T4 part B May 2012 answers

Note: This report is far more comprehensive than would be expected from a candidate in exam conditions.

It is more detailed for teaching purposes.

T4- Part B – Case Study Jot – toy case – May 2012 REPORT To: Jon Grun, Managing Director, Jot From: Management Accountant Date: 24 May 2012

Review of issues facing Jot Contents 1.0 Introduction 2.0 Terms of reference 3.0 Prioritisation of the issues facing Jot 4.0 Discussion of the issues facing Jot 5.0 Ethical issues and recommendations on ethical issues 6.0 Recommendations 7.0 Conclusions Appendices: Appendix 1 Appendix 2 Appendix 3 Appendix 4 Appendix 5 Appendix 6

SWOT analysis PEST analysis Analysis of three options for new order with outsourced manufacturer J Cash flow forecast for July to December 2012 Alternative ways to finance working capital Email on the differences between cash flow and profit and ways in which in Jot can manage its cash flow more effectively

1.0 Introduction Jot is a small unlisted company which designs and outsources the manufacture of a range of children’s toys. It has grown rapidly since it was established in 1998.

It is profitable but high growth is continuing to put pressure on cash flows, especially in the second half of each calendar year due to the seasonality of sales. As a small unlisted company it has restricted access to sources of cash and it is currently highly dependent on its bankers.

The over-riding issue for Jot is to improve its cash flow management, which could have a severe effect on the company, and its planned growth, if it is not resolved.

The Jot brand name is known for quality toys but it is important that its products appeal to costconscious retailers and price sensitive customers. Jot can use the cost-leadership strategy, using Porter’s generic strategy framework, to negotiate cost reductions with Manufacturer J in respect of the higher than expected sales for its new product called BEEP.

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2.0 Terms of reference I am the Management Accountant appointed to write a report to Jon Grun, Managing Director of Jot, a toy company, which prioritises, analyses and evaluates the issues facing Jot and makes appropriate recommendations.

I have also been asked to write an email to explain the differences between cash flow and profit and to explain ways that Jot could manage its cash flow more effectively, together with my recommendation. This is included in Appendix 6 to this report.

3.0 Prioritisation of the issues facing Jot 3.1 Top priority – Higher sales The top priority is the need to negotiate a new outsourced manufacturing contract to meet the higher sales orders for the new product called BEEP and its accessories. In order for outsourced manufacturer J (J) to meet production deadlines, the contract needs to be signed in 2 weeks, making this the top priority. Therefore, this issue is urgent. Following initial negotiations, Michael Werner has a choice of 3 different pricing alternatives for the new contract with J. 3.2 Second priority – Forecast cash flow The second priority is considered to be the forecast cash flow statement. Jot has an overdraft limit of €1,500,000 and needs to ensure that it can meet its forecast of sales and manufacturing costs within this limit. Alternative sources of funding will need to be found and this will take time to put in place. Action is needed to ensure that Jot does not face a cash flow crisis which could result in bankruptcy, if not managed in time. This is the second priority, as it is not urgent in the next 2 weeks, but the forecast shows that Jot will effectively run out of cash, by exceeding its agreed overdraft limit, in early November 2012. Jot’s bank has stated that it is not prepared to extend its overdraft or grant any further long-term finance. Cash flow is therefore a key issue, as higher sales will result in higher cash flow requirements, in order to finance the outsourced manufacturing of the extra volumes.

3.3 Third priority – Outsourced manufacturers This is considered to be the third priority as clearly Jot’s sales volumes are expanding and it is only just managing to get the quantities of its products manufactured in time. Also the concerns about factory conditions could adversely affect Jot’s reputation. There is the additional problem with placing an urgent order with another manufacturer to meet the shortfall left by outsourced manufacturer Z’s inability to supply 40,000 units of Product DD following a fire.

3.4 Fourth priority – IT system problems Jot has grown rapidly and may have managed with the mix of different IT systems when the company was smaller but clearly the current IT systems and their lack of integration is leading to problems. Additionally this is affecting customers’ invoices and any problems could negatively affect Jot’s reputation and delay payment and affect Jot’s cash flow. Therefore, the problem with Jot’s IT systems should not be whether the company can afford new systems, but whether it can afford not to invest in IT solutions. In the interim, improved procedures should be implemented.

A SWOT analysis summarising the strengths, weaknesses, opportunities and threats facing Jot is shown in Appendix 1.

A PEST analysis is shown in Appendix 2.

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4.0 Discussion of the issues facing Jot 4.1 Overview As a small, fast growing unlisted company, cash flow is crucial for the very survival of the company. Due to current economic circumstances, banks are restricting the finance that they give to small companies and Jot could be the victim of its own success. It has growing sales revenue but is short of working capital. If it does not manage its cash flow and take immediate action, then it could find itself in severe difficulties.

4.2 – Higher sales Jot has received confirmed sales orders from its seven main customers that exceed the volumes in its current contract with outsourced manufacturer J (J) for the new product called BEEP and its accessories. Therefore it has the ability to negotiate a lower manufacturing price per unit for this second contract with J. This will enable Jot to increase its margins for this product in 2012, even though selling prices to its customers cannot be increased.

Jot’s operating profit margin was 5.6% in the financial year ended 31 December 2011, which is materially lower than some of its larger competitors. For example, the Lego Group achieved an operating profit margin of almost 32%.

Therefore this second contract gives Jot the opportunity to reduce its manufacturing costs for this product. There is an urgency to agree the new contract in the next 2 weeks in order to ensure that J can manufacture the additional volumes to meet the agreed delivery schedule. Jot has been given 3 alternatives for the additional volumes for this new contract, which are: Option 1 - a cost reduction of 10% per unit from the current contracted cost on only the additional volumes required to meet the latest planned sales volumes.

Option 2 - a cost reduction of 20% per unit from the current contracted cost, but only if the additional volumes required to meet the latest planned sales volumes are further increased by 30%.

Option 3 - a cost reduction of 30% per unit from the current contracted manufacturing cost provided Jot accepts a one-off charge which would allow J to set up a more automated production line.

The additional volumes for this second contract with J are as follows: Original planned sales volumes

Latest planned sales volumes

Units

Units

Additional volumes for new contract Units

BEEP

40,000

60,000

+ 20,000

Additional software packages

10,000

40,000

+ 30,000

Protective covers

30,000

50,000

+ 20,000

Total number of units

80,000

150,000

+ 70,000

Therefore, across the total product range, the second contract with J requires a total of 70,000 units.

