Managing Financial Resources and Decisions - Coursework Example

Table of content Task a) Capital budgeting techniques………………………………………………….3 b) Sources of finance…………………………………………..…………………5 2. Task 2 a) Profitability ratios……………………………………………………………..7 b) Liquidity ratios…………………………………………………….…………..8 c) Efficiency ratios……………………………………………………….………8 d) Gearing ratios………………………………………………………….……..10 3. Task 3 a) Internal decision makers……………………………………..………………11 b) Purpose of financial statements…………………………………….………..11 c) Different formats of financial statements…………………...……………… 13 4. Task 4 a) Importance of financial planning……………………………...……………..14 b) Cash budget………………………………………………………………….14 c) Advice of liquidity………………………………………..………………… 15 5. Task 5 a) Minimum bid price………………………………………………..…………15 b) Total cost and unit cost per attendee…………………………..……………..16 6. References………………………………………………………………………….…….19 7. Appendix…………………………………………………………………………………20 Managing financial resources and decisions Task 1 Incremental cash flow computation PROJECT A 1 2 3 4 taxable profits 20,000 20,000 11,000 11,000 less: capital allowance 11,550 7000 3850 3850 8450 13000 7150 7150 Taxation (25%) 2112.5 3250 1787.5 1787.5 6337.5 9750 5362.5 5362.5 Add capital allowance 11550 7000 3850 3850 incremental cash flow 17887.5 16750 9212.5 9212.5 PROJECT B 1 2 3 4 taxable profits 12,000 10,000 20,000 20,000 less: capital allowance 10,500 3500 7000 7000 1500 6500 13000 13000 Taxation (25%) 375 1625 3250 3250 1125 4875 9750 9750 Add capital allowance 10500 3500 7000 7000 incremental cash flow 11625 8375 16750 16750 a) i) payback period Project A= 1+15112.5/16750= 1.9022 years Project B= 2+10000/16750= 2.597 years ii) Net Present Value and IRR Project A Cash flow PVIF PVs -33000 1.000 -33000 17887.50 0.8772 15690.79 16750 0.7695 12889.13 9212.50 0.6750 6218.44 9212.50 0.5921 5454.72 NPV= 7251.89 IRR= 26.014% Project B Cash flow PVIF PVs -30000 1.000 -30000 11625 0.8772 10197.45 8375 0.7695 6444.56 16750 0.6750 11306.25 16750 0.5921 9917.68 NPV= 7864.77 IRR= 25.165% iii) Accounting Rate of Return= Average annual accounting profit / Initial investment Project A= (53062.5/4)/33000= 40.20% Project B= (53500/4)/30000= 44.58% Recommendation Project B should be picked because it has a higher NPV and Accounting Rate of Return. Even though it has a lower IRR compared to project A, its IRR is still way above the weighted average cost of capital. b) Sources of finance There are several sources of funds available to the company. These are the capital markets, loan stock, retained earnings, bank borrowing, government sources, venture capital and angel investors and sales and lease back arrangements. Costs of each source of finance These sources of funds have different costs. Borrowing in the capital market will require the company to pay the cost of capital which is the rate of return that borrowers pay investors. Additional supply of funds in the capital market lowers this cost of borrowing. The cost of using loan stock and bank lending is expressed as a rate of interest. This interest rate is relatively high because it depends on the companys credit rating. The interest has to be paid whether or not the company makes a profit. Retained earnings are funds that are believed to cost nothing because it has no issue costs as the company just needs to set aside part of their profits. Government sources are normally free because they are part of the policy to develop the national economy,; however; there are some conditions that must be met. For instance, a company must be in the relevant industry and a specific location. Venture capitalists and angel investors usually require a high expected rate of return on their investments so as to compensate them for the high risk. As a result, the cost of obtaining such funds is usually very high. The cost of sales nd lease back arrangement is often the ongoing lease payments. Implications Each source of finance has a set of implication, for instance, for sources like bank lending and loan stock, the borrower is required to pay some amount of interest on the principal. In addition, they can be penalized for infractions of the written contract between them, for instance, late payments. With retained earnings, the company will have to forgo dividend payments that may affect its image in the eyes of investors as they go for companies that pay regular dividends. As for government sources, the company will be under government control. Finally, with venture capital and angel investors, the company will be penalized for infracting