Steps 1-5 - Assignment 2 | Megan S Accounting L

Assessment 2 - Steps 1 - 5

Company: NEXTDC

My Blog: https://meganbittner95.wixsite.com/megan-s-accounting-l

Step 1: KCQ’s Chapter 6 ‘Understanding Key Cost Relationships’ and Chapter 8 ‘We Have Got to Make Some Decisions’ in the Study Guide’

In Chapter 6, I very much liked the concept of allocation of costs is just like a messy bedroom. I thought this was clever and very true. When moving into my own home one of the first things I was excited about was making sure everything I had had a spot and was organised. Accounting and cost objects all have a home, and it is our responsibility to make sure they stay neat and organised. I would feel that if everything continued to ‘be thrown in the cupboard’ then we could lose sight of what is relative and land our accounts in some hot water.

I strongly agree with how Martin talks about making sense of the costs, costs are everywhere in life and importantly in our businesses. It is crucial to have the right relationship with costs and start nice and easy, ever so quickly can things get out of control. As a manager, I’ve had struggles with costs in the business and there have been times when I have felt, oh it’s okay I can dip and dabble all between the lines on a P&L, but through understanding how each part of costs plays their part and affects the business and the structure of the P&L, I’ve been able to plan and make better choices for the teams I work for and the overall business. All actions have consequences, and we must make the right decisions. If we don’t then we can end up hurting more than just costs.

In chapter 8, I found quite interesting the way Martin explains ‘focus on what is relevant’. Decision-making is hard and as managers, we know that sometimes the smallest decisions we make can have a large impact. I enjoyed the example Martin used in this section about sunk costs. I’ve never heard of that phrase before which astounds me as I like the phrase and I should have overheard it somewhere before. Sunk costs are the costs that are not directly involved with our product or service but are the costs that help us get the business to where we need to be, we can’t change the costs as they have already happened. The decisions regarding these costs on reflection seem very important as I feel that these are the tiny decisions that pave our pathway forward.

I connected with the subject of ‘long-term decisions’. Martin discusses how managers will sometimes need to make decisions that will have a long-term impact on the business. The financial decisions sometimes involve large amounts of money whether it involves investments or other sources of revenue, the decisions are to benefit the business over quite a few years. I believe that sometimes we are faced with decisions every day that it feels like we are constantly putting out fires just to get by. I believe that it is quite important to plan and commit to long-term planning as this is where our business can grow.

Step 2: Three products of service – Next DC

Next DC is an independent, eco-friendly data centre that operates Australia-wide. They are the leaders in their field and provide colocation services to foreign and domestic companies. The three services that Next DC provides are reflected below:

Colocation services
Data migration and relocation
Building suits and wholesale data centres.

Next DC produces products and provides a service. Given the extensive range and options one must choose, the selling prices and variable cost prices are estimated for the purpose of this assignment. When determining the variable cost price and contribution margin, I have reviewed the Cloud Storage Services in Australia industry trends and cost structure to give an educated guess when finding these figures. These figures showed that variable costs are averaging 68% for 2023 and I will be using this figure for the purpose of this assignment.

Service

Selling Price (P)

Variable Cost Price (V)

Contribution Margin (C)

Colocation Services

Quarter Rack - $8,000

Half Rack - $11,500

Full Rack - $15,000

BYO Rack - $5,000

$8,000 x 0.68 = $5,440

$11,500 x 0.68 = $7,820

$15,000 x 0.68 = $10,200

$5,000 x 0.68 = $3,400

$8,000 - $5,440 = $2,560

$11,500 - $7,820 = $3,680

$15,000 - $10,200 = $4,800

$5,000 - $3,400 = $1,600

Data migration and relocation

$17,000

$17,000 x 0.68 = $11,560

$17,000 - $11,560 = $5,440

Building suits and wholesale data centres

$25,000/m3

$25,000 x 0.68 = $17,000

$25,000 - $17,000 = $8,000

Contribution Margin, Selling Price, Variable Cost, and Calculating Constraints

The contribution margin formula is C = P – V.

Next DC has quite a large variable cost of 68% of the cost structure of our services, and our cost price is the same for all three of our services. This is due to the similarities between the services on offer. The variable costs are made up of labour, raw materials, supplies, distance of travel, use of external companies (i.e. moving trucks), electricity, fees, rates etc. Which can be slightly different depending on the type of service the customer chooses.

