Finance in the Hospitality Industry - Assignment Example

Finance in the Hospitality Industry Table of Contents Cover Sheet…………………………………………………………………..……………….1 Table of contents………………………………………………………..…………………….2 Task 1………………………………………………………...……………………………….3 P1.1…………………………………………………………………………………………….3 P1.2…………………………………………………………………………………………….5 Task 2……………………………………………………...………………………………….6 P2.1…………………………………………………………………………………………….6 P2.2…………………………………………………………………………………………….9 Task 3…………………………………………………………….………………………….10 P 3.3 ………………………………………………………………………………………….10 P 3.4…………………………………………………………………….…………………….12 Task 4……………………………………………………………………….……………….13 P3.1, 3.2……………………………………………………………………...……………….13 P 4.1, 4.2……………………………………………………………………..……………….16 Task 5…………………………………………………………………………….………….19 P5.1……………………………………………………………………………..…………….19 P 5.2, 5.3…………………………………………………………………………..………….20 P5.2, 5.3 ………………………………………………………………………….………….22 References………………………………………………………………………….………..23 Task 1 P1.1 A business has several options from which the trader can access finances for capital expenditure. These include owner’s capital, ploughing back profits, friends and relatives, bank loan, and leasing. Owner’s capital is the primary source of finances for the business. The sole trader must raise a greater proportion of the required £50,000. Owner’s capital is quickly turned into long-term, fixed assets, which cannot be readily converted into cash (Dyson, 2007). This source of capital is advantageous to sole traders because it is less costly; the owner does not need to pay interest for using his or her own capital. Owner’s capital, however, is in most cases limited since the sole trader may not have adequate savings to finance capital expenditure. Ploughing back profits involves re-investing the income from the business. Profits for reinvestment are readily available in the business provided the business earns profits. The opportunity cost of reinvesting capital is lower compared to other sources of capital (Fields, 2011). Ploughing back profits will help the sole trader avoid the huge costs of interest paid on bank loans and leasing of the required machinery. The only disadvantage of this source of capital is that it is not always available, especially during periods when the business is not making profit. Banks provide short-term, medium-term and long-term finances to the businesses. Banks will finance all asset needs of the trader including working capital, equipment and machinery. Bank loans are usually readily available sources of capital expenditure (Fields, 2011). This is because banks are always ready to invest in businesses in terms of providing loan to earn interest. Another advantage of banks is that they offer some degree of flexibility such that the borrower can pay off the loan early and terminate the contract to avoid accumulation of interest (Drury, 2003). Banks, however, require huge interest rates and collateral, which limits the accessibility of these finances. This implies that the sole trader will need to work hard in order to generate enough cash flow to cover the interest payments and return the principal. Additionally, banks will require assurance of payment by requiring personal guarantees and secured interest on personal assets. Friends and relatives can support sole traders when establishing business enterprises. They can provide finances for buying capital goods. As a sole trader, I can either receive the full some for buying the required machinery, or contribute a proportion of the £50,000. This source of finance is the most economical for funding business enterprises because there is no interest charged (Drury, 2003). However, friends and relatives may not be ready to provide the finance, and if they provide, they may over-control the sole trader in the way he or she is spending the money because they are the providers. Alternatively, the sole trader can lease the required machinery for use. Lease machinery can be easily available, but leasing companies charge huge interest rates for using the machinery. The best methods I would select for financing the required machinery are leasing, ploughing back profits, and bank loan. A leased machine has the potential for paying back the interest and meeting the required maintenance costs because the business is profitable (Wood & Sangster, 2008). I can also plough back profits; this is because the enterprise is currently doing well. I prefer ploughing back profits because it is a cheap method of financing capital expenditure. I can apply for a bank loan because the bank can provide the required sum; the projected income from the use of the required machinery will meet the loan interest costs. Fields (2011) argues that the cost of bank loan is usually slightly lower than leasing; therefore, I will rank bank loan ahead of asset leasing. P1.2 Restaurants charge car-parking fees for their