The AGM Company’s Financial Review in 2022: Profitability & Liquidity

Introduction

Financial analysis is crucial to business management since it provides insight into a company’s financial health. This report analyzes Avont Group Manufacturing (Holdings) Ltd’s (AGM) financial performance for the fiscal year ended 31 December 2022. The study focuses on the company’s profitability, liquidity ratios, segment analysis, and the AutoChip proposal’s pertinent cost analysis.

The study suggests that the company’s financial performance was uneven, with some indicators showing development and others showing a deterioration compared to the previous year. The company’s gross profit margin and liquidity ratio fell from the prior year, which suggests it may need help servicing its short-term commitments. Yet, the return on equity ratio increased, indicating that the company generated more profit from its owners’ capital.

In addition, this report analyses the AutoChip idea and specifies the relevant expenses, including the costs of feasibility, transportation, and materials. The research indicates that the company should assess the reasons for the decline in Gross Profit Margin and adopt remedial measures while considering the AutoChip proposal’s associated expenses.

Analysis of Avont Group’s Financial Performance

Profitability

• Gross Profit Margin: AGM’s gross profit margin in 2022 was 32.54%, lower than the industry average of 35.26%. This suggests that AGM may not be generating as much profit on sales as its competitors.
• Operating Profit Margin: AGM’s operating profit margin in 2022 was 10.16%, which is also lower than the industry average of 7.20%. This indicates that AGM’s operating expenses may be higher than those of its competitors.
• Return on Shareholder Funds: AGM’s return on shareholder funds in 2022 was 18.28%, lower than the industry average of 21.18%. This implies that AGM could not be making as much money for its investors as it could.

Efficiency

• Inventory Turnover Days: In 2022, AGM’s inventory turnover days were 54.32, higher than the industry average of 48.02 days. This indicates that AGM may not be managing its inventory as efficiently as its competitors.
• Trade Receivables Collection Days: In 2022, AGM’s trade receivables collection days were 123.08, higher than the industry average of 72.64 days. This suggests that AGM may be having difficulty collecting payments from its customers.

Liquidity

• Current Ratio: AGM’s current ratio in 2022 was 0.95:1, which is lower than the industry average of 1.17:1. This indicates that AGM may have difficulty meeting its short-term obligations.
• Quick Ratio: AGM’s quick ratio in 2022 was 0.70:1, which is lower than the industry average of 0.99:1. This suggests that AGM may have difficulty meeting its short-term obligations without relying on inventory.

Gearing

• Gearing Ratio: In 2022, AGM’s gearing ratio was 5.49%, lower than the industry average of 10.26%. This suggests that AGM has a relatively low level of debt compared to its equity.

Investment

• Return on Capital Employed: In 2022, AGM’s return on capital employed was 21.09%, higher than the industry average of 25.32%. This indicates that AGM is generating a good return on its capital investment.

Comparison to the Prior Year

The gross profit margin and return on shareholder funds for AGM decreased compared to 2021; however, inventory turnover and trade receivables collection days grew. Return on invested capital and operating profit margin remained constant. Additionally, the gearing ratio rose while the liquidity ratios fell. The gross profit margin increased marginally from 31.67 percent in 2021 to 32.54 percent in 2022 when compared to the financial analysis of the AGM with the previous year, 2021. The return on shareholder money declined from 25.75 percent in 2021 to 18.28 percent in 2022, while the operating profit margin decreased from 10.83 percent to 10.16 percent. The gearing ratio grew while the current ratio and quick ratio shrank. The return on capital employed stayed the same.

The Usefulness of Having a Segment Analysis

A segmented analysis can reveal the company’s financial performance across several areas or divisions. This can reveal the company’s areas of strength and weakness and offer guidance on how to raise performance. For instance, a segment analysis can show that one region is doing better than others, indicating that the business should concentrate on growing in that area. Alternatively, a segment study can show that a particular division is underperforming, so the company might need to restructure or allocate more resources to boost performance.

