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Introduction of Business Management Accounting And Finance Assignment
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This report shall provide a brief insight as to how cash flow is different to profits and the essentials, importance and relevance of conducting both Cash flow and Profit. Additionally, this report shall also discuss the proposed sales initiatives for DD ltd with respect to the encouragement of a new product. This report shall also throw light on various appraisal methods available for organisations to consider for a project and discuss the limitations of the major appraisal methods including NPV, IRR and payback period. The added emphasis of this report is to discuss financial ratios, their relevant classifications and limitations associated with the ratio analysis and financial performances. Moreover, this report shall also mention the limitations and problems of budgeting and suggest when to incorporate Zero Based Budgeting to ensure operational excellence of a company. Moreover, this report shall also discuss the advantages of employing Zero Based Budgeting with a particular company as compared to other available budgeting techniques.
2: Discussion on the relationship between Cash Flow and Profit
The fundamentals associated with the financial performance analysis of a concerned organisation largely consist of Income Statement, Cash Flow Statement and Balance Sheet. The components of Income Statement largely include sales figures, cost of sales, gross profit and net profit. As per the opinions and explanations of Griffin (2018), the components of a cash flow statement further include Cash from Operations, Cash from investing activities and cash from financing activities. The actual difference between profits and cash flow statements of a company is purely based on accounting principles. Furthermore, profit of a company is based on an accrual basis of accounting whereas; the cash flow statement considers cash-based accounting principles (fitchratings.com, 2022). Another major point of difference existing between cash flow and profits includes the long run definition of sustainability for a business. The long-run profitability can be understood more with a suitable net profit, while the short-run profitability of a business can be well defined by Cash flow statement (investorschronicle.co.uk, 2022).
The astute and important differences existing between both Cash flows and profitability of a company can be further well defined by considering the overall financial metrics of a company. Contino (2019), explained that relevance and existence of cash flows particularly for new business establishments are necessary to define perpetual business and asset growth. Moreover, the balance sheet illustration of DD Ltd. has been mentioned in detail to evaluate the basic and important differences existing between cash flows of a company and profits of a company [Refer to Appendix 1 and 2].
3: Discussion of the proposed new sales initiative
The new sales initiative for DD ltd. holds an extra provision to accommodate and sell De-Luxe chairs at an incremental cost and price. The revised budget plan for DD ltd to revive its business makes new amendments to give 75% weightage on standard chairs and 25% weightage on De-Luxe chairs. The budgeted level of manufactured units and selling units for the De-luxe chair is slated to be 14,000 units. However, the business implementations and processes for the organisation are facing a plethora of challenges and competition, hence a 20% weightage is recommended, instead of 25% weightage for de-luxe chairs. The total sales units can be increased to 15,000 units instead of 14,000 units, which shall allow 3,000 units of sales and production for De-Luxe chairs. As per the estimated variable cost breakdown, £11 is slated to be per unit cost of chairs, which should be increased to at least £14 per unit. The management of the organisation should also consider adding indemnity and insurance charges at £ 80,000 annually. The revised profit from the sale of chairs can be cut down to around £ 35,000 to £ 40,000 instead of £ 46,000. The major reasons for cutting down on profits and increasing in variable cost of the de-luxe chairs are purely based on unknown reactions of customers with respect to new products. Moreover, a positive overview regarding the product reaction from customers can allow the organisational management to increase production and sale of De-luxe chairs to ensure maximised profitability.
4. Critical appraisal of capital investment options.
4.1: Discussion on Investment appraisal methods
In order to discuss the capital appraisal and investment options of DD ltd, the project requires considering two major available project buildings including small Buildings as well as Medium buildings. The estimated figures of cash outflow and inflow for both small and medium buildings have been taken on the basis of a 6% discounting factor or capital cost. As opined by Lord et al. (2020), the applicable methods of appraisal largely include Net Present Value method, Payback period method and Internal Rate of Return method. Further discussion on the features, advantages and disadvantages of these three critical appraisal methods has been mentioned as follows.
