Finance - Healthy Hearts Cardiff - Assignment Example

Finance Assignment Question a. Calculate the corresponding ratios for Healthy Hearts (Cardiff) to facilitate a comparison of their performance with that of the most profitable club in the group for the year ending 31/12/08. S.No. Ratio Best Firm Healthy Hearts (Cardiff) 1 Operating Profit 36% 125000 24% Operating Assets (476000+50000) 2 Operating Profit 10% 125000 8% Sales 1650000 3 Sales 3.6 x 1650000 3.13 x Operating Assets 526000 4 Expenses 90% 1525000 92% Sales 1650000 5 Sales 3.94 x 1650000 3.47 x Fixed Assets 476000 6 Sales 41.7 x 1650000 33 x Current Assets 50000 7 Sales 181.8 x 1650000 206.3 x Stock 8000 8 Sales 153.85 x 1650000 117.85 x Debtors 14000 9 Current Ratio 1.8:1 50000:30000 1.7:1 10 Quick Ratio 1:1 42000:30000 1.4:1 b. Analyse your results in a) and those of the most profitable club highlighting the Cardiff club’s strengths and weaknesses. Suggest ways in which they could improve their performance. In order to understand where Healthy Hearts (Cardiff) stands when compared to the most profitable club, it is essential to critically analyze the ratios and the underlying causes to pin point the strengths and weakness and to devise an action plan for the near future. Profitability: The profitability of Healthy Hearts is 24 % whereas that of the most profitable club is 36 %. It is evident that Healthy Hearts has to improve its utilising of the assets to generate net income. The low profitability can be attributed to the following reasons. First, the operating margin (operating profit / sales) is 8 % for Healthy Hearts, whereas it is 10 % for the other. It indicates that there are still some more opportunities to cut down costs and optimize the process (Samuels et al, 2000). This is also substantiated by the Expenses / Sales ratio (90% for Healthy Hearts to 92%). Efficiency: The asset turnover rate, i.e., the efficiency of the assets in generating revenue (Samuels et al, 2000) is 3.13x for Healthy Hearts when compared to the benchmark value of 3.6x. More assets are used by Healthy Hearts to generate revenue. This increased usage of assets can further be broken down between fixed and current assets to identify the area of concern. The difference in Sales to Fixed Assets ratio is comparatively lesser (3.47x for Healthy Hearts to 3.94x). However the Sales to Current Assets ratio of Healthy Hearts is 33x whereas that of the most profitable club is 42.7x. It is evident that Healthy Hearts has to improve its utilisation of the current assets to generate more revenue. The current assets include the inventory and the receivables. The longer it takes for the inventory to be sold, the lesser is the efficiency. Similarly, the longer it takes for the company to collect its receivables, the lesser is the efficiency (Burke and Wilks, 2007 & Arnold et al, 1985). The Sales to Stock and Debtors ratios can be used to compute the stock turnover period and the debtor collection period as shown below: MPC Healthy Hearts Stock turnover period (365/x): 2 days 1.7 days Debt collection period (365/x): 2.4 days 3.1 days The stock turnover period indicates that Healthy Hearts is more efficient in moving the stock. However, it can improvise on debt collection period, since it takes 3.1 days for the company to collect cash whereas the benchmark period is 2.4 days. Liquidity: As far as the liquidity ratios are concerned, there is no much difference in the current ratios (1.8:1 and 1.7:1). But the quick ratios (1:1 and 1.4:1) indicate that Healthy Hearts is in a stronger liquidity position comparatively and can meet the liabilities very easily (Marshall et al, 2008). Question 2: a. Using Table 1 in the case study descriptor (Profit & Loss Account for the year ending 31/12/08), Tables B & C below and any other information available allocate and apportion revenue & costs to the identified cost centres and calculate the profitability of each. The expenses incurred by the Healthy Hearts (Cardiff) is identified and apportioned to the cost centres in the following tables. The cost drivers for the expenses specify the percentage to be used to apportion the expenses to the cost centres. The last expense (Centre Specific) relates to any specific expenses incurred by that cost centre.     Cost Centre Expenses Cost Driver 1 2 3 4 Asset Value n/a 30% 10% 2% 5% Rates & Ins. Asset Value 75000 25000 5000 12500 Fuel & Power A.V. 30000 10000 2000 5000 Rep. & Main. A.V. 22500 7500 1500 3750 Security A.V. 15000 5000 1000 2500 Cleaning Mtls. A.V. 7500 2500 500 1250 Salaries Given Sal. % 95000 30000 175000 35000 Salary rel. costs Given Sal. % 23750 7500 43750 8750 Depreciation A.V. 12000 4000 800 2000 Head Off. OH A.V. 45000 15000 3000 7500 Centre Specific Area (1 & 2) 25000 5000   80000      (Chemicals)  (Chemicals)    (Supplies) Total Expenses   350750 111500 232550 158250 The total expenses on chemicals amount to 30,000. This is allocated to the two pools (1 and 2) based on the proportionate area covered by each of the swimming pool (in the ratio of 1750:350).     