Cash Budget for Omega Solution Limited and Evaluating R-n-D Projects - Assignment Example

UNDERSTANDING MANAGEMENT ACCOUNTING AND FINANCIAL ACCOUNTING: By (Insert both names) (Name of class) (Professor’s name) (Institution) (City, State) (Date) CASH BUDGET FOR OMEGA SOLUTION LIMITED Introduction This report delivers a cash budget for Omega Solutions Limited for the months of October, November and December for this year and January and February for next year and provides recommendation focusing on the outlined projections. Based on the sales projections for the period specified, the preparation of the cash budget is based on the below key assumptions. Sales and production volume would go up by 50% The selling prices to be decreased by 10% so as to sustain an increased demand. The payment of trade receivables will be made in two months. Based on the above assumptions, the cash budget was developed as illustrated in appendix A. It is projected that Omega Solutions Ltd. Will maintain cash balance surplus at the end of every month over the next five months. It was noted that apart from increased payment period for the trade receivables, all the policies of working capital would be maintained as they are presently. The price, sales volume and payment period changes if they would occur will begin with the sales transacted from December 1 of this year. Recommendations: From the unfolding developments, the following recommendations were put forward. The sales price should be reduced by 10% to give discounts and attract more business. The payment period should be allowed to be completed in two months. Appropriate credit terms should be negotiated by the buyers so as to allow them purchase more goods and at the same time the company also remains competitive in the market. The production volume to improve by 50%, to realize this, the company should make credit arrangements with its suppliers so that they could be allowed to pay for the goods on later date agreed upon. This will also enhance the liquidity position of the company. Budgeting: According to (Antoniou et al. 2009) a budget is a statement outlining the planned business performance. These plans ideally deal with financial units; however, they may also consist of certain measurable units, for instance, output units. Developing a budget enables a firm like Omega Solutions Limited to plan forward and then review its performance against the figures budgeted. The disparity between the figures budgeted and the actual figure is referred to as variance. Variance is a vital management instrument since it allows an investment to manage its investment operations. For example make informed choices focusing on the management information (they way actual performance relates to the budgeted performance, could be unfavorable or favorable. Thus, a favorable variable is the one whereby the actual performance of the business demonstrates to be better compared to what has been budgeted for. Budget in the context of Strategic Objectives and Plans It is vital for financial managers to come up with the future business plans, since it provides a precise direction of where a firm plans to be. When establishing these plans, managers need to consider the following as Antoniou et al. (2009) suggested. Objectives and Mission: This is usually a description (statement) which decodes the organizations’ long term objective to a more definite and quantifiable goals. Identify strategic options: This entails selecting the finest strategy that can be broken-down to arrays of plans. Such plans are hence termed as the budget. Perform a position analysis: This characteristically evaluates where a firm is presently positioned, versus where it intends to be. Identity and examine strategic choices: The organization looks at where it is currently and where it expects to be in the next few years. Review and control: Within this context, the organization assesses the actual results with the budget. The management are capable of determining whether things are running as they had planned, and for control, it will be applied in the event of the actual performance seems to be mismatching the budget. Benefits of the Budget: Planning orientation: According to (Barclay and Smith 2009), budget development process takes managers way from their day-to-day, short-term running of the business and compels them to reason in long term basis. This is the principal budgeting goal, even whether the management fails to attain its goals as illustrated in the budget, at minimal they are thing about the organizations’ financial and competitive and how to enhance it. Profitability Review: it can be very possible to lose the view of where an organization is generating lots of its revenue, in the course of day-to-day scrambling for management. A well structured budget highlights what components of the business generate revenue and which aspects of the uses money. This compels the management to review whether they need to drop certain components of the investment or expand in some. Assumptions review: The process of budgeting obliges the management to reflect why the organization is doing business, and also its major assumptions concerning its business environment. An occasional re-assessment of these matters could result into assumptions which are altered, that could in turn change the manner through which the management chooses to run