Managing Finance Resources and Decisions Subject - Assignment Example

Managing Finance Resources and Decisions Table of Contents Task 3 3 Part 3 Part 2 5 Part 3 6 8 Task 4 9 Part 9 Part 2 10 Reference List 13 Task 3 Part 1 a. As far as the sales budget of North Seaton Engineering Company is concerned, it is evident from the given data that there is a huge discrepancy between the monthly budget and the actual sales figures. The discrepancy continued to increase drastically with every passing month. This implies that, the company has continuously failed to achieve the sales forecast at least for the first six months. The company failed to adopt appropriate strategies in order to generate appropriate sales that actually meet its budget. This might lead the company to incur significant losses, as a majority of financial strategies are based on the sales forecast made by analysts (Stovall and Maurer, 2011). When it comes to the cash flow forecast of North Seaton, the prediction shows that the company is failing to generate adequate income to cover its expenditures. A relatively comparison of the income and expenditure data suggests that the increase in expenditure is not being equally complemented with a similar or greater level of increase in the net income (Schleifer, Sullivan and Murdough, 2014). That is why the monthly surplus figures are far lower than the deficits which in turn results in the company incurring significant proportion of cash flow deficits every month. Moreover, the company is failing to attain economies of scale and scope which is why the purchase expenditures have been increase in the last six months of the year. The cash deficits that has been realized every month is also because of the insurance premium of £55,000 and £50,000 paid in the month of January and May respectively. This has largely depleted the profit margin for the company. The quarterly bill paid for electricity and heat has also reduced the company’s margin of income. Although the expenditure behind buying company vehicles was one off, but it has proven to be big burden for the company given the fact that they have to incur a constant maintenance expense of £11,000 throughout the year. All the above mentioned facts are largely responsible for the cash deficits incurred by the company every month. b. The major reason behind such problems within the sales budget can be attributed to the failure of the company analysts in forecasting the demand for products. The inaccurate predictions led to a demand supply gap which in turn led the company to incur negative variances between sales budget and the generated sales (Nugus, 2009). Other reasons that can be attributed to this discrepancy are inappropriate marketing strategies adopted by the company, incompetency of the sales force and deteriorating levels of customer satisfaction towards the company’s products (Maness and Zietlow, 2004). As far as the cash flow forecasts is concerned, the main reason behind the continued cash deficits is the company’s failure to attain economies of scale and scope. The managers have failed to reduce the expenditure made behind product purchase. This has depleted the company’s profit margin by a significant level. Moreover, North Seaton has also failed to generate adequate sales which in turn have weakened its sustainable source of profit. This is largely due to the depleting customer base of the company as a result of deteriorating customer satisfaction level (Kruschwitz and Löffler, 2006). c. In order to achieve the sales budget, the first and foremost step to be taken is to bring upon improvement in the way demand forecast is made. Precise demand forecast should be made and the data should be properly interpreted into the sales budget. This will remove any form of demand supply gap following which sales budget can be achieved on a continuous basis. In order to accumulate cash surplus, North Seaton could opt for debt finance as it is a cheaper source of capital and can be used to purchase raw materials. This strategy will reduce any bulk cost that the company used to incur up front. By doing so, North Seaton can increase its margin of profit to a level that would be adequate enough to cover overall expenditure, thereby, leaving sufficient cash surplus at the company’s disposal. In order to reduce its expenditure behind raw materials the company could diversify its chain of suppliers which in turn would increasing their bargaining power thereby providing them with an opportunity to obtain cheaper source of supply. The insurance cost can be easily reduced by reducing the number of vehicles that are currently being owned by the company. Given the fact that currently the company’s primary objective should be to convert its net income to cash surpluses, they should sell some of the vehicles which in turn would reduce their insurance cost as well as the expenditures