The problems of control account receivables turnover and ineffective finance leverage of minh phu seafood joint stock company

UNIVERSITY OF ECONOMICS HO CHI MINH CITYInternational School of Business ---Nguyen Trang Kieu Diem THE PROBLEMS OF CONTROL ACCOUNT RECEIVABLES TURNOVER AND INEFFECTIVE FINANCE LEVER

TABLE OF CONTENTS

Executive Summary 5

CHAPTER 1: INDUSTRIAL OVERVIEW AND COMPANY BACKGROUND 6

1.1 Industry overview 6

1.2 Company background 7

CHAPTER 2: IDENTIFICATION AND DEFINITION OF THE PROBLEM 11

2.1 Problems finding process 11

2.2 Company’ symptoms 11

2.2.1 The significant decrement of profitability in 2015 11

2.2.2 The remarkable much lower of profitability compared with average industry’s ratio in 2015 13 2.3 Possible reasons behind the circumstance 14

2.4 Actual reasons behind the circumstance 16

2.4.1 Bad management of gross margin, operating expense, interest and taxes resulted in the lower profit margin 16

2.4.2 Ineffective control accounts receivable days, inventory days and fixed-asset turnover resulted in the lower asset turnover 18

2.4.3 Ineffective financial leverage 21

CHAPTER 3: DESIGN SOLUTIONS AND SUGGESTIONS 26

3.1 Possible solution to improve efficiency in asset turnover and use effective finance leverage 26 3.2 Suitable solutions to improve efficiency in asset turnover and use effective finance leverage in Company’s circumstance 28

3.2.1 Revise credit collections 29

3.2.2 Increase collect efficiency 30

3.2.3 Manage inventory effectively 30

3.2.4 Using finance leverage in appropriate time 31

CHAPTER 4: ACTION PLAN 32

Reference 35

Appendix 37

UNIVERSITY OF ECONOMICS HO CHI MINH CITY

International School of Business

-Nguyen Trang Kieu Diem

THE PROBLEMS OF CONTROL ACCOUNT RECEIVABLES

TURNOVER AND INEFFECTIVE

FINANCE LEVERAGE OF MINH PHU SEAFOOD JOINT STOCK COMPANY

MASTER OF BUSINESS ADMINISTRATION

SUPERVISOR: Dr PHAM PHU QUOC

Ho Chi Minh City – Year 2018

LIST OF FIGURES Figure 1 Minh Phu Seafood Join Stock Company structure

Figure 2 Minh Phu’s profitability ratios in the period 2013-2015

Figure 3 Minh Phu’s ROA, ROE compared with industry’s ratio over the period 2013-2015 Figure 4 Financial ratios linked to return on equity

Figure 5 Possible solutions of Minh Phu’s case

Figure 6 Minh Phu Seafood Joint Stock Company Action Plan

LIST OF TABLES Table 1 Minh Phu’s profitability ratios in the period 2013-2015

Table 2 Minh Phu’s ROA, ROE compared with industry’s ratio over the period 2013-2015

Table 3 Minh Phu’s gross profit from 2013 to 2015

Table 4 Minh Phu’s portion of each components in income statement from 2013 to 2015

Table 5 Minh Phu’s account receivable and account payable turnover over the period 2013 – 2015 Table 6 Minh Phu’s inventory day over the period 2013 - 2015

Table 7 Indicators reflecting the asset structure of Minh Phu over the period 2013 - 2015

Table 8 Minh Phu’s indicators reflecting the resource structure

Table 9 Effects of some factors to Return on equity of the Company

Table 10 Analysis the possible solutions of Minh Phu

Table 11 Minh Phu Seafood Joint Stock Company Action Plan

CHAPTER 1: INDUSTRIAL OVERVIEW AND COMPANY BACKGROUND 1.1 Industry overview

Even Vietnam has a great potential for marine aquaculture, the sector also faces many challenges According to some reports, the country is blessed with nearly 250,000 hectares of total area of marine and island aquaculture, of which the aquaculture area is over 150,000 hectares, the lagoon, hinterlands and islands are nearly 80,000 hectares, and the rest is open sea This area can be used to develop marine aquaculture including bays, coastal tidal areas and parts

of islands and open seas Additionally, Vietnamese sea houses many species of fish that can be naturally distributed into the sea such as grouper, snapper, orange fish, sea bass, cobia, sea bass

