Enager Industries Inc. is a young company whose growth was profound up to 1993 when it amassed sales over $222 Million. This company is comprised of three main divisions that are all considered to be independent from one another. The first and oldest division of the company is the Consumer Products Division which designs, manufactures, and markets a variety of kitchenware. The Industrial Products Division focuses its efforts on creating machinery that is uniquely and specifically designed in a job shop environment.
The Professional Services Division adds a different aspect to the company in comparison to the other two product-based divisions. Professional Services provide a variety of planning and consulting services including: land planning, landscape architecture, structural architecture, and consulting engineering services. There are only a few corporate level managers and general staff available to carry on the varying degrees of operation between all divisions. Strategy Enager has experienced rapid growth in its early stages, which has contributed towards its current success.
As of 1992, they attained a gross return on assets of 9. 3 percent. In the eyes of Henry Hubbard, the Chief Financial Officer, gross return on assets for Enager should be reaching levels of above 12 percent for all divisions of the company. In 1992 the company changed the objectives and performance evaluations of each division from profit centers to investment centers. This was done to better able to relate each division’s profit to the assets the division used to generate its profits; at least that is what the top management believed.
As well, each division was measured as based on its return on assets starting in 1992 – on Hubbard’s belief that this method “made the sum of the [divisional] parts equal to the [corporate] whole. ” With return on assets in mind moving into the future, top management concluded that any new investment proposals would have to show a return of at least 15 percent in order to be approved. This is in line and closely reflects Enager’s high growth strategy, and works towards driving gross return from 9. 3 percent up to 12 percent. Situational Analysis
Key Inferences from Statement of Cash Flow (Appendix A) From the calculations that we got from building the Statement of Cash Flows, the net cash from operating activities in 1993 amounted to $14,826,000. A large portion of the net income in 1993 was earned in cash and that fact is supported by the quality of income ratio of 1. 22 (Operating cash flow/Net Income). This high ratio represents Enager’s ability to generate cash from its operations; and also recognition of their strong operational performance. The net cash from investing activities for 1993 were -$28,158,000.
This indicates that long-term fixed assets were purchased in planning for the expansion of the business and rightly so, $25,230,000 of that was used to purchase property, plant and equipment. One can make a statement that the disappointing return on assets in 1993 was due to the massive increase in fixed assets of over $28,000,000. With the increase in assets and a comparably slight increase in net income of $1,249,000 from the previous year, there is certainly room for an argument that poor ROA was a result of these massive additions. The net cash from financing activities for 1993 was $13,257,000.
With capital investments of $28,158,000, as calculated above in the investing activities section, Enager was able to finance around half of it ($13,257,000/28,158,000=47%) with external financing. The heavy increase in debt financing can be seen in the 1993 income statement for Enager Industries Inc. This company paid $2,928,000 of interest that directly affected net income; which ultimately affected the ROA in 1993. Substantial increase of 69% in interest expense does not go unnoticed. Financing of the company has also been attained by a large issuance of common shares in 1993 of $6,320,000.
However, this financing was eventually “cancelled out” by the large dividends that were paid in cash in 1993; $6,285,000. It is to note that a thorough examination can be done if statement of cash flows were performed for each division, since the top management would like to see which division did not perform as well as others as company-wide ROA dropped year-to-year. Statement of cash flow by division can provide a better analysis to study which division performed well in terms of operations, and which division made poor judgments in their investments. Enager Industries Inc.’s situation, based on the operating activities of the statement of cash flow, is fine in terms of managing its operating and day-to-day cash flows which able them to finance their multiple investments and operations. However, if the economy or the industry were to ever tumble, Enager Industries Inc. bears a very high risk since it relies heavily on the operating activities of the company. For a company that reached $222 million in sales in a year, cash balance of only $4,407,000 shows that the company is driven for a high growth in a very short amount of time. Key Inferences from Balance Sheet (Appendix B)
From the 15% increase in inventory from 1992, we analyzed that Enager Industries Inc. is forecasting higher sales in the future. One could also argue that the increase was due to the company not able to sell its budgeted inventory in 1993. Acquisition of new plant, equipment, and other assets represents the company’s strategy of high and quick growth to generate more revenue. However, as stated in the section above, this leads to a decrease in ROA since the year-to-year increase in net income ($1,249,000) is significantly lower than the year-to-year increase in total assets ($34,161,000).
This suggests that the additional assets did not generate as much income as originally forecasted. Increase of 22% in long-term debt suggests that Enager Industries Inc. took on more financing to finance its acquisition of new plant, equipment and other assets. From the examining the year-to-year increase in long-term debt (including the current portion) and interest expense, we calculated the interest rate to be 9% for the new long-term debt. This signifies the high interest rate levels, when compared to average interest rates in 1993, for Enager Industries Inc.
