Pampers Health Spa and Financial Accounts - Assignment Example

Pampers Health Spa Name: Institution: Professor: Course: Date: Task.1 Trading profit and loss account for the period ended 31st Dec. 2009 £. £. Sales 2,965,000 Less Cost of sales: Add Opening stock 57,300 Purchases 494,000 Goods available 551,300 Less closing stock (67,600) (483,700) Gross profit 2,481,300 Less expense: Wages & salaries 1,445,000 Motor expenses 8,900 Insurance 28,700 Rates 20,400 Repairs & renewals 54,700 Professional charges 17,500 Advertising 67,000 (1,642,200) Net profit 839,100 Balance sheet as at 31st Dec. 2009 £. £ Fixed Assets Motor vehicle 26,000 Fixtures, fittings & equipment 275,000 Premises 1,680,000 1,981,000 Current assets Stock 67,600 Debtors 31,000 Bank 33,000 131,600 Total assets 2,112,600 Less current liabilities Creditors 45,500 (45,500) Capital employed 2,067,100 Financed by: Capital 1,360,000 Less drawings (132,000) 1,228,000 Net profit 839,100 2,067,100 Task.2 Breakeven point Total costs = expenses = £. 1,642,200 B.E.P =  P.V ratio =  Sales – variable costs = contribution Variable costs = 30% of Total Costs V.C =  1,642,200 = £. 492,660 Contribution = 2,965,000 – 492,660 = £. 2,472,340 P.V ratio =  = 0.8338 Fixed cost = total cost – variable cost = 1,642,200 – 492,660 = £. 1,149,540 B.E.P =  = £. 1,378,675.94 Margin of safety Margin of safety = actual sales – breakeven sale Or  = 2,965,000 – 1,378,675.94 = £. 1,586,324.06 Or = = 53.50% Task 3 Payback period Proposal to cost = £. 750,000 Payback period =  For proposal 1 Year Cash flow £. Cumulated cash flow £. 1 270,000 270,000 2 295,000 565,000 3 345,000 910,000 4 325,000 1,235,000 PBP =  = 2years 6.4months For proposal 2 year Cash flow £. Cumulated cash flow £. 1 160,000 160,000 2 189,000 349,000 3 225,000 574,000 4 254,000 828,000 PBP =  = 3years 8.3months Accounting rate of return ARR =  For proposal 1 Average annual profit =  = 82,000 Average capital investment =  = 187,500 ARR =  = 43.73% For proposal 2 Average annual profit =  = 87,500 Average capital investment =  = 187,500 ARR =  = 46.67% Net present value NPV  For proposal 1 year cash flow PV factor @12% Present value Cumulated present value 0 (750,000) - - (750,000) 1 270,000 0.893 241,110 508,890 2 295,000 0.797 235,115 273,775 3 345,000 0.712 245,640 28,135 4 325,000 0.636 206,700 (178,565) NPV = £. (178,565) For proposal 2 year cash flow PV factor @12% Present value Cumulated present value 0 (750,000) - - (750,000) 1 160,000 0.893 142,880 607,120 2 189,000 0.797 150,633 456,487 3 225,000 0.712 160,200 296,287 4 254,000 0.636 161544 134,743 NPV = £. 134,743 Task 4 Financial accounts Financial statements have immense importance to business organizations. They provide information on the financial position of the business over a certain period. There is a variety of financial statements such as; the trading, profit and loss account; income statements; cash-flow statement and balance sheet. The trading, profit and loss account, is prepared mainly to summarize the expenses and income of a business over a specified period. A balance sheet, by stating clear values of a business’ assets, liabilities and shareholders’ equity; gives a clear picture of business’ financial state. Through the balance sheet, users of the accounting information can know how the company’s intangible and tangible goods. In simple terms the balance sheet supplies information on how much the company owns (assets) and owes (liabilities) with the difference being the net worth (shareholders equity) of the company. Looking at the financial statements of Pampers Health Spa, the business can be seen as doing well. The businesses generates an income that cover’s the company costs, and still remain with a considerable amount of funds that can be used for further expansion. The business high profit margin is contributed by the company’s high sales volume with fewer expenses. The net profit of £.839, 000 raises the share holders’ equity by more than 60%, which is a highly encouraging result as far as the share holders of the company are concerned. The balance sheet reveals that compared to assets worth £.2, 112, 600 the company has a debt of only £.45, 500. This shows that the business maintains excellent relations with its suppliers; this is an encouragement to the company shareholders. The financial accounts of Pampers Health Spa show a positive reflection of the company, to both the management of the company and its shareholders. Break-even point The break-even point of a business is where the revenues that are generated by the company are just enough to cover the expenses without any losses or profit generated. It shows the management the exact amount of sales to make, at the current level of costs to avoid incurring loss and can be used frequently to check the progress the business by comparing it with the actual sales. The lower the break-even point the appropriate it is for the business since with a lower break-even point the business can realize exceptionally high profits. But, if the break even is unusually high then the business is forced to ensure extremely high sales to avoid incurring losses. Through break-even analysis: the business can assess the productivity of the current business line; the effect of profitability if operating costs increase; and the minimum amount to be sold at the present price; to make up for a rise in the cost of sales. The records of Pampers Health Spa show that its margin of safety is less than half of the total sales for the period ended December 2009. This is a positive sign