Reference no: EM132431132

Problem: Brighton Food Co., Ltd. (Brighton Food) is a privately-owned limited company with several shareholders. It has been in the food business for many years. Mr. John Chan is the company's biggest shareholder holding 40% of the shares. He is also the company manager who takes care of the company's business operations. In the past few years, the business is blooming as both the sales and the net income have been growing steadily at around 10% per year. However, this situation has been changed a couple of months ago since another keen competing food company entered and competes keenly in the market. Since this new competitor opened, Brighton Food has gradually lost a considerable number of customers because this competitor not only offers attractive discounts, but also gives out delicate promotional gift items to its customers. Brighton Food is not able to catch up with such flexible market promotion initiatives. Mr. Chan is very worried that the annual sales and net income growths may not be able to reach 10% any more. In the middle of the year, he prepared the following projected income statement and balance sheet for the whole financial year of 2019 in order to foresee the final business results at the year end. 

It has been a normal practice over the past few years that Brighton Food pays a special bonus to Mr. John Chan for rewarding his outstanding performance in managing the company to attain significant net income growth. However, there is, in fact, a condition for this bonus payment, which is that the net income growth must be maintained at 10% in each year. On the other hand, Brighton Food has borrowed a long-term loan from Western Bank and one of the essential terms in the loan agreement is that the 'return on assets' ratio must be at least 10% in a year. Otherwise, Western Bank is entitled to demand for the full repayment immediately even though the bank loan is still not due. 

Mr. John Chan also hires a financial consultant, Mr. Tim Lee, who is specialized in food business, to analyze the business situation of Brighton Food. After having studied the current business practices of the company, he comes up with the following important findings. First, Brighton Food only purchases its goods, i.e. inventories, from one single supplier, i.e. the Apex Food Manufacturing Co., Ltd., but the cost prices are generally 5-10% higher than that of the other similar suppliers in the market. Secondly, the bulk purchasing policy of Brighton Food has put the company in a disadvantageous position. As a matter of fact, the inventory turnover rate of similar companies is 10-12 times per year. Thirdly, the average collection period of the accounts receivable of Brighton Food is 70 days while that of the other similar companies is normally 30 days. Moreover, a higher than average proportion of the accounts receivable becomes long overdue. As a result, they turn out to become uncollectible eventually, i.e. bad debts. Fourthly, the company's cash is currently sitting in a bank current account, which bears no interest income at all. Fifthly, the long-term bank loan was borrowed two years ago with a fixed interest rate of 12% per annum. However, the prevailing bank loan interest rate has actually come down to a much lower level of 8% per annum recently. Lastly, as usual, Brighton Food is going to declare and pay a cash dividend of $15,000 <..(@$0.3 per share) to its shareholders soon after the first six months of business in a financial year. 

In fact, Mr. John Chan has connection with another bank, Eastern Bank, which may also lend money to Brighton Food. This can help the company to raise additional capital fund through debt financing. However, Eastern Bank will require its potential clients to meet a series of financial ratios based on their projected financial results of the current year in order to determine the eligibility for obtaining the long-term bank loan.

Being uncertain whether Brighton Food will be able to obtain the loan from Eastern Bank or not and also being very worried about the forthcoming situation in the second half of the financial year, Mr. John Chan even once thought of an idea to secretly create some fictitious key buyer companies and then place large amount of purchase orders to Brighton Food on credit in December 2019 in order to boost the sales figure at the end of the year. However, such kind of purchases orders will be cancelled at last, without any actual payment, in January 2020. 

Required:

Question 1: Discuss whether Mr. John Chan's secret plan will actually help solve the company's problem or not. But what are the potential adverse consequences if his plan is actually carried out?

Question 2: Based on the important findings collected by Mr. Tim Lee, suggest appropriate measures to improve Brighton Food's net income.