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Accounting and Financial Management

27 Pages 6685 Words 1972 Downloads

Introduction

Accounting and financial management is the process of formulating financial statements and managing the performance of the organisation so that business can be executed successfully. For all the managers it is very important to keep financial and accounting information in the form of accounting reports so that stakeholders can analyse actual position of the company (Alves, 2012). Main aim of this assignment is to enhance knowledge about financial and accounting management of an organisation. In this project report two different companies are going to be analysed first one is Bitmap Plc which is a manufacturing company of furniture and established in London, UK. Second company is Toyland Ltd which is a toy manufacturing company and operating business in London. For the purpose of analysis, various topics are discussed under this report that are financial ratios, working capital cycle, different types of investment appraisal techniques their benefits and limitations and sources of funds. Budgets, budgeting process and their relation with strategic plans and objectives are also covered in this report.

Part- A

Introduction

Bitmap Plc is manufacturing company which is dealing in furniture and operating business in London, UK. The Board of directors of the company have identified changes in financial statements. They have asked the management accountants of Bitmap Plc to form a report on the results of last two years of income statement and balance sheet. In this report different financial ratios and working capital cycle have been calculated (Armstrong, 2014).

1. Computation of financial ratios in order to analyse performance of the company

Ratio analysis: It is a technique which is used by various organisations to evaluate their profitability, efficiency, liquidity and other factors that may affect overall performance of business operations. Management accountant of Bitmap Plc have been asked by the directors to calculate financial ratios so that cause of changes in income statement and balance sheet can be identified (Arroyo, 2012). Different types of profitability, gearing, liquidity, asset utilisation and investors potential ratios are calculated in order to analyse actual performance of the company. The calculations are as follows:

  • Profitability ratios:When the managers are willing to analyse actual profitability of the company than such type of ratios can help to determine that company is generating profits or facing losses. It also guide stakeholders to evaluate organisation's ability to acquire profits and this will help them to formulate appropriate decision regarding investment, providing credit and other. The management accountant of Bitmap Plc calculated gross profit and net profit ratio to determine overall profitability of the company (Beatty and Liao, 2014).
  • Liquidity ratios:All ratios that are used to analyse organisations liquid strength are called liquidity ratios. Current and quick ratios are calculated by management accountant of Bitmap Plc to analyse overall liquidity of the organisation.
  • Gearing ratios:Such ratios that are related to capital structure of a company and calculated to establish proper balance in to assets and liabilities are called gearing ratios. It is focused with the assessment of long term financial stability of business entities. It guides managers to analyse the proportion of funds which is related to internal and external sources. Management accountant of Bitmap Plc have calculated debt equity and total assets to debt ratio under gearing ratios.
  • Asset utilisation ratios:All the ratios that are mainly used to analyse that organisation is appropriately using its assets to generate revenues or not. Management accountant of Bitmap Plc calculated fixed assets and total assets turnover ratio to assess utility of assets of the company.
  • Investors potential ratios:The ratios that are calculated to provide appropriation information to investors are known as investor potential ratios. They use such ratios to analyse the rate which is going to be offered by the company on the invested amount. In Bitmap return on equity and dividend coverage ratios are calculated by management accountant of the company (Cheng and et.al., 2014).

Name of the ratio

Formula

Calculation

Ratio

 

 

2016

2017

2016

2017

Profitability ratios:

 

 

 

 

 

Gross profit ratio

Gross profit/total revenues * 100

9100/18000*100

12200*23000*100

50.56%

53.04%

Net profit ratio

Net profit after tax/total revenues * 100

3220/18000*100

4060/23000*100

17.89%

17.65%

 

 

 

 

 

 

Liquidity ratios:

 

 

 

 

 

Current ratio

Current assets/Current liabilities

4150/1500

5160/1100

2.77

4.69

Quick ratio

Quick assets/current liabilities

2350/1500

2800/1100

1.57

2.55

 

 

 

 

 

 

Gearing ratios:

 

 

 

 

 

Debt equity ratio

Total debts/total equities

3500/12000

54600/15760

0.29

0.29

Total asset to debt ratio

Total assets/total debts

15500/3500

16760/4600

4.43

3.64

 

 

 

 

 

 

Asset utilisation ratios:

 

 

 

 

 