Appendix 3 (page 1) shows the cost per unit, total costs and gross margin for the 3 pricing alternatives offered by J. An alternative approach to these calculations is shown in Appendix 3 (page 2).

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Option 1 Option 1 will only reduce the cost by 10% but Jot can order only the additional volumes it forecasts that it will require i.e. 70,000 units across the range of products. Appendix 3 shows that the cost of this option is €589,500 for all 70,000 units which is a cost saving compared to the current contract of €65,500. This will generate a gross margin on these additional 70,000 units of 43.9%. The average cost per unit (across all 3 products) for Option 1 is €8.42.

Option 2 Option 2 offers Jot a 20% manufacturing price reduction but this option requires Jot to place an order with J for a larger volume of units, 30% more. This is an additional 21,000 units. If Jot considers that it could sell these extra 21,000 units, 30% extra volumes, then this is a good choice, as costs are 20% lower. The total cost of Option 2 is €681,200 for 91,000 units. This results in an average cost per unit of €7.49, which is 11% lower than option 1.

The key question here, however, is whether Jot can sell these additional 21,000 units. If it cannot, then this option is not realistic, as Jot would be paying €91,700 more than Option 1 for 21,000 products it cannot sell. It the 21,000 extra units are not sold, then this could result in an inventory write-down, or perhaps selling prices could be reduced to move any unsold inventory.

The value of the inventory would be €157,200. If these additional volumes cannot be sold, then this would result in a significant inventory write down.

Alternatively, if Jot could sell these extra 30% volumes, then they could generate additional revenues of €315,000. It would be possible that if these additional 30% of volumes could not be sold at the usual prices, then Jot could reduce the selling prices substantially in order to sell any unsold inventory.

With Option 2, if additional orders are placed by customers, then Jot will have inventory immediately available.

In summary, Option 2 is the riskiest and costs the most at €681,200. Together with Jot’s forecast cash shortage, this adds additional unnecessary costs to manufacture products that Jot may not be able to sell.

Option 3 This option would reduce the unit price charged to Jot by 30%. This is very attractive and it makes sense to automate the production line. However, Jot would need assurances that the product quality will be maintained.

Automation of the production line would also help J to respond quicker in producing additional products in this range if Jot were to place further additional orders this year, if sales are even higher than currently envisaged.

The cost of option 3 is €458,500 plus the one-off charge to set up the production line of €150,000 which is a total cost of €608,500. The average cost per unit for option 3 is €8.69, which is €0.27 or 3.2% higher than option 1.

The cost of Option 3 is only €19,000 higher than Option 1 for the same volume of products, but the production line could be used for any future orders for Jot this year. Jot would need reassurance from J that the automation of the production line will not delay the manufacture of products and that delivery deadlines could be met.

In the longer-term, if the product BEEP is successful, and it becomes a regular product that Jot will sell in future years, after any necessary changes and updating, then the automation of the production line by J could help Jot to reduce its unit manufacturing costs. This could have a longer-term positive effect on Jot’s margins.

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Summary of options Jot has 3 options and the volumes, total costs, gross margin % and unit costs are summarised below: Option 1 Option 2 Option 3

Units Total cost Gross margin %: Value of inventory if the extra 30% volume of units for Option 2 is NOT sold Unit cost

€

10% reduction

20% reduction but 30% higher volumes

30% reduction + set-up cost of €150,000

70,000

91,000

70,000

€ 589,500

€ 681,200

€ 608,500

43.9%

50.0%

42.0%

-

€ 157,200

-

8.42

7.49 (but this unit cost is only relevant if all extra products can be sold)

8.69

In summary, the lowest cost per unit is Option 2, but this will cost the most and runs the risk of Jot having an extra 21,000 units that it may not be able to sell. The unit cost for Option 2 increases to €9.73 per unit (€681,200 / 70,000) if the additional 21,000 units cannot be sold. The total value of these extra volumes, which would increase inventory values if Jot was unable to sell them, is €157,200. For a company undergoing cash flow problems, procuring extra inventory with no known certainty of sales is extremely risky.

There is not much difference in the total cost between Option 1 and Option 3, but if Jot were to receive further orders in 2012, then the cost per unit for any further manufacturing will be lower with Option 3 as the set-up cost will have already been incurred.

This could be a very popular product for Jot which could be adapted for other age ranges and updated in future years. Therefore setting up an automated production line seems to be a realistic route for Jot to select.

The company Leapfrog Inc has just launched its version of an iPad for children, called a LeapPad and this retails at €87.00 (£79.00). Hamley’s toy shop has tipped this product as being a best selling product.

In summary, with Jot’s forecast cash shortage, it needs to minimise its expenditure and reduce any unnecessary inventory, so option 2 is considered to be not feasible.

4.3 - Forecast cash flow Jot is showing classic signs of overtrading and the seasonality of sales makes the situation worse. Whilst Jot is a profitable company, it is forecast to run out of cash during November 2012, which is only in 6 months’ time. There is insufficient cash for Jot to manage the remainder of 2012 without finding additional sources of finance.

Appendix 4 shows the forecast cash flow by month for the remainder of 2012. This shows that Jot will exceed the agreed overdraft facility of €1,500,000 shortly after the end of October 2012, or potentially even earlier if some customers pay later than forecast.

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Additionally, the increased volume of sales of BEEP and its accessories, means even more money would be tied up in working capital as Jot will need to pay the outsourced manufacturer before its customers pay for these products.

Jot is caught up in the classic cash flow problem, profitable but short of cash. If this situation is not managed and a new source of finance is not put in place, then in theory, Jot’s bankers could withdraw the overdraft or not honour any payments by Jot in excess of the overdraft limit, which could cause the company to go into liquidation. This is a very serious situation.

The cash flow forecast in Appendix 4 shows that Jot’s overdraft will reach €1,930,000 at the end of November and €2,230,000 at the end of December 2012. These forecast overdraft levels are materially higher than the agreed limit of €1,500,000. The case material has stated that Jot’s bankers are unable to extend the overdraft. This is very similar to what is happening in real life to many small companies.

Tani Grun, Finance and IT Director, needs to take urgent action to ensure additional financing is put in place. Additional short-term finance is required to fill the needs in 2012 but Jot also needs to consider its longer-term financing needs in order to sustain its planned growth.

Jot has seven main customers and it is likely that they would be unwilling to place further orders with a company which is in financial difficulties, as they would not want to be let down by potential non-delivery of the products they order from Jot. Additionally, their concern about Jot’s financial situation could actually worsen Jot’s position if they withheld or delayed payment. Jot is heavily dependent on these customers and must not allow the forecast cashflow to damage its reputation with these customers. If Jot’s customers were to suspect Jot could be in serious financial difficulties, their actions, such as delaying payment could bring about problems sooner.