dedicated customers. The fee from parking provides a substantial amount of income used for meeting the expenses for other services such as security, rates and taxes, and rent. This source of income is advantageous because it does not require huge expenses for collection. Charging fee, however, is disadvantageous because it may discourage some customers from seeking the services of the restaurant. Most customers believe that parking is one of the free services restaurants should offer; however, some restaurants may strategise on raising additional revenue from loyal customers to support the quality of services. The restaurants charge fee for services such as playgrounds, swimming, conference halls, and games. Money collected from these services accounts for approximately 20% of the restaurants’ income (Fields, 2011). Collection of fee from services requires incurring of collection expenses. For example, playgrounds must be maintained, water in the swimming pool must be kept clean, conference halls require regular maintenance, and most games must be purchased and installed; all these require huge investments in terms of finances and time in the short-run, but long-term benefits surpasses the initial capital outlay. Restaurants sell products such as coffee and snacks to the public. Foods and drinks are prepared, and sold to customers with the objective of earning profits. Sale of products is the primary objective of setting up restaurants. The income from sale of food products accounts for 60% of the restaurants’ income (Fields, 2011). The management deducts costs of preparing products from the revenues to arrive at the profit from operations. Profit from restaurant operation is either retained or ploughed back to the business for purposes of expansion. Income from sale of products is beneficial to the restaurant management because it is used to pay cooks, restaurant attendants, and supervisors. Additionally, the management use the income from sale of products to meet operation expenses such as paying for food supplies, paying bills, and taxes. Modern restaurants have established clubs for their loyal customers. Members of these clubs pay subscription fees and periodical membership fee. The restaurant use these finances for making better the restaurant services in order to retain consumers and attract prospective customers. Club members have access to beneficial services that non-members do not have. The fee from registration and subscription provides finances for improving social services; the revenues from club membership contribute 5% of the restaurant’s total income. The sole trader has several options from which he can access capital for financing the planned capital expenditure. The most common sources of finance include owner’s capital, ploughing back profits, friends and relatives, bank loan, and leasing. The three best sources of finance for the sole trader include are leasing, ploughing back profits, and bank loan. A chain of restaurants has several methods through which the owners can generate income. Income generated from these sources is critical in meeting the expenses of the restaurant business. The sources of income include parking fee, fee for services, sale of products, and member subscription and registration fee. Task 2 P2.1 Costs of production consist of payments to factors of production. Costs of production can be divided into fixed and variable costs. Fixed costs are costs that do not vary as output varies. Fixed costs are associated with fixed factors of production such as rent, rates, insurance, interest on loans, and depreciation (Wood & Sangster, 2008). Marks and Spencer must incur these costs whether production is taking place or not. Overheads consist of expenses on the income statement excluding direct labour, direct materials, and direct expenses (Dyson, 2007). Examples of overheads incurred by Marks and Spencer include legal fees, repairs, rent, advertising and accounting fees. Overheads are part of fixed costs because they are unavoidable in the production process. Variable costs, on the other hand, are related directly to the output; examples include wages of labour, costs of raw materials, power and fuel. If Marks and Spencer wants to calculate the total costs, they combine fixed costs/overheads and variable costs using the formula: Total costs (TC) = fixed costs (FV) + variable costs (VC). There are several methods of controlling costs. First, the company should place switches and other gadgets for controlling lights at strategic points where the staff can easily access them to avoid wastage of energy. Second, the company should strategize on proper approaches for retaining staff to avoid staff turnover, which is expensive in terms of recruiting and training. Third, the company should select marketing practices that are not too costly, for example paying marketers on commission to avoid