behind their maintenance. As far as electricity bill reduction is concerned, managers of North Seaton can opt for solar cell panels which would consume energy from sunlight in order to provide electricity within their office. This in turn would reduce the electricity bills by a considerable margin. By adopting these strategies the company is expected to realize cash surpluses in a matter of six months or so. Part 2 Given information: Magic and Sparkle Company’s single product Z Plc has approached the business and requested to purchase 1500. Offered price = £14000. From the above mentioned information we can obtain the selling price per unit: = 14000/1500 = £9.33 The usual selling price at which Magic and Sparkle sells its products = £ 15/unit Price difference = 15 – 9.33 = £5.67/unit Variable production cost is £ 1.20/unit Therefore contribution per unit can be calculated as the selling price per unit less the variable production cost = 9.33 – 1.20 = £8.13/unit Therefore, the overall contribution/ benefit to be realized on this special order = 1500 units * 8.13 = £12,195. The calculation reveals that if this offer is accepted, then Magic and Sparkle Company would realize a profit of £12,195 if the product is sold at £9.33/unit. However, if 1500 units had been sold at the usual price of £15/ unit, then the company would have realized a profit of (15 – 1.2) = £13.8/unit. This is equivalent to generating a profit of £20,700. Therefore, selling the products to Z Plc will deplete Magic and Sparkle Company’s profit margin by £8,505. Therefore, the offer from Z Plc should not be accepted. Part 3 To, The Director North Seaton Engineering Company Sub: Evaluation of project A and B The initial investment for project A is estimated to be £450,000. The future cash flows are as follows: The initial investment for project B has also been estimated to be £ 450,000. The future cash flows are as follows: The Net present value of a project gives the present value of all future cash flows less the initial investment (Booker, 2006; Berk and DeMarzo, 2011). In other words, net present value denotes the present value of a project benefits less the present value of costs incurred in that project (Appelbaum, Vigneault and Shapiro, 2009). It expresses the price of an investment decision as the amount of cash that is received today (Abor, 2005). The net present value for both these projects was run using the PV function in excel and thereafter the initial investment was deducted from the present value of the cash inflows. Having applied this formula, the NPV for project A came out to be £254,680. By applying the same formula, the NPV of project B was found to be £121,380. The NPV of project A is far greater than that of project B considering that both these projects require the same amount of investment. According to payback investment rule, between two projects, the one which pays back the initial investment quickly is a better one (Subramanyam and Wild, 2009). In other words, a project that has a lesser payback period value is the more profitable one (Will, Subramanyam and Robert, 2001; Booker, 2006). In case of project A it takes slightly more than 2 years for the project to pay back the initial investment. This was found out by adding the corresponding cash inflows till it exceeds the initial investment. The residual value was then divided by the cash flow in the year that exceeds the initial outflow. Having applied the same formula, the payback period for project B came out to 3 years and 29 days. In this case as well, project A proves to be more profitable compared to project B given that the payback period of the former is far lesser than the later. Therefore, given the fact that the NPV of project A is higher and payback period is lower than capital B, acceptance of project A is strongly recommended to the directors. NPV Advantages Disadvantages Importance is given to time value of money. Cash flows before and after the life cycle of a project is taken into consideration. Assumption of discounting appropriate might not be inaccurate. May not provide a proper evaluation when projects of unequal life span are considered Payback period Advantages Disadvantages Relatively easy to understand and calculate. The risk factor associated with a project is taken into consideration. Time value of money is not taken into account. High emphasis is given on liquidity rather than profitability Task 4 Part 1 As far as financial report formats of sole traders are concerned it includes the balance sheet, the profit and loss statement and trial balance statement. On the other hand, the financial report formats of publicly listed companies include the statement of financial position, the income statement and the cash flow statement (Alexander, 2001). One of the major differences that can be seen within the financial reports of sole traders and publicly listed companies