Instead, Jot’s management team needs to take action now to urgently gain a new source of finance.

Tani Grun is considering the following three alternatives. These will be analysed using the Johnson, Scholes and Whittington’s model of suitability, acceptability and feasibility.

Alternative (A) - offering customers a discount of 2% if payment is made within 30 days.

Suitability This method is suitable to Jot to try to speed up payment. However, its seven main customers generate around 68% of sales revenue and therefore the success of this proposal depends on how many of the seven main customers would be willing to pay Jot in 30 days in return for a 2% discount.

Acceptability It is forecast that only 25% of sales revenue would result in the customer paying within 30 days of invoice date. This would enable Jot’s cash inflow to be speeded up and therefore this method is an acceptable way to try to meet some of Jot’s forecast cash needs. It would cost Jot a discount of 2% for 30 days, which is the annual equivalent of approximately 24% each year.

This is twice as expensive as Jot’s current overdraft which is at 12% interest per year.

The unseen material states that Jot forecasts that only 25% of sales revenue would be paid in 30 days. Is this forecast of 25% realistic and on what basis has this 25% take up been made?

Have Jot’s customers been asked whether they would be interested in paying early? The forecast of only 25% of sales revenue that would be paid within 30 days is quite low. Also, if one large customer intended to pay in 30 days, but paid later, say in 40 days, then this would increase the strain on cash flows and possibly cause the overdraft limit to be breached, which is risky.

Feasibility If Jot’s customers did not choose to select this early payment discount then this method would be ineffective. Alternative (A) is risky method of finance as Jot may not achieve 25% sales

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revenue being paid 30 days early and therefore Jot’s overdraft of €1,500,000 would still be in danger of being breached.

Appendix 5 shows that Jot’s forecast overdraft will reach €1,526,000 in November 2012 assuming that 25% of sales revenue is paid 1 month early. Therefore this alternative does not generate sufficient cash to ensure that the overdraft limit is not breached.

Alternative (B) – offering customers a discount of 10% if they make part payment when they place their orders for Jot’s products Suitability This method is NOT suitable for Jot as its customers may fear that Jot is in financial difficulties and could reduce the level of their orders, not place any orders from Jot or make payment of goods delivered even later.

This alternative would damage Jot’s reputation and could have damaging long-term effects on its customer base and should not be pursued.

Acceptability This is a large discount to be paid, at 10%. It should be noted that Jot only achieved an operating profit margin of 5.6% in the year ended 31 December 2011. If orders are placed by customers in May or June each year for delivery in October or November, for the peak Christmas sales, this is roughly a 6 month period and therefore the annualised cost of this interest is around 20%. This is cheaper than Alternative 1 at 24% but more expensive than the overdraft at 12.0% each year.

Feasibility Would alternative (B) be attractive to the seven large customers? It is unlikely that these large customers would be willing to make a payment for goods that have not even been manufactured. This also could indicate to Jot’s customers that Jot is in financial difficulties and this could result in lower orders. Therefore this method is not feasible.

Alternative (C) - Factoring Suitability This alternative is where a factoring company collects the money from Jot’s trade debtors and pays Jot an advance based on the value of invoices it has raised each month, less the factoring fee. The factoring fee in this alternative is given as 3%. This is a suitable method for Jot to use to reduce, or even eliminate, its bank overdraft. The cost of factoring at 3% is expensive, but it provides immediate finance, saving Jot having to wait 2 months for customers to pay. Therefore, on an annual basis the cost of factoring is approximately 18% per year (3% x 12 months / 2 months).

Factoring will result in the factor collecting trade receivables from Jot’s customers and will result in a saving in Jot’s administrative costs each year.

Factoring would generate a large amount of short-term finance and would make Jot cash positive for the remainder of 2012 as shown in Appendix 5. It would also enable Jot to become much less dependent on its bank.

Acceptability Debt factoring is a very common method of financing working capital and there is no longer an adverse reaction from customers paying invoices directly to a debt factor. Therefore this method is acceptable.

Feasibility Appendix 5 shows that factoring will completely eliminate Jot’s overdraft as all money, less the factor’s fee, will be paid in the same month that the invoices are raised. Jot could even earn

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money on its cash surpluses, albeit at the current very low rates of interest receivable. The extra cash could also be used to pay a dividend to Jot’s shareholders.

This is a feasible solution and would eliminate Jot’s overdraft completely and make the company cash positive. It is a safe and reliable way to generate the required working capital for a small fast growing company and it is a widely used method of financing.

Other sources of finance: An alternative source of finance is invoice discounting, which in effect is a short-term loan based on the value of invoices raised. This is similar to debt factoring but Jot would still collect the trade receivables from its customers.

Jot could re-schedule its long-term loans, one of which is repayable in January 2014, and raise more long-term finance. However, this could take time and perhaps could not be put in place before Jot simply runs out of cash in October / November 2012.

Jot could seek an external business partner to invest in the company either as a debt provider, or more likely as an equity investor. An external investor could take an equity stake and help provide finance to enable Jot to grow further. It would then seek to exit in a few years when the company could be listed on the European equivalent of the UK’s AIM exchange, for small companies.

The current shareholders may be in a position to invest further funds into the company to overcome this short-term problem.

However, time is of the essence and as additional short-term finance is NOT available from the bank (as stated in the case material) then short-term finance from other sources needs to be put in place over the next couple of months.

Jot should also try to secure alternative long-term finance in order to fund its expansion programme.

4.4 – Outsourced manufacturers Jot has been successful, and perhaps rather lucky, with its outsourced manufacturers to date.

However, Jot now needs to select them using more detailed criteria and also to audit and check them much more rigorously to identify poor practices in their factories and ensure that these poor practices are addressed if the outsourced manufacturers want to continue to win Jot’s business in the future.

With the increasing volume of products that Jot is planning over the 5-year plan period, Jot needs to ensure that its chain of supply is adequate to meet the growing needs. Michael Werner needs to ensure that its outsourced manufacturers have sufficient capacity to meet Jot’s growth.

This is especially important if Jot were to choose to terminate the supply contracts with 1 or more outsourced manufacturers, if they did not choose to address the poor practices and working conditions. Additionally, if there were to be exceptional events such as damage to a factory due to fire or unexpected events such as an earthquake or flooding, Jot would need alternative outsourced manufacturers to meet the planned sales volumes.

