Tuesday, 12 January 2016

Three products of Nestle


The products listed below are priced in the Nigerian local currency Naira.
Milo 500g                                            $700
Variable Cost                                      $300
Contribution Margin                           $400
 
Maggi Seasoning (100 cubes)             $220
Variable Cost                                      $140
Contribution Margin                           $80
 
Nescafe Gold Blend 100g                  $1075
Variable Cost                                      $800
Contribution Margin                           $275
 
For this step the assumption that the sales price and the variable cost remains the same and there are no economies of scale gained in larger production units or sales discounts for larger purchases. In practice both of these would normally exist.

The contribution margin could change depending on the volume of purchases as larger retailers may get better prices for bulk purchasing. This would lower the sales prices thus changing the contribution margin. Therefor different customers would have different contribution margin for the same product. In turn the larger production of a particular product could lower the variable cost and also change the contribution margin.  

The contribution margins will not be the same for all products. There are several reasons for this. Firstly if all the contribution margins were the same the company would not be competitive in the marketplace. If all the above three products had the same contribution margin as the Milo tin of $400 this would affect the selling price. The Maggi seasoning cubes would now be sold at a price of $540, more than double the original price. The customer may not want to pay this price and the company will see reduced sales and therefore less profit. The sales price can also be determined by the marketplace and increased competition or a monopoly can alter the contribution margin of a product.

Also there are different processes involved for different products. Each product contains different ingredients which come at different costs. These differences will impact on the variable costs of each product and thus alter the contribution margin. For example some raw materials may need to be imported and some can be produced locally resulting in different costs. 

The marketing department can also have an impact on the contribution margin. How a company markets itself in contrast to other competitors will alter the contribution margin. Although in a different category to Nestle this can be seen in the technology landscape. Apple markets itself as a premium product and through its very successful marketing team enjoys higher margins than much of the sector. A company marketing itself as a cheaper alternative may enjoy more sales but lower contribution margins.

A firm may produce a range of products with different contribution margins for varying reasons. The products may be complimentary products. For example if Apple had only stayed with the Mac computer it would not have reached the popularity it enjoys today. The interconnectivity of its products is an important part of its success in the highly competitive technology sector.
 
Profitability is also a reason to produce multiple products. By only producing the product with the highest contribution margin you are limiting sales. There is only so much of one product customers can buy. To increase profitability and stay relevant other products need to be offered. Although they may have a lower contribution margin they may still generate profits above the cost of capital and increase overall profits.
 
A potential constraint on Nestle would be changing consumer attitudes. This may involve consumer tastes, attitudes towards health and attitudes towards labour or resource practices. Changing attitudes towards healthier products would impact on the amount of Milo it may produce or awareness of labour practices could impact on the popularity of products such as Milo or Nescafe.

Resource quality and cost may act as a constraint. Improved labour practices may increase the cost of raw materials and thus impact the amount of production.

The political environment can change and act as a constraint on productions. For example a new government could demand more production locally and less imports. It may introduce a quota system or simply increase taxes on imports. The economic environment can impact on the types of food people will buy. A luxury item such as Nescafe Gold may become unpopular in down times and less expensive brands may become more popular. This may be especially important in Nigeria as the country’s economy is plagued by corruption, high unemployment and linked to the prices of oil which in recent times as fallen.

Restating the financial statements: comments and concerns

I didn’t have too many difficulties in restating my firm’s financial statements. Although now I have written that statement I bet I have got it all wrong.

I was lucky as my firm didn’t have too many items in its statements. My firm also separated operating activities and financing activities in the statement of comprehensive income. So all I had to do was rearrange the statement into the format shown in chapter 4 and to calculate the tax benefit for both the operating and financial activities. The one issue I had for the statement of comprehensive income was other comprehensive income. My firm only had other comprehensive income for two years and I wasn’t sure where to add the tax effect for these items. I left them in the other comprehensive income section separate to the operating and financial sections so it didn’t pollute those figures. In chapter 4 I did see property fair value movements included. I didn’t see anything like that in my firm. They did have an impairment loss on property, plant and equipment but that was for a discontinued product line and as such it should remain in operating activities.

