1107493652_2003_Business_Studies_Assessment_Task_Bernadette.Enright by ashrafp

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									   1. EXECUTIVE SUMMARY
   This report is based on the large telecommunications company; Telstra and aimed to analyse its liquidity, solvency,
   profitability and efficiency over the years 2000 and 2001. In doing so, it was revealed that Telstra is increasing its
   net profit levels annually, however, the evident decline in efficiency by 13.3% per year is cause for concern and
   must be reversed via the three recommendations included. It was also revealed that Telstra must work to improve
   liquidity, as based on current trends, a state of liquidity is not forecasted for Telstra until 2003-2004. Changes within
   the company must occur immediately to improve Telstra’s solvency, as currently, they rely on external long-term
   liabilities to an unacceptably high degree. The report also provides three specific recommendations for each of the
   four financial aspects and which, if implemented, would not only improve that particular financial aspect of the
   company, but also assist Telstra in the achievement of its corporate goals.

   2. EFFICIENCY
   Expense Ratio= Expenses
                   Sales
2001                                                           2000
 = 15837m                                                      = 14544m
   18679m                                                        19343m

 = 0.85:1 (correct 2 d.p)                                        = 0.75 1:1 (correct 2 d.p)
2.1 EFFICIENCY ANALYSIS
This ratio indicates the amount of sales that are allocated to individual expenses and Telstra’s efficiency on a day-to-
day basis. In 2000, Telstra had $0.75 of expenses for every $1 of sales. In 2001, Telstra had $0.85 expenses for every
$1 of sales. As a lower ratio is an indication of higher efficiency, it is evident that Telstra’s efficiency rate has
declined by 13.3% over the two year period. Clearly, Telstra is not working as efficiently as possible on a day-to-day
basis; maximum profits are not being achieved using the least amount of resources and costs/delays are not being
minimized. Consequentially, this adds expenses and reduces profit margins for Telstra.

2.2 EFFICIENCY FORECAST
Based on the 2000/2001 efficiency results, it is estimated that efficiency will continue to decline by 13.3%. In 2002,
their efficiency ratio will be 0.96:1. In 2003, it will be 1.08:1. In 2004 it will be 1.23:1. At this point, Telstra would
suffer from outstandingly poor efficiency, with $1.23 expenses for every $1 of sales.

                                                                                Figure 2:1: Efficiency Ratios, Analysis and Forecast
   2.3 RECOMMENDATIONS
   2.3.1     APPLICATION OF THE CLASSICAL/SCIENTIFIC MANAGEMENT THEORY
   This is characterized by a strict division of labor; each worker is allocated a specific task which they concentrate on,
   repeat and resultantly, become proficient in completing. It is also characterized by the presence of rules and
   procedures1, which greatly assists in reducing levels of disruption, distraction and accidents. Through both these
   features, Telstra’s operating cycle speed is increased. This creates efficiency because it means that Telstra can derive
   more from its resources (both physical and human) on a daily basis. As the human resources become more proficient
   at their jobs, it reduces human resource requirements. Thus, efficiency is created by cost minimization.

   Under this theory, it is the manager’s role to control; monitoring the planning, leading and organizing processes to
   ensure that Telstra’s objectives are being met. This will also increase efficiency as it means that any expense or
   delay-creating problem within Telstra is quickly identified and amended.

   2.3.2     JIT (JUST IN TIME) INVENTORY MANAGEMENT
   JIT is a production method involving the reduction of purchased component levels (inventory) and requires suppliers
   to continually adjust to changes in production requirements 2. Efficiency is created through expense reduction,
   including rent, inventory storage and insurance costs. As inventory arrives “just in time,” JIT eliminates inventory
   queues and bottle necks. Thus, efficiency is created as time delays are reduced and consequentially, Telstra can
   increase its operating cycle speed and can derive a maximum amount from its resources on a day to day basis.

   2.3.3    TRAINING AND EDUCATION PROGRAMS FOR EMPLOYEES
        By acquiring an elevated degree of knowledge, skills and abilities, employees will become more highly capable
   and more motivated to fulfill their roles3 within Telstra. This allows things to be done faster and better.
        Accident levels are reduced as employees are less likely to make mistakes. This reduces expenses.

