Financial analysis, appraisal and decision making
Question 1
A).
Difference between long term and short-term finance of Back2Nature Ltd: -
Short term financing provides the one-year borrowings for the short-term repaying period whether the long-term financing provides the long-term loans in equal instalments which is payable over the years.
Short term financing doesn’t need any collateral statements of books for company whether the long-term financing needs to know about the financial statement of borrower so that they can know about the repayment capacity of such borrower.
Short term financing includes the easy application even by their mobile phone whether long term financing includes sufficient amount of scrutiny to know about the creditworthiness and ability of their borrowers.
Short term financing helps to sort out different liquidity requirements of company and long-term financing is use for the larger use of company and sort out their capital incentives, development projects etc.
It is the higher interest rates from company whether the long-term financing leads the lower interest rates of company.
Examples of short-term financing of Back2Nature Ltd company: - Bank overdraft, trade payables etc
Examples for long term financing of Back2Nature Ltd company: - Loans, mortgage and HP agreements.
B).
There are some ratios which helps to know about the capital structure of company here are some gearing ratios: =
Debt equity ratio |
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|
2014 |
2013 |
Total liabilities |
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1126 |
1298 |
Shareholders’ equity |
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1734 |
1020 |
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Formula |
total labilities/ shareholders’ equity |
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Debt equity ratio |
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0.64937 |
1.27255 |
Equity ratio |
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|
2014 |
2013 |
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Total equity |
1734 |
1020 |
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Total assets |
2510 |
1910 |
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Formula: - |
Total equity/ total assets |
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|
Equity ratio |
0.69084 |
0.53403 |
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Debt ratio |
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2014 |
2013 |
Total liabilities |
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1126 |
1298 |
Total assets |
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2510 |
1910 |
Formula: - |
Total liabilities/ total assets |
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Debt ratio |
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0.448606 |
0.679581 |
According to the following calculation Back2Nature Ltd company will have increasing amount of debt in their company including long term and short-term loans. By the whole capital structure of comp any they need to increase their total assets so that company can sort out their loans and advances of company other than that Back2Nature Ltd company should also increase their equity by encouraging other investors to spend their money in company so that they can earn profit and investors may earn their incentives of company. according to the calculation Back2Nature Ltd company have increasing amount of loan or debt in comparison to their equity that is 0.64 in 2014, other than that they have only 0.690 of their equity and assets which should ne increase in future times.
C).
Recommendation for financial issues of company: -
Back2Nature Ltd company have adverse amount of gross profit in 2014 with the huge amount of cost of sales that means company needs to increase their productivity and sales by encouraging consumers to buy their product in sake of discounts other than that company is also have decreasing amount of net profit and they should also motivate their investors to spend their money in company for the sake of incentives. They should also increase their current assets so they can sort their short-term loans and advances of company. By applying these steps Back2Nature Ltd company will surely increase their sales and profits for company.
D). two advantages and disadvantages that why organic growth is better than merger and acquisition: -
Advantages: -
With organic growth Back2Nature Ltd company can maintain their goodwill in comparative market.
Company can also lead their name in biggest industries with the organic growth and increasing profits of Back2Nature Ltd company.
Disadvantages: -
If company is getting loss, its better to merge their company rather than facing immense loss in future times.
By merging process both companies will share their loss and profits together.
Question 2
Recommendation on the development of products using criteria of expected value
Expected value: The expected value on the profits from each of the available products can be calculated by adjusting the net profits/losses with the probabilities of the given scenarios. In the given case, the scenarios recession (35%), static (40%) and boom (25%).
State of the economy |
Recession |
Static |
Boom |
|
£ |
£ |
£ |
Probability |
0.35 |
0.4 |
0.25 |
Product A |
-30000 |
285000 |
455000 |
Product B |
8000 |
245000 |
465000 |
Product C |
-48000 |
280000 |
495000 |
Net profit/ loss |
-70000 |
810000 |
1415000 |
Profits adjusted with probabilities (EV) |
-24500 |
324000 |
353750 |
In the given scenario, it can be seen that in recession time the company has to suffer losses the expected value of losses in this case is -£24500. In the static situation the overall profits from three products is £810,000, when adjusted with the probability the expected value comes out to be £324,000. In the boom situation, the expected value of overall profits will be £353,750.
Product wise profits |
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Recession |
Static |
Boom |
Total |
|
£ |
£ |
£ |
|
Probability |
0.35 |
0.4 |
0.25 |
|
Product A |
-10500 |
114000 |
113750 |
217250 |
Product B |
2800 |
98000 |
116250 |
217050 |
Product C |
-16800 |
112000 |
123750 |
218950 |
Net profit/ loss (EV) |
-24500 |
324000 |
353750 |
|
The profits by the product A (after adjusting probabilities) are £217,250. Similarly other two products are also reporting profits. This leads to the conclusion that these products are profitable for the company, as per their expected values. Based on the preference, product C will provide most profits, being the total amounting to £218,950, hence it should be selected.
