The Financial Aspects Of The Companys Operation

Published Date: 02 Nov 2017

This is to draw your attention that the Prospect company’s sales have averaged about £1,000,000 annually for the three-year period 2010-2012.The firm’s total assets at the end of 2011 amounted to £800,000.The company’s performance has been satisfactory in terms of profit and shareholders have gained profit on their investments .The operation of the company defines that the company’s performance in relation to profitability, liquidity, assets utilisation, gearing and investors ratios are as follows-

Shareholders and potential investors are primarily concerned with high rate of return on their investment. The company is able to meet the short term financial obligation and the utilisation of funds and assets are in proper usage. Company has its efficient usage in all aspects of performance in terms of utilisation of their assets. In comparison of the company’s activities where the total funds i.e. borrowed funds is invested and is compared to the owner’s funds.it is the sum of total amount invested during the three year period 2010-2012. Investor’s ratios have increased to certain level whereas earning per share and return on investment have been averaged every year.

As we already know that the performance of the company are measured according to the sale, profit, efficient usage of assets, earning per share, amount of debt, return on capital, return on investment to the shareholders and potential investors etc.

The company’s performance has been increasing at every level there is increase on sale by 100%, 103% and 106% it indicates that the amount of product being purchased are almost sold by every year it implies that the profitability to the company as well as the shareholders and investors have received year after year. Company is efficiently making an effort to meet the financial obligations and to clear the debts remaining. The usage of company’s fund have been utilised in all aspects to generate the sale year after year. The assets of the company’s has an efficient usage, whereas the Assets sold to receive the cash to meet some of the financial obligation and to meet the quantity of order to meet the demand of the product made by the retailers and our potential consumers. In comparison of the company’s activities where the total funds invested is 40%, 45% and 52%, as compare to the owner’s funds.it is the sums of total amount invest during the three year period 2010-2012. It is a measure of the firm’s financial leverage or risks. Hence these leverage or risks are the indirect measures of the company’s business risk. The cost of sales as a % of sales is 60%, 66.4% and 70% whereas the sales have averaged about £1,000,000 annually for the three-year period 2010-2012. Hence Shareholders and potential investors are primarily concerned with high rate of return on their investment.

This is to certify that all the given detail in the above information is true and best of my knowledge hence the company needs adequate fund to run the business to meet all the debts and requirement made by the retailers and our potential customers. It is our duty to maintain the borrowed funds as well as the efficient usage of fund in to proper guidance.

There should be a high rate of return to the shareholders and the potential investor’s invested in a company to grow.

Hence the performance of the Prospect Company is averaged and satisfactory to meet all the requirements and company needs to perform efficiently to increase the sales to meet the organisational goals.

PART: D

A

The main sources of finance available to business are as follows-

Internal sources

External sources

Equity

Debt

Hybrid (both equity and hybrid)

Personal sources

Classification of time period:

Short-term (up to 1 year)

Medium-term (1 to 7 years)

Long-term (7 years or more)

Depend upon choosing the sources:

Cost

Duration

Gearing

Company size

Term structure of interest rate

Internal sources:-

Retained profit-is the amount of cash generated from business, when the business trades are done profitably, it provides self-dependence, saving on interest and maintains the secrecy of business. Hence misuse and wastage of funds can lead to failure of business.

Personal sources-it is an arrangement of funds which is done personally, it can borrowing from friends and family, personal saving or other cash balance and credits cards, in fact it is the most common method used for small businesses. It can lead to misunderstanding and can leads to the failure of business.

Shared capital (Owners investment)-it sum of capital invested by the founder of the business to start-up the business, it helps to retain the full control over the business and the rate of return is guaranteed.it keeps you self-motivated. It is a permanent burden on the company to pay the fixed rate of dividend.

Credit control- It is also known as debtors management, It receives the goods on credit, it focus on the customer to receive full cash on time, Hence the business increases its risk of suffering bad debts from the customer.

Stock control- It is a process of maintaining the amount of stock should be held and how much needs to be reordered and when, it maintains the efficient operation of the business.it can meet the sudden change in demand, get advantages on buying bulk. Hence it can affect you on cost of storage, rent and insurance.