   Therefore, training/education programs allow Telstra to use its human resources more effectively and derive a
   maximum amount from them; they are working faster yet cheaper, to increase profit levels.
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           3. PROFITABILITY
           Net Profit Ratio = Net Profit / Sales                                 Return On Owners Equity: Net Profit / Owners Equity

2001                                                      2000                   2001                               2000
 = 4061m                                                  = 3673m                 = 4061m                           = 3673
   18679m                                                   19343m                   13722 (number taken               11602
= 0.22:1 (correct 2 d.p.) or         22%                   = 0.19:1 (correct 2   from balance sheet)
                                                          d.p.) or 19%           = 0.30 (30%)                       = 0.32 (32%)
3.1 NET PROFIT ANALYSIS                                                           3.2 RETURN ON OWNERS EQUITY ANALYSIS
This ratio measures the percentage of sales revenue which is profit.             The higher the ratio, the better the return for the owner. The
In 2000, $0.19 of net profit was produced for every $1 of sales. This            above ratio reflects how the shareholder received a return of
increased by 15.8% in 2001, as in this year, Telstra earned $0.22 of             30% in the year 2001, and this was a decrease of 6.67% from
net profit for every $1 of sales. A high net profit ratio is an                  2000, where the shareholder received a return of 32%. This low
indication of a highly profitable business and therefore, it is evident          return rate indicates that this Telstra investment is not a good
that Telstra’s expenses are not low enough for them to generate                  one; funds provided by investors is not effectively generating
sufficient profit levels. This holds detrimental implications for                profit.
Telstra’s share price and on its ability to pay dividends.
3.1.2 FORECAST                                                                   3.2.1 FORECAST
Based on the 2000/2001 results, it is predicted that net profit will             Based on the 2000/2001 results, it is predicted that returns
continue to rise by 15.8%. Thus, in 2002, Telstra’s net profit ratio             received by investors will continue to drop by 6.67%. Therefore,
will reach 0.25:1. in 2003, it will be 0.28:1 and in 2004, it will be            in 2002, a return of 27.9% will be received. In 2003, it will be
0.32:1.                                                                          26.03% and in 2004, it will be $24.3%.
           Figure 3:1: Profitability Ratios, Analysis and Forecast

      3.3 RECOMMENDATIONS
      3.3.1 JIT (JUST IN TIME) INVENTORY CONTROL (Variable Cost Control Method)
      JIT refers to a process, where if implemented into Telstra, would cause its level of purchased components to drop
      greatly and would also cause Telstra’s suppliers to continually adjust to its production requirement changes. JIT will
      increase profit margins for Telstra by reducing expenses, particularly those associated with inventory storage, rent and
      insurance4.

          JIT reduces lead times which means that Telstra can more swiftly react to dynamic customer demand.
          As JIT removes inventory queues and bottlenecks, it also eliminates product deterioration risk, which is notably
      high at that point in production

       Subsequentially, JIT increases profitability as it creates a higher quality product and improves customer satisfaction
      with Telstra. Additionally, excellent quality products eliminates the need to run extra production in case there are
      quality losses. Thus, profitability is further increased via reduced expenses.

      3.3.2       DOWNSIZING OF MIDDLE MANAGEMENT LAYER (Expense Minimization)
      This refers to the elimination of middle-level managers within Telstra. It is recommended that middle-level managers
      are downsized, as many of the decisions they once made have become automated through communication technology,
      which has also overtaken their informational and communication roles, by allowing information to become widely and
      easily accessible5 via, for example, the communication method of E mail. Downsizing will substantially increase profit
      levels, resulting from:
           Reduced payroll expenses
           Increased productivity from “surviving” staff, apprehensive about their job security and who perceive the change
      as a message from management that the status quo is no longer acceptable.
           Increased productivity from satisfied employees who have moved vertically or horizontally, through new position
      openings.

      3.3.3      OFFSHORE OUTSOURCING OF SOFTWARE DEVELOPMENT
      This is where Telstra contracts their software projects out to overseas suppliers. Infosys and Satyam are two India-
      based software development companies recommended, as Telstra has initiated expense-saving ($17m) outsourcing
      agreements with them previously. This will increase profitability by:

      Major cost reductions due to inexpensive labor.
      Increasing sales and product quality as the result of Telstra gaining access to technology/ services its own resources
      cannot provide and also, as a result of outsourcing allowing Telstra to focus on key competencies.

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   4. LIQUIDITY
   Current Ratio= Current Assets
                  Current Liabilities
2001                                                              2000
= 6253m                                                           = 4889m
  9279m                                                             9421m

= 0.67: 1 (correct 2 d.p)                                       = 0.52:1 (correct 2 d.p)
4.1 LIQUIDITY ANALYSIS
From 2000 to 2001, Telstra increased its asset volume by $1364m (27.9%). This was primarily due to a 43.3% cash
increase. Liabilities decreased by $142m (1.5%), and this was the result Telstra’s reduction of borrowings by $712m
(21.5%). In 2000, Telstra had $0.52 current assets for every $1 of current liabilities. In 2001, this increased by 28.9%, as
in this year, Telstra had $0.67 current assets for every $1 of current assets. A ratio of 2:1 indicates that the business is
able to pay their short term debts, however, it must be noted that businesses with a ratio of 1:1 have been able to operate
successfully. Therefore, in both 2000 and 2001, it is evident that Telstra has not been liquid; they do not have levels of
working capital which are high enough to pay for short term debts as they fall due. Consequentially, this could lead to
increased expenses from late debt payment penalties and it also acts detrimentally to Telstra’s credit ratings.