In fact, in a brief report presenting in Norway in August 2016, the emerging East Asia economy was stated to have an estimated seafood production of 6.55 million tons, making the country the

4th largest seafood producer, the 8th largest fishing nations, and 3rd world largest exporter of fish and fisheries products Furthermore, Vietnam is also the 3rd largest in the world in breeding, raising, and selling Tiger Prawns, and Shrimps Most recently, in 2017, with export growth of more than 10% in the second quarter, total seafood export value of Vietnam in the first half of

2017 was about USD 3.6 billion, up 14.6 percent over the same period last year Such explosive growth and potential has made marine aquaculture a key industry in the development of Vietnam economy

Beside the geographical advantages mentioned above, Vietnam also faces many challenges and difficulties Most companies in the country remains small scale both in capital and modern technologies The lack in capital and technologies hinder the sector’s ability to enter into the developed market with high requirement in quality For instance, the Europe is the largest importer of agricultural, forest and food products in the world But the European market

Executive Summary

Minh Phu Seafood Joint Stock Company (Minh Phu), the largest shrimp processor in Vietnam and was known as the shrimp king of Vietnam had always operated at high profit since

2012 However, the Company’s performance faced a significant down trend, even made loss in

2015 After a thorough investigation on the case, the circumstance was found there are two main problems related to control over account receivables turnover and ineffective finance leverage of the Company In detail, the accounts receivable turnover in 2013 was 13.27 and 13.02 in 2014, while the figure decrease 10.28 in 2015 which show that management of account receivable has the problem About the using finance leverage, the debt ratio in the period from 2013 to 2015 always high and maintain at 74% - 75% while the aquatic economic face many challenges and difficulties in 2015 In the bad economic times, the high financial leverage made the profitability worse In addition, the interest rate is higher than the return on equity before tax and interest means that the Company use the loan will decline return on equity Financial leverage to amplify reduce return on equity and financial risk of the company in 2015 increased

As for solution, the author recommends on improving the problems through improve account receivable turnover and the efficiency of finance leverage Firstly, Minh Phu can improve account receivables turnover through revise credit term, tight control the account receivables and increase collection efficiency Secondly, Minh Phu can use the finance leverage effectively by reduce financing the debt, increase equity and use finance leverage in appropriate time based on the economic status

requires high quality of goods to ensure the safety for local consumers In an interview with Ms Miriam Garcia - Ferrer, First Counselor, Delegation of the European Union in Vietnam, the lady representative of the Europe has expressed great concern on the capability to ascertain marine products’ quality of Vietnam She even presented the case of Vietnam's bivalve molluscs has been approved by the EU on the list of Vietnamese exporters, but now banned by the European Union because of the problematic inspection by the EU as an example In another example, Vietnamese pangasius have also been stopped recently by some French super markets not because of food safety but also environment problems Nonetheless, with such geographical and weather advantages, Vietnam marine aquaculture has great future and potential to be tapped into

1.2 Company background

Minh Phu’s precursor was a private enterprise It was established on 14th December 1992 After over 20 years of continuous development, so far Minh Phu has become one of leading seafood corporations with largest seafood export revenue nationwide as well as in the region and all over the world

The principal activities of the Company are to process and trade in aquatic products, aquatic breeds and aquatic foods, machinery and equipment for aquaculture The structure of Group was showed in the charge below:

Figure 1: Minh Phu Seafood Join Stock Company structure

Principal targets of the corporation:

- Focus on its main business production lines in 2011, which are producing disease-free and clean baby shrimp, expanding areas for raising commercial shrimp, producing biological products for the aquaculture industry, producing and processing shrimp for export

- Make best efforts to maintain its role as one of Vietnam’s leading seafood exporters

- Maintain current export markets, continuously develop new export market and especially build Minh Phu as strong brand

- Continuously expand areas for disease-free and industrial shrimp and associate with forestry and fishery farms in Ca Mau to raise shrimp in large scale in other to provide raw materials of clean shrimp to Minh Phu’s processing factories