External sources:-

Loan capital- it is commonly used as bank loan or bank overdraft, bank loan are usually long term loan whereas bank overdraft are short term loan, both can be used for the start of the business or firm. Borrowing too much can lead to decrease cash flow.

Shared capital (outside investor)- it is the sum of capital invested by the friend or family member to start-up the business, it may sign positive but it also leads to tension and disputes in family and friends.

Finance leases- is a method of purchasing the business assets and leases it out, it is flexible and cost saving, it is mostly lending and borrowing.it can be rewards as well as risks.

Sales and leaseback- method of selling assets and then lease it back, it suffers a liquidity problem.

Bills of exchange- is a written unconditional order by one party to another party to pay certain amount sum, either immediately or on a fixed date for the payment of goods and services.it can be quick as well delay in payment.

Debt factorising-method of collecting debt for business, hence it does not take any responsibility of bad debt arising from credit sales, it is helpful for the small size business, it lose the control of debt management.

Invoice discount- is the process of paying in advance of the face value and then business repays the advance in short terms, it is cheaper than factoring.

Securitisation of assets- it is a method in which the business assets are secured for the purpose of lease or cash in the market, it is also called as sales Securitisation.it can be a rewards or risks.

Ordinary shares-it is issued in stock market, shareholders have voting right and they are the owner of business. Shareholders have the maximum risk.

Preference shares-are issued in stock market, shareholders have no voting rights and they are not the owner of the business, they have less risk than ordinary shares.

B

Budget:-is a company’s annual financial plan, it is a financial document used to identify future income and expenses. Hence it is a set of plan that states about the sales, expenses, production volume and various financial transactions and measurements of the firm for the coming period. In other words it can be a set of statement that states about the company’s finances and operation. Budgets are prepared at various levels of an organisation. The master budget is defined as the overall financial plan for the period, which reflects the organisation’s goals and objectives.

At the start of the period it act as a "plan" and at the end of the period it act as a "control", i.e. it is planned to improve the future performance of an organisation, the use of budgets to control an organisation’s activities is called as budgetary control. Hence the method of preparing budget is referred as budgeting.

Therefore the budget can be divided in to two category i.e.

Operational budget

Financial budget

The master budget includes operating and financial budget. Operating budgets show the company’s planned sales and operating expenses, whereas the financial budgets reflects the financial plans such as borrowing, leasing, and cash management. Hence these plans are used throughout the year.

Planning: - is future-oriented. A plan specifies in some form what management wants to do. Management has certain variables that it can control. Some of the variables are financial resources, plant and equipment, products, production methods, and human resources.it involves forecasts and assumptions about the organisation’s external environment, which is uncontrollable. Planning is most important part of any organisation and its activity; hence it is starting point of any business and their organisation.

Controlling: - is monitoring and implementation of plan and taking corrective action as needed. It is a continuous process. Control is based on the use of feedback about the activity being controlled. All control system must have some kind of feedback mechanism.

Usage of budgets as a means of planning and controlling the various business activities are as follows: -

Planning involves developing objectives and preparing various budgets to achieve those organisational goals.

Controls involves the steps taken by management to increase the likelihood where the organisation is planning to work together in order to achieve towards the organisational goal.

It should be effective, a good budgeting system must provide for both planning and control.

Therefore good planning without effective control is time wasted.

It communicates plans and its organisational goals.

It forecast over future plans and objectives.

It is proper modes of allocation of resources.

It helps to change the product mix produced.

To determine the amount to be spent on research and development for a new and improved products.

To determine the size and rate of expansion of the business.

To analyse the profit level and return on investment level desired.

To create shareholder value over the long run.

To identify objectives of the organisation and potential strategies and also alternative strategic options.

To implement the long-term plan in the form of the annual budget.

To monitor actual results.

PART:-A

A

The four different investment appraisal methods:-

Payback period (PP)

Accounting rate of return (ARR)

Net present value (NPV)

Internal rate of return (IRR)

: - Pearson limited a food manufacturer

Purchasing a new machine for £200,000

Annual running costs are expected to be £15,000 plus straight line depreciation charge.

