Question

Mr. Preprah is the chairman of PALOO company and has become concerned about the accumulation of cash in hand and in the deposit accounts shown in the company's statement of financial position. The company is in the manufacturing sector, supplying engines to the auto markets in the Ghana and Africa. For the last 30 years the company has grown predominantly by acquisition and has not invested significantly in research and development on its own account. The acquisitions have given the company the technology that it has required and have all tended to be small, relative to the company's total market capitalisation.

The company has a healthy current asset ratio of 1.3, although its working capital cycle has an average of 24 unfunded days. The company has not systematically embraced new manufacturing technologies nor has it sought to reduce costs as a way of rebuilding profitability. Managerial and structural problems within divisions have led to a number of substantial projects overrunning and losses being incurred as a result. It has also proven difficult to ensure the accountability of managers promoting projects – many of which have not subsequently earned the cash flows originally promised. At the corporate level, much of the company's accounting is on a contracts basis and over the years it has tended to be cautious in its revenue recognition practices. This has meant that earnings growth

has lagged behind cash flow.

Over the last year the company has come under strong competitive pressure on the dominant defence side of its business which, coupled with the slow-down in spending in this area across the major African economies, has slowed the rate of growth of its earnings. The company's gearing ratio is very low at 12% of total market capitalisation and borrowing has invariably been obtained in the European fixed interest market and used to support capital investment in its Africa production facility. In the current year, investment plans are at the lowest they have been in real terms since the company was founded in the 1930s.

In discussion, the chairman comments upon the poor nature of the company's buildings and its poor levels of pay which could, in his view, be improved to reflect standards across the industry. Directors' pay, he reminds you, is some 15% below industry benchmarks and there is very little equity participation by the board of directors. He also points out that the company's environmental performance has not been good. Last year the company was fined for an untreated discharge into a local river. There are, he says, many useful things the company could do with the money to help improve the long-term health of the business. However, he does admit some pessimism that

business opportunities will ever again be the same as in previous years and he would like a free and frank discussion at the next board meeting about the options for the company. The company has a very open culture where ideas are encouraged and freely debated.

Mr. Preprah asks if you, as the newly appointed Finance Director, would lead the discussion at the next board.

Required

(a) In preparation for a board paper entitled 'Agenda for Change', write brief notes which identify the strategic financial issues the company faces and the alternatives it might pursue.

(b) Identify and discuss any ethical issues you believe are in the above case and how the various alternatives you have identified in (a) may lead to their resolution.

Answer 1

a) The financial issues faced by the company and its alternatives to be pursued are given below :

• The working capital cycle remained unfunded for an average of 24 days. Now this is a big setback for the company as they lack behind in collecting cash or revenue from their customers. To overcome this problem the company should make provisions and try to collect revenue faster from its customers to improve the conversion cycle.
• The company is incurring huge costs in manufacturing the materials to sell and therefore they are not able to make huge profits. Now, to change the circumstances, company should develop technologies that reduced cost and try to buy raw materials at an optimum rate not too high to maintain the costs. While maintaining the cost company can make profits.
• Projects of the company are found to be incurring losses. This is an important issue as company is loosing its opportunities where it could have invested in proper projects and would have made huge profits. So, to overcome from this, the managers in their respective divisions need to analyse each project carefully, should know their future aspects and accordingly decide which project should they invest on. This would help in the selecting the project that has capability to make huge profits.

b) There are many ethical issue the company is facing due to its unhealthy approaches. We would be discussing taking example of an issue in the case above and see how the alternatives presented above lead to their resolution.

It is being mentioned that company was made to pay the fine for discharging its untreated wastes into the river. This is not an ethical way to dispose of the wastes.

As suggested above, to improve the financial health of the company, new technologies should be adopted, these technologies will not only improve the financial health and reduce costs but also these will help treating the wastes such that they can be recycled and made to reuse. And the resedue obtained should be dumped inside the ground so that pollution is not created in the environment.

This way the company is contributing towards environmental also and saving its resources at the most it could.

So, here we saw how to remove the ethical issue by the alternatives suggested earlier.