paying for work that has not been done. Forth, the Marks and Spencer should adopt Six Sigma tools to eliminate all unnecessary functions within the company with an objective of eliminating wasteful use of resources and finances. The company can use gross profit percentages measures the margin of trading profitability on sales throughout the trading year. Profitability percentages measure the efficiency of managing both buying and selling prices. There are two types of gross profit percentages; these are gross profit margin and gross profit mark-up. The formula for measuring gross both margin is: Gross profit margin=gross profit/sales*100%. For example, if Marks and Spencer makes sales worth £115,200 and makes a gross profit of £44,000 in a particular financial period, gross profit margin will be £44,000£115,200=38.19%. Gross profit mark-up is the percentage of gross profit to cost of goods sold. The formula for gross profit mark-up is: Gross profit mark-up=gross profit/cost of goods sold*100. For example, if Marks and Spencer earns a gross profit of £44,000 from cost of sales amounting to £70,800, gross profit mark-up for that accounting period is calculated as: £44,000/£70,800 * 100=62.15%. Selling price is the market value or the agreed exchange value that the company offers for purchasing of a definite quantity, weight and other measures of their goods and services (Field, 2011). Selling price forms the essential basis for commercial transactions since it is the consideration in exchange for the transfer of ownership. Demand is the primary determinant of price; according to the law of demand, ceteris paribus, quantity demanded is inversely proportional to price. Manufacturing companies calculate their selling prices by determining the cost of unit production and adding a profit margin to the product. Marks and Spencer is a retail company; for them they buy in large quantities from producers and pay wholesale price. Their selling price is arrived at by adding the retail profit margin. The clothing industry where Marks and Spencer operates is a perfect competition market characterised by perfect knowledge of buyers and sellers; therefore, the company’s selling prices must reflect those of other retailers because of high price elasticity of demand. P2.2 Marks and Spencer can select any methods for stock and cash control. Methods of controlling stock include Economic Order Quantity, Re-Order Quantity, and Just-in-Time. Economic Order Quantity is the amount of stock that minimises the costs of stock holding and ordering. The formula for determining Economic Order Quantity is: Economic Order Quantity=√(2DK/h) , where: D=annual quantity demanded K=fixed cost per order h=annual holding cost per unit. Re-order Quantity is a method of stock control that requires the company to buy additional units of inventory in order to avoid running out of stock during business transactions (Wood & Sangster, 2008). Marks and Spencer has set a level below which their clothing stock cannot drop; this allows the company there is always adequate inventory on hand. Just-in-Time method requires the company to order for additional inventory at the exact time when it is needed in the production process (Wood & Sangster, 2008). This method helps the company to avoid the costs of stock holding, which include spoilage, spillage, energy costs for warehouses, and salaries for warehouse personnel. The best method of controlling cash for Marks and Spencer is the Baumol Model. This model recognises the similarities between cash balances and inventory levels (Drury, 2003). Baumol, therefore, developed a cash control model similar to Economic Order Quantity. The Baumol’s formula is: Q= √ (2CoD/Ch) Where Co=transaction costs, D=demand for cash and Ch=cost of holding cash. The company can use the formula to determine the amount of cash that should be in hand at any particular moment. Bank reconciliation is another method for controlling cash. Bank reconciliation explains the differences existing between the bank balances as it is the company’s books of account as supplied by the bank, and the corresponding amount in the accounting records of the company (Wood & Sangster, 2008). The bank reconciliation process involves identifying differences in the items of the bank statement and the cashbook and entering them into the cashbook and bank columns. Possible causes of errors that necessitate bank reconciliation include bank charges, direct credits and payment of standing orders. Marks and Spencer incurs both fixed (overheads) and variable costs. Profitability percentages can be classified into gross profit margin and gross profit mark-up. The selling price is the value that the company exchanges their products. Stock and cash control is critical to the success of Marks and Spencer. The company can use any of the following methods to control stock: Economic Order