Moreover, this analysis could be helpful in the instance of AGM in examining the revenue produced in the UK and other regions. This research could show which locations are performing well and which are underperforming in revenue for the organization. Additionally, it might offer perceptions of how Brexit and COVID-19 affect the firm’s operations in various locations, enabling the corporation to make tactical choices to reduce risks and maximize opportunities.

For instance, the business might prefer to expand its operations in the UK rather than purchasing businesses in other countries if the segment analysis shows that the income earned in the UK is much higher than in other regions. However, the segment analysis suggests that income earned outside the UK is expanding more quickly. In that case, the business may want to consider allocating more resources there to seize the growth potential.

Relevant Cost Analysis of the AutoChip Proposal

The decision to accept the AutoChip order by AGM will rely on several variables that will affect the total cost of manufacturing and delivering the AutoChip. It is necessary to discern between incremental, preventable, and irrelevant expenses to find the relevant fees (Brigham and Houston, 2021). The total costs are incurred particularly for this opportunity, while the avoidable expenses will only be spent if AGM accepts the AutoChip order.

Irrelevant prices are those that will not be affected by choice. Similarly, the cost of material ABC is relevant since it is an added expense that will be spent particularly for this opportunity and will affect the total cost of making the AutoChip. Casing-line equipment is an expense that should only be incurred if AGM approves the AutoChip order, making it a relevant cost. Instead of taking the order, AGM will sell the extra capacity to smaller enterprises and make income.

Relevant Costs

• Cost of material RQS.
• Cost of material ABC (incremental cost).
• Cost of casing-line equipment (opportunity cost).
• Labor cost (avoidable cost for regular working hours, total cost for overtime hours).
• Production engineer cost (not relevant, as it is within his contract with AGM).
• Cost of transportation.
• Fixed overhead cost (not relevant, as it is a fixed cost and does not change with the decision).
• Profit mark-up.

Not Relevant Costs

• Cost of feasibility report (a sunk cost).

Reasons for Listing the Costs as Relevant or Irrelevant

• Cost of feasibility report: this cost is a sunk cost.
• Cost of material RQS: this is a direct and incremental cost, as it is only incurred if AGM accepts the order and needs to purchase the additional material.
• Cost of material ABC: This is an incremental cost, as AGM needs to purchase additional material units to fulfill the order.
• Cost of casing-line equipment: this is an opportunity cost, as AGM can sell the excess capacity to smaller companies if they do not use it to produce the AutoChip.
• Labor cost: regular working hours are avoidable costs, as they are already part of the company’s operations, while overtime hours are incremental costs, as they are only incurred if AGM accepts the order.
• Production engineer cost: This is irrelevant, as it is part of his contract with AGM.
• Cost of transportation: as it is only incurred if AGM accepts the order and needs to ship the AutoChip to the African auto assembly facility, this cost is both direct and incremental.
• Fixed overhead cost: as this is a fixed expense that is unaffected by decisions, it is irrelevant.
• Profit mark-up: this is relevant, as it is the desired profit margin AGM aims to achieve from the AutoChip order.

Cost Value

• Cost of material RQS: £14.24 per unit x 35,600 units = £506,144
• Cost of material ABC: (17,800 units – 10,700 units in-store) x £267 per unit = £1,901,400
• Cost of casing-line equipment: 22 hours x (£890 per hour – £972 per hour) = £17,380
• Labour cost: 160 hours x £35 per hour + 8 hours x £43 per hour = £6,080
• Cost of transportation: £70,120.

Importance

Relevant costing is vital to managers’ decision-making because it enables them to identify and analyze the expenses a particular action will impact. By concentrating on applicable costs, managers can make educated choices that optimize resource use and maximize profits (Brigham and Houston, 2021). Management should consider that irrelevant expenses might result in inefficient use of resources, misallocating costs, and ultimately decreased profitability (Brigham and Houston, 2021).

Relevant costing enables managers to effectively evaluate the costs and advantages of various alternatives, which is vital for making strategic choices that line with company objectives and guarantee long-term success. Using relevant costing provides managers with a clearer understanding of the financial ramifications of their actions, allowing them to make more informed decisions and achieve better business results.

