Accounting Assignment Case Analysis
(Background and problem identification) A brief description of the situation and a clear statement identifying the issues to be addressed in the discussion/analysis section.
Note that, in this section, you must clearly:
- state the purpose of the analysis;
- identify the target audience;
- relate to your role; and ideally
- provide an outline/agenda of your presentation.
Discussion and analysis
A logical in-depth analysis of the identified key issues and problems paying particular attention to the interrelationships among these issues, and the possible ways of resolving the issues (if required).
A summary of what have been discussed.
A set of appropriately justified courses of action logically linked to the issues and/or problems discussed.
(This case is fictional.)
The world’s best bottled water comes from New Zealand, according to a survey by Decanter magazine. Twenty years ago, if you tried to sell a bottle of water to a Kiwi for $2, people would think you are mad. Now, New Zealanders spend a staggering $60.4 million a year, and the total market has grown by about 20 per cent per annum in recent years. H-2-O LIMITED is a small but competitive mineral water supplier that has won several awards in New Zealand. However, its former owner wanted to pursue other business interests.
Just before Christmas 2016, the business was put up for sale for a reasonable price. Jane McDougal has family living in the area where H-2-O LIMITED is located. She availed herself of the opportunity to acquire her own company. Jane’s husband Ray Hall helped her with the purchase, and things moved very quickly after her first expression of serious interest. Both Jane and Ray became directors of the company, with Jane becoming the Managing Director and Ray the Finance Director. The new company started on January 1, 2017.
However, as the company started gearing up its operations, its cash flow position started to deteriorate fast and, to make matters worse, a phone call came from the leasing company in December 2017 to say that the first repayment was due. Jane contacted her bank, but the bank manager said that the company was overdrawn by $60,000 and he wanted a serious discussion with both Jane and Ray in a few days, as no overdraft facilities had been negotiated.
Ray telephoned Jim Ambrose for advice. Jim is a Chartered Accountant and provides business advisory services. Both Ray and Jim became good friends while studying at Massey University in the 1990s. On graduation, both joined Jacob and Company in Wellington, which was affiliated with one of the large international accountancy firms. Both became trainee accountants, but Ray left Jacob and Company to pursue other interests. Jim later qualified as a chartered accountant and now owns an accountancy practice in Palmerston North, while Ray developed a career in retail business in Albany. They both met during a Christmas party in December 2017 in Wellington held for Massey graduates and renewed their contact there.
In the phone call, Ray told Jim that he had business problems. Seeing his old friend in trouble, Jim decided to visit Ray and help him to evaluate H-2-O LIMITED’s financial challenges.
On 6 January 2018, Jim arrived at the premises of H-2-O LIMITED. Jim’s first impression of the premises and its surroundings was favourable. Ray met him at his office, and they exchanged New Year’s greetings. Ray quickly got down to business and described his business operations.
“At the moment we produce bottled water in a glass bottle rather than in plastic containers or aluminium cans, in a one-litre size. It is a fairly simple operation.”
“So, what’s the problem?” asked Jim.
“Actually, the immediate problem is cash flow or, rather, lack of it,” responded Ray. “Also, there is a shortage of both operating and financial data, so it is difficult to say where the problem lies. I shall start at the beginning.”
Ray continued, “Last year Jane wrote two cheques and gave them to our solicitor to incorporate a new limited company with myself and Jane as the two directors. The first cheque, $200,000, represented the share capital of the business. The second cheque, $400,000 represented an interest-free loan from me to the company. The company’s first transaction was to acquire the buildings and goodwill of the old business for $400,000. Effectively, we paid a lot of money for the goodwill of the business. We then needed to acquire the equipment of the ‘old’ company. In order to finance this, we signed a finance lease agreement with a finance company. The lease agreement requires us to pay $50,000 at the end of each year for the next five years. The finance company is charging me 12 per cent per annum as the fair market value of these assets was $180,000. At the end of the five years, the equipment will be worth nothing.
“We have a quality product, but business planning is not our strong point. I must admit that I got distracted by some things that had nothing to do with the business during the year.
“Basically, the business model is sound, and the 10 or so Kiwi companies operating in this segment of the market achieve a net profit to sales margin of between 2 and 3 per cent. Obviously, there is competition, and one of the most obvious competitors is Coca-Cola’s mineral water, which has a nationwide advertising campaign budget in excess of $2,000,000. The concept of bottled water is now firmly established in New Zealand, and our average per capita consumption is about 40 litres a year, compared to about 100 litres per head consumed by our Australian neighbours. The sales growth in the market over the past few years was due, in my opinion, to clever marketing, but the public’s concerns about poor water quality and fluoride in tap water are also relevant factors. Anytime there is a water scare in New Zealand, consumption of bottled water increases, and afterwards they don’t necessarily go back down to the levels they were at. However, we are a small player in the market at the moment and operate at about 50 per cent of our capacity.
” Jim interjected, “Tell me more about bottled water.”
“Well,” Ray responded, “bottled water is not simply water in a bottle, and this is where the clever marketing comes in. Bottled water falls into one of three classifications – natural mineral water, spring water, or plain bottled water, and most consumers do not realise the important distinction. ‘Natural mineral water’ represents water that is safe and, other than filtration, no other treatment is permitted. Nothing can be added. It is water from a completely natural source, which meets very stringent quality and purity standards and is free from all environmental contamination or pollution. Bottling must be carried out at source under stringent conditions. It is the ‘grade A’ of bottled water.
“Then there is the grade B stuff, which is classified as ‘spring water’. This will typically undergo some treatment in order to ensure that the minerals that it contains fall within the maximum limits set by legislation. Typical treatment could involve killing bacteria or reducing the level of iron.
“All other bottled water on the market is classified as ‘bottled water’, and this represents the lowest quality bottled water, as it can legally be treated in the same way as municipal water.
” Jim enquired, “Where do you fit in to all this”?
Ray replied, “Actually, we produce ‘natural mineral water’. Our ongoing tests indicate that it is, microbiologically, remarkably pure, with a high potassium content that contributes to its refreshing flavour. It is important to realise that it’s not what’s in the bottled water that defines its quality, but rather what’s not in it. The lower the amount of minerals, then the purer the water is.
“However, consumers like to drink carbonated (or fizzy) water, so we basically add carbon dioxide as the water passes through the filling process in the equipment. When the bottle is filled, a label is added, and the bottle is sealed. There is a final test for leaks and proper filling, labels, etc., before being sent to the warehouse for packaging and distribution .
“Who are your main customers?” asked Jim.
“Well, at the moment we have only two main customers: Countdown and PAK’nSAVE – the two big supermarket chains, and several smaller customers. Last January, I signed contracts to supply Countdown and PAK’nSAVE with their own brand of bottled water for the next three years. They were hard contracts to negotiate. Even though you are bottling their product, they still want you to advertise in their shops and also sponsor some of their projects. Already, I have written cheques totalling $100,000 for this, which is a significant portion of the $600,000 that I have spent on overall selling and distribution costs. Then, they require specific delivery dates, and we use a special courier to deliver and stack the shelves for them. If you don’t do what they want and invoice them correctly, they won’t pay you promptly! That’s one reason I owe the bank so much money.