With similar variable price factors, Next DC can produce a range of services which is important as we can meet the needs of our customers. It is important to have a range as people have many different needs and requirements for our services. Take colocation services for example, if we only provided this service of a Full Rack, yes, we are making $15,000 in revenue from one customer, but the customer might not require all that data and it can become wasted. However, if we offer Half Racks, to two separate customers, we use the same amount of space and receive a combined revenue of $23,000, therefore we are not wasting space, and we can provide our services to more customers.

I believe that the use of contribution margins is extremely valuable for management when making decisions because it gives us an understanding of each cost. It allows us to make an informative decision regarding where each dollar goes and then keep track of each dollar. The decisions that management might need to make that are supported by the contribution’s margins are the decisions that impact our profitability as well as the ability of the service to thrive in the market. Prices too high can be just as damaging as prices too low.

A few resource constraints Next DC may face are finding the right locations that have enough space for expansions and growth in the business, there are security measures we must consider, and global expansion regulations in foreign countries. The reason we must consider these constraints to be relevant is due to the overall impact on profit and revenue they will have. Without expansion and growth, Next DC will never increase its revenue and profit.

Step 3: Ratios

*Please refer to the Excel spreadsheet for Next DC ratio calculations.

Ratio analysis helps us analysis our firm’s relationship between two items on our financial statements. It is up to the person reading these statements to determine whether they find the information adequate. We can use this information to determine future decisions we want our firm to make and potentially which direction the firm is to head in. Over the four years 2020-2023, there has been a huge disruption to the world and industry with the global pandemic. Due to this pandemic and constant change and disruption, it has been hard to determine the causes for such loss. Overall, we can see improvements throughout all the losses.

Profitability Ratios

Gross Profit Margin: The Gross Profit Margin ratio is where we can determine whether our firm is making a profit or not. We can see that over the four years, Next DC has been in the negatives with 2022 almost reaching that positive. The industry has shown some ups and downs over the last four years but should not be operating at a loss.

Net Profit Margin: The Net Profit Margin ratio is used to measure how much sales/revenue a firm gets to keep after we take out items such as taxes and interest charges. Next DC only saw a positive in 2022. However, there were large improvements year on year from 2020 to 2022, then only a minor setback in the negatives in 2023.

Return on Assets: The Return on Assets ratio gives us insight into the firm's profitability versus our total assets. Next DC has only performed at a slight loss when it comes to their assets. 2022 was able to pull in just over the line with a positive at 0.3%. It does become concerning as assets are normally a last resort to saving our profit vs losses.

Efficiency Ratios

Days of Inventory: The Days of Inventory ratio tells us how long we hold our inventory stock before it has been sold. Given that Next DC provides more of a service to our clientele rather than selling products, I find that this ratio is not quite relevant to this company’s financial portfolio.

Total Asset Turnover Ratio: The Total Asset Turnover ratio signifies the firm's efficiency when using its own assets and circulating them into revenue/sales. The company does not have a large amount of revenue that has been formed from their assets but Next DC has kept a consistent level ranging from 0.8 to 0.10 over the last four years since 2020.

Liquidity Ratios

Current Ratio: The Current ratio is where we can determine our quick fixes or short-term problems. We can assess our assets and liabilities and find quick cash here if needed. Next DC does not have much to draw on but has made consistent improvement. A massive jump from 2020 to 2021 with the world going into lockdown and everyone moving online. We can see consistency from 2021 to 2022, and as we have learned to live in a world with covid and online presence we have made a substantial jump again at the end of 2023.

Quick Ratio 1&2: The Quick 1 & 2 ratio allows firms to assess their ability and make payments without taking from their inventory or other areas of the business. Again, we see that we don’t have a lot to draw from, but Next DC does continue to increase year on year from 2020-2023.

Financial Structure Ratios

Debt/Equity Ratio: The Debt/Equity ratio is where we can identify how much debt our firm is in. From 2020-2023 Next DC has had quite a lot of debt under their belt, but in 2023 we can see that they have reduced that debt significantly, dropping that number right down to 7.62%.

Equity Ratio: The Equity ratio allows us to assess our firm’s resources and uncover how much we require our shareholders to contribute. For Next DC this is quite a lot. We very much rely on our shareholder's money. Through the pandemic, this time was quite difficult and there was a lot of uncertainty Next DC averaged around 60% mark for shareholder equity.