Different attitudes that the company might have to risk and how it impacts in decision making-
Developing product C in risk prone scenario: If recession situation only product B is profitable. Hence the product B should be preferred which will bring profits of £8000 even in recession time. On the other hand the product B will incur losses amounting to £48000.
Producing product B in boom scenario: In case the company decides to play safe and go with the production of product B, the profit is second lowest in the boom scenario. The product C is having most profits in boom time, amounting to be £495,000. At the same time, the profits earned by product B are only £465,000.
Producing product A: In static scenario, which is 40% (most likely) to happen, the profits of product A are £285,000, which is highest among three available products.
If Runways plc expects a boom time the profits are highest with product C, but all the products are profitable as well. If the company risks launching product B, it has to risk lowest profits in static scenario. The product A and C are riskiest in recession situation. The expected value of profits is highest with the product C.
Question 3
(a) Problems and opportunities that have emerged from the cash budget of Storm Ltd.
The big opportunity or advantage of the cash budget is that it ignores the debt as well as it is forced to budget better. In the Storm Ltd. cash budget there is no debt and the cash sales of the company is increased in next 3 months (Jan, Feb and Mar) and the problems or disadvantage of the cash budget of Storm Company is that the In Mar the opening balance was in the negative. It is the big problem of the company. If the opening balance of the company is in the negative then it will directly affects the profitability of the company. In Mar, the net cash of the company was (29) and it was increased compared to the previous month. The total receipt of the company is increased in next three months and it is the big opportunity of the company to increase the probability as well as productivity. In the cash budget, there are different types of opportunities as well as problems in the company. The opportunities and problems are as follows:
Quickly identify potential deficits: It is the big advantage or opportunity of the cash budget for the Storm Company. It quickly identifies the potential deficits of the company. In the cash budget of the Storm Company, the net cash of the company was decreased. The cash budget of the company can quickly examine the cash to meet their obligations.
Cash Inflow of the Storm Ltd: In Jan, the Storm company total inflow was £320,000, in Feb It was increased to £ 333,000, in Mar the total cash inflows of the company was also increased to £ 344,000 compared to the last month. It shows that the cash inflows of the Storm Company are performs better and it is big opportunity for the company. In the company, it is important to increase the cash inflows because it shows that how much the company earn the profits.
Cash outflow of the Storm Ltd: If in the company total cash outflow is higher than it will negative impacts on the businesses value. In Jan, the total cash outflow of the Storm Company was £ 302,000, in Feb the total outflow was £ 418,000. It is the issue for the company because the outflow of the company was increased compared to the last year. In Mar, the outflows of the Storm Company were £ 373,000 and it was decreased compared to the previous month.
Enough cash: The big problem of the Storm Company is that the company has not sufficient cash to make profits. If the company doesn’t have enough cash than it will directly impacts on the company’s reputation as well as profitability. It is important to maximise the company’s opening balance to improve business value.
Able to communicate the financial performance: The cash budget also helps to communicate the financial performance of the company. The financial performance of the Storm Company is not well because the closing balance of the company was in the negative and it impacts the business value. It is also a big problem of the company. The total payment is higher than the total receipts and it also a big problem for the company. In Mar, the dividend payment was £ 50,000.
Recommendation:
Storm ltd should decrease the expenses of the company. In Feb, the total payments were increased compared to the last year. The company should improve the value of the business. If the total payments of the company are lower than the total receipt then the result of the net cash will in positive and it important for the company that the net cash is positive. The company should increase the productivity as well. The Storm Ltd. should increase the opening balance as well as reduce the expenses of Forklift truck, dividend payment, etc. The company should build the credit profit to increase the efficiency as well as avoid the debts. The company should also increase the total cash inflows as well as reduce the total cash outflows.
(b) Pay- back period: The pay- back period helps to the Storm Ltd to determine or examine the time length required to recover the initial amount in the project. It also used to compute the total time required to earn back the initial amount incurred in the company’s investments via the cash flows of successive.
Formula: Pay- back period = Initial investment/ cash inflows
Advantages:
In the Storm Ltd. the method of pay- back period is very useful because it is easy to use as well as understand, and also easy to compute,
It helps to the Storm Company to recover the initial amount,
The pay- back method is beneficial as well as useful for the Storm Company because the investments of the company is become obsolete very fast,
It measures or examines the project liquidity of the Storm Company.