Fixed asset turnover ratio

Total revenues/Fixed assets

18000/11350

23000/15200

1.59

1.51

Total asset turnover ratio

Total revenues/total assets

18000/15500

23000/16760

1.16

1.37

 

 

 

 

 

 

Investors potential ratios:

 

 

 

 

 

Return on equity ratio

Net profit after tax/total equity*100

3220/12000*100

4060/15760*100

26.83%

25.76%

Dividend coverage ratio

Profit after tax/Dividend

3220/200

4060/300

16.1

13.53

From the above ratios it has been analysed that organisation is having good profits as gross profits of year 2016 has been increased in current year. Organisation's liquidity is increased in year 2017 which means Bitmap Plc. is performing good and having higher liquidity that helps to operate business successfully. Company's debt equity ratio is very low as compare to ideal ratio which 2:1. It depicts that the organisation is not able to use outsider's fund appropriately to operate business successfully. Organisation is properly utilising assets in order to enhance its revenues. It has been observed form the asset utilisation ratios. Changes in  revenues, equities and dividends has been resulted in decreased investor potential ratios because they are not able to get higher returns in current year as compare to previous year. From all the above calculated ratios it has been observed that changes in income statement and balance sheet have taken place due to fluctuations in figure of the elements that are recorded in balance sheet and income statement.

2. Computation of working capital cycle

Working capital cycle: It can be defined as the period in which a company can convert all its current assets in cash. It guides the managers to make strategic decision so that efficiency of the company can be enhanced (Cullingford and Blewitt, 2013). For Bitmap Plc calculation of working capital cycle is as follows:

For year 2016

Inventory collection period

Formula =Inventory/Sales per annum*365 = 1800/18000*365 = 36.50 Days

Trade Receivables period

Formula =Trade receivables/Sales per annum*365= 1600/18000*365 = 32.44 Days

Cash and marketable securities period

Formula =Cash/Annual sales*365 = 750/18000*365 = 15.21 Days

Trade payables period

Formula =Trade payable/Annual sales*365 =1500/18000*365 = 30.42 Days

 

Working Capital Cycle in Days:

Particular

Days

Inventory collection period

36.50

Add: Cash and marketable securities period

32.44

Add: Trade receivables period                             

15.21

Less: Trade payables period

30.42

Working Capital Cycle in days

53.73

For year 2017: Inventory collection period

Formula =Inventory/sales per annum*365 = 2,360/23000*365 = 37.45 Days

Trade Receivables period

Formula =Trade receivables/ Sales per annum*365 = (2300/23000*365) = 36.50 Days

Cash and marketable securities period

Formula =Cash/Annual sales*365 = (500/23000*365) = 79.35 Days

Trade payables period

Formula =Trade payable/Annual sales*365 = 1100/23000*365 = 17.46 Days

Working Capital Cycle in Days

Particular

Days

Inventory collection period

37.45

Add: Trade receivables period

36.50

Add: Cash and marketable securities period

79.35

Less: Trade payables period

17.46

Working Capital Cycle in Days

135.84

From the above calculations it has been analysed that working capital cycle for year 2016 was 53.73 days and for year 2017 it is 135.84 days which means the organisation's ability in year 2017 of converting its currents in cash is being decreased in year 2017.

Conclusion

From the above report, reasons for changes in income statement of company have analysed. It is prepared by management accountant of Bitmap Plc to present in front of directors of the company. Changes have occur due to fluctuation in revenues, incomes, expenses, profits, assets and liabilities.

PART B

1. Different types of investment appraisal techniques

Toyland Ltd is a well established toy manufacturing company in London. Directors of the organisation want to increase the demand of their products in future but currently it is not possible for the business entity to meet increased demand (Ewert and Wagenhofer, 2012). Directors have decided to buy a new machine, two different options are available for the company and they have asked the finance manager to produce a report. This report will help them to make investment related decision. Different type of investment appraisal techniques are described below that will guide the manager to form decision:

Following information is same for Machine A and B:

Initial investment

£ 500000

Salvage value at the end

£ 50000

Value of depreciation per year

£ 75000

Depreciation method

Straight Line Method

Life of machines

6 Years

  1. The payback period:

Payback Period= (A-1)+(Cost-cumulative cash flow)(A-1)/Cash flowA

Machine A: Initial investment=500000

Years

Cash Inflows  

Cumulative cash Inflows  

1

300000

300000

2

250000

550000

3

200000

750000

4

150000

900000

5

50000

950000

6

70000

1020000

Total

1020000

 