Times Interest Earned: The Times Interest Earned ratio is used when a firm needs to determine whether it can interest its finances and meet all its financial obligations for the future. There was an increase for 2023 with almost hitting 10%. Next DC managed to hover around the same mark from 2020-2022 but improved their profit by 9.67% in 2023.

Market Ratios

Earnings per Share (EPS): The Earnings per Share (EPS) ratio helps a firm to understand its place and its value, it signifies how much a firm’s stock earns and determines the corporate value. Next DC has stayed very consistent in breaking even over the last for years.

Dividends per Share (DPS): The Dividends per Share ratio tells us how much a firm's earnings are paid to the firm’s shareholders. Next DC did not have any money paid out.

Dividends Yield Ratio: The Dividends Yield ratio is used for when we need to evaluate the firm's stock prices vs its dividends. Next DC did not have any money paid out therefore we cannot confirm between the two.

Price Earnings Ratio: The Price Earnings Ratio tells us how much the firm’s shares are and if they fit within our budgets. Next DC has fluctuated over the years which could be caused by the constant changes in the market.

Net Asset Backing per Share Ratio: The Net Asset Backing per Share Ratio gives us insight into the firm’s profitability on its assets. We can see that Next DC has kept a steady pace over the last four years.

Market/Book Ratio: The Market/Book Ratio is often used by investors to evaluate the market's value and how it compares to other firms' value. Next DC has a very strong market value, they have increased year on year until 2022 with a slight drop in 2023.

Current Operations

Overall, these ratios tell us that Next DC has not had the most successful four years. They have only had one strong year in 2022 with the rest all operating at a loss. For assignment one I had struggles understanding the flow of all the balances but completing the ratio task has made my understanding a lot clearer. I do believe it is not all bad, what they do lack in profit they make up for in equity. Unfortunately, I don’t believe it will be enough if they continue on this current downward trend.

Future Operations

Next DC are going to have to put some serious plans in place if they want to undo some of the debt, they are in. I don’t believe they are in any position for quick fixes, it will all need to be strategic planning for the long game. Next DC has survived the last 4 years of the pandemic. I think now that we are past the hard parts they very well need to buckle down and focus on growing profit, looking into how this is down, and what impacts their ability to grow their clientele. Next DC has been working on expanding not only within Australia but also overseas, potentially this is an area that might need to hold as we all know you have to spend money to make money but focus on gaining more business in current operations than they can pay off their debt and can move back to the expansion plans.

Step 4: Capital Investment Options

Next DC is looking into developing its capital investment portfolio. Through passion and planning, they are considering expanding operations and venturing out of Australia over to either Tokyo, Japan, or Auckland, New Zealand. NEXT DC is internationally established and will continue to expand worldwide. It is just a matter of choosing where to invest in the global industry.

The below table will summarise two capital investment decisions for Next DC.

AK1 Auckland Data Centre

TK1 Tokyo Data Centre

Original Cost

$700 Million

$950 Million

Estimated Life

10 Years

Discount Rate

Estimated Future Cash Flow

2024 (Year 0)

-$700

-$950

2025 (Year 1)

-$500

-$800

2026 (Year 2)

-$350

-$650

2027 (Year 3)

-$150

-$450

2028 (Year 4)

-$50

-$350

2029 (Year 5)

$150

-$50

2030 (Year 6)

$350

$150

2031 (Year 7)

$550

$450

2032 (Year 8)

$750

2033 (Year 9)

$850

$950

2034 (Year 10)

$900

$1200

* Please refer to Excel spreadsheet for calculations of Next DC payback period, NVP, and IIR*

#1 AK1

#2 TK1

Recommended Option

Payback Period

8 Years

10 Years

AK1

Net Present Value (NPV)

$272

$-1103.16

AK1

Internal Rate of Return (IRR)

10.4%

1.0%

AK1

My recommendation for the capital investment is option 1 Auckland, New Zealand for the new data centre. As you can see from the figures, we can achieve the payback period in 8 years compared to Tokyo, Japan which has a payback period of 10 years. A faster payback period means that Next DC can get back on track with their financial obligations a lot quicker. We have learned before that they need to find quicker ways to get cash, having a faster repayment can help them achieve goals quicker.

The Net Present Value (NPV) is used to determine a firm’s current value of future payments for its next project. Even though AK1 has a small value of $272, this value is bringing in a positive return compared to TK1 which is at a negative of -$1103.16.