4.2 FORECAST
Based on the 2000/2001results, it is predicated that Telstra will continue to increase it’s liquidity at a rapid rate of
28.9%. Therefore, in 2002, they will have a liquidity ratio of 0.86:1. In 2003, this will increase again to 1.1:1. In 2004, it
will reach 1.4:1 and thus, it is likely, that based on current trends, they will become liquid in this year.
                                                                              Figure 4:1: Liquidity Ratios, Analysis and Forecast
   4.3    RECOMMENDATIONS
   4.3.1 OPERATING LEASING ARRANGEMENT REGARDING PERSONAL COMPUTER FLEET
   This is a contractual arrangement where equipment is bought by the lessor and lent to Telstra. For its use, Telstra
   must make payments of a periodic charge6. Telstra should acquire its personal computer requirements through a
   lease agreement. A recommended lessor is IBM, as Telstra already hold a cost-reducing leasing agreement with
   them, also involving information technology. Through leasing, Telstra can gain access to the personal computers
   (PC’s) it needs with minimal upfront costs7. This increase liquidity as it allows Telstra to hold a much larger
   volume of working capital, particularly compared to if they were to normally purchase the PC’s.

   Leasing also augments profit margins; allowing Telstra to increase its competitive advantage as a result of
   accessing newer, higher quality PC’s than their own. Also, the entire lease payment are tax deductible and at the
   end of the term, leasing gives Telstra the option of simply returning the PC’s and therefore, allowing Telstra to
   avoid costly obsolesce and the expense and hassle of disposing the equipment. Thus, this means that there are less
   expenses incurred by Telstra, profits can be increased, and sub sequentially, working capital levels can be
   reimbursed.

   4.3.2    RECOURSE FACTORING
   This refers to the selling of Telstra’s accounts receivables to a third party for less than the book value 8. A
   recommended third party to undertake factoring with is Baycorp Advantage; the largest factoring business in
   Australia. Instead of having to wait up to 90 days for customers to pay their accounts, factoring converts 90% of
   Telstra’s accounts receivables into cash in 48 hours 9. Consequentially, Telstra gains immediate access to its
   working capital and thus, liquidity is improved.

   As Baycorp Advantage (or any other factoring company) will pay Telstra in 48 hours, Telstra can avoid penalties
   from their suppliers for late payment. Factoring may also allow Telstra to attain discounts from its suppliers for
   early payment. Therefore, factoring will also increase liquidity as the additional profit it creates via reduced
   expenses, can be injected into working capital levels.

   4.3.3    MORE EFFICIENCY DEBT/RECEIVABLES COLLECTION
   The following suggestions will allow Telstra to obtain the receivables owing to them at a quicker rate. In turn, this
   will improve liquidity as it will increase the availability and amount of working capital:
        Acquiring debtor software that ensures letters were sent at the appropriate times to those owing debt and
        which keeps tabs on how much was owed and by whom.
        Extend the ways in which customers are reminded of their outstanding debts to include for example, SMS and
        Email reminders. Batch more frequently.
        Offering discounts for prompt payment

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     5. SOLVENCY
     Debt to Equity Ratio: Total Liabilities
                           Owners Equity

2001                                                           2000
= 23751m                                                       = 18737m
  13722m                                                         11602m

= 1.7: 1 (correct 2 d.p.)                                       = 1.6:1 (correct 2 d.p.)
5.1 SOLVENCY ANALYSIS
In 2000, Telstra had $1.6 of external long-term liabilties for every $1 of owner’s equity. In 2001, this increased by
6.25%, as Telstra then held $1.7 of external liabilities for ever $1 of owner’s equity. As a general rule, a debt to equity
ratio of around 100% is an indication of a solvent business, and therefore, it is evident that Telstra is not solvent; they
rely greatly on borrowed funds, are not sufficiently able to meet their long term financial commitments and are
becoming more highly geared each year as a result. This is particularly dangerous in light of other excessively geared
companies who have collapsed due to insolvency, including HIH and Bond Corp.

5.2 FINANCIAL FORECAST
Based on the 2000/2001 results, it is estimated that Telstra’s solvency ratio will increase by 6.25% per year.
Therefore, in 2002, Telstra’s solvency ratio will be 1.8:1. In 2003 it will be 1.9:1. In 2004, it will be 2.0:1.
                                                                               Figure 5:1: Solvency Ratios, Analysis and Forecast
   5.3 RECOMMENDATIONS
   5.3.1 OUTSOURCING IT PROCESSES
   Purchasing IT on a regular basis is necessary for Telstra in maintaining its competitive position. However, it is also
   extremely expensive and creates additional long-term debt. IT outsourcing reduces Telstra's need to purchased PC's,
   as the function they once fulfilled is now contracted out to another company. As PCs are considered a long term
   debt, IT outsourcing subsequentally, reduces their levels of long term external debt and prevents Telstra from
   becoming further dependant upon it.