Depreciation 4 year

Scrap value of machine 20% 0f £200,000 i.e. £40,000

Annual revenue (forecasted) £80,000

And the cost of capital is 10%

: Payback period (PP) Annual revenue (forecasted)

Year 1 80,000

Year 2 80,000

Year 3 80,000

Year 4 80,000

Year 1 + Year 2 = 160,000

2 year + 40,000/80,000*2 = 6

Therefore 2 year + 6 months (Payback period) or 2.5 years

: Accounting Rate of Return (ARR)

ARR = (Average cash flow/Average investment) * 100

Average cash flow =80,000

Average investment =200,000 + 40,000 / 2

=120,000

Whereas ARR = 80,000 / 120,000 * 100 = 66.66% i.e.66.7%

: Net Present Value (NPV)

Year

cash inflow

cash outflow

net cash in

cost of capital {10%}

present value

0

-

(200,000)

(200,000)

1

(200,000)

1

80,000

15,000

65,000

0.909

59,085

2

80,000

15,000

65,000

0.826

53,690

3

80,000

15,000

65,000

0.751

48,815

4

80,000

15,000

65,000

0.683

71,715

Total = 233,305 – 200,000 = 33,305

Hence the result is Positive = 33,305 {NPV1}

Year

cash inflow

cash outflow

net cash in

cost of capital {20%}

present value

0

-

(200,000)

(200,000)

1

(200,000)

1

80,000

15,000

65,000

0.833

54,145

2

80,000

15,000

65,000

0.694

45,110

3

80,000

15,000

65,000

0.579

37,635

4

80,000

15,000

65,000

0.482

50,610

Year cash inflow cash outflow net cash in cost of capital present value

0 - (200,000) (200,000) 1 (200,000)

1 80,000 15,000 65,000 0.833 54145

2 80,000 15,000 65,000 0.694 45110

3 80,000 15,000 65,000 0.579 37635

4 80,000 15,000 65,000 0.482 50610

Total = 187,500 – 200,000 =12,500

Hence the result is negative = 12,500 (NPV2)

: Internal rate of return (IRR)

IRR = R1+ [NPV1/NPV1 – NPV2 * R2 – R1]

= 10 + [33305/33305 + 12500 * 20 – 10]

= 10 + [33305/ 45805 * 10]

= 10 + [0.727 * 10]

= 10 + 7.27

= 17.27 %

Yes the project is feasible the payback period is 2year+6 month or 2.5, and the total life of the machine is 4 year, therefore the remaining 1.5 year is profit period.

Hence 17.27% is the simply discount rate at which NPV would be equal to zero.

So, the cost of capital should always be below 17.27% to gain profit.

B

Payback period- is the amount of time taken for the net cash flow resulting from an investment to match (=), the initial cost of the investment.

Pros-

It is simple and easy to understand and use

Its main objective is to use cash flow.

Cons-

It ignores the time value of money.

It ignores cash flows after the payback period.

Accounting rate of return (ARR) – is the total net cash flow for the life of the project, always remember to add any scrap value, resale. Hence a return measurement by using average annual profit.

Pros-

It helps in internal and external comparisons.

It is also simple and easy to understand and use.

Cons-

It is difficult in use when it is with same ARR and various project sizes.

Infact it ignores the time value of money.

Net present value- is the present value of the net cash inflows which is less than the initial investment.

Pros-

NPV is concerned with shareholder wealth.

NPV looks at the whole life of the project.

Hence it takes account of risk.

It also takes account of the time value of money.

Cons-

NPV is not easily understood by the manager.

It has an opposite effects on accounting profits in the short run.

It helps in choosing the discount rate.

Internal rate of return (IRR) - the return value of measurement takes into the account where it is the time value of money.

Pros-

IRR takes the account of the time value of money.

Infact it is easily understood by the managers.

Cons-

IRR is difficult to use in choosing projects of different sizes.

Hence it is more difficult to choose when it has the same IRR.