In real life, there has been extensive flooding in parts of Thailand during October and November 2011, which has damaged many manufacturers’ premises resulting in a large loss of business for the manufacturers as well as a loss of deliveries of finished products for the Western companies which rely on these manufacturers.

This issue is split into 3 aspects, which are:

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1. The problems with outsourced manufacturer Z which has suffered a fire.

2. The key criteria for the selection of new manufacturers.

3. The key performance measures for existing and new manufacturers.

Outsourced manufacturer Z There is an urgent need to appoint an alternative outsourced manufacturer for the 40,000 units of product DD, as outsourced manufacturer Z (Z) has suffered a fire and will not be operational until November 2012. This is too late for it to manufacture this product in order to get it shipped to Jot’s customers to meet the Christmas sales period.

Therefore alternative manufacturer(s) needs to be urgently selected and appointed. Michael Werner should urgently organise for other outsourced manufacturers to tender for the 40,000 units of product DD. Additionally, Jot should give notice of termination of its supply contract with outsourced manufacturer Z, whose factory burned down and caused 10 fatalities. Jot should not continue to do business with a company which has failed to protect its employees.

The key criteria for the selection of new manufacturers The key criteria when appointing a new outsourced manufacturer are shown below. Jot should also consider the manufacturer’s business processes, its financial strength and the quality of its senior management team. However, the most important criteria are that Jot’s management team needs to be convinced that any new outsourced manufacturer can deliver the products ordered on time and at the agreed quality specification for the agreed price.

Quality of manufacture Respect for IPR’s Ability to deliver on time in accordance with contract terms Responsiveness to changes in volumes Outsourced manufacturer company is financially sound Good factory conditions and treatment of employees Competitive price Able to meet Jot’s required volume capabilities Production line set-up time and costs Currency for payment of manufacturing costs (local currency or Euros) Overall Jot must be convinced that the new suppliers can deliver products on time, and to an agreed quality specification, whilst at the same time offering a competitive price. Ideally Jot would wish to build long-term relationships with its outsourced manufacturers which could produce a range of products and be re-appointed each year.

Essentially Jot must ensure that the products it outsources meet European regulations on toy safety, and in particular the Council Directive 2009/48/EC which came into force in July 2011, and comply with the international standard on product safety ISOTC 181. Using Mendelow’s framework, Jot’s outsourced manufacturers are key stakeholders.

Important considerations in the appointment of outsourced manufacturers are the lead times and the responsiveness by outsourced manufacturers to any changes in Jot’s sales demand.

Furthermore, shortening the supply chain by “near shoring”, by utilising manufacturing in a nearby country, could result in Jot being able to reduce its inventory holding position. Therefore, Jot should consider using at least one outsourced manufacturer which is based in a European country rather than all outsourced manufacturers being based in China.

The unit price of the outsourced manufacturer for each product should not be the sole criterion.

Jot should evaluate and understand the larger total cost picture and what will best meet the company’s needs and that price is only one factor in the decision making process. With increasing levels of sales and shorter product life (with updated products re-launched most years), Jot should consider that the lead time and the responsiveness of the outsourced manufacturer to further orders, should also be factors to be considered.

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The risk of obsolescence of a product if it does not sell as well as expected is another key factor.

The loss of potential sales should a new product be more successful than expected, such as the product BEEP, is another factor in selecting outsourced manufacturers. Jot needs to ensure that they can be responsive to its needs and any volume changes.

Key performance measures for existing and new manufacturers As outlined above, there are many factors apart from price, which Jot’s management team should use in the selection of outsourced manufacturers. When each outsourced manufacturer has been appointed, the following are suggested performance measures which should be prepared and monitored.

One possible framework that could be adopted would be Kaplan and Norton’s Balanced Scorecard, whereby measures could be determined using the four headings of customer, business processes, innovation and financial.

Some appropriate key performance measures are as follows: Business processes: Product quality and recall rates Safe factory conditions Treatment of employees – based on confidential interviews or surveys.

Manufacturing processes – has the company been awarded China’s Compulsory Certification (CCC) from one of the three agencies nominated by the CNCA? Deliveries on time – number of late deliveries Healthy working environment for its employees including sick leave and injury rates, working hours, pay rates.

Innovation Use of new technology to produce products of required quality Automation of its production line Financial: Profitability of the outsourced manufacturers based on their accounts Financial strength based on their assets, gearing and level of reserves Customer (Jot would be the outsourced manufacturer’s customer): Experience of the outsourced manufacturer’s senior management team – review of their CVs The outsourced manufacturers employee turnover and length of time with the company Flexibility – the outsourced manufacturers’ ability to cope with late orders.

4.5 – IT system problems Jot has a mix of different IT systems which is typical of a small company which has grown rapidly. The danger of the current systems and incorrect invoicing is that this could upset its customers and deter them from dealing with Jot. Therefore, a more robust and professional inventory control and invoicing system needs to be put in place urgently as well as improved procedures for faulty goods returned to Jot. In respect of the cost of any new IT systems for Jot, the question is not whether Jot can afford new IT systems but whether the company can afford NOT to invest in IT solutions. If Jot does not invest in IT systems to serve its customer base, then the company could lose some of its customers if it repeatedly invoices them incorrectly.

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Jot could easily use a licensed “off-the-shelf” integrated IT system and appoint an IT outsourcing company to help to get its data transferred.

The company should be concerned about the lack of integrity of its data. There appears to be a variety of problems ranging from the levels of inventory to the accuracy of its trade receivables.

This needs to be urgently investigated to ensure accuracy of the raw data.

In respect of each of the specific issues raised by Tani Grun, these are discussed as follows: The level of invoicing errors Jot needs to work with its global logistics company, which is responsible for shipping products to customers, to determine why quantities delivered to customers differ from those invoiced. For example, do the logistics company’s shipping notes agree with any documentation from Jot’s warehouses, or its Chinese manufacturers if supplied direct to customers? Alternatively, can the problem be isolated to particular products or warehouses?

There also appears to be a weakness in the system whereby replacement products to customers are treated as new sales. Jot needs to consider its procedures and ensure that a separate document for these deliveries, to create either a “free of charge” invoice, or alternatively a credit note, for the customer. The credit note, however, must not have the effect of adding back into inventory any damaged or faulty products returned by customers.

Returns to Jot’s manufacturers Jot needs to review its return systems, both with its global logistics company and with staff at its own warehouses. This appears to be an occasional problem, so some system must already be in place. Jot needs to review the particular instances that have occurred, to establish whether this is only a problem at one of its warehouses or whether it affects all three warehouses.

