Table of Contents
Financial analysis
Chester registered mixed financial position in the year ended December 31, 2023 following a challenging operating environment. The following is a discussion of the financial performance and position of Chester over the last five years, 2018 to 2023.
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Financial performance
Our company struggled in terms of financial performance with a negative return of sales 9.9 percent and a loss of $11.5 million. Our cumulative loss was $83.7 million thus trailing the other players in the industry. The market leader, Erie had a cumulative profit of $74 million. The main challenge that Chester faced was in terms of the emergency loan of $55 million that was very expensive. Whereas our company made an EBIT of $7.3 million, the interest cost of $25million caused us to suffer a net loss. The poor performance registered by Chester is also evident from the negative return on assets of 8.5 percent and a negative return on assets of 45.1 percent which was the highest loss in the industry. Our current debt amounted to $74 million and long term debt of $83 million. On a more positive note, our low cost strategy helped us record some of the lowest variable costs in the industry. Our contribution was however second lowest in the industry at 23.3 percent compared to a margin of 41.9 percent that was earned by Baldwin.
Other than the poor profitability registered, Chester had a low asset turnover of 0.86 compared to a turnover of 1.42 registered by Baldwin. This is an indicator that our efficiency in terms of generating sales from investment in assets was poor. This could be experienced by the investment of $51million that was made in plant improvements during the year whereas benefits were only realisable later. The major lesson learnt from the financial results of Chester is the need to maintain healthy cash flows so as to avoid the need to acquire emergency funds. The major undoing for Chester was the emergency short-term borrowing that was too expensive. This caused us to suffer from huge interest cost that ate into our earnings. Our working capital management practices were also poor given the huge inventory balances that we held during as at the close of year 2023 ($73.6 million) which was the highest in the industry. Wood and Sangster (2005) argue that it is critical for a company to manage its working capital effectively so as to get optimal returns from these investments. Some of the redundant investments are in inventories and accounts receivables. In this case, Chester had significant redundant investments in inventories.
Stock market summary
The poor financial performance registered by Chester was also evident from the poor stock prices that were registered by our company. Our market capitalisation was $3M compared to $241 that was realised by Baldwin. The company share price was $1 compared to the price of $92.36 for Baldwin. Shareholders were mainly not attracted to purchase a stake in our company mainly due to our high gearing and poor earnings. For instance, shareholders in Chester suffered negative earnings per share of $4.04 which was the second highest in the industry. In addition, the company had a negative price earnings rate of 0.3.
Bond market summary
Chester had the highest level of gearing in the industry and thus investors demanded the highest yields. Gitman (2003) argues that bond investors seek higher yields to purchase bonds that have high default risk. The company’s bonds were classified as junk, class DDD and thereby commanded some of the highest interest rates in the industry. The major source of the company’s cash flows was debt (long term debt $45.6 million and $55 million from an emergency loan). There is need for the company to reduce its outstanding debt financing through early repayment.
SWOT Analysis
The following is analysis of the company to assess its strengths, weaknesses, threats and opportunities.
Strengths
Chester has recorded resilience in serving the low end market with a leading product, Cedar generating 2,760 units. The company was therefore forced to operate an extra shift so as to take care of the extra production that was required. In addition, Chester was strong in serving the traditional market with its Cake product selling 1,606 units against a capacity of 1,000. The contribution margin earned from this product was also the highest for the product at 36 percent. As such, Chester has some of the most popular brands in the market being offered at the competitive prices in the market.
Weaknesses
One of the major weaknesses that face Chester is its poor financial performance as noted under the financial analysis section. There is need to reduce the level of gearing in the business and particularly the urgent need to repay the emergency loan that is too expensive. Further, the company has made significant losses over the past five years and thus its poor stock prices making it difficult to raise cash from sale of stocks. Moreover, its bonds are classified as junk and thus commanding very high yields. Pricing of some of the company’s products was also poor such as product Cure that caused the demand for the product to be too poor. The product features in terms of performance and size was also not well matched with the target market which caused their depressed demand. There is need to ensure that the company’s products are well aligned to the needs of the target market.
Threats
The company has cut its capacity thus causing it to be less prepared to deal with competition in the future. With minimal product diversification, competitors might cause a collapse of the business in case existing products do not generate sufficient sales. The market leaders such as Baldwin have on the other hand maintained its capacity with high utilisation and thus the company is significantly exposed to the competition. There is also a threat of inability to attract additional debt financing given the already high gearing in the company and the negative rating of the ousting bonds. Further, the going concern of the company is at risk given its huge accumulated losses which according to Madura and Gitman (2001) is an indicator that a company is technically insolvent. Sourcing funds from shareholders is very critical at this point to salvage the company from imminent collapse.
Opportunities
The company invested heavily in plant improvement and automation which prepares it to capture market share in future. The competition has not made significant investment in automation and thus unlikely to match the excellence of Chester in future. Given the huge demand that the company’s products attracted particularly in the traditional and low end market, there is an opportunity to increase capacity for these products so as to generate even more sales in future.
- Gitman, L.J., (2003). Principles of managerial finance: brief. Boston: Addison Wesley Publishers
- Madura, J and Gitman, LJ 2001, Introduction to finance. Boston: Addison Wesley Publishers
- Wood, F, and Sangster, A. (2005) Business Accounting 1 (10th ed.). Prentice Hall