Quantity, Re-Order Quantity, and Just-in-Time. The company can also use the Baumol model and bank reconciliation methods to control their cash balances. Task 3 P 3.3 Process and purpose of Budgetary control The budgetary control process is the method by which an organization plans for its future expenses by forecasting them and then controlling them when they incurred using strategies such as comparisons (Wood & Sangster, 2008). This means that the process of budgetary control aims at forecasting various factors such as sales and expenses. After forecasting the costs, organizations then compare the actual results with the budgeted results. This process is known as budgetary control and it aims at determining variances and their nature. This is because variances may be adverse or favourable meaning that some may be desired by the company while others may be avoided by formulating new techniques of control. The budgetary process mainly aims at controlling factors to ensure that actual results match with the budgeted outcome. Other purposes of budgetary control include communication, coordination, and evaluation. Communication and coordination ensures that different departments in an organization work towards achieving similar goals. Evaluation, on the other hand, helps to identify weaknesses and formulate ways of eliminating them to improve the performance of companies (Drury, 2003). The process is also essential because it enables companies to plan efficiently. The budgetary process involves various stages that begin with communication. The budget committee communicates with the management so that they may understand the long term plans that the managers have made for the company (Drury, 2003). Communication at this stage also enables the budget committee to understand changes that are expected both in the company and outside the, for example, change in the market demand and salaries. The understanding of these changes ensures that the budget is made while taking them into account. The next step in the cycle is determining of the limiting factors in the budgeting process. These factors are weaknesses that the budget committee must take into account because they do not improve, for example scarcity of workers. The next process in the cycle is the formulation of the sales budget, which then helps in forecasting other factors such as expenses. The fourth step is the preparation of preliminary budgets such as purchases, materials, and labour budgets. The managers who are in charge of these activities together with their employees make these. After formulating the initial budgets, the next process is that of discussing them with senior managers so that they can accept and endorse these plans. The discussions ensure that senior managers explain to low-level employees and leaders the reasons for acceptance or rejection of the budgets (Drury, 2003). After the discussions, the next step is that of coordinating all the departmental budgets to ensure that they correspond with one another. This process helps to eliminate discrepancies that may arise between two or more functional budgets. The following step is that of formulating a final budget that is known as the master budget. This is made by combining all other budgets after making corrections in case of any disagreements between the plans. The last step is that of reviewing the budget after certain periods such as three months. This is the control process that helps the company to avoid adverse variances that may arise in the course of business. P 3.4 Analysis of Variances Yuri Company has experienced adverse variances in usage of both labour and material and in the number of units that were sold during the period. These variances are unfavourable because they indicate that the company sold fewer units than planned, and it also spent more funds on both labour and materials. The company may avoid these variances by using techniques such as training workers so that they can acquire the required skills to avoid adverse labour efficiency variance. Yuri managers may also enter into long term contracts with suppliers who provide high quality steel to ensure that there is no shortage of raw materials (Drury, 2003). This also ensures that the company produces spoons of high quality. When the company acquires high quality steel and produces spoons, it may then conduct extensive marketing campaigns to promote the product. The company may give customers discounts and promotions when they purchase. This increases the market share of the firm and it reduces adverse variance in the number of units sold. Task 4 P3.1, 3.2 i.) Additional furniture will lead to the following entries in the trial balance. There will be a debit entry of £ 525 in the furniture account because this is an asset. The double entry for this transaction will be a credit of £ 525 in the loan account because the furniture has