written agreements between them and the private investors c) A highly geared organization has a high proportion of debt compared to equity. They, therefore, need to borrow from the capital market in order to balance the dent and equity proportions. A low geared organization has more equity financing than debt financing, it therefore should borrow through loan stock, bank lending, angel investors, venture capital and lease arrangements in order to strike a balance between equity and debt components. d) Finance increases expenses in terms of interest payments that in turn lower the company’s net income. However, leasing helps an organization to avoid expenses that would otherwise lower their bottom line. Finance is the main reason why financial statements are prepared because an organization cannot do without it in a financial statement. It increases the liabilities of the organization thus decreasing its net worth. Task 2 Profitability ratios 2010 2009 Industry average Profit margin 37.5% 32% 30% Net profit margin 12.5% 11.4% 10% ROCE 34.04% 41.82% 15% Profitability ratios determine the company’s bottom line and the returns it gives to the investors. These ratios indicate the company’s overall performance and efficiency. Profitability ratios indicate the ability of a firm to generate its earnings comparative to sales, assets, and equity (Kapil, 131-132). The company’s profitability ratios (profit margin and net profit margin) have increased in 2010. This indicates an increase in its efficiency and overall performance that in turn implies an increase in profitability. These ratios are above the industry average value; this implies that the company is more profitable than other firms in the industry. The company is profitable enough to meet its operating expenses and other expenses and still realize some earnings from its operations. On the contrary, the company’s return on capital employed has decreased considerably. This is unfavorable because it implies that fewer dollars of profits are produced by each dollar of capital employed. However, the firm is still efficient in generating profits from its capital employed because its ratios are way above the industry average. Liquidity ratios 2010 2009 industry Liquid ratio 5.07:1 3.4:1 2:1 Quick ratio 2.33:1 2.5:1 1:1 Liquidity ratios show the ability of a firm to meet or pay for its short-term liabilities or short-term debt obligations as they fall due (Khan and Jain, 6.3). The firm’s current ratio has increased over time indicating that the firm’s ability to meet its short-term debt obligations has increased as well. This shows that the company is able to meet its short-term liabilities with lots ease. The firm has a quick ratio of more than one indicating that its most liquid assets are high enough to meet its short-term liabilities. This indicates the under-leveraged nature of the firm hence implying that it is paying its bills too slowly, collecting its receivables quickly, or growing its sales with lots of ease. The company’s liquidity ratios are greater than the industry average. This implies that it is more liquid and is able to meet its short-term liabilities as they fall due. Efficiency ratios 2010 2009 Industry Debtor collection period 46 days 73 days 45 days Creditor payment period  43 days 44 days 60 days Inventory turnover period 94 days 33 days 60 days These ratios measure how effectively a company is utilizing its assets to generate income and how well it is managing its liabilities. Such ratios are, therefore, used by the management of the firm to help improve it. They show how efficiently the assets of the company are working to generate sales revenue. Receivable collection period shows how efficient the companies issues credit to the customers and collect it back in a timely manner (Sinha and Gokul, 133-134). Debtor collection period has decreased throughout the period, which shows that the time taken by the company to collect its receivable has decreased. The company’s debtor collection period is greater than the industrys showing that the company takes more time to realize its accounts receivable thus reduction in its efficiency. The decrease in the creditor payment period indicates reduction in efficiency because the firm pays out cash quickly. Further, the ratio is lower than that of the industry. This indicates that the company is less efficient that the industry. They take a shorter time than the industry to pay their creditors hence they have less money on hand, which is bad for free cash flow and working capital. The