The one thing I enjoyed about the restating and how it was done is that it actually makes you read through the notes to better understand items. This was very helpful when restating the balance sheet. The item cash and cash equivalents were broken into cash and bank balances and call deposits. I didn’t know what a call deposit was and upon further research I found it was an interest earning account where money could be pulled from at any stage if needed. This is similar to a savings account I have. I decided that similar to myself the purpose of this account is to earn interest and as such I classified it as a financing activity.

I also considered classifying the bank overdraft as financing as it is essentially a short term loan from the bank. A loan from a bank would normally be considered financing however as it results from the day to day operations I included it as operating. I was then rereading chapter 4 and realised the answer was already there and I didn’t need to think about it so much.

My firm also provides loans and advances to company employees. Although these are loans which must be paid back with interest I kept these in the operating section as they are not used for financing activities. I consider these a cost of doing business and a tool used to keep employees much the same as fringe benefits and as such they are related to operating activities.

The other concern I had was the item trade and other payables. Within this item was included an import finance loan. I didn’t know what an import finance loan was so I had to research this term. After consideration I believe it is a financing activity even though it is used as a facility to ease the burden of imports which are an essential operating activity. Unlike a bank overdraft it is not linked to any other accounts and the cash is not used for day to day operations.  



Sunday, 10 January 2016

Chapter 4 ideas, reflections and reactions



Before I read this chapter I must say I was keen to explore. I wondered if there would be some hidden secret to unlocking the information provided in financial statements. I have never really analysed financial statements before so this was all going to be new to me.

The analogy of the fish markets made sense. Capital markets are predictions on future cash flows based on publicly available information. Predictions take into consideration past performance, competitors, legal landscape, future needs and much more. Not all of this can be known so the future predictions may be right or they may be completely wrong. The point is with the fish market or any other physical item for that matter you can see it, touch it, even smell it if you want to however this cannot be done in the capital market. In the capital market you can only base decisions for resource allocations on predictions. As such there needs to be some sort of framework to make these predictions.
We are also at the mercy of management and their chosen accounting methods of choice and disclosure practices. I guess this is similar to the McDonalds burger ads you see on TV. They look so fresh and full yet when you receive your order the burger is not the same. What I mean by this is the financial statements can be manipulated to a certain extent to promote a positive performance just like the burgers on the ads are manipulated to show them in their best light. However what you get may not necessarily be what is promoted just like financial statements to an extent.

Looking at the free cash flow examples shows how you can be easily misled if you focus only on the cash flows with no thought of the surrounding numbers or information. In fact the same can be said for net present value (NPV) and internal rate of return (IRR) ratios. In fact the same can apply for any ratio as there is no single measure which gives you all the information you need. For example if you had two competing projects and could only choose one, logic would say choose the project with the higher NPV however all this does not show the money that needs to be invested. This is exactly what is shown in the example in this chapter. One project may have a higher NPV but it may require a lot more to be invested to earn that profit. If more money is tied up in an investment this also increases the risk of the project, something which NPV does not consider.
Reading through the economic profit section and more specifically the cost of capital really makes you think of your own life. It is definitely true that capital can only be used or invested on one thing at a particular time. Capital can be money or even time. I think of all the opportunities forgone by making the decisions I have so far in my life time. It’s funny how you don’t really consider the cost of capital in our own private lives. Especially in regards to future finances.  Oh my I wish I could go back and change some of them. I am sure many people are like that and such is the value of hindsight. Lucky we have ratios and other frameworks to assist in our finance investments. Unfortunately they are not foolproof.

The difference between the economic profit ratio and other ratios is that it takes the cost of capital into account. It essentially reduces the operating income down to an amount over and above the cost of capital the company employs. The cost of capital may be an arbitrary figure or it may be based on a weighted average and take into account such things as the debt structure of the company and the risk free rate of return or the return on government bonds.