   If Telstra were to sell the PCs no longer required within the business due to IT outsourcing, the money generated
   from their sale could be used to repay the long term liabilities of the business and therefore, also improving solvency
   by reducing the extent to which Telstra is dependant upon long term debt. Finally, outsourcing increases profit by
   allowing Telstra to provide a superior quality service/product(s) and also by allowing them to focus on their key
   competencies. This will also increase solvency via an increased level of retained profit.

   5.3.2 OPERATING LEASE – CAR FLEET
   This refers to a contractual agreement where a car fleet is purchased by the lessor and lent to Telstra. For its use,
   Telstra must make payments of a periodic charge10. Telstra should acquire its car/transport needs through a leasing
   agreement. A recommended lessor is Custom Fleet; a reputable company who provide fleet-leasing especially for
   corporate companies.

   Leasing helps reduce the extent to which Telstra is dependant upon external debt as it is an “off-balance sheet”
   option, meaning that it does not appear as another long-term liability11. This also preserves credit lines. Finally,
   leasing also reduces expenses. The tremendous expenses associated with car fleet ownership, including registration,
   insurance and maintenance is taken care of by the lesor. The savings made through leasing can be used to pay off
   long term debt and therefore gearing is also improved as the level of long term debt is lowered.

   5.3.3 SELL SMS MANAGEMENT AND TECHNOLOGY LIMITED SHARES
   In 2000, Telstra invested $20m in SMSMT. In 2001 they invested a further $6m, to hold 4.87% ownership of it. It is
   recommended that Telstra sell these shares as the performance of SMSMT continues to decline; nearly a quarter of a
   billion dollars in write downs has generated a full year net loss of $264 million. If the additional funds the sale
   creates is redirected back into owner’s equity or if it is used to pay off long term debts, this will allow Telstra to hold
   a lower debt to equity ratio and therefore, solvency is improved.

   6. CONCLUSION
   Through an analysis of Telstra’s 2001 financial report, it has been established that all four financial aspects of the
   business; profitability, solvency, liquidity and efficiency, contain areas which call for improvement. It is urged that
   Telstra serious consider all twelve specific recommendations, particularly those relating to solvency, as each will not
   only improve the financial aspect it relates it, but it will also assist Telstra in achieving its major corporate goals.

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1
 McQuire, C (et al)(1994) “How Business Works: HSC Course.” International Thomson
Publishing Company: South Melbourne.
2
 Brown, P (2001) “Business Studies: Year 12 HSC Course 2001.” Leading Edge Education:
Sydney
3
 Brown, P (2001) “Business Studies: Year 12 HSC Course 2001.” Leading Edge Education:
Sydney
4
    Fleming, L (2001) “Excel HSC: Business Studies.” Pascal Press: Glebe NSW
5
 McQuire, C (et al)(1994) “How Business Works: HSC Course.” International Thomson
Publishing Company: South Melbourne.
6
 Chapman, S (et al)(2000) “Business Studies in Action: HSC Course”. John Wiley and Sons
Australia Ltd: Qld.
7
    Fleming, L (2001) “Excel HSC: Business Studies.” Pascal Press: Glebe NSW
8
 McQuire, C (et al)(1994) “How Business Works: HSC Course.” International Thomson
Publishing Company: South Melbourne.
9
 Chapman, S (et al)(2000) “Business Studies in Action: HSC Course”. John Wiley and Sons
Australia Ltd: Qld.
10
 Chapman, S (et al)(2000) “Business Studies in Action: HSC Course”. John Wiley and Sons
Australia Ltd: Qld.
11
  McQuire, C (et al)(1994) “How Business Works: HSC Course.” International Thomson
Publishing Company: South Melbourne.

Bibliography
   Chapman, S (et al)(2000) “Business Studies in Action: HSC Course”. John Wiley and
Sons Australia Ltd: Qld.
   McQuire, C (et al)(1994) “How Business Works: HSC Course.” International Thomson
Publishing Company: South Melbourne.
   Fleming, L (2001) “Excel HSC: Business Studies.” Pascal Press: Glebe NSW
   Brown, P (2001) “Business Studies: Year 12 HSC Course 2001.” Leading Edge
Education: Sydney

      www.telstra.com.au

      www.imb.com/IMB/finance/

      www.customfleet.com.au

      www.baycorpadvantage.com



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