Payback Period of Machine A =1+(500000-300000)/250000 =1.8

Machine B: Initial investment =500000

Years

Cash Inflows  

Cumulative cash Inflows  

1

20000

20000

2

50000

70000

3

150000

220000

4

200000

420000

5

250000

670000

6

350000

1020000

Total

1020000

 

Payback Period of Machine B =4+(500000-420000)/250000 =4.32

  1. The discounted payback period:

Discounted Payback Period = (A-1)+(initial invest- discounted cumulative cash flow)(A-1)/Discounted Cash flowA

Machine A: Initial investment =500000

Years

Cash Inflows  

P.V. Factor @10%

Present Value

Cumulative Present Value of cash Inflows  

1

300000

0.909

272700

272700

2

250000

0.826

206500

479200

3

200000

0.751

150200

629400

4

150000

0.683

102450

731850

5

50000

0.621

31050

762900

6

70000

0.564

39480

802380

Total

1020000

 

802380

 

Discounted Payback Period of Machine A =2+(500000-479200) / 150200 =2.14

Machine B: Initial investment =500000

Years

Cash Inflows  

P.V. Factor @10%

Present Value

Cumulative Present Value of cash Inflows  

1

20000

0.909

18180

18180

2

50000

0.826

41300

59480

3

150000

0.751

112650

172130

4

200000

0.683

136600

308730

5

250000

0.621

155250

463980

6

350000

0.564

197400

661380

Total

1020000

 

661380

 

Discounted Payback Period of Machine B =5+(500000-463980)/197400 =5.18

  1. The accounting rate of return:

Accounting Rate of Return= Average Net Profit / Average Investment

Machine A: Initial investment =500000

Salvage Value of machine A at the end  = 50000

Years

Cash Inflows  

Depreciation

Net Profit

1

300000

75000

225000

2

250000

75000

175000

3

200000

75000

125000

4

150000

75000

75000

5

50000

75000

-25000

6

70000

75000

-5000

Total

1020000

 

570000

Average Net Profit= 570000/6 =95000

Average Investment = (Initial investment+Salvage Value)/2 =(500000+50000)/2 =275000ARR =95000/275000*100 =34.55%

Machine B: Initial investment=500000

Salvage Value of machine B at the end =50000

Years

Inflows  

Depreciation

Net Profit

1

20000

75000

-55000

2

50000

75000

-25000

3

150000

75000

75000

4

200000

75000

125000

5

250000

75000

175000

6

350000

75000

275000

Total

1020000

 

570000

Average Net Profit =570000/6 =95000 Average Investment =(Initial investment + Salvage Value)/2 =(500000+50000)/2 =275000ARR =95000/275000*100 =34.55%

  1. The net present value:

Net Present Value =Present value of cash inflows – initial investment

Machine A: Initial investment =500000

Years

Cash Inflows  

P.V. Factor @10%

Present Value

1

300000

0.909

272700

2

250000

0.826

206500

3

200000

0.751

150200

4

150000

0.683

102450

5

50000

0.621

31050

6

70000

0.564

39480

Total

1020000

 

802380

Net Present Value =802380-500000 =302380

Machine B: Initial investment=500000

Years

Cash Inflows

P.V. Factor @10%

Present Value

1

20000

0.909

18180

2

50000

0.826

41300

3

150000

0.751

112650

4

200000

0.683

136600

5

250000

0.621

155250

6

350000

0.564

197400

Total

1020000

 

661380

Net Present Value =661380-500000 =161380

  1. The internal rate of return: trial and error method is used to determine the rate for IRR method for both the machines.