4.1.1: Discussion on Net Present Value Method
The first important method of critical investment appraisal includes the Net Present Value (NPV) method. The calculation and importance of NPV method mostly consider the present value of projected future cash inflows corresponding to the initial outflow or project cost required at the beginning of a project (journalofaccountancy.com, 2022). The advantages of employing the NPV method allow an organisation to estimate the actual time value of finance concerned with a company towards implementation of a project. Additional benefits of employing the NPV approach help an organisation to determine multi-currency project acquisitions and values at applicable discounting rates. The disadvantages of employing the NPV method mostly include non-consideration and failure to calculate hidden values of a project. The additional disadvantage of employing NPV approach includes failure to estimate accurate project values based on different bandwidths and sizes of projects.
4.1.2 Discussion on Payback Period Method
The second critical appraisal method available for an organisation as an investment appraisal method includes Payback Period method. Salient features and workings associated with the Payback Period method involve the actual time needed for the project to recollect the initial cost of project outlay. Payback Period method can be further subdivided into discounted payback period method, where cost of capital is being considered an integral part of the calculation process. The basic advantages attached with the application of payback period method include a simple process of calculation and an increased level of project appraisal reliability. The additional advantages and benefits attached to the calculation of the payback period method include a true and fair assessment of project investment risks. The disadvantages attached with the implementation of payback period method include possibilities of fund and capital blockage in the project and minimal consideration to enhance future profitability associated with the project.
4.1.3: Discussion on Internal Rate of Return Method
The third important critical appraisal method available for an organisation as an investment appraisal method includes Internal Rate of Return [IRR]method. The principle working and theorem associated with the application and implementation of the IRR method involves consideration of two costs of capital, where cumulative cash flows and NPV are considered for calculations. The working of IRR is different to ARR, as IRR considers interpolation of two costs of capital (gov.uk, 2021). The advantages associated with the application and implementation of IRR with a company includes ranking projects on the basis of profitability and NPV calculations. Additionally, advantages include letting an investor know the present actual returns of a project with respect to future values. Disadvantages associated with the application and implementation of IRR includes the possibility of incomplete project estimations and a lack of adequate room to consider scope for reinvestments.
Project Appraisal Methods
(Source: Created by Learner)
4.2: Decision of the company related to selection of a particular project
In order to select the appraisals and feasible returns from a particular set of projects, the management of an organisation needs to primarily consider NPV as the most important critical method. Trabelsi and Siyahhan (2021), illustrated that the election of projects from multiple available ones should be done on the basis of NPV, IRR and payback period appraisal. In this scenario, the management should consider opting Small Build (SB) project as the resulting NPV, Payback and IRR are significantly greater than that of Medium Build (MB) project. Moreover, the chances of MB expanding can be a critical decision making part, however, as per appraisal analysis, SB should be chosen.
5. Discussion on Application of Accounting Ratios
A company values its operational efficiency as the paramount area of importance to justify a stronghold in business operations in the market. In addition to the importance and relevance of operational paradigms of an organisation, the financial paradigms and parameters also carry a significant amount of weightage for a company to justify and define long-run market sustainability (corporatefinanceinstitute.com, 2021). In order to further evaluate the essential prospects of financial paradigms, ratio analysis is considered an important tool to encourage the actual financial findings. The relevant discussion on ratios, the various types of ratios has been carried out in detail as follows.
5.1: Discussion on Ratios
5.1.1: Liquidity Ratios
The first important aspect of financial analysis consists of the liquidity ratios of a concerned company. In order to suitably and feasibly measure the liquidity ratios of a company, the ratios are further classified as Current Ratios and Quick Ratios. Current Ratios are also known as Working Capital ratios, which define the abilities of a company to generate liquidity of its respective current assets. Mathematical representation of Current Ratios can be identified as the proportion of Current Assets with Current Liabilities. The second component of Liquidity Ratios consists of Quick Ratios, which consider calculation of the Working Capital Ratio excluding inventory held by the company. The mathematical representation of Quick Ratios can be explained as the difference of inventory with Current Assets and its respective proportion with Current Liabilities.