showing how the business is able to achieve high sales volume. With high sales volume, the business is unlikely to fall into debt as all costs can be covered from the high revenue generated by the business. With a lower margin, of safety in comparison with sales eliminating possibilities of incurring debts; this raises the business’ profile. With a positive profile, it means that the company’s sales are likely to continue going up over the coming periods. Margin of safety This is the amount by which the targeted or present sales surpass the break-even sales. It is an indispensable measure of a company’s vitality. When it is large enough, significant fall in the company’s sales would not eliminate the generation of profits. On the other side, if the margin is small, then a decrease in sales volume would cause the company to experience loss. Most investors use this percentage in relation to the business’ intrinsic value to determine the best option to invest in, when deciding on investing in a business. This is what makes this concept of considerable importance. It provides the investor with a degree of security from uncertainties arising in the market. A margin of safety of not less than 40% of intrinsic value is quite satisfactory, though a wider margin makes it even better. With a 53.5% margin of safety, Pampers Health Spa has a high potential of attracting investors. The company is also safe from risk of incurring loss even if there is a slight decrease in sales due to market factors. Payback period Payback period is the time it takes a project to completely recover the initial cost of the project or proposal. It is calculated by counting either the; years, months or both of cumulated the cash flows generated by the project up to the exact time of recovery the initial cost. This method is usually used in making investment decisions when it comes to choosing among a number of proposed projects. The project with the lowest payback period is usually considered as it means that the investor(s) are able to recover their money early enough for other plans and still continue enjoying the dividends from the project. The method is quite straightforward and can be used to quickly sample and select projects for investment. For Pampers Health Spa, the first proposal is to be considered over the second one. The first proposal has a short payback period of less than 3 years compared to the second which is more than 3 years. Accounting rate of return The ARR is the financial ratio calculated from the net earnings realized from a proposed capital venture. It gives the estimated earnings from total income prior to tax and rate of interest deductions. It serves the purpose of assessing the profitability of investments to be made in a project. It is mostly used in capital budgeting where a lot of forecasting is done in determining whether a long-term investment is worth pursuing or not. The method is easy to understand and can be easily calculated from available information. Usually in capital budgeting, when making a choice among proposed projects; the project with a higher percentage is considered over the others. Pampers Health Spa in this situation would be advised to invest in the second proposal as it has a higher accounting rate of return percentage. Net present value Net present value measures the present value of future cash flows of an investment less the initial cost of the project. When the value is positive the project is considered, and when the value is negative the proposal is disregarded, in the case where the projects are many then the one with the highest positive value is considered. This capital budgeting tool is the most useful in valuing project proposals. The method is unique and requires a lot of precision especially when the projects are related and give very small variations. In accounting the method is most preferred, because it takes into consideration the time value of money, giving the investors a glimpse of the future profitability of the projects to be considered for investment. For the proposals presented to Pampers Health Spa, the second project should be considered since it gives a positive net present value. The first projected should not be considered because of the negative net present value which shows that the project is not very productive in the future. Conclusion The first two methods payback period and accounting rate of return are not particularly appropriate methods of valuing and assessing proposals. They only best used where there is either no alternative method for analysis or in situations where a quick analysis is required. The two methods have shortcomings such as they; they are not directly related to wealth maximization, they do not provide adjustments for risk, and they do not also account for the time value of money. The payback period method after the payback period it does not attach value to the cash flow generated afterwards. As for accounting rate of return, it is relying on values that comprise of non-cash items. This leads to the adoption of a more appropriate tool such as the net present value which takes into account, the time value of money, allows comparison of diverse interest rates to be measured, it is also the best for comparison in situations where the projects have similar initial cost. The best option for Pampers Health Spa to consider in this situation would be according to the net present value results which is the second project. Reference: Lucey, T. (1996). Management accounting (4th Ed.). London, UK: DP publications. Read More