not been paid. ii.) The interest income of £50 will be credited in the interest income account while it will be debited in the cash account of the company. This is because an increase in income is credited in the income account. This increase also leads to an increase in cash in the business, and this means that the cash account is debited. iii.) The payment of accrued expenses will lead to a decrease in cash by £200. This means that the cash account is credited by this amount. The reduction in expenses, on the other hand, is credited in the accrued expenses account by the same amount. This completes the double entry for this transaction. The balance of furniture and van in the balance sheet indicates that these assets depreciate at 24.5% annually. Since the new furniture falls in this class, it means that it will also depreciate at this rate per year. However, the calculation of depreciation will be done for ten months because this is the time that the company has owned the asset during the year. 0.245*525*10/12 = £107 R Riggs Adjustment of the Profit and Loss Account £ Net profit 23,937 Add interest income 50 Balance 23,987 Less accrued expenses 200 Less depreciation of furniture 107 Adjusted net profit 23,680 The adjusted net profit of the company becomes £23,787 after adding the interest income of £50 and deducting the accrued expenses £200. The transaction that involves addition of furniture does not affect the profit and loss because furniture is an asset and not an item of income. R Riggs Adjusted Cash and Bank Account Dr. (£) Cr. (£) Balance before adjustment 4,424 Interest income 50 Accrued expenses 200 Balance c/d 4,274 Total 4,474 Total 4,474 R Riggs Adjusted Furniture and Van Account Dr. (£) Cr. (£) Balance before adjustment 6,650 Depreciation 107+1630= 1,737 Additional furniture 525 Balance c/d 5,438 Total 7,175 Total 7,175 R Riggs Adjusted Balance Sheet as at 31 Dec 2012 £ £ £ Fixed Assets Office furniture and van 7,175 Less depreciation 1,737 5,438 Current Assets Stock 2,400 Debtors 12,316 Less provision for doubtful debts 496 11,820 Prepaid expenses 230 Cash at bank and hand 4,274 18,724 Total Assets 24,162 Current Liabilities Furniture on credit 525 Creditors 5,245 Accruals 412 6,182 Financed by : Capital 11,400 Add net profit 23,680 Less drawings 17,100 17,980 24,162 P 4.1, 4.2 Gross profit margin =gross profit/sales *100 Gross profit margin =£62,645/£157,165*100=39.86% Net profit margin=net profit/sales*100 =£23,680/157,165*100= 15.07% Current ratio=current assets/current liabilities =£18,724/£6,182= 3:1 Acid test ratio=current assets-stock/current liabilities =£18,724-£2,400/£6,182= 2.6:1 Stock turnover=cost of sales/average stock =£94520/(0+2,400)/2= 78.77 Debtors turnover=credit sales/average debtors =£157,165/(0+12,316)/2=25.52 Debtors average collection period=360/debtors turnover =360/25.52= 14 days Creditors turnover=credit purchases/average creditors £94,520+£2,400/(0+5,245)/2= 36.96 Creditors collection period=360/creditors turnover =360/36.96= 9.7 ≈ 10 days Memorandum Report The organization is liquid as indicated by the current ratio and the quick acid test ratio whose values are 3:1 and 2.6:1. These ratios indicate that the company is capable of paying its debts from its current assets and from stock. The company can pay for its current liabilities three times using the current assets that include stock and it can pay for them 2.6 times using other current assets apart from stock. This is an indication that the firm is liquid meaning that it cannot become bankrupt easily because even after paying for current liabilities using current assets, the company may still remain with some assets to continue their business. R Riggs Company should continue maintaining current assets and liabilities at this level to avoid bankruptcy. However, the organization should ensure that its current ratio does not increase beyond this level to avoid holding too much stock and debts. This is because too much stock and debts leads to the reduction in the company’s profits. Low profits would then mean that the company may become bankrupt. The gross profit and the net profit margins of the company indicate that sales produce a gross income of 39.86% and net income of 15.07% of the value of sales. These values mean that the sales of the company are highly profitable and the management of the firm should continue selling the product. The company may improve its product by increasing its quality to continue increasing its profitability. The organization may also adopt other strategies such as marketing its product to increase market share. For example, the company may market itself by using social media such as Face book and Twitter that are used by numerous consumers who mostly include the youths. The stock turnover, on the other hand, shows the company the number of times that it has converted stock into sales. The