Assignment Task

Sam Holdings Ltd is a manufacturer and distributer of mine steel and pipes. All of its customers are in the extraction industry. The technology in the extraction industries has been changing rapidly in recent years. As a result of this rapid change, Sam Holdings Ltd has been investing significantly in research and development in order to keep pace with the changes in the industry. The company is focused on becoming the market leader in the existing product offering. The company has patented many of its existing products. This was obviously done to protect the company’s intellectual property.

Sam Holdings Ltd has a wide range of products that it manufactures. It manufactures products developed in house and it also manufactures products that have been designed by market leaders. In 2017 Sam Holdings entered into an agreement with Shaka Structured Ltd. Shaka Structured Ltd is based in Munich Germany and it is a global leader in the manufacturing of specialized high carbon content mine drills. Sam Holdings Ltd obtained the right to manufacture and sell the high carbon content mine drills. The specialized high carbon content mine drills will be distributed in Southern Africa. Sam Holdings Ltd pays a fixed royalty in Euros for each unit of specialized high carbon content mine drills manufactured and sold. The royalties are paid quarterly in arrears. The specialized high carbon content mine drills have proved to be very successful in South Africa because of the relatively complex geological structure of the Southern African region. The total revenue from the high carbon content specialized drills represents 30% of the total annual revenue of Sam Holdings Ltd. Sam Holdings Ltd’s focus has been primarily on South African customers. However, Sam Holdings Ltd has also supported the subsidiaries of South African customers that are located in the rest of Africa and the Middle East. The revenues from these foreign subsidiaries constitute about 10% of the total annual revenue. These subsidiaries are also invoiced in Euros. The mining industry in South Africa has been under a lot of pressure during the past few years. This was caused by the COVID-19 pandemic which caused a muted global economic growth. Consequently, Sam Holdings has struggled to grow its revenue over the past three years. A special type of steel is used in the manufacture of specialized high carbon mine steel and pipes. The steel prices have also been very volatile over the past few years, due to the COVID-19 pandemic. Thus, this has also added to the pressure on the company’s profit margins.

For Sam Holdings working capital management has become very crucial in order to stay afloat. This was as caused by a number of factors. Initially, a significant number of customers have been placing orders at the last moment. This caused Sam Holdings to hold larger volumes of inventory in order to meet the unexpected demand from these customers. It is important to note that all Sam Holdings Ltd’s sales are on credit. Sam Holdings Ltd allows its customers 60 days to pay from the invoicing date. A lot of customers have been delaying payments due to cash flow problems. As a result of this Sam Holdings Ltd’s bank overdraft has been increasing over the years, such that it has become a permanent source of finance. The interest on overdraft is 10% per annum, compounded monthly. Sam Holdings Ltd has had no other debt since 2020. Bankers are currently not very willing to grant Sam Holdings Ltd long term finance. This is due to concerns about the company’s cash flow generation ability and the negative outlook in the mining industry in general.

In order to improve the cash flows; the following two options have been proposed by the management:

• The company proposes to offer a 10% settlement discount to all customers that pay within 30 days. This is expected to increase revenue by 5%. The company expects 20% of all customers (by revenue value) to make use of the settlement discount. The introduction of the settlement discount is expected to reduce bad debts by 5%.

• This option involves Sam Holdings Ltd discontinuing the manufacture of specialized mine steel and pipes. Sam Holdings Ltd would purchase the equipment directly from Shaka Structured Ltd. Sam Holdings Ltd would be granted payment terms of 30 days from the invoice date. The option of purchasing would expose Sam Holdings Ltd to foreign currency movements. However, the finance manager has advised the board that any exposure to currency movements would be hedged using forward or option contracts.

Extracts from the income statement for the year ended 31 December 2021

Extracts from the Balance Sheet as at 31 December 2022

Required

• Evaluate the working capital position and the profitability of Sam Holdings Ltd for the 2021 and the 2022 financial years
• Evaluate the impact of introducing the settlement discount on the profitability and cash flows of Sam Holdings Ltd
• Discuss the factors which Sam Holdings Ltd should take into account in deciding whether to discontinue the manufacture of specialized and purchase the steel and pipes from Shaka Structured Ltd