ARR method calculates the return by dividing average net profit by average investment on machinery and is shown as a percentage. If the percentage is above the capital costs incurred by the company this return can be considered to be acceptable.
ARR = Average annual profit X 100
Average investment
This method has some drawbacks which are given here. The figure taken is net income and does not take the cash flow into consideration. It does not take into account the inflation rate and fluctuations in income. (Lesson 27: Annual Rate of Return Method. 2000).
The Payback Period is a very simple method of calculating the return of investment. It is arrived at by dividing the total investment by the average annual cash inflow from the investment.
PP = Total investment cost
Cash inflow
This method is very simple but has the following limitations. It does not take into account the benefits the company can receive after the payback period. The inflation factor is also ignored. (Payback Period: Limitations of Payback Period. 2008).
The Net Present Value or NPV is a more sophisticated method of arriving at the return on investment. This is mainly because it takes into account relevant factors such as risk, inflation, alternative interest rates etc into account while calculating returns. Moreover, the time factor which is a crucial element in long term investments is also considered. In this method, the expected earning at the end of a projected period is calculated as being received immediately taking into account the above factors. “The NPV indicates an investment’s net value of in today’s dollars. All costs and benefits are adjusted to “present value” by using discount factors to account for the time value of money.” (Net Present Value (NPV)).
If the value is more than the intended investment, then the project is viable. For example, if the investment is 30,000 with a return of 10% per year would be worth 27,272 in todays or present value. So, we can either opt for waiting for one year to 30,000 or accept 27,272 today. Calculating the PV for the whole of the project period and finding the average will let the finance manager take a decision on whether to go ahead with the investment proposal. The Thai-Lay Fashion Company had used this method previously to take investment decisions and will continue to do so in future as well.
Financing the Business
The Thai-Lay Company has made the capital investment decisions and should now see how the financing of the business is to be done. There are many ways in which finance can be obtained. It could be raised from the market through the issue of shares, raised from the organization’s own resources or through a bank loan. Financing again can be classified into internal and external financing and long term and short term financing. It is proposed that the Thai-Lay Company will resort to bank loans to finance the project.
Capital budgeting
Capital budgeting can be defined as “The process of determining which potential long-term projects are worth undertaking, by comparing their expected discounted cash flows with their internal rates of return.” (Capital Budgeting: Definition. 1997-2008). So all the techniques used in investment decisions form a part of capital budgeting. The Thai-Lay Fashion Company, as mentioned above will use the Net Present Value in taking investment decisions and will resort to availing a bank loan for financing the project.
Capital Rationing
Capital rationing is the “act of placing restrictions on the number of new investments or projects undertaken by a company. This is accomplished by imposing a higher cost of capital for investment consideration or by setting a ceiling on the specific sections of the budget.” (Capital Rationing). Capital rationing is essential in cases some a subsidiary may perform below expectations and the rate of return from them is lower than the cost of capital.
In such a case imposing a higher capital cost will be deemed beneficial. It is also resorted to when an organization faces a resource shortage all departments and subsidiaries cannot be allocated the required funds. In such a case rationing of capital will be the only option available. There is no such practice in place at the moment in the Thai-Lay Fashion Company as it has adequate funds available for its expansion plans as well as day to day operations. Moreover, it is moving into new markets and at such a stage rationing might not be advisable.
Conclusion
The Thai-Lay Fashion company Ltd. is a well-managed company with more than twenty-seven years of experience in the garment export and manufacturing business. It has formed an efficient finance department manned by capable and trained staff with a qualified management professional at its head. The actions and plans of the department and its policies have been very beneficial to the company. Hence, it can be concluded that the financial management in Thai-Lay Fashion Company Ltd. is extremely satisfactory.
Bibliography
Meaning of Financial Management. (2006). Financial management. Web.
Lesson 27: Annual Rate of Return Method. (2000). Web.
Payback Period: Limitations of Payback Period. (2008). 12MANAGE – The Executive Fast Track. Web.
Net Present Value (NPV). Web.
Capital Budgeting: Definition. (1997-2008). Investorworlds. Web.
Capital Rationing. Investopedia.com – A Forbes Digital Company. Web.