the business as Barclay and Smith (2009) found out. Performance evaluations: Managers can work with staff to outline their goals for a period of budgeting as well as tie incentives and other bonuses on the way they perform. They can then develop budget against the actual reports to provide the staff feedback concerning their progress towards the stated goals. This model is very common to financial objectives; however operational goals (for instance lowering the rate of product rework) may as well be included to the budget for the purposes of performance appraisal. This approach of assessment is known as responsibility accounting (Watson and Head 2010). Nonetheless, budget implementation is not a simple exercise, since there are certain elements that may bring setbacks. Some of those elements comprise: Unrealistic Budgets: A standard budget is developed in alignment with realistic projected results; however some managers could use the figures of the budget as a motivational instrument, through drawing figures of the target in excess of a realistic result. When a target cannot be attained, it can act as a factor of demotivation. Demotivating budgets: Ideally a budget is meant to encourage ownership and participation, though the actual impact could be much different to what is intended. When the budget is basically authoritarian, staff could possibly be less interested or resentful to cooperate and work to realize the budget. Inflexibility: when the process of setting budget is not quick to respond to short-term changes, its implementation may result into undesirable outcomes. In highly stiff process where the budget is developed in advance, it implies that the managers may not be in a position to respond to unanticipated events. Recommendations The merits of the budget may conflict with each other since that budget could be applied as a model of authorisation that will allow the management to use up their budget to the limit, and this could be improvident. The quarrel between the various users implies that the management needs to provide priorities to certain users at the expense of the other. EVALUATING R&D PROJECTS: PART B: INVESTMENT EVALUATION REPORT Introduction According to As (Holme 1998) companies which are successful are consistently looking at approaches through which they are able to change and develop. The top management is often confronted with various proposals, which could range from the new product development to establishing the presence of an organization within the new section of the globe or region. The organization may only have limited sum of capital by itself available and investors and lenders are simply prepared to provide limited finances. The management is thus confronted with the need to determine which among its proposals to fund. There is no one way of evaluating and comparing the various proposals (projects) the factors which should be looked into for example include: The level at which the projects are consistent with the long term goals of the company. The risks which are attached to the project The availability of the essential resources supposing the capital is available. Capital investment enables companies to recurrently obtain cash flows to sustain profitability of the investment operations. Capital investment proposals entail vigilant assessment since they will require huge sums of money to be obtained and invested, and also they will determine if the organization is profitable in long term. This report endeavours to examine the various methods which can be applied in making decisions for investment, hence providing certain recommendation on the best approach that Zeta Organic Plc can undertake. Evaluation Techniques The following techniques are applied to evaluate the potentials for the two alternatives for the proposed projects. 1) Payback Period: This technique outlines the number of years that the organization will take to get back its initial investment in every project. Here, the projects are ranked looking at the number of years each project will take to payback the organization on the initial outlay, providing inclination to the proposal which has the shortest Payback duration. This simple technique concentrates on the liquidity availability and recovery of capital from every proposal. The method does not tackle the profitability of the project and it assumes the time value of cash. This technique should simply be applied where the recovery of liquidity and capital are the major factors. Hence, the management will have to identify in advance the optimum allowable payback duration of any proposal in order to allow only the proposals which have least payback period below the pre-determined benchmark is considered the better option (Watson & Head 2010). 2) Net Present Value (NPV): According to Watson and Head (2010) this technique is worked out as the variation between the current value of cash inflows and the current value of cash out-flows of a given proposal. The technique considers the ‘time value of money’ and it seems to be detailed since it factors in all the cash flows happening within the whole period of the project in computing its worth. Nonetheless, objective use of this technique relies on the reliability of the project estimates in terms of capital cost and cash flows. Again there is a concern in using this technique when assessing projects which have unequal lifespan. 