Key Inferences from Income Statement (Appendix C) Sales for Enager Industries Inc. in 1993 saw a very disappointing increase of only 4. 94% year-to-year. This is relevant when counting the fact that there were substantial acquisitions in capital expenditures as aforementioned. The gross margin saw a positive increase year-to-year, since the cost of goods sold increased by a lesser percentage (3. 97%) than sales in 1993. In all, the net income rose by 11. 45% year-to-year since Enager Industries experienced a lesser increase in total expenses (6. 45%) than gross margin (8. 10%).
As a result, this company saw many of its ratios increased but only slightly. Return on sales and return on owner’s equity were highlighted in the case as some of the profitability ratios that went up. However, return on assets and gross return on assets were also highlighted that saw decreases. Management Control Systems Issues and Alternative Solutions Enager Industry Inc’s recent implementation of investment centers, from profit centers, had not only created tensions between the divisions and the headquarters, but may also be hindering the growth of the company as a whole.
There are several issues with the current management control systems that need to be carefully analyzed; and alternative solutions for each ones respectively. Issue 1: Requirement of 15% ROA for new investment proposals Enager should determine the feasibility of projects based on net present value (NPV). Therefore, any project with a return on investment greater than cost of capital should be accepted. Economic Value Added (EVA) is a reliable measurement that also leads to better goal congruence because EVA specific to a division is not very comparable across divisions; the managers will then be able to focus more on operating efficiencies.
The new product proposal from Sarah McNeil of the Consumer Products division attains a positive EVA (refer to Appendix D). At the same time, it has 13% ROA which is should be accepted since it is greater than the firm’s internal rate of return of 12%; even if it doesn’t seem align with Hubbard’s decision to reject any proposals that does not show a return of at least 15%. Issue 2: Identical performance measurement and target for all divisions Each of the divisions performs different business activities as well as risks.
Therefore, they should also be evaluated with different standards. For example, because Industrial Products division experience more risk than Consumer Products division depending heavily on each individual project undertaken, a higher ROI should be required to approve projects. Enager should set the ROA target based on EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) for company-wide as well as for Consumer Products division and Industrial Products division. This will allowdivisional managers to focus more on operation and less about tax and debt management. On the other hand, the professional service division carries significantly fewer assets to be included in the ROA calculation. Their assets are mostly intangible assets in the forms human capital and resources.
For this reason, the performance measurement based on ROA does not effectively describe its actual performance. As well, using ROA for the Professional Services division tends to exaggerate and inflate the actual performance, when also compared to other divisions.Instead, percentage market share and/or revenue per salesperson can be more suitable to gauge divisional performance. Issue 3: Corporate administrative expenses distribution Corporate headquarter expenses are attributed towards individual division based on revenue. However, division’s actual use of the administrative expense may vary greatly depending on its operational activities. For example, the Professional Service division probably requires more administrative services, so this division should be allocated a larger portion of the administrative service expenses.
Issue 4: ROA performance calculation that includes the NBV of assets Gross book value should be used instead for ROA to discourage the usage of old machineries for purpose of increasing ROA performance. As a result, the Consumer Product division will be motivated to produce less of the lower quality products from the old machineries, and be encouraged to acquire new plant, properties, and equipment which results in higher quality products. Issue 5: Tensions between the divisional managers and the corporate headquarter Once a fairer performance measurement system is in place, the tension between the divisions would ease.
As well, performance measurement based on the balance scorecards creates a more equitable standard that is specific to each division (refer to Appendix E). Much of the tension stated in the case was generated by the frustration of the general manager of Industrial Products division. With balanced scorecard in place as another performance measurement, he is encouraged and supported by the top management to purchase new plants, property and equipment. Issue 6: Goal congruence Enager appears to have a difference of interest amongst the top management.
On one hand, the company’s president, Mr. Randall, is more concerned with the shareholders and maximizing the EPS than other performance indicators. On the other hand, the CFO, Mr. Hubbard, is focusing more on the ROA. Therefore, this difference in objective causes confusion amongst the subordinates, like Sarah McNeil of the Customer Product division. The solution is for the president and the CFO to communicate and standardize the measurement objectives tailored to each individual division in the organization. Conclusion
It is important to state that no financial performance measurement is perfect. There are always flaws in different situations and the economic conditions can make a financial performance measurement that was useful yesterday irrelevant today. But having multiple performance measurements can minimize any gaps or missing holes, such as the balanced scorecard that we offered as another measurement or ROA target based on EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). For any companies or organizations, it is about finding the right balance for anything.