I have never broken a financial statement down into operating and financing activities. I think it is a good thing. It allows more clarity and you can see each activity more clearly. It is important to see both the debt structure of a firm and how its operations are performing. Separating both also gives you a better measure of management performance. I was lucky as my firm already separated most of its operating and financing activities in the income statement so it was really only the balance sheet which required much attention to detail. For me restating the financial statements also allowed me to understand the underlying data more clearly as I was forced to read the attached notes when deciding whether an item was operating or financing.  

When I first saw the statement of changes in equity section I was bracing myself for the pain. I haven’t had much to do with this report and whilst it is relatively small it raises questions for me. However proceeding through the section I realised my hesitance was unfounded. In fact this looks the easiest section to restate. I wish I had time to restate other company’s financial statements to get the hang of it and develop a deeper understanding.

I used the tip and printed out my firms financial statements for the assignment to place either an O or an F next to them. It was quite helpful as it allowed me to browse through the notes to the financial statements on my computer and record the F or the O on the printout. I was able to go back and forth between the two without any confusion. At first I thought a bank overdraft would be considered a financing activity because it is essentially a short term loan provided by the bank to the company. I only vaguely knew what a bank overdraft was so I researched the term through google and after reflection I agreed that it would be an operating liability as the purpose of this item if for day to day operations. It is also linked to other operating accounts so it doesn’t really meet the requirements to classify it as a financing loan.

The ratios were familiar to me not only from previous courses but also previous work experience in an industrial supplies company. The profit margin was used mostly to ensure we had enough margins in our sales compared to other industry competitors or other customers. Where the margins were a bit light or small we investigated opportunities to increase whether through higher sales price or lower buying price. This sometimes involved renegotiating buying contracts to get better discounts which in turn required us to buy more stock in some instances. Thus we had to explore the costs and capabilities of having more stock in our warehouse and also the opportunity cost of the increased purchases.


Wednesday, 9 December 2015

Nestle Nigeria PLC KCQ's

The first thing I noticed whilst looking at the financial statements was that there were no restatements. This is good as it makes comparability easier and there is no wondering why there was a change of accounting method.


It is interesting to see the shareholder representations. As previously mentioned Nestle S.A, Switzerland now holds 63.48% or 503,177,098 shares. There a total of 29,101 shareholders of which just over 60% own only between 1-1,000 shares. In fact 86% of shareholders only own a combined total of just under 3% of the shares in the company. I am not sure how this compares to other companies but it is an interesting look at the wealth distribution of one of the biggest companies in Nigeria.


The company has recorded consistent growth in revenue however the operating profit has not maintained the same growth. In fact profit after tax has somewhat stagnated over the last 3 years. This would mean the growth in the costs of business has exceeded the growth in revenue. I wonder what the cause of this is and whether it is expected to continue into the future. Looking through the income statement I can see marketing and distribution costs and finance costs seem to be the major contributors.


I wonder what might be the cause of these rises. I can see there are notes attached to the finance costs and in 2014 there was a much larger net foreign exchange loss than previously. This makes sense as in the chairman's statement there is a discussion about the economic environment within Nigeria. Although the country has experienced continual GDP growth, declining oil prices amongst other factors led to a devaluation of the Naira which is the national currency. The uncertainty surrounding the global market and the resources sector may continue to have an influence over the company's results.


It's hard to tell what the cause of the increase in marketing and distribution is as it only appears in the notes of the 2014 financial statements. There does seem a large increase of around 60% in sales promotion expenses. Why is this so? Is there increased competition? If so, what impact will this have on future revenue or the costs of future promotions?


Looking further into the statements and another area of concern develops. The current ratio of the company is less than 1. This means the company does not have enough current assets to cover their current liabilities. In fact cash and cash equivalents dropped from 13,716,503 thousand Naira to 3,704,505 Naira. This is very concerning, I wonder why this is. The notes contain a lot of information surrounding liquidity risk and credit risk among others. IT is a bit confusing but definitely something that would require deeper investigation.