company’s inventory turnover period has increased implying that the firm takes more time to convert its inventory to cash. This implies that the company is inefficient in turning around the inventories. The firm is inefficient in their operations because the ratio is more than the industry average. In terms of efficiency, the firm is relatively more efficient in their operation than other firms in the industry. Gearing ratio 2010 2009 industry Interest cover 29 times 27.6 times 10 times Dividend cover 5.44 times 5.17 times 20 times Gearing 37.23% 53.57% 60% Gearing ratio assists a firm in comparing its equity to the borrowed funds. It indicates the firm’s activity that is funded by the borrowed funds in comparison to those activities that are funded by the equity. The gearing ratio not only measures the company’s financial leverage but also measures its business risk indirectly. It measures a company’s long-term solvency (Brigham and Michael, 120). Interest cover is the measure of the firms ability to pay for its interest payments. An organization’s ability to pay for its interest payment has increased in 2010. The company has a higher interest cover than the industry. This shows that it can easily finance its interest on debts. The firm is, therefore, able to meet its long-term solvency requirement. Dividend cover indicates the ability of a firm to pay dividends out of profit that can be attributed to shareholders. The dividend cover has increased however it is way below the industry. The company is retaining lower portion of its earnings than the industry to meet its financing requirements. This may result in lower dividend payouts in the future. Gearing ratio is a measure of a firm’s financial leverage. It shows its activities that are funded by equity versus borrowed funds. The company’s financial leverage has reduced implying that it is using fewer borrowed funds. In comparison with the industry, the firm is low geared. A company that is low geared is less risky because it can meet its interest and principal repayments thus lowering the possibility of it being bankrupt. In terms of gearing, the firm is relatively less risky than other firms in the industry because it uses fewer debts. In addition, it has less business risk because it can meet its interest payments with lots of ease. Task 3 (a) Internal decision maker and their respective information needs Accounting information assists various user to make financial and investment decisions. Internal users or primary users of accounting information include management, employees and owners. Management requires information such as cash flow trends, profits, incomes and returns, future growth prospects and corporate social responsibility to analyze the performance and position of the organization. This enables them to take suitable measures to improve the results of the company. Employees require information on remuneration, employee benefits, profits company’s reputation, employee development programs, future growth potential, and Anti-corruption and bribery. This helps them assess the profitability of the company as well as its future consequences on their job security and remuneration. Owners require information on future growth potential of the company, cash flow trends, profitability, liquidity and environmental issues so as to analyze the profitability and viability of their investment. (b) The purpose of the main financial statements Financial statements help communicate business activities to stakeholders. Financial statements are normally periodic reports that a company publishes for the purpose of giving information to external and internal user. There are four primary financial statements: income statement, statement of financial statement; cash flow statement and statement of stockholder’s equity. The income statement is basically a financial statement that outlines the revenues and expenses of a company over an interval of time. It reports whether the firm was in a position to generate sufficient revenue to cover for the costs and expenses of running a business. The income statement, therefore, shows investors and managers whether the firm lost or made money during the duration being reported. The statement of stockholders’ equity, on the other hand, is a financial statement that sums up the changes in shareholders’ equity over an interval of time. The statement of stockholders’ equity assists financial statement users to identify the factors or reasons for changes in the owners’ equity over the accounting periods. It discloses