Inventory discrepancies at Jot’s warehouses All documentation relating to purchases, sales and returns should automatically be integrated within the inventory control records. Where there are inventory discrepancies on a particular product a detailed audit of movements in and out of the warehouse needs to be undertaken.

Whilst it is inevitable that some products may get damaged through mis-handling, and the nature of the products may result in theft, there should be procedures in place for recording damaged products, to reduce the inventory holding levels.

Jot’s finance department should work closely with the warehouse managers and there should be a regular counting of products. It may be that a sample of products could be counted on a regular basis, and any differences with the inventory records reconciled. This should hopefully quickly determine any weaknesses in the IT systems.

Impact of inaccurate invoicing The lack of accuracy of Jot’s invoicing could delay customers from paying Jot whilst queries are investigated and this could have an adverse effect on Jot’s cash flow, which could put increased pressure on its level of bank overdraft. Additionally, extensive errors in Jot’s invoicing and delivery of faulty products could result in a loss of some customers and this would have a significant impact on the company’s profitability. This emphasises the need for tighter procedures and improved IT systems for Jot. If Jot is to select the option of factoring to generate cash, an improved IT system which generates accurate invoices will be required, so that the factoring company can collect the debt with a minimum of queries. This is especially important as the factor would be very concerned if Jot’s invoicing is not accurate.

An integrated IT system would allow better management of the company’s operations, especially as it is experiencing high growth and plans to grow considerably over the next 5 years.

However, in the short-term, Jot needs more expertise in IT. A possible action would be to appoint an IT Manager, with experience in problem solving, to help identify the key weaknesses

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in Jot’s current systems and to try to overcome the problems. Alternatively, or additionally, Jot could seek assistance from an IT outsourcing company to help fix specific problems in its individual IT systems for the short-term.

5.0 Ethical issues and recommendations on ethical issues 5.1 Range of ethical issues facing Jot There are a range of ethical issues facing Jot including the following: 1. Factory conditions and fire at Z’s factory with fatalities.

2. Faults on Product QQ. 3. Incorrect invoicing – unprofessional and lacks integrity.

5.2 – Factory conditions and fire at Z’s factory with fatalities 5.2.1 Why this is an ethical issue The poor factory conditions and the recent fire at Z’s factory demonstrates that Jot does not care about the factory conditions of its outsourced manufacturers and their employees. Whilst Jot has repeatedly told some of its outsourced manufacturers that it is not happy with conditions, it has allowed the poor conditions to persist.

5.2.2 Recommendations for this ethical issue It is recommended that Michael Werner should formally draw up a list of factory conditions which it expects its outsourced manufacturers to meet. This should include working hours, factory working temperatures, safety issues, child labour and treatment of employees.

It is further recommended that Jot follows The Lego Group’s approach of requiring all its suppliers to sign up to a Code of Conduct covering issues such as child labour and health and safety.

It is recommended that Jot should audit all of its outsourced manufacturers’ factories and draw up a list of urgent, and less urgent, matters that it wants improved together with an agreed time limit for improvements. This should include short-term immediate improvements as well as longer-term improvements if the manufacturer is to be re-appointed for further contracts in future years. If improvements are not made, then the outsourced manufacturer’s contract should be terminated by Jot, or at least not renewed in the future years.

New outsourced manufacturers should be identified and invited to tender for specific contracts.

Before any new outsourced manufacturers are appointed, Jot should inspect their factory conditions to ensure that they comply with Jot’s documented requirement for the standard of factory conditions.

It is also recommended that Jot should immediately terminate its contract with outsourced manufacturer Z, which suffered the fire and had 10 fatalities. Jot should not be associated with, or continue to do business with, a company which has such poor respect for its employees.

5.3 – Faults on Product QQ 5.3.1 Why this is an ethical issue There is a dilemma as to whether Jot should tell its customers about the faults found or whether they are not considered serious enough to inform its customers. Should Jot be open and honest with its customers?

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It would appear that Boris Hepp is prepared to condone the faults in product QQ on the grounds that he considers this to be a minor fault and that the product is selling well. However there is also an ethical aspect in relation to integrity and professional behaviour in knowingly to continue trading with a supplier which is producing products with faults.

Additionally, outsourced manufacturer P (P) does not know about these faults and the product testing that has been carried out. There needs to be a closer liaison to ensure that any faults identified are communicated back to P, so that if P is appointed for future manufacturing of product QQ, P can improve the quality and try to eliminate the fault.

5.3.2 Recommendations for this ethical issue It is recommended that Jot should contact its customers who have previously bought product QQ and to advise them of the minor fault and to offer to replace any unsold inventory and cover the replacement cost of any products that end customers may return to Jot’s customers.

It is also recommended that Jot should communicate the fault found on the product to outsourced manufacturer P as well as the outcome of its product testing, so that quality for future production is improved.

It is recommended that Jot obtains quotes from other outsourced manufacturers as a contingency in the event that P will not co-operate with addressing these faults.

5.4 – Incorrect invoicing 5.4.1 Why this is an ethical issue Jot’s IT systems are clearly not providing sound information of integrity in order to prepare accurate invoicing. This is not professional and could reflect badly on Jot’s reputation. Jot could be accused of wrongly invoicing its customers for goods that were delivered only as replacements for faulty products. Jot’s lack of clear procedures and lack of integration of its IT systems is not a professional way to operate in business.

5.4.2 Recommendations for this ethical issue It is recommended that Jot’s procedures for returned goods and faulty products are reviewed so that replacement products are not invoiced. Invoicing procedures should also be reviewed.

It is also recommended that Jot recruits an experienced IT Manager to work with Jot’s sales and finance teams to review Jot’s IT systems and to try to amend the procedures that are causing these faults.

Furthermore, a longer-term review of Jot’s IT systems should be undertaken and new IT system requirements should be specified and justified.

6.0 Recommendations 6.1 – Higher sales 6.1.1 Recommendation It is recommended that Jot should select option 3 and gain a 30% cost reduction in return for setting up a more automated production line.

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6.1.2 Justification Option 3 would be advantageous if Jot should require any further additional orders for the product called BEEP or its accessories in the current year. The cost of this option is only €19,000 higher than option 1, which would only generate a cost saving of 10% per unit.

Option 3 will deliver a gross margin on these products of 42.0%, which is higher than Jot’s average gross margin in its 5-year plan for 2012, which was 32.3%.

Option 1 would only generate a cost reduction of just 10%, but it is the cheapest option.

However, if further production of this popular product is required later this year, then Jot will not gain the greatest cost advantage.