IRR= LDR (P.V. of LDR- Initial investment/ P.V. of LDR- P.V. of HDR) (HDR- LDR)

Rate of Return= (Cash Inflow-Initial investment)/ Initial investment*100*1 / No. of Years

Machine A: Initial investment=500000

Cash inflow= 1020000

Life = 6 Years

Rate of return=(1020000-500000)/500000*100*1/6 =17.33

The rates that are assumed for Machine A are 36% and 37%

Years

Cash Inflows

P.V. Factor @36%

Present Value

1

300000

0.735

220500

2

250000

0.541

135250

3

200000

0.398

79600

4

150000

0.292

43800

5

50000

0.215

10750

6

70000

0.158

11060

Total

1020000

 

500960

 

Years

Cash Inflows

P.V. Factor @37%

Present Value

1

300000

0.730

219000

2

250000

0.533

133250

3

200000

0.389

77800

4

150000

0.284

42600

5

50000

0.207

10350

6

70000

0.151

10570

Total

1020000

 

493570

IRR =36+(500960-500000)/(500960-493570)*(37-36) =36.13%

Machine B: Initial investment=500000

Cash inflow= 1020000

Life= 6 Years

Rate of return =(1020000-500000)/500000*100*1/6 =17.33

Rates that are assumed for both the machines are 17% and 18%.

Years

Cash Inflows

P.V. Factor @17%

Present Value

1

20000

0.855

17100

2

50000

0.731

36550

3

150000

0.624

93600

4

200000

0.534

106800

5

250000

0.456

114000

6

350000

0.390

136500

Total

1020000

 

504550

 

Years

Cash Inflows

P.V. Factor @18%

Present Value

1

20000

0.847

16940

2

50000

0.718

35900

3

150000

0.609

91350

4

200000

0.516

103200

5

250000

0.437

109250

6

350000

0.370

129500

Total

1020000

 

486140

IRR = 17+(504550-500000)/(504550-486140)*(18-17) = 17.25%

Recommendation: The financial managers of the company has recommended the directors of Toyland Ltd. To choose machine A because its pay back period and net present value is good as compare to Machine B.

2. Benefits and limitations of investment appraisal techniques

Investment appraisal techniques: These are the techniques that are used by organisations to compare two or more investment options and then choose the best option from them. Purpose of using all the techniques is to measure the overall performance and result of business portfolio (Horngren and et.al., 2012). Following techniques are considered as the part of investment appraisal techniques:

Payback period: This method is a part of capital budgeting that helps to analyse the period in which all the investments that are made by an organisation are going to be recovered. It helps to analyse risk associated with a particular business project. Tesco use this method to determine the period in which all its investments will be recovered (Payback period method, 2018).

  • Benefits:It is a very simple method and easy to calculate. It provides a quick estimate to the company of that period in which expenses and investments are going to be recovered.
  • Limitations:Time value of money is ignored in this method. Overall profitability of an investment cannot be determined with the help of this method.

Discounted pay back period: It is a capital budgeting technique which is used to determine profitability of a business project. All the calculations under this method are done after considering discounted future cash flow and time value of money. Waitrose Limited is using this method to assess the specific period in which all the amount of investment will be reimbursed after discount (Maskell, Baggaley and Grasso, 2016).

  • Benefits:Time value of money is considered in this method. It helps to analyse actual risk which is involved in a business project.
  • Limitations:It cannot determine that an investment will increase value of a company or not. If there are multiple cash outflows than calculation of this method get complex.

Net present value: It is the difference between total cash inflows and initial investment of a company. This method is used to evaluate a project that it will be profitable or not. This method is used by C & K holding company to analyse the profitability of their construction projects.

  • Benefits:It results in good measures of overall profitability. It guides to make assumption for re investment in future.
  • Limitations:Sunk cost is ignored in this method and managers may face difficulties while determining required rate of return.

Accounting rate of return: It is also known as Average rate of return in which cash generated upon a particular investment is calculated. This technique is used by Airdri to analyse the rate of return for the investment which is made in projects (P. Tucker and D. Lowe, 2014).

  • Benefits:It is a simple method which is easy to use and understand. It can result in better comparison of different business projects.
  • Limitations:Life of a project is not considered in this method and size of an investment is ignored while calculation ARR.

Internal rate of return: It is used to analyse the lucrativeness of a potential investment that organisation is willing to make in future period. This method is used by CDC group of UK in order to determine profitability of the investments before investing money in a business.

  • Benefits:It helps to show the return on the actual monetary resources that are invested in business. Working capital and scrap values are considered to get accurate results.
  • Limitations:It is very lengthy technique as it is based on trial and error method. It is very tough and complex method (Schaltegger and Csutora, 2012).