- Enhance the tasks of business administration, personnel organization and payment policy, consistently give training, attract excellent employees, have good incentive policies to the company’s leading officers, management personal and workers

Medium and long-term development strategy:

- Associate with Vietnam’s leading producers of shrimp feed to invest in building factories producing feed for shrimp to supply the feed to Minh Phu’ shrimp raising enterprises, forming a full circle process from producing feed and disease-free shrimp babies, raising clean shrimp to processing for export Our target is for Minh Phu to feed 5.000ha of industrial shrimp and make improvement to over 70% of whole shrimp needs of the Corporation by 2015

- Invest strongly in science and technology to study and select the line of chemical treatments of shrimp Breeding white leg shrimp for desirable general characteristics such as fast growth and adaptability to changes in climate and weather

- Research and build a modern model, which achieves high rates, low prices and ensures safety in the biological work to foster sustainable and profitable shrimp production

- Associate with manufacturers of carton packaging, coated PA/PE, plastic trays, tray soap, flour production as well as the leading manufacturers of sauce in Vietnam and the world to build packaging, supplies, materials, etc factories to create a system of surrounding factories around Minh Phu – Hau Giang factory to provide for factories

of Minh Phu Seafood Joint Stock Company

- Join with local and foreign partners to build the Container Port on Hau Giang

- Establish shrimp distribution companies in EU, Russia and China, etc in order to increase export profits and enhance the efficiency of producing, processing, exporting and distributing shrimp globally

CHAPTER 2: IDENTIFICATION AND DEFINITION OF THE PROBLEM

2.1 Problems finding process

In order to identify the company’s problems, these following steps will be executed:

- Analysis the financial statement, finance ratio and compare with the industry to identify the symptoms;

- Review the literature related to the symptoms;

- Further study of the company financial, accounting data and the industry;

- Interview with management personnel, Board of Management of the Company, for further information

2.2 Company’ symptoms

After deep analysed the financial statement and investigated the financial ratios, the symptoms of the problem had revealed as following:

- The significant decrement of profitability in 2015 and ;

- The remarkable much lower of profitability compared with average industry’s ratio in

2015

2.2.1 The significant decrement of profitability in 2015

Minh Phu experienced the toughest year 2015 in the last decade with the loss of VND 6.9 billion even though it was the largest shrimp processor in Vietnam and was known as the shrimp king of Vietnam, it had always operated at high profit since 2012 The table 1 below shows the profitability ratios over the period from 2013 to 2015:

2015 2014 2013 2015 against 2014 against

Net operating profit 7,740 1,052,7 375,906 (1,044,97 -99% 676,80 180%

Profit before tax 12,136 1,047,5 365,756 (1,035,40 -99% 681,78 186%

Profit/(loss) after tax (6,946) 921,048 293,834 (927,994) -101% 627,21 213%

Table 1 Minh Phu’s profitability ratios in the period 2013-2015

The table shows that the profit decreased significantly, even loss in 2015 Profit after tax was reach VND 921 billion in 2014 while it was negative VND 6.9 billion in 2015, that decreased by 101%, equivalent to 928 billion VND Return on assets rose sharply from 4.23% in

2013 to 10.89% in 2014 and went down significantly to -0.08% in 2015 In 2014, the ROA of 10.89% means that every 100 VND capital of the enterprise will generate after-tax profit of 10.89 VND While every 100 VND capital in 2015 made a loss 0.08 VND In addition, it can be seen that the return on equity increased from 17.28% in 2013 to 42.88% in 2014 and decreased noticeably to -0.31% in 2015 The indicator show that while each 100 VND of equity generated 17.28 VND and 42.88 VND of profit-after tax respectively in 2013 and 2014, each 100 VND of equity in 2015 made loss of 0.31 VND The EPS showed the noticeable down-ward trend in

2015 From 2013 to 2014, the EPS increased steadily from VND3,882 per share and got the peak

at VND10,930 per share in 2014 However, in 2015, the EPS went down steeply and reached the lowest point was VND474 per share The figure below show the overall picture of decrease of profitability from 2013 to 2015:

Figure 2 Minh Phu’s profitability ratios in the period 2013-2015 2.2.2 The remarkable much lower of profitability compared with average industry’s ratio

in 2015

Table 2 Minh Phu’s ROA, ROE compared with industry’s ratio over the period 2013-2015

The table 2 shows that the average ROA of aquatic industry also experienced the trend, ROA decreased from 3% in 2013 to 2% in 2014 and 1% in 2015 However, it can be seen that the ROA of Minh Phu went down noticeably from 10.89% in 2014 to negative 0.08% in

down-2015 The much lower ROA compared with average one of aquatic industry in Vietnam demonstrates the lower efficient of using assets of the Company

The return on equity increased from 17.28% in 2013 to 42.88% in 2014 and decreased noticeably to -0.31% in 2015 When compared with the average ratios of the same industry in Vietnam, it showed the significant lower of ROE of the Company

2013 2014 2015

Figure 3 Minh Phu’s ROA, ROE compared with industry’s ratio over the period 2013-2015 2.3 Possible reasons behind the circumstance

Kostini el at (1) measured the profitability based on analysis of Return on Asset (ROA), Kostini states that ROA is the effective profitability measurement used to assess the effectiveness in generating profit of the company’s assets

Collier (2) presents financial analysis of a bank by DuPont analysis which based on analysis of return on equity which is disaggregated into net profit margin, total asset turnover and the equity multiplier

Isberg (3) carried out a study to get insight of the firm’s performance, liquidity, leverage, operating efficiency and profitability used the DuPont ratio The formula is defined clearly as: Net Income/Total Equity = (Net Income/Net Sales) x (Net Sales/Total Asset) x (Total Asset/ Total Equity); or it can be rewritten as

Net Income/Total Equity = (Net Income/Net Sales) x (Net Sales/Total Asset) x (Total Asset/Total debt) x (Total debt/ Total Equity)

-0.1 0 0.1 0.2 0.3 0.4 0.5

Kieu Minh Nguyen (4) stated that profitability is affected by profit margin, asset turnover and financial leverage and impacted by below factors:

Figure 4 Financial ratios linked to return on equity

The figure 4 provides the quick insight into factors affecting the profitability including: gross margin, operating expense, interest, taxes, accounts receivable days, inventory days, fixed-asset turnover, leverage and coverage

Therefore, there are 3 possible problems below can cause the decline of ROE:

- Bad management of gross margin, operating expense, interest and taxes resulted in the lower profit margin;

- Ineffective control accounts receivable days, inventory days and fixed-asset turnover resulted in the lower asset turnover;

- Ineffective financial leverage

2.4 Actual reasons behind the circumstance

The author performed deep analysis on financial statement by measure all factors showed

in Figure 4 to investigate the real problem of the Company in 2015 and found that there are 2 actual reasons cause the problems:

- Ineffective control accounts receivable days;

- Ineffective financial leverage

2.4.1 Bad management of gross margin, operating expense, interest and taxes resulted in the lower profit margin

2.4.1.2 Analysing gross margin over the period from 2013 to 2015

Table 3 Minh Phu’s gross profit from 2013 to 2015

The gross profit from VND2,016 billion in 2014 to VND1,072 billion in 2015, decreased

by VND944 billion, approximate 47% This is the problem of not only Minh Phu but also of whole aquatic industry in Vietnam in 2015 Vietnam Association of Seafood Exporters and Producers reported that global shrimp industry during 2015 was not facing trouble relating to EMS syndrome, diseases that lead to the significant increase in globally source of materials as well as processed shrimp while consumption demand decreased That resulted in the significant decrease in unit price during 2015 and lost some foreign customers, as Vietnamese companies had to experience the competition for foreign company offering the competitive price The

decrease of selling price, loss market and the competition with foreign competitors resulted in

the total cost divide total revenue was high are the common problems of whole aquatic industry

in Vietnam Therefore, the decrement of gross margin is not due to bad management cost of sales

of Minh Phu’s management

2.4.1.2 Analysing operating expense over the period from 2013 to 2015

In order to identify if operating expense including selling expense and general and administration expense is the main factor leading to the decrement of gross margin, the table 4 showed the portion of each components in net revenue over the period from 2013 to 2015