Option 2 would generate a cost saving of 20% but would require Jot to order additional 30% volumes, resulting in the volume for this second order of 91,000 units in total, rather than 70,000 units. Whilst this is a cheaper alternative if the products could be sold, it is riskier and could leave Jot with unsold inventory worth €157,200 which if unsold would need to be written down.

Option 2 also would incur an additional cost of €91,700 compared to Option 1. With Jot’s forecast cash shortage, it is not sensible to spend limited cash in order to manufacture products that it may not be able to sell.

6.1.3 Actions to be taken Jot should go ahead and sign a new contract with J for the manufacture of 70,000 units and for the automated production line to be set up.

Jot to pay the agreed fee of €150,000 for the setting up of the automated production line. Jot has sufficient cash and overdraft limit at this time to pay this set-up cost.

Jot should ensure that quality and delivery dates are specified in this new contract and should closely monitor J’s progress with the manufacture of all 150,000 units for both contracts for BEEP and the accessories.

6.2 – Forecast cash flow 6.2.1 Recommendation It is recommended that debt factoring (Alternative 3) should be selected in order to improve Jot’s short-term cash flow problem. It is recommended that debt factoring should commence from all invoices raised from 1 September 2012.

6.2.2 Justification Additional short-term finance is required as Jot will exceed its overdraft limit by over €730,000 by the end of the year. The bank will not allow this to happen, which could put Jot in the dangerous position of bankruptcy at worst or unable to pay its outsourced manufacturers.

Jot needs to identify an additional source of short-term finance and factoring is the most suitable method.

Alternative 1 of offering customers a 2% discount for payment in 30 days is rejected as this is a risky method and it is unlikely that Jot’s seven large customers will pay within the 30 day limit.

Even with the forecast of 25% of sales revenue paid within 30 days, it is still forecast that the overdraft limit of €1,500,000 would be breached in November 2012.

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Alternative 2 of asking customers to pay a deposit when an order is placed is considered to be commercially unrealistic and could damage Jot’s reputation and the business confidence that Jot’s customers have in Jot. This could result in a loss of sales orders and long-term damage to Jot’s brand reputation. With a small number of large customers, Jot could lose a considerable volume of sales if just one customer considered that Jot was in financial difficulties, and its orders were reduced or cancelled or even payment delayed. Therefore, this alternative has been entirely ruled out as not feasible.

6.2.3 Actions to be taken There are many debt factoring companies to choose from. Jot should meet with a few debt factoring companies and decide which would be the best company for it to work with.

In the future, Jot should secure additional long-term finance, with either a stock exchange listing, such as the AIM, within the next 5 years or alternatively to find an external business investor to invest in Jot in exchange for a share of Jot’s equity.

Jot needs to start planning how it will repay, or re-finance, the long-term loan which is repayable in January 2014.

6.3 - Outsourced manufacturers 6.3.1 Recommendations It is recommended that a document with the key criteria and performance measures for outsourced manufacturers needs to be written by Michael Werner and agreed by Jot’s senior management team within the next month. This should then form the basis for appointing and monitoring outsourced manufacturers in future.

These documents on key criteria and performance measures should ensure that Jot takes account of other factors outside the current cost and quality criteria. There should be greater emphasis on factory conditions and treatment of factory employees. Additionally, responsiveness to changes in the volume of Jot’s orders and lead times should also be considered.

It is recommended that Michael Werner should send out an invitation to tender documents for product DD to a range of outsourced manufacturers within the next week.

It is recommended that Jot’s contract with outsourced manufacturer Z should be terminated immediately.

6.3.2 Justification It is necessary for Jot to prepare a document setting out the key criteria for the selection of outsourced manufacturers in order to put this important process on a more professional basis.

This will enable Jot to make its choice of manufacturer based on a range of criteria, rather than solely on cost. This will also address the concerns of Jot’s management team over the poor factory conditions for some of its current outsourced manufacturers.

Following the preparation of the key criteria, Jot’s management team needs to agree what performance measures it will establish to monitor its outsourced manufacturers. Jot will also need to work closely with each of the outsourced manufacturers to identify the quality of the information for each of the performance measures and how the data will be collected.

Product DD can no longer be manufactured by outsourced manufacturer Z following the fire.

Therefore it is necessary to urgently invite other manufacturers to tender for this contract. It is

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already the end of May 2012 and it is likely that delivery will be required between September and early November, so it is urgent to identify and appoint a new outsourced manufacturer.

Jot’s management team must be concerned that one of its outsourced manufacturers has allowed its factory conditions to be so bad that there was a fire due to poor ventilation and inadequate maintenance of machinery, which resulted in 10 fatalities. Jot should not do business with a company which has such poor regard for its employees and the contract with Z should be terminated immediately. Z should not be re-appointed in the future.

6.3.3 Actions to be taken Michael Werner should prepare a document outlining the key criteria for the selection of outsourced manufacturers. This then needs to be approved by the Jot Board.

Michael Werner should prepare a document outlining the key performance measures to be used to monitor its outsourced manufacturers. He may need help from specialised agencies to help prepare a useable and well structured set of performance measures.

Existing outsourced manufacturers need to be audited and a list of improvements, both urgent and other less urgent actions, should be agreed with each outsourced manufacturer.

Notice needs to be given to all outsourced manufacturers to take action on the points raised in the audit and that failure to take action will result in a termination of their manufacturing contracts.

On-going audit and dialogue with manufacturers needs to continue so that Jot establishes long-term close links with its supply chain and that its outsourced manufacturers conform to the standards expected by Jot. Tender to be sent out to outsourced manufacturers for product DD within the next week.

6.4 – IT system problems 6.4.1 Recommendation It is recommended that Jot appoints an IT Manager with experience of problems solving, as soon as possible, as Tani Grun has significant other demands on her time, especially with the pressures from Jot’s cash flow. The new IT Manager should work closely with Jot’s sales and finance teams to review Jot’s IT systems and to try to amend the procedures that are causing these faults.

The new IT Manager could seek support from an experienced IT outsourcing company which could help to make specific recommendations on short-term improvements to Jot’s existing IT systems. Additionally, the IT Manager should work with Tani Grun on the preparation of a proposal in the longer-term for the implementation of an integrated IT system.

It is also recommended that procedures for the despatch of goods to customers, return of faulty goods, and all aspects of invoicing are urgently reviewed to improve the accuracy of Jot’s invoices.

It is recommended that Jot arranges a meeting with its global logistics company to discuss possible causes of the problems. A review will be needed of both the logistics company’s shipping note advices compared with Jot’s own warehouse paperwork.

It is recommended that Jot should urgently count its inventory at all three warehouses and that it reconciles any differences to the accounting system and that any inventory losses are written off.