Cost Centre Expenses Cost Driver 5 6 7 8 Asset Value n/a 40% 5% 3% 5% Rates & Ins. Asset Value 100000 12500 7500 12500 Fuel & Power A.V. 40000 5000 3000 5000 Rep. & Main. A.V. 30000 3750 2250 3750 Security A.V. 20000 2500 1500 2500 Cleaning Mtls. A.V. 10000 1250 750 1250 Salaries Given Sal. % 45000 25000 35000 60000 Salary rel. costs Given Sal. % 11250 6250 8750 15000 Depreciation A.V. 16000 2000 1200 2000 Head Off. OH A.V. 60000 7500 4500 7500 Centre Specific         100000            (Supplies) Total Expenses   332250 65750 64450 209500 The expenses are apportioned for the eight cost centres as shown in the tables. In order to compute the profitability of each profit centre, it is essential to apportion the expenses incurred by the cost centre no:3 (Reception/Admin) to the other seven profit centres. This cost is allocated based on the proportion of the ‘number of users’ of each centre, as the admin and reception are mostly involved in registering members and other similar services. The profits of each centre are computed as shown in the following table.   Admin Exp.s (232550)   Profit Centre Revenue Expenses Difference % Users Proportion Profit 1 500000 350750 149250 20% 46510 102740 2 120000 111500 8500 10% 23255 -14755 4 240000 158250 81750 10% 23255 58495 5 250000 332250 -82250 25% 58138 -140388 6 150000 65750 84250 10% 23255 60995 7 60000 64450 -4450 5% 11627 -16077 8 330000 209500 120500 20% 46510 73990           232550             Net Income 125000 b. Write a report to Alison discussing key issues identified in your results. Your report should include your views on whether it is good policy to expect every profit centre to make a profit. In order to assess the profitability of the cost centres, the ratios are computed. The Asset turnover rate (Revenue/Assets) is computed for each profit centre. The efficiency of utilizing the assets in each profit centre is estimated using the Centre Profit (without admin charges) and the assets utilized to generate that profit. The final estimate gives the ratio of overall profit (with admin charges) to the revenue generated by the profit centre. The ratios are presented in the following table.   Assets (526000) Sales Centre Profit Overall Profit Profit Centre % Value Revenue Asset TO Rate Centre Profit CP/ Assets Profit Profit/Sales 1 30 157800 500000 3.17x 149250 0.95x 102740 20.5% 2 10 52600 120000 2.28x 8500 0.16x -14755 n/a 4 5 26300 240000 9.13x 81750 3.11x 58495 24.4% 5 40 210400 250000 1.19x -82250 n/a -140388 n/a 6 5 26300 150000 5.7x 84250 3.2x 60995 40.7% 7 3 15780 60000 3.8x -4450 n/a -16077 n/a 8 5 26300 330000 12.5x 120500 4.6x 73990 22.4% There are a number of issues that can be clearly picked out from the above table. These issues and the rationale behind all centres not being profitable are discussed in the following section. As it can be seen from the table, larger swimming pool generates high profit comparatively, whereas the children’s swimming pool generates low centre profit and when admin charges are included, it equates to a loss. However, the children’s swimming pool utilizes the assets efficiently (revenue is 2.28x times the assets used). Hence it is essential that it continues to operate, as it makes efficient utilization of the assets to generate sales. Centres 4 and 8 (licensed bar and snack bar) have a high asset turnover rate and generate high centre profits. Snack bar is very efficient, as it generates revenue which is 12.5 times the asset value, whereas the licensed bar (though utilizes only 5% of assets), generates a high revenue and also high profit margins (about 40.7%, including the admin charges). Gymnasium (centre 5) utilizes a lot of assets (40%) but generates revenue which is only 1.19x times the assets utilized. The calculations indicate that the gym makes a loss. But, it is important to understand that it has the highest number of users (25%). This obviously, has a profound effect on the licensed bar and snack bar profits. However, the gym can be refurbished with new equipment and additional premium charges can be collected for other valued services. This will increase gym membership and also improve the profits to a great extent. The squash court (centre 6) effectively utilizes the assets and generates overall high profits. Hence, the number of squash courts can be increased in the future at the expense of some space from the gymnasium, as it is not a highly profitable investment. As many people frequent the squash courts, an increase in the number of courts will also increase