Barking Welfare Organisation - Business Plan Example

Barking Welfare Organisation Introduction: The Firm’s ability to find out and implement the successful capital investment opportunities often decided its long term profitability and economic progress. (Measuring the Long-run Profitability of the Firm: A Simulation Evaluation of the Financial Statement Based IRR Estimation, 2005). There is no second opinion regarding the fact that the true and appropriate measurement of profitability and the suitable valuation of the firms’ financial assets are very important determinants of the progress and economic viability of the firm, and the directional impetus by which the firm is charting its future growth prospects. It is also a very important measure with reference to the economic welfare of the country. There are several methods of ranking projects and also to provide opinions whether they should be included for the purpose of capital budgeting, and they are: 1. Payback 2. Discounted payback 3. Net Present Value 4.Internal rate of return (IRR) 5.Modified internal rate of return (MIRR) and, lastly, 6.Profitability Index. (Brigham & Ehrhardt 2004). Payback periods do not consider the long term cash flow implications and, may thus, be inclined to take a short term perspective, to the oblivion of long term financial benefits that may accrue for projects. Hence, it may not find ready applicability in all cases. Therefore, it has become necessary to consider the net present value (NPV) of projects using DCF method, known as discounted cash flow method. The main advantages of the DCF, is that a positive NPV, would indicate the fact that the project generates more cash inflows rather than resource outflows, used up for servicing of the project. It is, therefore, the discretion of the management to decide whether the project may be accepted and implemented after taking cognisance of all the related facts and figures. Financial analysis is important because they form the bedrock of strategic corporate decision making and creating value additions for shareholders and others who are having financial interests in the Company and its operations. Methodology: The method for finding out the Net present value is as follows: Step 1: We find out the present value of the cash flow, which takes into account, both the cash inflows and cash outflows, after discounting it at the present value using discount factor. Step 2: Sum these discounted cash flows to arrive at the projects NPV. Step 3: If the NPV results in a positive figure, the project may be accepted and if negative, it should be rejected. (Brigham, Eugene F. and Ehrhardt, Michael C. (2004): Financial Management Theory and Practice: Capital Budgeting: Capital Budgeting Decision Rules: 509) In the Case Study of Barking Welfare Organisation (BWO), it is proposed to use the NPV, in order to calculate and determinate the profitability of the project, according to the abovementioned steps. “The net present value method is a modern method of evaluating investment proposals .This method taken into consideration the time value of money and attempts to calculate the return on investment by introducing the factor of time element.” (Gupta & Sharma). In this case study, the NPV has been considered the best option available, since it recognises the time value of funds that are being injected into the project, and is best suitable since in this case, both the cash inflows from the sale of plants, are controlled by market forces, and also the outflows depend upon the use of assets at different points of time in the period of determination. In this case, it is also seen that the NPV also considers, the aspects of maximum generation of incomes and profitability, owing to future inconsistencies in cash inflows and outflows. We shall now consider the major characteristics, which govern this case study, In the first place, this Welfare Organisation has rehabilitated and made employable, the physically disabled people, to lead socially useful lives for themselves and their community settings. Being a Charitable Organisation, it is a Company limited by Guarantee and as such, the individual liability of Shareholders are limited to their Guaranteed Amounts. Profitability is not the main criteria for this org. but it remains sanguine that regular cash flows are necessary for the upkeep and maintenance of funds, consistent with its cash outflows. “Without a viable cash flow plan, a company could easily spend more than its revenue, putting it in peril.” (Why is cash flow planning important? What is cash flow Planning? 2006). The main factor, that could accrue, is that for the long term sustenance of this Company, it is vital to take up cash rich projects that could be both profitable and augur well for its growth and development. However, the projects taken up for implementation need to be financially sound, and ensure cash inflows that are regularly consistent. This is because, any wrong decision could lead to project losses which, if accumulated over a period of time, could erode profitability and consequently, endanger the long term sustainability of this project. In the case of Barking Welfare Organisation, (BWO), marketing of their produce could be a major factor, centring around retail and wholesale business. Retail business, although profitable and capable of cash inflows, cannot be implemented at the present stage, due to infrastructural reasons in terms of low key marketing etc. Therefore, the company has to depend upon wholesale business at the present juncture. It is seen that the Local Council has agreed to assist the Company, by offering to accept their produce at an average price of £3.20 per 20 plants. The chief advantages of these are that there is a guaranteed outlet for the produce of the company, and also, a ready market that may generate inflows to sustain the expenses of the Company. However, it is necessary that for the long term markets, the retail sector has to be capitalised upon, in order to generate long term viability and profitable operations, and to build capital reserves for future prospects of the company. Since, in future, there are aspects of enhanced expenses in the form of Rental increases, training expenses and Rise of Retail Price Index (RPI), there would be added pressures for keeping farm equipments in serviceable conditions. For this, there