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6.4.2 Justification The rationale for the above recommendations is that these actions should quickly determine any weaknesses in Jot’s IT systems. It is further recommended that Jot, after working through the above proposals, works with its external auditors to review the effectiveness of the documentation recording the movement of goods between Jot’s suppliers, its warehouses and its customers, and asks for their recommendations.

The rationale for these recommendations is that the invoicing errors are causing problems for Jot’s customers, and also affecting Jot’s cash flows.

Also, with the recommendation in paragraph 6.2.1 above, which recommends that Jot should move to use a factoring company to collect trade receivables, it is important that all invoices raised by Jot are accurate.

6.4.3 Actions to be taken The Jot Boards should agree to appoint an IT Manager, to assist Tani Grun, to specifically review and advise on short-term changes to its IT systems.

Jot should appoint its external auditors to review the changes in procedures to ensure accuracy of invoices raised and inventory levels.

Jot should introduce a separate document to record delivery of replacement products to customers.

Documentation relating to Jot’s return of any products to its manufacturers should be reviewed and a new procedure established to ensure that all IT systems, and any invoices raised, accurately reflect each product movement.

7.0 Conclusions Jot has been very successful since it was established in 1998 and has grown the business considerably. It continues to be innovative and to create new toys and has expanded its geographical markets substantially.

There is every reason to consider that Jot will continue to be successful and profitable but it needs to urgently address its forecast cash shortage and start to plan its longer-term future and how the company can be financed long-term. It is likely that the company could become listed in the future. However, there is no future for a company that constantly has cash flow difficulties, so this issue must be addressed so that Jot’s owners can concentrate on the business of designing and outsourcing the manufacture of its range of innovative toys.

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Appendix 1 SWOT analysis

Strengths Successful and fast growing company Good product designs Profitable company High growth in sales revenue (almost 18% last year) Expanding geographical markets Experienced and committed management team Good safety record on its products

Opportunities Higher sales of BEEP and its accessories Reduction in unit cost of outsourced manufacturing of BEEP due to higher volumes Improved cash flow if debt factoring is agreed or if discounts are offered to Jot’s customers Improved control over outsourced manufacturers To invest in IT solutions in order to improve the quality of data for decision making

Weaknesses Dependent on just 7 customers for 68% of sales revenue Dependent on product designers and key employees Reliant on outsourced manufacturers Lack of integrated IT systems Highly dependent on customers’ changing preferences Seasonal business with peak sales in quarter 4 Dependent on Jot’s senior management team and a loss of any member would have serious consequences Weak IT systems which do not provide all of the required management information

Threats Forecast breach of Jot’s bank overdraft limit in November 2012.

Cash flow difficulties as a result of forecast higher sales Reduction in net margin due to cost of discounts or factoring Poor conditions at many of Jot’s outsourced manufacturers’ factories which could lead to reputational damage to Jot brand Potential loss of sales for product DD unless a new outsourced manufacturer can be appointed Safety issue with product QQ Lack of integrated IT systems resulting in conflict of data and could result in poor decision making.

Losing key employees

Note: The above SWOT analysis is detailed for teaching purposes. However, in exam conditions a SWOT containing fewer bullet points, which cover the main issues from the case and the unseen material, is expected.

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Appendix 2 PEST analysis

Political/Legal Changes in product safety requirements.

Problems with product QQ. Breach of Jot’s IPR’s and loss of sales from “copied” products.

Economic Recession resulting in lower disposable income resulting in lower levels of sales.

Increased wage rates in China resulting in higher outsourced manufacturers’ prices.

Current economic conditions resulting in restricted finance being available from Jot’s bankers.

Social Changing consumer tastes which could result in lower or higher sales for new products.

Changing consumer tastes which could result in inventory write down.

Technological Increased cost of new technology and electronic chips.

New IT systems to help Jot’s management team.

Risk of faults on key electronic components.

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Appendix 3 (page 1) Analysis of the 3 options for new order with outsourced manufacturer J Option 1 Cost reduction of 10% Additional volumes BEEP Extra software Covers Set-up cost Total / average New order:

BEEP Extra software Covers Set-up cost Total Gross margin

20,000 30,000 20,000

Cost / unit € 19.35 4.05 4.05

70,000

8.42

Total cost € 387,000 121,500 81,000 589,500

Sales

Cost

€ 640,000 270,000 140,000

€ 387,000 121,500 81,000

€ 253,000 148,500 59,000

1,050,000

589,500

460,500 43.9%

New order:

Margin

Option 2 20% cost reduction but 30% higher volumes Additional volumes Cost / unit Total cost +30% € € 26,000 17.20 447,200 39,000 3.60 140,400 26,000 3.60 93,600 91,000

7.49

681,200

Sales Cost Margin Assuming higher volume is NOT sold € € € 640,000 447,200 192,800 270,000 140,400 129,600 140,000 93,600 46,400 1,050,000

Sales

681,200

368,800 35.1%

Cost

Margin

Option 3 30% cost reduction + set-up cost of €150,000 Additional volumes Cost / unit total cost € € 20,000 15.05 301,000 30,000 3.15 94,500 20,000 3.15 63,000 150,000 70,000 8.69 608,500 Sales € 640,000 270,000 140,000 1,050,000

Cost

Margin

€ 301,000 94,500 63,000 150,000 608,500

€ 339,000 175,500 77,000 -150,000 441,500 42.0%

Assuming higher volumes can be sold

BEEP Extra software Covers Set-up cost Total Gross margin

832,000 351,000 182,000

447,200 140,400 93,600

384,800 210,600 88,400

1,365,000

681,200

683,800 50.0%

Note: Under Option 2, the bottom box shows sales of €1,365,000, and assumes that all of the additional volumes (all 91,000 additional units) can be sold.