the number of visitors and in turn, increase the licensed bar and snack bar revenues. The table tennis court, though efficiently utilizes the assets to generate revenue (3.8x) make a loss, as the % of people using the facility is very less (5%). If this continues to be the case, it will be worthwhile to get rid of this facility and extend the snack bar area, as it generates higher profits. Question 3: Using the six months forecast (Table 4) and the points above, prepare a budgeted Profit and Loss Account for the year ending 31/12/09. The budgeted profit and loss account for the year ending 31/12/09 is put down based on the six month forecast made by Alison and the points raised by the team members. The changes are summarized below. Revenue: There will only be a 2% increase in second half. Rates & Insurance: 3% rise in first half and a further 1% in the second half. Fuel & Power: 1% rise in the first half and no change in the second half. Repairs & Maintenance: No change in these costs. Chemicals: 20% costlier when compared to 2008. Security: 15% rise over the year Cleaning Materials: Same as that of 2008. Salaries: 3% rise in the first half and then another 4% in the second half. Depreciation: No change in the depreciation costs. Snack Bar & Licensed Bar supplies: 5% rise in the first half and then remains the same for the second half. Head Office Overhead: Increase by 2% in the first half and then by 4% in the second. These changes are taken into account and the budgeted profit and loss account is shown in the following table. Particulars First six months Second six months Total % Change Value % Change Value Revenue 5% 866250 2% 883575 1749625 Expenses:           Rates and Insurance 3% 128750 1% 130038 256788 Fuel and Power 1% 50500 0% 50500 101000 Repairs and Maintenance 0%       75000 Chemicals 20%       36000 Security 15%       57500 Cleaning Materials 0%       25000 Salaries 3% 257500 4% 267800 525300 Salary related costs 3% 64375 4% 66950 131325 Depreciation 0%       20000 Snack Bar supplies 5% 52500 0% 52500 105000 Licensed Bar supplies 5% 42000 0% 42000 84000 Head office Overheads 2% 76500 4% 79560 156060 Total Expenses -1572973 Net Income 176852 Question 4: a. Compare Fred’s current position with his potential new position regarding profitability, break even and margin of safety. Fred’s Current Position: No. of Units = £ 600,000 / £ 25 per unit = 24,000 units Fixed Costs = 50 % of (£ 240,000) and 80 % of (£ 150,000) = £ 240,000 Variable Cost per unit = (£ 110,000 + 50 % of £ 240,000 + 20 % of £ 150,000) / 24,000 = £ 10.83 per unit Contribution per unit = Selling Price – Variable Cost = £ 25 - £ 10.83 = £ 14.17 Breakeven point = Fixed Costs / Contribution per unit = 16,938 units Margin of Safety = (Sales – BE Sales) / Sales = (£ 600,000 - £ 423,450) / £ 600,000 = 29.43 % Profit earned = £ 100,000 Fred’s Potential New Position: New Selling Price = 80 % of £ 25 = £ 20 per unit No. of Units = 24,000 + 30 % of 24,000 = 31,200 units Sales = 31,200 * £ 20 = £ 624,000 Fixed Costs = £ 240,000 + 10 % of £ 120,000 = £ 252,000 Material Cost per unit = 1.05 * (£ 110,000 / 24,000) = £ 4.8125 per unit Total Materials Cost = 31,200 * £ 4.8125 = £ 150,150 Variable Cost per unit = £ 4.8125 + (50 % of £ 240,000 + 20 % of £ 150,000) / 31,200 = £ 9.62 per unit Contribution per unit = Selling Price – Variable Cost = £ 20 - £ 9.62 = £ 10.38 Breakeven point = Fixed Costs / Contribution per unit = 24,278 units Margin of Safety = (Sales – BE Sales) / Sales = (£ 624,000 - £ 485,560) / £ 624,000 = 22.18 %   Current Potential Sales £600,000 £624,000 Expenses     1. Materials £110,000 £150,150 2. Labour £240,000 £240,000 3. Overheads £150,000 £162,000 Total Expenses £500,000 £552,150 Profit £100,000 £71,850 Breakeven Point 16,938 24,278 Margin of Safety 29.43% 22.18% It is evident that the current position is more favourable to Fred. If the prices are lowered, the break even point increases to 24,278 units and also the margin of safety reduces to 22.18%. Moreover, the profit earned is also lesser (£ 71,850). Hence it is advisable to stick to the current level of prices. b. Explain with examples why it is important to analyse costs into their fixed and variable elements in the context of making decisions. Expenses incurred can be classified as fixed or variable. Fixed costs do not vary with the production levels, for instance, rent, insurance, etc (Weston and Copeland, 1988). Variable costs are directly related to business output and are incurred based on the production levels. It is essential to differentiate the costs into these two categories, so that the decision making is process is simplified and is supported with credible financial figures (Pendlebury and Groves, 2004). When a company has to cut down costs, the practical solution is to