5.1.2: Profitability Ratios
The second major component of financial analysis paradigms of an organisation consists of Ratio calculations based on profitability measures of an organisation. The categorisation of profitability ratios can be further divided as Gross Profit ratio, Operating Profit Ratio, Return on Capital Employed and Net profit ratio (investopedia.com, 2021). The calculation for Gross Profit ratio considers gross profit of a company along with its respective proportion to sales. The computation of the Operating Profit Ratio considers deduction of operating expenses from gross profit to arrive at operating profit. Mathematical representation of the Operating Profit Ratio can be considered as the proportion of the Operating profit of an organisation with its sales or revenue value. Return on capital Employed is considered on the basis of returns available for a company with respect to average capital invested within an organisation during a particular financial year. Mathematical presentation of Return on Capital Employed can be attributed as the proportion of Profit before Interest and Tax with Capital employed in a year. Calculation of Net profit ratio considers tax deductions, interest expenses paid from Profits before Interest and Taxes. The mathematical representation of the Net profit ratio can be attributed to the proportion of Net Profit with Sales.
5.1.3: Activity or Efficiency Ratios
The third major fundamental principle of Financial analysis and ratio calculations of a company consists of Activity or Efficiency Ratios. The classification of Efficiency ratios can be further categorised as Inventory Turnover Ratio, Debtors Turnover Ratio, Creditors Turnover Ratio and Working Capital Turnover Ratio. Inventory Turnover Ratio refers to the Inventory holding capabilities of a company with respect to cost of sales. Mathematical formula associated with the calculation of this ratio includes the cost of sales with a proportion of average inventory. Debtors' Turnover ratio is mathematically calculated as the net credit sales occurring with a company for a financial year with proportion of average debtors for the entire financial year. The creditors' Turnover Ratio is mathematically calculated as the cost of sales or credit purchases with a company proportional to the average creditors of the company within a particular financial year. Working Capital Turnover Ratio consists of a mathematical formulation of Net Sales happening within a financial year for a company corresponding to the proportion of Working capital.
5.1.4: Solvency or Gearing Ratios
The fourth major ratio calculations include the solvency or gearing ratios of a concerned company. This can be further divided as debt to equity ratio, debt to total assets, equity to total assets and interest coverage ratio. Mathematical calculations of the debt-equity ratio consider debt funds proportionate to equity funds. Mathematical calculations for debt to total assets and equity to total assets consist of debt and equity funds with corresponding proportions to total assets of a company. The mathematical calculations of interest coverage ratio consist of Profits before Interests and taxes, proportional to interest expenses for the financial year.
5.2: Limitations of Ratios
There is however certain limitations associated with the suitable calculations of ratios for a company. The primary limitation associated with the calculation of ratios involves a lack of considerable substance to integrate and measure human or individual elements circling around a company. As per explanations and statements of Haddad, Fatima and Haddad (2020), this is a major hindrance to ratio calculations as a comparison of organisational workforce and other human-oriented elements cannot be facilitated by the ratio analysis. The second major disadvantage associated with the suitable calculation of financial ratios involves least adherence and involvement to consider cyclical economic changes. Major ramifications of a country's economy cannot be compared with the help of ratio calculations as the overall economic perception cannot be determined through ratios.
6. Critical discussion of the problems of budgeting and the role of Zero Based budgeting to solve those problems.
6.1: Problems with Budgeting
The major problems associated with the process of suitable organisational budgeting involve indecision regarding available finances. This is considered to be an area of grave concern for major large scale organisations as the decision to incorporate suitable budgeting with the company module allows room for achieving a financial stronghold. According to Ibrahim (2019), the second disadvantage associated with the budgeting issues is largely attributed to incorrect usage and application of budgeting methods. The incorrect usage and application of budgeting methods, further hampers the operational paradigms of the organisation, thereby resulting in incremental operational costs and reduced profitability for the organisation in long and short run.
6.2: Role of Zero Based budgeting to solve these problems.