3. Effective sources of funds for the investment of Bitmap Plc

When an organisation is willing to buy a new equipment or machine than sufficient funds are required to purchase the same. As Toyland Ltd is willing to make investment in a machine than different sources are required to buy that machine. Following sources can be used by directors of Toyland for the purpose of investment:

Selling old assets: The new machine can be bought by Toyland by selling old assets that are not used by the company. It is a good source of investment and directors do not have to contact external parties to ask for investment.

Bank loan: For the purpose of investment the company can contact the bank by providing a collateral to the bank. When the borrower fails to pay the borrowed amount than bank can recover the amount by selling the asset.

Both the above described options can be used by Toyland to make investment in machine for the purpose of increasing profits and sales (Sharma and Kuang, 2014).

PART C

1. Budget and its relationship with strategic plans and objective

Budget: Most of the organisations are using budgets so that all the future activities can be performed successfully. Strategic planning is required to formulate budget appropriately and when budgets are implemented than it results in achievement of goals.

For example as Toyland Ltd is willing to buy a new machine so that demand of its products can be increased for this purpose proper planning and budgets are required. Proper formulation of budget require strategic planning so that business objectives can be achieved. If the plans and budged are formed appropriately than objectives will be attained.

From the above described example it has been identified that budgets, strategic plan and objectives are interrelated with each other.

2. Budgeting process and interlinking of budgets that are used in an organisation

Budgeting process: It is the procedure in which budgets are formulated by the organisations in order to operate business successfully. It guides managers to allot monetary resources to functional departments according to their requirements. Following steps are required to be followed in budgeting process:

Step 1: First of all the managers of the companies are required to set financial goals for future period so that profitability can be increased.

Step 2: After setting goals managers and directors are required to determine various sources of income that can be used to evaluate overall monetary funds of the company (Warren Jr, Moffitt and Byrnes, 2015).

Step 3: In this stage managers estimate possible future expenses that may take place. The estimation is used to form a budget.

Step 4: When a budget is formulated than managers present it in front of board of directors and top executives so that they can analyse the budget and mark their approval for implementation.

Step 5: When the approval from the side of top executives is received than budget is implemented by the mangers to execute business successfully.

Step 6: In last step the implemented budget is evaluated, controlled and monitored in order to get positive results.

There are different types of budgets that are formulated by organisations and that are interrelated to each other. Some of the budgets are as follows:

Expenditure budgets: All type of direct, indirect, operating and non operating expense are recorded in expenditure budget. It provides detailed information of all the expenses that have taken place in a specific period of time (Weil, Schipper and Francis, 2013).

Operating budget: All operating expenses and incomes are recorded in operating budget. It provides information of revenues, costs, operating expenditures, profits and losses that are recorded by an organisation in an accounting year.

Expenditures and operating budgets are related with each other because if operating budget fails to provide detailed information of a particular expenditures than managers may get its information from expenditure budget as it is very vast and detailed.

Conclusion

From the above project report it has been concluded that accounting and financial management is the process of keeping appropriate information of operation in financial statements and managing performance of business activities. Different types of capital budgeting techniques, financial ratios and budgets are used to manage performance. Effective budgetary planning can result in proper execution of business activities because budgets are formulated to provide sufficient funds to all departments of the organisation.

References

  • Alves, S., 2012. Ownership structure and earnings management: Evidence from Portugal. Australasian Accounting, Business and Finance Journal. 6(1). pp.57-74.
  • Armstrong, P., 2014. Limits and possibilities for HRM in an age of management accountancy. New Perspectives On Human Resource Management op. cit. at, pp.154-166.
  • Arroyo, P., 2012. Management accounting change and sustainability: an institutional approach. Journal of Accounting & Organizational Change. 8(3). pp.286-309.
  • Beatty, A. and Liao, S., 2014. Financial accounting in the banking industry: A review of the empirical literature. Journal of Accounting and Economics. 58(2-3). pp.339-383.
  • Cheng, M. and et.al., 2014. The international integrated reporting framework: key issues and future research opportunities. Journal of International Financial Management & Accounting. 25(1). pp.90-119.
  • Cullingford, C. and Blewitt, J., 2013. The sustainability curriculum: The challenge for higher education. Routledge.
  • Ewert, R. and Wagenhofer, A., 2012. Earnings management, conservatism, and earnings quality. Foundations and Trends in Accounting. 6(2). pp.65-186.
 
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