significant information regarding equity reserves that are not provided discretely elsewhere in the financial statements. Such information may be crucial in understanding the type of change in equity reserves. The statement reveals stock sales and repurchases by a company. Statement of financial position contains summarized information on the assets and liabilities of the company. It, therefore, helps in determining the financial standing (financial position) of the company as it outlines what the business owns and what it owes. Finally, statement of cash flow shows how changes in income and balance sheet accounts affect cash and cash equivalents by breaking down the analysis into financing, investing and operating activities. The cash flow statement presents information about the organizations gross payments and gross receipts for a particular period of time. In addition, it helps in anticipating the future cash flows. It also provides information on non-cash financing and investing activities. (c) Difference between the FORMATS of financial statement of these different types of business. Each business form has different economic sectors hence have different formats of financial statements. Sole traders have simple financial statements because it is just a report that serves the sole trader. It may lack balance sheet and income statement as the report only shoe profit and loss account. Public Limited Liability Company must prepare its financial statements based on generally accepted accounting principle (GAAP) and international financial reporting standard (IFRS) because of the need to compare them with those of other organizations. The financial statements of a limited company must show non-current and current assets and liabilities, earnings per share, profits, sales and cost of income tax payable. The financial statements of partnership relate to profits and interests of the partners. The financial statements aim at showing the profit, balance sheet, and income and loss statement. Income statement is prepared first since the profit or loss is part of the partner’s capital account. Partners’ account is prepared second since the ending balance of partner’s capital is taken to the balance sheet. Partnership financial statements analyze the profits and capital of the company and are circulated within the company. Task 4 a) Importance of financial planning Financial planning allows an organization to measure progress in their ventures. It also helps to priorities their expenditures. The business owner is able to identify those expenditures that results in immediate improvements in efficiency, productivity or market penetration. Financial planning enables an organization to set quantifiable targets that are comparable to actual results during the year. It, therefore, helps in spotting trends. Further, financial planning helps an organization to manage cash. It allows an organization to have a cash cushion that may be used to take advantage of investment opportunities that may arise. Projection of cash receipts and disbursement i) Cash budget CASH BUDGET FOR THE TWO MONTHS ENDING JANUARY 31 December January Total Cash balance 10,000 49,550 10,000 Add collections from customers 285,800 156900 442,700 Total cash available 295,800 206450 452,700 Less Disbursements Merchandise purchases 183750 183750 367500 Variable manufacturing overhead 50000 25000 75000 Fixed manufacturing overhead 12500 12500 25000 Total disbursement 246250 221250 467500 Excess (deficiency) of receipts over disbursements 49,550 (14,800) (14,800) c) The company can redeploy the excess cash into the business to enhance the growth of the company. This available cash is, therefore, used to finance a company’s operations. The company can also take the excess cash and invest it in traditional class assets or excess returns that arise from skill-based strategies. On the contrary, the company needs to borrow funds from outside sources in case it has deficit deficiency of receipts over disbursements. This helps in maintaining the liquidity of the company hence being able to meet its short-term debt obligations. The cash deficiency is financed from sources like additional cash contribution or bank loan so as to maintain a stable cash balance above the immediate cash needs. Task 5 a) Minimum quoted price In this case we need to gauge whether the company will realize additional profit from the contract. Revenue (250000*90) 22,500,000 Cost Total variable cost (35*250000) 8,750,000 Total fixed manufacturing overhead 7,800,000 Fixed manufacturing