The primary role of implementing Zero-based budgeting is to ensure mass scale flexibility in the budgeting process available for an organisation to be implemented. The Zero-based budgeting method allows flexibility in operational paradigms as well as a selection of appropriate budgeting methods to justify the excellence of the company as per pre-described standards. As illustrated and explained by Alkaraan (2018), the second major advantage associated with the application of Zero Based Budgeting involves a decrease in operational costs for an organisation. As the process of Zero-Based Budgeting is considered to be based on the simple application of a budgeting module, the associated costs of operations can be further optimised and stimulated by the organisations to achieve maximum revenue scope. The application and implementation of the Zero-Based Budgeting Method by ABCD Ltd. should be done on a measured basis to achieve optimum levels of growth and justification for the organisation. As stated by Henly (2019), the phase-wise implementation of Zero Based Budgeting further allows an organisation to incorporate essential components of operations to ensure robustness and market stability. Moreover, James et al. (2018), suggests that timely implementation of Budgeting methods gives the organisation ample opportunities to make necessary modifications and changes for justifying operational growth and market dominance.
References
Books
Contino, RM 2019, Equipment Leasing and Financing : A Product Sales and Business Profit Center Strategy, Business Expert Press, New York. Available from: ProQuest Ebook Central. [30 March 2022].
Griffin, MP 2018, Financial Statements, BarCharts, Inc., Boca Raton. Available from: ProQuest Ebook Central. [30 March 2022].
Journals
Alkaraan, F. 2018, "Public financial management reform: an ongoing journey towards good governance", Journal of Financial Reporting and Accounting, vol. 16, no. 4, pp. 585-609.
Haddad, A.E., Fatima, B.S. and Haddad, R. 2020, "Voluntary disclosure of accounting ratios and firm-specific characteristics: the case of GCC", Journal of Financial Reporting and Accounting, vol. 18, no. 2, pp. 301-324.
Henley, T.N. 2019, "BOOK REVIEW OF ETHICS IN FISCAL ADMINISTRATION: AN INTRODUCTION 1", Public Finance and Management, vol. 19, no. 3, pp. 232-236.
Ibrahim, M. 2019, "Designing zero-based budgeting for public organizations", Problems and Perspectives in Management, vol. 17, no. 2, pp. 323-333.
James, C., Gmeinder, M., Rivadeneria, A.M.R. and Vammalle, C. 2018, "Health financing and budgeting practices for health in South Africa", OECD Journal on Budgeting, vol. 17, no. 3, pp. 95-127.
Lord, R.A., Saito, Y., Nicholson, J.R. and Dugan, M.T. 2020, "CEO compensation, portfolio holdings and strategic investments", Journal of Financial Economic Policy, vol. 12, no. 1, pp. 137-160.
Trabelsi, D. and Siyahhan, B. 2021, "Startup cash flows and venture capital investments: A real options approach: MDE", Managerial and Decision Economics, vol. 42, no. 3, pp. 737-750.
Online Articles
fitchratings.com, 2022, cash flow and operating profit [online], Available at: https://www.fitchratings.com/research/corporate-finance/fitch-assigns-hela-apparel-holdings-first-time-aa-lka-national-rating-outlook-stable [Accessed on: 29.03.2022]
gov.uk, 2021, capital appraisal methods [online], Available at: https://www.gov.uk/government/speeches/the-quiet-revolution-redefining-the-how-of-government-spending [Accessed on: 29.03.2022]
investorschronicle.co.uk, 2022, cash flow and operating profit [online], Available at: https://www.investorschronicle.co.uk/ideas/2022/03/29/on-the-results-beat/ [Accessed on: 29.03.2022]
journalofaccountancy.com, 2022, capital appraisal methods [online], Available at: https://www.journalofaccountancy.com/news/2022/mar/billionaire-minimum-tax-pose-difficulties.html [Accessed on: 29.03.2022]
Websites
corporatefinanceinstitute.com, 2021, application of accounting ratios [online], Available at: https://corporatefinanceinstitute.com/resources/knowledge/accounting/accounting-ratios/ [Accessed on: 29.03.2022]
investopedia.com, 2022, application of accounting ratios [online], Available at: https://www.investopedia.com/terms/a/accounting-ratio.asp [Accessed on: 29.03.2022]