Net revenue 12,286,624,409,955 15,094,740,952,959 11,111,950,055,331 100% 100% 100% Cost of sales 11,214,768,939,264 13,078,415,992,602 9,955,628,683,286 91% 87% 90% Financial

Table 4 Minh Phu’s portion of each components in income statement from 2013 to 2015

The table 4 show that the operating expense including selling expense and GA expense made up the small portion in total net revenue The portion of operating expense kept the quite stable portion In detail, the selling expense only holds 4%, 5% and 6% respectively in 2013,

2014 and 2015 In addition, the GA expense only occupies 1% in whole 3 years in this period For this reason, the management of operating expense also not the actual problems of Minh Phu

in 2015

2.4.1.3 Analysing interest expense over the period from 2013 to 2015

The tables 4 indicates the opposite trend of interest expense from 2013 to 2014 and 2014

to 2015 The interest expense decreased by VND47.8 billion, approximate 16% from 2013 to

2014 On the contrary, the interest expense increase significantly by VND182.9 billion, approximate 71% from 2014 to 2015 In addition, in can be seen that the portion of interest expense in 2015 made up 4% double the one in 2014 Correspondingly, the management over the interest expense in 2015 is the main reasons lead to the decrease of profit margin in this year Kieu Minh Nguyen (8) concluded that the larger interest expense implied the increase in financial leverage The financial leverage was deeply analysed in the part 2.4.3 below

2.4.2 Ineffective control accounts receivable days, inventory days and fixed-asset turnover resulted in the lower asset turnover

2.4.2.1 Analysing accounts receivable days over the period from 2013 to 2015

10 Days of account payable turnover =

Table 5: Minh Phu’s account receivable and account payable turnover over the period

2013 – 2015

The accounts receivable turnover in 2013 was 13.27 and 13.02 in 2014, while the figure decrease 10.28 in 2015 The amount decreased by 2.73, approximate 21% compared with 2014 The Company's accounts receivable turnover decreased at the end of 2015 show that the management of account receivable has the problem The lower the turnover, the longer the time between sales and collecting cash There is an opportunity cost of holding receivables for a longer period of time, resulted in the lower asset turnover Days of account receivable turnover is the length of time it takes to clear all Accounts Receivable, or how long it takes to receive the money for goods it sells According the table above, the average collection period in 2013 was 34.29 days, 30.83 days in 2014 and increased to 33.11 days in 2015 The collection period increased by 2.28 days or 7% compared with 2014 The reason is that in 2015 the rate of increase

of the Company's accounts receivable at a 3%, equivalent to VND 35 billion while the average revenue had a down trend by VND 7.6 billion, approximate 19% This represents the problem in collecting receivables from customers of the Company

Account payable turnover of Minh Phu had a significant increase from 29.79 in 2013 to 39.35 in 2014 and 70.66 in 2015 The amount increased by 31.31, approximate 80% compared with the turnover in 2014 This indicated that Minh Phu had to follow the strict credit term of suppliers while the Company manage the collecting from customer not good, the Company had

to borrow loans to make payment for suppliers Correspondingly, accounts payable days also decreased from 12.25 days in 2013 to 9.28 days in 2014 and 5.17 days in 2015

Compared the account receivables and account payables, the author found that Minh Phu’s capital was noticeably occupied in 2015 The poor management over the account receivables turnover lead to the lower asset turnover in 2015

2.4.2.2 Analysing inventory day over the period from 2013 to 2015

Table 6 Minh Phu’s inventory day over the period 2013 - 2015

The inventory in 2013 was 4.24 and rotation period was 84.85 days inventory, in 2014 inventory turnover reduce to 3.78, correspondingly the period of rotation went up by 95.18 days

In 2015, inventory turnover was 2.56 and the period of rotation was 140.67 days Inventory turnover increased in 2015 compared to 2014 1.22 shows that the company faced the difficult in selling goods in 2015 As mentioned in the part 2.3.1, Vietnam Association of Seafood Exporters and Producers (5) reported that global shrimp industry during 2015, the difficulty in selling goods due to the lower global’ demand is the common problems of the industry Hence, the

management over the inventory is not the main reason affecting the lower asset turnover