It is the top management’s job to find a practical financial performance measurement that best fits the industry and business that a division is in. They also have to keep in mind that as well as the short-term goals, long-term goals and survival of the company are key factors; so make sure to have financial performance measurement that reflects the long-term goals. Appendix A Appendix B Appendix C Appendix D Appendix E Balanced Scorecard for Customer Products Division Measures Importance of Measure Innovation and learning perspective Innovation is important for Enager’s growth.
Therefore, it should be accurately measured, by first, counting the number of new products released and the amount of money spent on R&D. On the other hand, employee growth can be gauged with number of training days per employees, turnover rates, and number of workshops. Due to the fact that the kitchen wares industry is a mature one, Enager must differentiate themselves with new products to capture the audience. On the other hand, a better trained, reliable workforce is able to perform their duty with efficiency and lower cost. Internal Business perspective
The product quality can be measured based on the number of product returns and warrantee expenses. Since this division’s profitability depends on the product, it is vital that quality is maintained. More product returns signals customer dissatisfaction, and loss of confidence in the brand. Also, producing quality products reduces the potential cost of defective products. Customer Perspective A good measurement indicator of the customer base is the market share of kitchenware products. Also, repeat purchase, referrals are all good measurements as well.
A good market share usually means profitability for a manufacturing industry such as kitchenware. On the other hand, kitchenware products can be purchased by the same customer numerous times, so it is crucial to have loyal customers. Financial Perspective Percentage revenue growth and ROI measured residual income can both be used as performance indicators. Stable sale growth is important to the company’s ability to earn profit, and the ROI signals the long-term survivability of the company. Balanced Scorecard for Industrial Products Division Measures Importance to Measure Innovation and learning perspective
– Expenditure on research & development as a percentage of previous sales – Personnel development days per employee per year Innovation within this division is absolutely critical. This division operates as a large job shop environment in which all of the products developed for customers are one of a kind products designed with state of the art technology; therefore, continuous investment in new assets and equipment is crucial to innovation and ability to respond to customer demands Just as new equipment must be purchased to keep up with customer demands, Enager must also be training its personnel on new processes and equipment Internal Business Perspective – Efficiency, effectiveness, & use of capacity Making great use of materials, equipment, and other capital assets is crucial towards covering the continuous capital expenditures and reducing overall costs Being in a job shop environment, the products being manufactured are usually longer term projects that can take up to several months to complete with dozens of stages throughout the entire process; therefore, being able to effectively manage projects is key to satisfying customers and using capacity to reduce costs
Customer Perspective – Customer feedback through customer relationship management (CRM) The industrial division is designed to make uniquely specific equipment/products for customers using state of the art technology. Keeping in touch with customers, checking up on products, and involving customers throughout all stages of a projects design and manufacturing is critical. Moreover, a large job shop environment consists of low amount of product produced with high flexibility in product design and therefore, fewer customers with larger projects.
Customer relationship management is critical to ongoing improvement and future success Financial Perspective – Return on Investments (ROI) Return on investment is a standard performance evaluation for corporations that the industrial products division must habitually revisit in order to properly determine where and when their investments should be made, which investments were financially good decisions, and those that were poor Balanced Scorecard for Professional Services Division Measures
Importance to Measure Innovation and learning perspective Employee growth can be gauged with number of professional training days per employees, turnover rates, and number of developmental workshops Having the know-how, skills, abilities and knowledge are the keys to having the winning edge in this industry. To compete against competitors, the employees in this division must take on personal developments and keep up with the micro/macroeconomics of the industry. Internal Business Perspective
The service quality can be measured based on the number of discontinued projects, client complaints, and surveys from the clients. Also, measuring time utilization for amount of sales compared to the hours worked is important. The service quality is important in the industry that this division is in. They have to compete on the services and consultations that provide to the clients. Also, acquiring the most capacity from the employees to capitalize on the growth is important for the growth of this division so there must be a measure.
Customer Perspective A good measurement indicator of the customer base and loyalty is the market share of similar services. Also, repeat clients and referrals are all good measurements as well. Word of mouth is very important when a business is selling its services. People depend more on what other people say and recommend. A good market share usually means profitability for the services that this division provides.
These services can be purchased by the same client numerous times, so it is crucial to have royal customers. Financial Perspective Performances can be measure by either or both – Revenue by salesperson – Market share growth Stable sale growth is central to the company’s ability to earn profit, and capitalizing on the market share is vital for the long-term survival. But also motivating and stimulating market capitalization by each salesperson are important.
