Industrial Financial Decision Making & Risk Analysis

ABC Ltd is a large wholesaler of electrical goods formed four years ago by the amalgamation of two smaller companies. Extracts from its annual accounts are shown below.

Early in year 4, one of ABC’s most important suppliers insisted that all future deliveries should be paid for on or before delivery. As a result of this, ABC decided not to use this supplier and to source its goods elsewhere.

Management were aware that sales were significantly down in year 4 and had taken the prudent step of drastically reducing ABC’s overheads. Staffing levels had been reduced at each of the depots and in every department at head office, including marketing and accounting.

Due to cost cutting, ABC’s ‘quarterly’ catalogue, from which most of its sales originate, had been revised only once during the year.

The accounts section lost one-third of their staff and could not keep up with the demand for information. They usually produced management accounts on a quarterly basis but the last set produced was for the first quarter and these were not completed until the middle of month 5.

The chief accountant made a positive decision to concentrate on cash management in order to keep the business afloat.

Early in the year, the chief accountant realised that the company was going to breach its overdraft limit of £110,000. He approached ABC’s bank who agreed to increase this to £120,000. But just before the end of the year, he had no choice but to ask the bank for a further increase of £25,000. Very reluctantly, the bank agreed to this, but only on a temporary basis for three months.

As soon as the accounts for year 4 were approved by the auditors, the management team held a meeting to discuss the results. They were aware that, due mainly to a downturn in the house-building market, year 3 had been disappointing compared to year 2.

It had been assumed that its results would be worse than those of the previous year but when the pre-tax loss of £40,000 was announced, the directors were shocked.

It seemed to them that the drastic cost-cutting exercise of last year had been in vain. They could not see any other overheads that could be reduced without directly harming the business – all the fat had been dispensed with. In fact, they knew that there were certain areas which were in desperate need of more money being spent on them rather than less. They realised that immediate remedial action was necessary, but they did not know what to do or where to start.