3) Accounting Rate of Returns (ARR): This technique describes the mean profit of a proposal in terms of the percentage of the mean size of capital investment. The method is an accounting evaluation of profitability which is easy and simple to comprehend. Nonetheless, this technique applies accounting data which incorporate non-cash substances and may be affected by the organization’s options of accounting procedures. In addition, the technique assumes the ‘time value of money’. When application this technique to arrive at a decision, the Accounting Rate of Return for every proposal is measured up to with the organization’s pre-determined ROCE (Return on Capital Employed as Holme (1998) found out. As such, only the proposals whose ARR is greater compared to the fixed ROCE will be taken as highly viable and acceptable. When mutually exclusive proposals are being ranked, the technique requires the proposals which have the highest ARR be considered. 4) Internal Rate of Return (IRR) As (Holme 1998) points out, the IRR, in some cases it is referred to as the discount cash flow rate of the return (DCFROR) is the rate of discount established through trial and error that equates to the sum current value of the projected after the benefits of the income tax cash-flows, to the sum value of outlays capital cost (for example both fixed capital and working capital). In more simplified terms, IRR is the discount rate established through trial and error that renders NPV=0. Its equation is ∑ (PV benefits) - ∑ (PV Costs) =0=NPV, Therefore r=IRR Thus, the IRR technique is normally considered most appropriate when the capital rationing or if the capital becomes a binding constraint. When decisions are being made, those proposals which provide IRR which is higher in comparison to the costs of capital is most suitable and should be accepted. Therefore always go for a project which has a higher IRR. Appraisal Outcome The findings from the evaluation of the two proposals (projects) under each technique are: Payback Period: The findings show that in option (A), it will take Zeta Organic Plc 1 years and 8 months to get back the initial investment, whereas in option B it will take the company 2 years and 6 months to recoup the initial investment as illustrated in the appendix 2. Thus, based on this technique, option A is the best project because provides a shorter recoupment period. Accounting Rate of Return (ARR): Option A and B provide ARR which is greater than organization’s latest return on capital employed of 20%. But when looking at the two options, they come out be mutually exclusive, as such option (A) provides a greater ARR of 47% should be considered. Net Present Value: From the evaluation, option (A) and (B) provides a positive NPV, and hence acceptable. Since both the options are mutually exclusive, the preferable option is B since it provides at greater NPV of £2.545m. And finally, Internal Rate of Return technique proves that both the proposals to be acceptable since their Internal Rate of Returns surpasses the cost of capital opportunity cost of 14%. However, when it comes to ranking, IRR technique considers option (A), which has a greater IRR of 45% as indicated in the appendix 2. Recommendations In light of the above appraisals, option (B) is thus recommended for Zeta Organic Plc as it provides the greater Net Present Value of £2.546m, implying that it will increase profitability and the shareholders’ earnings. From the discussed developments other techniques provide choices which are conflicting on the following basis. The ARR technique falls short in factoring the time value of money and works on the basis of accounting data that incorporate non-cash substances and could be prejudiced by the accounting policy choices. The IRR technique as expected provides inclination to smaller capital proposals, which renders it appropriate in a scenario where financing is a great constraint. Nonetheless, we presuppose Zeta Organic Plc would not have any issue obtaining the higher initial capital of £3.63m needed for the option (B), thus capital is taken as non-binding constraint. On the same line, the payback technique is dropped since the liquidity and capital recovery are not viewed to be priorities. Besides, this technique falls short of tacking the profitability of both the options. References Antoniou, A., Guney, Y. and Paudyal, K. (2009). The Determinants of Corporate Debt Maturity Structure. Annual Meeting of the European Financial Management Association 2003, Helsinki. Unpublished Manuscript. 45pp. Baker, M., Greenwood, R. and Wurgler, J. (2010). The Maturity of Debt Issues and Predictable Variation in Bond Returns. Harvard Business School Working Paper, Helsinki. Barclay, J., Marx, M. and Smith Jr., W. (2008). The Joint Determination of Leverage and Maturity. Journal of Corporate Finance, 9(1), p149-167. Barclay, J. and Smith Jr., W. (2009). The Maturity Structure of Corporate Debt. Journal of Finance, 50(2), p609-631. Holmes, P. (1998) Investment appraisal. London: International Thomson Business Press. Pettinger, R. (2000) Investment appraisal: A managerial approach. London: St. Martins Press.  Rohrich, M. (2007) Fundamentals of Investment Appraisal: An Illustration Based on a Case Study. Germany: Oldenbourg. Watson, D. and Head, A. (2010) Corporate Finance: Principles and Practice. 5th ed. Essex: Pearson. Read More