is that the later has the obligation to follow the accounting principles set within the International Financial Reporting Standards (IFRS) set by the International Accounting Standards Board (IASB). Companies that are run under sole proprietorship do not have any such obligation. They can report their financial figures the way they see appropriate and it is possibly reported in the simplest manner that is understandable to the owner itself (Rossouw, 2009). Given the fact that, publicly listed companies are large in size and are engaged in multiple lines of businesses, they often choose to report their financial figures on the basis of individual business segments. This is particular because their operations, unlike sole trading companies, are relatively complex in nature which necessitates the preparation of financial reports according to business segments so as to have a holistic view of individual business segment performance. This is not the same in case of sole trading companies where financial figures are reported in a consolidated manner. Companies have the obligation to report the value of their goodwill as well as the value of impaired goodwill according to the regulations specified within IFRS. On the other hand, sole traders do not have to disclose any such information. In addition, given the fact that sole traders have only one owner, unlike publicly listed companies who have equity holders, only the value of invested capital is reported in the balance sheet of sole trading companies. Part 2 As far as return on capital employed is concerned, Merlot has proved to be much profitable in the year 2013 with ROCE of 15.38% when compared to Grappa (10.19%). This implies that managers of Merlot have been able to make efficient use of their capital (McCrary, 2010). Although Grappa has also employed its capital effectively, its ROCE ratio is still lower than Merlot. Merlot has achieved a greater net asset turnover (1.39) compared to Grappa’s ratio of 1.2. A higher value of net asset turnover implies that Merlot has been able to generate more revenues for every dollar of assets employed (Fridson and Alvarez, 2011). The value of 1.2 also indicates a good performance considering the fact that Grappa may be from a different industry where attaining an net asset turnover of 1.2 is a standard. A higher gross profit margin indicates that the company is financially healthy. In this case, Grappa seems to be financially healthier than Merlot. With a gross profit margin of 12.5% compared to Merlot’s 12.2%, Grappa is in a better position to cover its expenditures. However, a difference of 0.3% between the two companies does indicate much of dissimilarity between the companies in terms of their performance (Garrison, Noreen and Brewer, 2003). As far as operating profit margin is concerned Grappa has attained a value of 10.5% which is relatively greater Merlot’s 9.76%. A higher value of operating profit margin for Grappa suggest that the company is in a better position to pay of its interest bearing liabilities when compared that of Merlot. A lesser value for Merlot indicates that the company has failed to achieve economies of scale that led the managers to incur significant expenditures. This in turn depleted the company’s profit margin (Chow, Song and Wong, 2010). The current ratio of Merlot is 1.28 which is a bit higher than Grappa’s value of 1.2. This ratio implies that both Merlot and Grappa have adequate current assets at their disposal that can be used to pay off the current liabilities. However, a higher ratio for Merlot indicates that the company has adequate cash assets at its reserve (De Franco, Kothari and Verdi, 2011). In this respect, Merlot is financially stable than Grappa. The account receivable period for Merlot (66) is lower than Grappa (73). This indicates that Merlot will receive its due payments from the customers relatively quicker than that of Grappa. Grappa’s higher value indicates that the company has been more lenient towards its customers. The company has delayed its period of collection. Such delays can have adverse impacts for the company if it does not have enough cash reserves at its disposal to pay off its current liabilities (Kruschwitz and Löffler, 2006). Grappa’s accounts payable period of 108 days is considerably higher than that of Merlot’s 77 days. However, if the gap between the accounts receivable and account payable days is wider then it is considered bad. This fact holds true for Grappa as the difference between its accounts receivable and account payable days is 35 days when compared to Merlot’s 11 days. The gap is considered unfavourably because it may induce companies to invest the receivables somewhere which in turn may leave no cash at reserve to pay off creditors. The scenario might be similar for Grappa. It is evident from the financial reports of Merlot that the company has maintained