Looking further into the cash situation I note dividends paid have almost tripled over the last 3 years, borrowings has increased and investments has decreased? Why has the dividends paid increased so dramatically? Cash spent on investments may have decreased as they had just finished their upgrades or new facilities which would not be a bad thing. However it may have decreased as they have looked to make savings which if this was the case would not be good as without investments the future may be bleak. Is the company financing its activities with too much debt? Is this the reason cash is down? Although many these are just a few of the questions raised in my head after looking at the cash and cash equivalents of the company.


A more in depth look at the statement might provide more questions as well of some of the answers. I never knew annual reports and more particular financial statements could be so interesting. That may sound a little nerdy but even after a brief look at I want to know so much more about them. I want to understand what the numbers mean and the business reality they are trying to convey.





Nestle Nigeria PLC Annual Reports 2012-2014


Nestle Nigeria PLC

Although the Nestle story starts way back in 1866 it was not until 1957 that they ventured into Central and West Africa. Nestle Nigeria PLC did not start trading until 1961 and was not listed on the Nigerian Stock Exchange until 1979.


Nestle Nigeria PLC forms part of the 22 regions under the control of Nestle Central and West Africa (CWA) Limited who is the major shareholder of the company. This is a concept Nestle has followed world wide in which smaller companies are organised into different regions. Although in 2014 Nestle CWA transferred it's 59.59% shareholding to Nestle S.A, Switzerland resulting in that company now holding 63.48% of total shares.


Nigeria itself has a population of over 170 million with more than 500 languages being spoken with English remaining the official language. Although rich in natural resources Nigeria remains one of the poorer countries with high unemployment rates and much corruption and political instability. This would present Nigeria PLC with the challenges of keeping prices low and distancing themselves from any form of bribery or corruption.


The product offering in the region is limited and not as extensive as you may find in other countries. Not surprising considering the previously mentioned high unemployment. With lower disposable incomes I would think the product line would have to be kept simple to thrive in the region. For instance the popular Kit Kat, of which 150 are consumed worldwide every second, is not distributed in Nigeria or in fact the entire Central and West Africa region. In fact there are no Nestle chocolate or confectionary brands distributed in Nigeria other than the aptly named Chocomilo.


Other than Chocomilo the other products include baby foods, cereals, water, Milo, some Maggi foodstuffs, full cream milk and coffee.




Taken directly from the Annual Report the company's objective is 'to be the recognised leader in Nutrition, Health and Wellness and the industry reference for financial performance'. As part of their "creating shared value" program the company is also committed to several social projects aimed at both people and the environment. These projects range from reducing saturated fats and removing trans fats in products to raising awareness of water conservation and improving access to water sanitisation to elimination of child labour in key categories.


It does make me wonder what they mean by "key categories". Surely they should want to eliminate all child labour not just in "key categories".


Other issues facing the company revolve around sustainability. Nestle has identified an increase of 70-80% by 2050 in agricultural food production to meet the demands of a growing global population. In Nestle Nigeria PLC much of this focus has been placed on water management.


Also of importance to the company is the issue of nutrition. Not only is this relevant in a global population that is increasingly looking for healthier options thus becoming more popular. But I would also think this is important considering the socio-economic status of the Nigerian people. With lower incomes sometimes the first sacrifice is nutrition and as such I would hope there is a high importance within the company to produce low cost high nutrition foods.


Further information on other commitments and creating shared value can be found on the following links. There is also a YouTube clip posted below the discussion.


http://www.nestle-cwa.com/en/csv/what-is-csv/commitments
- http://www.nestlecocoaplan.com/
- http://www.bloomberg.com/news/articles/2015-08-31/nestle-s-kitkat-to-change-cocoa-supplies-to-address-child-labor

Nestlé Waters Nigeria - Project WET on the Move