2.4.2.3 Analysing fixed asset turnover over the period from 2013 to 2015

Steven Bragg (6) stated that a manufacture services business including trading business that requires a minimal amount of fixed assets may have few or no noncurrent assets For this reason, the non-current is much lower than the current asset that indicated by the table 7 below:

Table 7 Indicators reflecting the asset structure of Minh Phu over the period 2013 - 2015

The current asset ratio was 76.88% and long-term assets ratio is 23.12% in 2013 In 2014, the ratio current assets was 81.77%, while the rate long-term assets was 18.23%, that means in 1 VND of total assets, the current assets accounted for 0.7688 VND, and long-term assets accounted for 0.2312 VND In 2015, the rate short-term assets was 78.75%, while the rate of long-term assets is 21.25% means that 1 VND of copper assets, the short-term assets accounted for 0.7874 VND, while long-term assets accounted for 0.2125 VND The ratio of assets invested

in current asset and long-term asset of the company over three years did not fluctuate too much

It can be seen that the proportion of assets invested in current asset was higher proportion of long-term asset This percentage is reasonable when compare with the average percentage of aquatic industry as the Company is operating as a commercial business Accordingly, the management over the fixed assets turnover is not the main reason of the lower asset turnover

2.4.3 Ineffective financial leverage

2.4.3.1 Analysing the leverage over the period from 2013 to 2015

The Company can use of financial leverage in the capital structure that maybe contributes heavily in the success or failure of companies, based on their ability to balance the general positive and negative possible effects of it The table 8 below provide the overview on the level using financial leverage of the Company compared with the aquatic industry in Vietnam

Debt ratio increased due to higher grow rate liabilities compared with the grow rate of total capital The Company's liabilities ratio increased during 3 years due to the Company use the loan to expand the business scale Loans increased mainly due to increase of long-term debt, which is mainly due to the Company issue bonds with amount VND 3,500 billion in 2015 Increasing debt ratio means that the financial risk of the company increases, the company is using the financial leverage to contribute to higher profit margins and return on equity as well The equity ratio measures how much of the Company’s assets were financed by investors In other words, this is the investors' stake in the company The ratio had a down trend through 2013

to 2015, that decreased from 26% in 2013 to 25% in 2014 and 24% in 2015 A lower ratio also shows potential creditors that the company is less sustainable and more risky to lend future loans Moreover, the equity ratio is always less than 0.5 show the low level of financial autonomy of the Company so the financial risk the company also increased

The use of financial leverage has both positive and negative impact on the business performance If the Company manage the loans well, or using financial leverage effectively, the return on the equity will increase However the financial leverage also means increased financial risks of the business, if the Company borrows too much, that can lead to loss the ability to pay the principal and interest expense How effective the Company use the financial leverage would

be analyzed more in the following part

2.4.3.2 Analysing the interest coverage over the period from 2013 to 2015

Kraus (7) stated that the optimal capital structure is determined by balancing the positives

& negative effects of financial leverage In other words, balancing the benefits of debt financing, that includes: tax savings, reducing agency cost, with the cost associated with the debt, that include direct and indirect bankruptcy costs

The use of financial leverage proven to be beneficial when the investment made by the leverage earn returns more than the cost of debt Miller (8) suggested that although that debt financing is affiliated with a higher chance of bankruptcy risks & costs These disadvantages are relatively small as compared to the tax shield that associates the use of financial leverage

Perinpanathan (9) showed that the financial leverage may have a negative impact if the investment that has been mad did not achieve sufficient returns (higher than the cost of debt) having no recognizable income to shield, meaning that the if the returns is lower than the cost of debt the company will be at a higher risk due to the level of debt they undertook, resulting in reducing the overall value of the company

Furthermore, Baxter (10) suggested that the use of financial leverage is linked to a higher possibility of bankruptcy risks & financial defaults Due to the commitment that is associated with the use of debts, such as the periodic interest payments, and the principle paid by the company, and because of these risks shareholders will demand a higher return, which puts the company in a critical situation

Abdallah (11) stated that there is another way to calculate the ROE as follow:

ROE = [ROAE + D/E (ROAE – i)] x (1 – t)