a steady gap between its accounts receivable and account payable days which is considered favourable for a company (Rose and Hudgins, 2008). The inventory holding period for Grappa and Merlot are quite close to each other (73 for Merlot and 70 for Grappa). A higher inventory period suggests that it takes 3 days more for Merlot to get rid of its entire inventory by selling them to the customers. It also exposes the company to a relatively greater degree of inventory obsolesce risk in which case the company may incur greater inventory holding cost. Resource wastage can be another implication if Merlot fails to sell products from the inventory (Diamond, 2002). As far as the capital gearing ratio is concerned it is considerably higher for Merlot (2.25) when compared to Grappa’s ratio of 0.87. This implies that, Merlot is excessively leveraged and grappa on the other hand has used a good mix of both debt and equity capital which is why it’s gearing ratio is lesser than Merlot. This also suggests that Merlot’s degree of exposure to interest rate and other market wide variances is greater than that of Grappa. Gearing ratio is a key determinant of a company’s stability and this financial measure does not stand in favour of Merlot. This fact is also evidenced by a lower interest coverage ratio of Merlot (3.33) compared to that of Grappa (6). This explains that Merlot is hugely burdened with debt expense (Stovall and Maurer, 2011). Therefore, considering all these factors, it needs to be said that acquiring Merlot may look fruitful in the short run but in the long run it may expose Victural to higher degree of risk as the later will have to assume all of Merlot’s debts in its books. On the other hand, acquiring grappa may look less prospective in the short run but given the fact that grappa is considerably less leveraged and has managed to maintain a stable performance, acquisition of this company will always prove to be profitable for Victural in the long run. Reference List Abor, J., 2005. Managing foreign exchange risk among Ghanaian firms. The Journal of Risk Finance, 6(4), pp. 306-318. Alexander, C., 2001. Market models: a guide to financial data analysis. New Jersey: John Wiley & Sons. Appelbaum, S. H. L., Vigneault, E. W. and Shapiro, B. T., 2009., Good corporate governance and the strategic integration of meso ethics. Social responsibility journal, 5(4), pp. 525-539. Berk, J. and DeMarzo, P., 2011. Corporate finance. Ney Jersey. Pearson education. Booker, J., 2006. Financial Planning Fundamentals. Canada: CCH Canadian Limited. Chow, C. K.W., Song, F. M. and Wong, K. P., 2010. Investment and the soft budget constraint in China. International Review of Economics and Finance, pp. 1-22. De Franco, G., Kothari, S. P. and Verdi, R. S., 2011. The benefits of financial statement comparability. Journal of Accounting Research, 49(4), pp. 895-931. Diamond, J., 2002. Performance Budgeting-Is Accrual Accounting Required? International Monetary Fund, pp. 1-30. Fridson, M. S. and Alvarez, F., 2011. Financial statement analysis: a practitioners guide. New York:  John Wiley & Sons. Garrison, R. H., Noreen, E. W. and Brewer, P. C., 2003. Managerial accounting. New York: McGraw-Hill/Irwin. Kruschwitz, L. and Löffler, A., 2006. Discounted cash flow: a theory of the valuation of firms. New Jersey: John Wiley & Sons. Li, X., and Wu, Z., 2009. Corporate risk management and investment decisions. The Journal of Risk Finance, 10(2), pp. 155-168. Maness, T. S. and Zietlow, J. T., 2004. Short Term Financial Management. USA: South-Western Educational Publishing. McCrary, S. A., 2010. Financial Statement Analysis. Mastering Financial Accounting Essentials: The Critical Nuts and Bolts, pp. 89-99. Nugus, S., 2009. Financial Planning Using Excel: Forecasting, Planning and Budgeting Techniques. United Kingdom: Butterworth-Heinemann. Padachi, K., 2006. Trends in working capital management and its impact on firms’ performance: an analysis of Mauritian small manufacturing firms. International Review of business research papers, 2(2), pp. 45-58. Rose, P. S. and Hudgins, S. C., 2008. Bank management and financial services. 7th edition. New York: McGraw Hill. Rossouw, D., 2009. The ethics of corporate governance: Crucial distinctions for global comparisons. International journal of Law and Management, 51(1), pp. 5-9. Schleifer, T. C., Sullivan, K. T. and Murdough, J. M., 2014. Projection and Budgets. Managing the Profitable Construction Business: The Contractors Guide to Success and Survival Strategies, pp. 181-194. Stovall, J. and Maurer, T., 2011. The Ultimate Financial Plan: Balancing Your Money and Life. New Jersey: John Wiley & Sons. Subramanyam, K. R. and Wild, J. J., 2009. Financial statement analysis. New York, NY: McGraw-Hill. Will, I., Subramanyam, K. R. and Robert, F. H., 2001. Financial statement analysis. New York: McGraw-Hill International. Read More