Investment Appraisal of a Project in an Associate Company

The following formula can be used to determine the project’s net present value:

• Year 0: -£6,370,000 (initial investment)
• Year 1: £4,482,100 / (1 + 17%) = £3,828,547
• Year 2: £3,487,299 / (1 + 17%)^2 = £2,507,983

Net Present Value (NPV) is a frequently used investment assessment approach that considers the time value of money by discounting future cash flows back to their present value using a set discount rate. One benefit of employing NPV is that it gives a direct measurement of the predicted financial gain or loss of the investment project, which may assist managers in making educated choices about the acceptance or rejection of a project. NPV analyzes all cash flows throughout the project’s life and indicates the project’s anticipated profitability. NPV depends on several assumptions, such as the discount rate, future cash flow estimates, and project risk, that could be more precise.

NPV = -£6,370,000 + £3,828,547 + £2,507,983 = £966,530

Since the NPV is positive, the project is acceptable as it generates a positive return and creates value for Zinon Limited. However, we should also consider the expected project’s NPV (ENPV) to determine if the estimated cash flows in each scenario were to occur with their respective probabilities.

• Combination A: ENPV = (0.6 * £966,530) + (0.3 * £1,865,147) + (0.1 * £1,475,930) = £1,253,751
• Combination B: ENPV = (0.6 * £966,530) + (0.3 * £2,247,399) + (0.1 * £2,158,422) = £1,528,675
• Combination C: ENPV = (0.6 * £966,530) + (0.3 * £2,326,931) + (0.1 * £2,281,776) = £1,630,292

Based on the ENPV analysis, the investment opportunity is even more attractive than the original NPV calculation suggests. We should choose the investment opportunity that generates the highest ENPV: Combination C.

Advantages and Disadvantages of Using Net Present Value as an Investment Appraisal Technique

Advantages

• Takes into account the time value of money, which is an important consideration when evaluating investment opportunities
• Considers all cash flows over the entire life of the project
• Assumes the risk of the project by using a discount rate that reflects the cost of capital

Disadvantages

• Requires accurate estimation of cash flows, which can be difficult in practice
• Requires a discount rate that reflects the risk of the project, which can be difficult to determine
• Ignores the project’s size and the investment’s scale, which can be essential factors to consider.

Other Investment Appraisal Techniques That We Have Not Used Include the Following

• The payback period measures the time it takes for an investment to generate enough cash inflows to recover the initial investment. This technique is easy to understand, but it does not consider the time value of money and ignores cash inflows beyond the payback period.
• Internal Rate of Return (IRR): calculates the discount rate that makes the project’s NPV equal to zero. This technique is helpful because it considers the time value of money and provides a percentage return that can be compared to other investment opportunities. However, it can be difficult to calculate and interpret in practice, especially when irregular cash flows.

Employing IRR is an alternative to the NPV approach for evaluating investments. IRR is a metric for measuring the profitability of an investment and indicates the discount rate that makes the net present value of cash inflows and outflows equal. In other words, IRR is the rate of return generated by the investment. The benefit of employing the IRR method is that it delivers a return on investment percentage that is readily comparable to the company’s cost of capital. If the internal rate of return exceeds the cost of money, the investment is deemed acceptable. However, the investment should be rejected if the IRR is less than the cost of capital. The IRR method presupposes that cash inflows will be reinvested at the IRR rate, which may need to be more practical.

Conclusion

As proven by the instance of Avont Group Manufacturing (Holdings) Limited, financial management is essential for the strategic planning, organization, direction, and control of an organization’s or institution’s financial operations. According to the research, the UK market segment generated the bulk of the company’s revenue, and an analysis of each section’s financial performance indicated that the UK market segment was more lucrative than the worldwide market segment.

The study emphasizes the need for systematic financial performance analyses to identify strengths and weaknesses and discover development prospects. Avont Group Manufacturing (Holdings) Limited should prioritize improving its profitability and investment performance while maintaining its liquidity. The company may focus on the most profitable divisions and enhance its financial arrangement with appropriate financial management.

Reference List

Brigham, E.F. and Houston, J.F., 2021. Fundamentals of financial management: Concise. Cengage Learning.