scrutinize the fluctuating costs, such as materials, advertising, etc and reduce the expenses in those areas. Cutting down expenses such as rent, insurance, etc will create operational difficulties and will incur expenses indirectly. Hence it is essential to clearly distinguish the two type of costs incurred. Moreover, classifying the costs as fixed and variable, assist the company in conducting breakeven analysis and the margin of safety (Samuels et al, 2000). This will enable the management to take effective decisions about the operational activities. Question 5: a. Prepare a cash budget for the six months January 1st to 30th June 2009. Details Jan Feb Mar Apr May Jun Opening Balance £28,000 £116,579 £149,138 -£20,687 £85,807 £133,801               Revenue £225,225 £121,275 £69,300 £242,550 £138,600 £69,300 Expenses             Rates and Insurance     £128,750       Fuel & Power £35,000     £35,350     Repairs & Maintenance £6,250 £6,250 £6,250 £6,250 £6,250 £6,250 Security £4,250 £4,250 £4,250 £4,250 £4,250 £4,250 Salaries £42,917 £42,917 £42,917 £42,917 £42,917 £42,917 Salary related Costs £10,729 £10,729 £10,729 £10,729 £10,729 £10,729 Chemicals       £16,500     Cleaning Materials       £12,500     Snack Bar Supplies £13,000 £13,650 £7,350 £4,200 £14,700 £8,400 Licensed Bar Supplies £14,500 £10,920 £5,880 £3,360 £11,760 £6,720 Repay Loan £10,000           New Equipment     £33,000                     Closing Balance £116,579 £149,138 -£20,687 £85,807 £133,801 £123,835 b. Discuss why the effective management of cash and working capital is so important in the running of a small business. Profits are a vital element of entity survival, but it is also necessary that there is a related cash inflow from operations to cover the capital expenses, taxation and dividends. Profitability ratios indicate the ability of the company to generate profits from the capital employed (Berry and Jarvis, 1996 & Britton and Watterston, 1996). But too little cash flow from operations and too much from additional borrowing are indicators of potential liquidity problems. It reveals a possible lack of operational viability and the firm’s inability to meet its expenditure requirements (Gillespie et al, 1997). One of the important elements of managing cash for a project is the Working Capital. Working capital represents the liquidity required to run the operations and is measured as the difference between the current assets and the current liabilities (Johnson and Kaplan, 1991). It is part of the operating capital and it ensures that the assets are able to generate the profits effectively. It is essential that the working capital is positive so that the firm is able to run its operations smoothly. It is also important that changes in working capital be taken into account when new projects are being considered. An increase in the working capital required due to the new project should be considered a cash outflow. When this working capital is liquidated at the end of the project, this is treated as a cash inflow. Hence changes in working capital can have significant effects on the way the new projects and ventures are being considered (Drury, 2005). Though a company is profitable, if there is continuous lack of cash inflows from operations, then it will ultimately lead to the demise of the entity (Lee, 1984, p94). Hence specific attention has to be given to the liquidity position and effective management of working capital, in the case of small businesses. References Arnold, J., Hope, T. and Southworth, A., 1985, Financial Accounting, 1st edn, Prentice Hall, Exeter Berry, A. and Jarvis, R., 1996, Accounting in a Business Context, 2nd edn, Chapman and Hall, London Britton, A. and Watterston, C., 1996, Financial Accounting, 1st edn, Addison Wesley Longman, New York Burke, L. and Wilks, C., 2007, Management Accounting – Decision Management, 4th edn, CIMA Publishing Drury, C., 2005, Management Accounting for Business, 3rd edn., Thomson Learning, London Gillespie, I., Lewis, R. and Hamilton, K., 1997, Principles of Financial Accounting, 1st edn, Prentice Hall, Europe Johnson, H. and Kaplan, R., 1991, ‘Relevance Lost: The Rise and Fall of Management Accounting’, Harvard Business School Press Lee, T.A., 1984, Cash Flow Accounting, Von Nostrand Reinhold, Wokingham Marshall, D. McCartney, J., Rhyn, D., Mc Manus, W. and Viele, D. (2008), Accounting: What the Numbers Mean, (2nd Edition), Mc-Graw Hill Pendlebury, M. and Groves, R., 2004, Company Accounts – Analysis, Interpretation and Understanding, 6th edn, Thomson Learning, London Samuels, J. M., Wilkes, F. M. and Brayshaw, R. E., 2000, Management of Company Finance, 6th edn, Thomson Learning, London Weston, J. F. and Copeland, T. E., 1988, Managerial Finance, 2nd edn., Cassell Educational Ltd, London Read More