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Appendix 3 (page 2) Alternative approach to the 3 options for new order with outsourced manufacturer J Original Plan

Latest Plan

Selling Price Per Unit €

Total Revenue €

Cost per Unit €

Total Cost (all units) €

Cost reduction per unit €

Units in excess of Original Plan

Option 1 – 10% BEEP

40,000

60,000

32.0

1,920,000

21.5

1,290,000

- 2.15

20,000

-

43,000

420

253

673.0

SW packages

10,000

40,000

9.0

360,000

4.5

180,000

- 0.45

30,000

-

13,500

45

149

193.5

Protective Covers

30,000

50,000

7.0

350,000

4.5

225,000

- 0.45

20,000

-

9,000

75

59

134.0

-

65,500

461

1,000.5

2,630,000

Total: Option 1

1,695,000

Savings from original contract €

Margin on original volume €000

Margin on additional volume €000

Total Gross Margin €000

Option 2 (a) – 20% & excess not sold BEEP

40,000

60,000

32.0

1,920,000

21.5

1,419,000*

- 4.30

26,000

- 111,800

420

193

612.8

SW packages

10,000

40,000

9.0

360,000

4.5

220,500*

- 0.90

39,000

-

35,100

45

130

174.6

Protective Covers

30,000

50,000

7.0

350,000

4.5

252,000*

- 0.90

26,000

-

23,400

75

46

121.4

369

908.8

2,630,000

Total: Option 2 (a)

1,891,500*

- 170,300

Option 2 (b) – 20% with extra all sold BEEP

40,000

66,000

32.0

2,112,000

21.5

1,419,000

- 4.30

26,000

- 111,800

420

385

804.8

SW packages

10,000

49,000

9.0

441,000

4.5

220,500

- 0.90

39,000

-

35,100

45

211

255.6

Protective Covers

30,000

56,000

7.0

392,000

4.5

252,000

- 0.90

26,000

-

23,400

75

88

163.4

684

1,223.8

2,945,000

Total: Option 2 (b)

1,891,500

- 170,300

Option 3 – 30% BEEP

40,000

60,000

32.0

1,920,000

21.5

1,290,000

- 6.45

20,000

- 129,000

420

339

759.0

SW packages

10,000

40,000

9.0

360,000

4.5

180,000

- 1.35

30,000

-

40,500

45

176

220.5

Protective Covers

30,000

50,000

7.0

350,000

4.5

225,000

- 1.35

20,000

-

27,000

75

77

152.0

-150

-150.0

442

981.5

Less: One-off charge Total Option 3

150,000 2,630,000

1,695,000

-

46,500

*Note: For Option 2 (a) the costs are based on the higher number of units e.g. 66,000 units of BEEP, but the revenues are based on the latest plan.

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Appendix 4 Cash flow forecast for July to December 2012

Cash balance start of month

July 2012

August 2012

Sept 2012

Oct 2012

Nov 2012

Dec 2012

€’000

€’000

€’000

€’000

€’000

€’000

1,450

1,040

-140

-820

-1,470

-1,930

570

600

1,100

1,100

1,540

1,680

Manufacturing costs

-600

-1,400

-1,400

-1,400

-1,650

-1,630

Other costs

-380

-380

-380

-350

-350

-350

1,040

-140

-820

-1,470

-1,930

-2,230

Sales

Cash balance month end

Note: The above cash forecast excludes finance costs on the overdraft.

The table above shows that Jot’s overdraft limit of €1,500,000 is breached in November 2012.

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Appendix 5 Alternative ways to finance working capital Alternative (A): Offering customers a discount of 2% if payment is made within 30 days Implement from 1 September 2012 based on forecast that only 25% of customers will take up the offer to pay in 30 days.

Sept 2012 €’000 Cash balance start of month Sales:

Collected 2 months late 25% paid in 1 month 75% paid in 2 months

Manufacturing costs Other costs

Nov 2012 €’000

Dec 2012 €’000

-140

-820

-1,093

-1,526

1,100 0 0

1,100 385 0

0 420 1,155

0 840 1,260

-1,400

-1,400

-1,650

-1,630

-380

-350

-350

-350

0

-8

-8

-17

-820

-1,093

-1,526

-1,423

Discount allowed at 2% Cash balance at month end

Oct 2012 €’000

This table shows that overdraft limit will be breached in November 2012.

Alternative (C): Debt factoring This would result in immediate payment of sales revenue less the 3% factoring cost.

Sept 2012 €’000 Cash balance start of month

Oct 2012 €’000

Nov 2012 €’000

Dec 2012 €’000

-140

674

1,654

2,913

1,100

1,100

0

0

Collected by debt factor

1,540

1,680

3,360

1,680

3% fee paid to debt factor

-46

-50

-101

-50

-1,400

-1,400

-1,650

-1,630

-380

-350

-350

-350

674

1,654

2,913

2,563

Sales revenue: Collected by Jot

Manufacturing costs Other costs Cash balance month end

Notes: 1. This shows that Jot’s overdraft will be completely eliminated and the company will be cash positive.

2. This cash forecast excludes the savings in administrative costs.

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Appendix 6 Part (b) – Email on the differences between cash flow and profit and ways in which in Jot can manage its cash flow more effectively.

To: Jon Grun, Managing Director From: Management Accountant Date: 24 May 2012 Re: Differences between cash and profit and ways in which Jot can manage its cash flow more effectively.

1. Profit is an accounting term which takes account of sales made and revenue expenditure incurred using the accruals concept and does not include any working capital requirements or capital expenditure or reflect the timing of sales receipts.

2. Profit includes non-cash items such as depreciation and provisions but excludes capital expenditure.

3. Due to the seasonality of Jot’s sales, it incurs large cash outflows to build up its inventory levels, which has no effect on operating profit during the year but has a large impact on cash flows. Therefore there are significant timing differences between cash flow and profit.

4. Cash is the life blood of an organisation, especially a small unlisted company such as Jot, which shows classic signs of over-trading; companies that go into liquidation are often trading profitably but suffer from significant cash flow shortages.

5. Jot is forecast to exceed its agreed overdraft of €1.5 million during November 2012 due to higher sales levels and the seasonality of trading.

6. By the end of December 2012, Jot’s overdraft is forecast to be over €2.2 million, which is €0.7 million over the agreed overdraft limit, so an additional source of financing needs to be urgently put in place.

Ways in which Jot could improve its cash flow: 7. Jot could offer customers a discount to settle their invoices quicker but, as they have a low number of large customers, this is unlikely to be successful or attractive to its customers.

8. Jot could ask for a part payment of the customer’s order when the order is placed, in order to obtain a discount, although most large customers may not like this and Jot could lose sales. It could also be viewed as a sign of financial difficulties and it is not the norm for companies to pay, or part pay, for goods when ordering, before the products are delivered.

9. Jot could use invoice discounting (which is where a cash advance is given to the company, at a fee, based on the level of invoiced sales); this differs from factoring where the debt is transferred to the factoring company and the factor collects the debt from the end customer.

Recommendation: 10. It is recommended that Jot should use a debt factor in order to improve its cash flow as this would generate cash immediately after despatch of goods and this would help finance the company’s growing working capital requirement.

Regards Management Accountant Note: The above 10 sentences are slightly more detailed for teaching purposes and in exam conditions brief sentences are expected.

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