overhead costs 300,000 Profit 5, 650,000 We then need to determine the opportunity cost and avoidable fixed cost Opportunity cost = 5650000 Avoidable fixed cost = [(35-13)*250000]-300000= 5700000 The opportunity cost is $5650000 and avoidable fixed cost is $5700000 resulting in a total relevant cost of ($50,000). The bid price will therefore be Bid price= 5650000/250000+ 13+6= $41.6 b) 1) 50 attend i) Total cost= $8000 Unit cost= 8000/50= 160 ii) Total cost= 20*50 +2000= $3000 Unit cost= 3000/50= $60 iii) Total cost= 50*50= $2500 Unit cost= $50 c) 200 attend i) Total cost= $8000 Unit cost= 8000/2000= $40 ii) Total cost= 20*200 +2000= $6000 Unit cost= 6000/200 =$30 iii) Total cost= 50*200= $10000 Unit cost= $50 d) 500 attend i) Total cost= $8000 Unit cost= 8000/500= $16 ii) Total cost= 20*500 =2000=$12000 Unit cost= 12000/500= $24 iii) Total cost= 50*500= $25000 Unit cost= 25000/500= $50 Comments The number of people attending the seminar determines the total cost and the unit cost per attendee. As the number of attendees increases, the total cost and unit cost increases particular for the schedule that varies with the number of attendees. When there are only 50 people, the sole speaker should go for the first schedule (fixed fee of $8000) because it is the highest total cost and unit cost of the three schedules. In the case there are 200 attendees; the sole speaker should go for the third schedule (an available charge of $50 per attendee) because it has the highest amount. Finally, in case there are 500 attendees, the sole speaker should again select the third option because it has the highest total cost and unit cost. This implies that the sole speaker will get more amount of money from the seminar. Sole speakers would choose a fee arrangement that produces highest total cost and unit cost. References Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2011). Intermediate Accounting. 13th Ed. New York: Wiley. Epstein, Barry J, and Eva K. Jermakowicz. Wiley Ifrs 2010: Interpretation and Application of International Financial Reporting Standards. Hoboken, N.J: Wiley, 2010. Print. Khan, M Y, and P K. Jain. Financial Management. New Delhi: Tata McGraw-Hill, 2007. Print. Kapil, Sheeba. Financial Management. Noida, India: Pearson, 2011. Internet resource. Sinha, Gokul, and Gokul Sinha. Financial Statment Analysis. New Delhi: PHI Learning Pvt Ltd, 2009. Print. Brigham, Eugene F, and Michael C. Ehrhardt. Financial Management: Theory and Practice. Mason, Ohio: South-Western, 2013. Print. Appendix Task 2 2010 2009 Profit margin =GP/net sales 1800/4800 =37.5% 1600/5000 =32% Net profit margin =NP/net sales 600/4800 =12.5% 570/500 =11.4% ROCE EBIT/capital employed 725/2130 =34.04% 690/1650 =41.82% Liquid ratio =current assets/current liabilities 2280/450 =5.07:1 1700/500 =3.4:1 Quick ratio = (Current Assets - Inventories)/Current Liabilities (2280-12300/450 =2.33:1 (1700-450)/500 =2.5:1 Debtor collection period Accounts Receivable/(Sales/365) 600/(4800/365) 46 days 1000/(5000/365) 73 days Creditor payment period  Accounts payable / (cost of sales/365). 350/(3000/365) 43 days 405/(3400/365) 44 days Inventory turnover period =365/(Sales/Inventory) 365/(4800/1230) 94 days 365/(5000/450) =33 days Interest cover =Earnings before interest and taxes (EBIT)/ interest expense 725/20 =29 times 690/25 =27.6 times Dividend cover = ( Profit after tax-preference dividend)/ordinary dividends (600-12)/108 =5.44 times (570-12)/108 =5.17 times Gearing =total debt/ shareholder’s equity 700/1880 =37.23% 750/1400 =53.57% Task 4 SALES BUDGET: Oct Nov Dec Jan Budgeted unit sales 1,800 2,500 3,000 1,500 Selling price per unit 100 100 100 100 Total Sales 180,000 250,000 300,000 150,000 SCHEDULE OF EXPECTED CASH COLLECTIONS: Oct Nov Dec Jan October sales 159,480 14,400     November sales - 221,500 20,000   December sales - - 265,800 24,000 January sales       132,900 February sales         Total Cash Collections 159,480 235,900 285,800 156,900 MERCHANDISE PURCHASES BUDGET: Oct Nov Dec Jan Budgeted unit sales 1,800 2,500 3,000 1,500 Add desired ending inventory 1,125 1,250 875 300 Total needs 2,925 3,750 3,875 1,800 Less beginning inventory 875 1,125 1,250 875 Required purchases 2,050 2,625 2,625 925 Cost of purchases @ $70 per unit 143,500 183,750 183,750 64,750 BUDGETED CASH DISBURSEMENTS FOR MERCHANDISE PURCHASES: Nov Dec Jan Feb Accounts payable 71,750       November purchases 91,875 91,875     December purchases   91,875 91,875   January purchases     32,375 32,375 Total cash payments 163,625 183,750 124,250 32,375 Read More