turnover of 78 means that stock has been changed to sales by these numerous times. This figure also means that the company is active. A higher stock turnover would still be acceptable and the company may achieve it by conducting extensive marketing campaigns to increase its customer base. The debtors average collection period is 14 days. This means that debtors take 14 days to repay their debts. This is a short enough period to let the company recover from debts and it means that the company may trust their borrowers. The company may still reduce this period by encouraging borrowers to pay debts on time. This may be by giving debtors discounts when they purchase goods in bulk. The creditors average collection period, on the other hand is the time that the company takes to repay the debts that it owes to creditors. A collection period of 10 times means that the company repays its debts ten days after acquiring them. This collection period is shorter than the time that it takes for debtors to repay their debts. This means that at times, the company may lack the money to repay creditors when debtors have not repaid their debts. The organization should try and ensure that the debtors’ collection period is less than the creditors’ collection period. This will ensure that the firm has the money to repay the debts. This will be achieved by using the strategy of giving debtors discounts and offers when they pay debts on time. Task 5 a.) P5.1 Fixed costs are those expenses that remain constant throughout a financial year even when the amount of output that a company produces increases (Drury, 2003). An example of these costs includes the rent that an organization pays for its business premises. Variable costs, on the other hand, are those expenses that an organization incurs, and they change with the amount of units that the company produces. This means that when the units produced increase, the variable costs increase, and when the units produced decrease, the variable costs reduce. An example of these costs is the expenses incurred to acquire materials that are used for direct production and salaries paid to workers. Semi-variable costs are those that have the characteristics of both fixed and variable expenses (Wood & Sangster, 2008). These costs remain constant up to a certain level, but beyond this point, they become variable meaning that they start changing with the change in the level of output an organization produces. b.) P 5.2, 5.3 i.) The break-even of all the proposals Formulas: The current selling price = sales revenue/ number of units Variable cost per unit = total variable costs/number of units produced Contribution margin = sales price – variable cost per unit Break-even sales = Total fixed cost/ contribution margin per unit Table 1: Summary of break-even sales and value of the three proposals Proposal Sales price(£) Variable cost per unit (£) Contribution margin (£) Break-even sales Total break-even value (£) Proposal 1 0.90*10=9 80,000/10,000=8 9-8= 1 £30,000/£1=30,000 units 30,000*£9=270,000 Proposal 2 1.10*10=11 80,000/10,000=8 11-8=3 £30,000/£3=10,000 10,000*11=110,000 Proposal 3 10 8+1.5=9.5 10-9.5=0.5 £30,000/0.5=60,000 60,000*10=600,000 ii.) Numbers of units that help reach target profit. Profit= sales revenue-variable costs-fixed costs Profit=units*selling price-variable cost per unit*units-fixed cost Proposal 1 £20,000=9X-8X-£30,000 £20,000+£30,000=1X X=£50,000/£1= 50,000 units 50,000 units should be sold for the first proposal to produce a profit of £20,000. Proposal 2 £20,000=11X-8X-30,000 £20,000+£30,000=3X X=£50,000/3 X=16,667 units 16,667 units should be sold for the second proposal to produce a profit of £20,000. Proposal 3 £20,000=10X-9.5X-£30,000 0.5X=£50,000 X=100,000 100,000 units should be sold for the second proposal to yield the company a profit equal to £20,000. c.) P5.2, 5.3 Since the company aims at making a profit of £20,000, it means that the variable costs and the selling price are insignificant. The factor that determines the proposal to be chosen is the number of units that the company produces. I would advise the company to choose the second proposal because it is the one with the lowest number of units to be produced. The units required to make the £20,000 profits are 16,667 units. This proposal is also the best because it has the highest contribution margin of £3 and its break-even sales of 10,000 units that are valued at £110,000 are the lowest. References Drury, C. 2003. Cost and Management Accounting: An Introduction. 5th edition. London: Thomson Learning. Dyson J R 2007. Accounting for Non-Accounting Students. Financial Times/Prentice Hall. Fields, E. 2011. The essentials of finance and accounting for nonfinancial managers. New York: American Management Association. Wood, F. & Sangster, A. (2008). Business Accounting 1. 11th edition. Harlow: Pearson Education Ltd Read More