Disadvantages:
The major disadvantage of the method of pay- back period is that it avoids the money time value which is very important in the company,
This method doesn’t present the position of liquidity of the Storm Company, but only presents the project ability to return the initial investments,
It also doesn’t consider the investment life- span, what if the asset life gets over more before the cost of initial investment is realised.
Net present value: NPV reflects the Storm Ltd evaluate of the possible profit & loss from the investment in the project. The NPV is the technique of the capital budgeting to analyse the investment or project’s profitability. It is computed by taking the difference in the between the cash inflows and cash outflows current value over the time of period.
Advantage:
The technique of net present value for analysing the particular investment or project profitability in the Storm Company,
This method takes into the consideration all the outflows, risk, time period, and inflows involved. It is also beneficial for the Storm Company to calculate,
This technique enables the process of decision making for the Storm Company and it helps in identifying the specific project is loss making or profit making,
Disadvantage:
The big disadvantage of the net present value is that the return rate has to be examined or determined. If the higher return rate is predicted, than it can present the negative net present value, also if the lower return rate is taken then it will present the positive net present value of the investment, therefore the result in wrong decision making,
It cannot to be used in the comparison the two investments in the Storm Ltd, which is not of similar time period.
The whole calculation of the NPV technique rests on the discounting the cash flows of the future to their current value using the required return rate. It is also the disadvantage of the NPV in the Storm Company.
It also takes into account the outflow and inflows of the specific investment or a project. It doesn’t consider the any hidden cost in the storm Company. This is the big disadvantages for the Storm Company.
Question 4
Part A
Basis |
Metal Work Department |
Fabric department |
Embroidery department |
Total |
hours Required |
400 |
600 |
300 |
|
per hour labor Wage |
16 |
30 |
20 |
|
Total |
6400 |
18000 |
6000 |
30400 |
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Basis |
Material |
Total |
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Quantity required |
500 |
1.5 |
0.5 |
|
Rate per kg |
4.3 |
3500 |
13 |
|
Total (in £) |
2150 |
3500 |
6.5 |
5656.5 |
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Total cost of the company |
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|
36056.5 |
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Minimum Amount of contract that the company should consider |
43267.8 |
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Metal work department takes 400 hours at a rate of £16, fabric department will take 600 hours at a rate of £30 and embroidery department took 300 hours at a rate of £20. Therefore total cost for all the departments will be £30,400. While talking about material consumed, total quantity required will be 502 kgs at different prices like £13, £13 and at £3500 in total. Total cost for material consumed is £5656.
Hence the total cost will be £36056. Profit margins are 20% therefore the minimum is 20% and hence the minimum cost of the contract will be £43267.
Part b
Contract decisions depend on the cost of different department that will be incurred while computing the cost of making that product. In the case above, departments like metal work department, fabric department and embroidery department. Contract pricing is suitable for making short term decisions as it will help in taking the decision of contract pricing based on it. This concept is not apt for making long term decisions. Labor rate and cost of material keeps on changing as per the prevailing economic condition or any other fluctuations. Like, for now the cost of labor of metal department is £16 per hour but it can be changed as it can be increased or decreased so long term price identification of the contract is not right as it will not be right and relaying on it. Apart from it, material price also changes due to many factors like suppliers price, quantity ordered and so. Sometimes, if the demand of the raw material is high then the supplier will increase the price of material and therefore it will affect the contract pricing. If the prices increase the contract price will increase and if the price of raw material decreases then the cost of the contract will increase and this will impact the profit margin of the contract. For example: if the material cost increases to £18 then the cost of that material will be £9.5 and this will also increase the cost of the product.
At the last it can be concluded that the company will not be able to take long term decisions regarding contract pricing as there are many dynamic factors that will affect the price of per unit.
Basis |
Metal Work Department |
Fabric department |
Embroidery department |
Total |
hours Required |
400 |
600 |
300 |
|
per hour labor Wage |
19 |
22 |
11 |
|
Total |
7600 |
13200 |
3300 |
24100 |
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|
|
|
|
|
|
|
|
|
Basis |
Material |
Total |
||
Quantity required |
500 |
1.5 |
0.5 |
|
Rate per kg |
5.3 |
4000 |
13 |
|
Total (in £) |
2650 |
3500 |
6.5 |
6156.5 |
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Total cost of the company |
|
|
|
30256.5 |
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Minimum Amount of contract that the company should consider |
36307.8 |
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It can be concluded that at the figures given in the question then the total amount of contract is £43267.8 and if the price changes in long duration then the contract price will be £36307.8. Therefore it is not recommended to take long term decisions through analyzing only relevant costs.
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