would be need for generating higher resources for future, that could meet all these and other emergency expenses that may be needed by BWO for time to time in order to keep the Company is a workable condition. “The Retail Prices Index (RPI) is the most familiar general purpose domestic measure of inflation in United Kingdom….. It is commonly used in private contracts for uprating of maintenance payments and housing rents. It is also used for wage bargaining.” (Finding RPI Data: Where to Find RPI Data, 2003). Coming to the aspects of costs, it is seen that training costs form a major ingredient of BWO works costs and therefore it is necessary to restore parity with other costs, and also to ensure that the type of charitable, and low margins activities that the Company does, there need not be a heavy burden of costs on BWO. Therefore, the Government had decided to subsidise the costs at 40:60, with the Government being the major cost bearer at 60% of costs. In order to ease the training costs on the Company, the Government has also decided that Training grants would commensurate with the level of productivity of Trainees. As is often the case, the productivity of trainees would be lower than that of other regular workers. It is estimated that the trainees would be working at 40% of their potential and hence, their remuneration would also be held at 40% of their Wage Bill and the Government would pay the rest. Conclusion: The NPV is a very significant indicator of the profitability or failure of any project. Since it is able to determine beforehand, the financial viability of any project, it could be used for determination of whether a project should be recommended or not. However, it is not enough for projects to register positive in the NPV Scale, it is also necessary to assess the degree and magnitude of the NPV in order to go ahead with the project. In this case, a main aspect is funds inflows which has been provided with the assistance of Local Council. There is a ready market for the produce, although at a lowered price. But for future years, it has become necessary to make forays into the retail and wholesale markets for sustained and build up of growth in the years to come. Should marketing become a problem area in future years, there are indications that the company may not be able to sustain competition, considering its dependence on loan capital and having no equity base to fall back upon. Based upon the above reasonings and the following calculations the writer opines that the Company could go ahead with the new project. Based upon the above, it is proposed to carry out the Computation of Net Present Value (NPV) based on the data provided by the case study. Computation: Net Present Value (NPV) for BWO to determine profitability of new project For determination of the NPV, we first find out the Net Present Value, of both the Cash Inflows and Outflows discounted at the present project cost of capital Next, we arrive at the total discounted cash flows which is termed at the project’s NPV. If the NPV is positive, the project is accepted or else it is dropped. We shall not consider the calculation of the NPV for the 1st Year. For the first year the Cash Inflow is follows: Although the total acreage is 11 Acres, only 50% can be cultivatable. Therefore, effectively, only 5.5 Acres are available for cultivation. Each acre is equivalent to 4840 sq. yards, and each year there are 2 yields. The Prices payable by the Council is £3.20 of every 20 plants. Therefore, the total cash flow for the First year would be: 5.5 acres x 4840 x 36 x 2 x £3.20/ 20 = £ 306,662.40 Therefore, in the 1st year, the cash inflows = £ 306,662.40 In 2nd year, cash inflows would remain same at 6% Retail Price Index =£306,662.40 In 3rd year, cash inflows would be adjusted at 5 % Retail Price Index = £303,595.77 In 4th year, cash inflows would be adjusted at 4 % Retail Price Index =£300,559.81 In 5th year, cash inflows will remain constant at 4% Retail Price Index = £300,559.81 After adjusting for the discounted value, the value of cash inflows for the first 5 years of the project cost would be like this: CASH INFLOWS FOR THE FIVE YEARS Year Cash Inflows for the year Discount Factor Product 1 year £ 306,662.40 0.8929 £273,818.85 2 year £306,662.40 0.8116 £248,887.20 3 year £303,595.77 0.7312 £221,989.22 4 year £300,559.81 0.6830 £205,282.35 5 year £300,559.81 0.5930 £178,231.96 Total £1128,209.58 Next, we shall consider the Cash outflows for the 5 years adjusted for the discount factor While considering the cash outflows we assume that training is being imparted to 16 trainees for the new project and their training costs based on 40:60 ratio borne by the BWO and the Government CASH OUTFLOWS FOR THE FIVE YEARS Year Cash outflows for the year Discount Factor Product 1 year £108,477 0.8929 £96,859 2 year £108,637 0.8116 £88,170 3 year £108,030 0.7312 £78,992 4 year £106,820 0.6830 £72,958 5 year £107,000 0.5930 £63,451 Total £400,430 Thus we see that the NPV of the project could be calculates as follows: 1. Total Present Value of Cash Inflows ( At discounted rates ) : £1128,210 Less: 2. Total Present Value of Cash outflows ( At discounted rates) : £ 400,430 Thus this project would yield a NPV of £ 727,780 It has been found that a positive Net Present Value could be considered as acceptance of the project. Hence this project could be accepted for completion. Bibliography Brigham, Eugene F., & Ehrhardt, Michael C (2004). Financial Management Theory and Practice: Capital Budgeting: Capital Budgeting Decision Rules: 506 Finding RPI Data: Where to find RPI Data. (2003). [online]. National Statistics. Last accessed 18 December 2007 at: http://www.statistics.gov.uk/cci/nugget.asp?id=21 Gupta, Shashi K., & Sharma, R.K (2005). Net Present Value Method Management Accounting: Principles and Practice: 29.15 Salmi, Timo., & Virtanen, Ilkka. (2005). Measuring the Long-run Profitability of the Firm: A Simulation Evaluation of the Financial Statement based IRR Estimation Methods. [online]. 1. Introduction 1.1. Background: Last accessed 18 December 2007 at: http://lipas.uwasa.fi/~ts/smuc/smuc.html#abst Why is cash flow planning important? What is cash flow Planning? (2006). Cash Flow Planning. [online]. Bajaj Capital. Last accessed 18 December 2007 at: http://www.bajajcapital.com/financial-planning/cash-planning/introduction.php Read More