The Internal Rate of Return (IRR) is used to establish how long a firm’s return on investment is, the greater the value the greater return on investment. AK1 is again the recommended option due to its value of 10.4% compared to TK1 which has a value of 1.0%.

Reviewing the evidence, it is quite clear that the option to expand and invest in Auckland, New Zealand for the new data centre will provide a quicker return and potentially stabilize the capital to continue the global growth of this company.

I believe that by completing these tasks we can plan to some extent what the influence of capital will have on Next DC. These tasks of estimating cash flow, NPV, and IRR can give us a potential timeline to be able to conduct future planning for our firm. The downfall of this is that it is only a guide, and we still cannot predict the future of Next DC.

PEER FEEDBACK SHEET: ASS#2

Feedback From: Megan Bittner

Feedback To: Natalie Mullins

My Comments

Step 1

KCQs – Chapters 6 and 8

This section was not complete to review.

Step 2

Identify three products or services of your firm

Estimate selling price, variable cost & CM

Commentary – contribution margins

Constraints – identify & commentary

Very detailed, good job on your 3 products. Gave a good explanation of why you chose these. Went into a lot of detail and provided a lot of meaning to why.

Step 3

This section was not complete to review.

Calculation of ratios

Ratios – commentary

Step 4

The capital investment proposal was very detailed, you gave a clear picture as to why we were doing it and what the options were. Potentially could have achieved this with a little less back story. The calculations look great, very clear to understand. Solid recommendation.

Develop capital investment decision for your firm

Calculation of payback period, NPV & IRR

Recommendation & discussion

Overall ASS#2

For the parts that were complete, they were very detailed with solid information backing the explanations.

Note: Please use this sheet as a guide. There is no need to provide feedback on each step. For example, the person may have little or no draft work completed for one or more of the steps prior to asking for your feedback.

PEER FEEDBACK SHEET: ASS#2

Feedback From: Megan Bittner

Feedback To: Jessica Hockey

My Comments

Step 1

KCQs – Chapters 6 and 8

Lovely layout in this section. It did just feel like you were repeating information back to me though rather than telling me your interpretation of the lessons you had learned. Pictures are a nice touch but not necessary. Takes away from your key thoughts and questions.

Step 2

Identify three products or services of your firm

Estimate selling price, variable cost & CM

Commentary – contribution margins

Constraints – identify & commentary

You managed to identify 3 products. Gave some good detail in why the contribution margins were important to their success and for their future. Good detail on the different trends in the market that Seek experienced. You were able to clearly identify what Seek needs to improve for the future.

Step 3

The ratios look good, and the calculations look correct. Very detailed explanations regarding the ratios. Not much justification on Seek in your commentary though.

Calculation of ratios

Ratios – commentary

Step 4

Good job on your capital budgeting, wasn’t overloaded with a lot of information which is nice, got straight to the point regarding cash flow and your options.

Develop capital investment decision for your firm

Calculation of payback period, NPV & IRR

Recommendation & discussion

Overall ASS#2

Very pretty layout of the assignment. Formatting and spacing could be neater but still a great job.

PEER FEEDBACK SHEET: ASS#2

Feedback From: Megan Bittner

Feedback To: Deni Baker

My Comments

Step 1

KCQs – Chapters 6 and 8

Very detailed KCQs. You have given a lot of thought to this area and captured what Martin is referring to. I liked how you were able to interpret what Martin was saying and explain it in what you have learned during your time at Bunnings.

Step 2

Identify three products or services of your firm

Estimate selling price, variable cost & CM

Commentary – contribution margins

Constraints – identify & commentary

You met what was required here. You identified 3 products and have all your pricing and costs which are set out very clearly. You gave very reasonable explanations which made sense to the content of your assignment. You have provided great responses to the constraints and gave excellent justification.

Step 3

Good job on the ratio’s Calculations are clear to read and understand. Your commentary was reasonable and made sense to the information you provided.

Calculation of ratios

Ratios – commentary

Step 4

Both options are outlined and expressed with enough information to follow along with your justification. Very detailed strengths and weaknesses, you expressed your point.

Develop capital investment decision for your firm

Calculation of payback period, NPV & IRR

Recommendation & discussion

Overall ASS#2

Overall, this is a very detailed assignment, and a lot of effort went into this. Was very nice to read.