Accounting and Financial Management

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 flow^A

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 flow^A

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

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