MFRD FINANCIAL DECISIONS ASSIGNMENT

TASK 2: INVESTMENT AND PROJECT APPRAISAL Outcome 3.3 Assess the viability of a project using investment appraisal techniques 3.3a The average rate of return for each project Estimated a

TASK 1: FINANCIAL DECISIONS BASED ON FINANCIAL INFORMATION

Outcome 3.1: Budgets and making appropriate decisions

3.1a Flexible budget and budgetary control: variance analysis

Flexible budget (also called a variable budget) is based on predicted amounts of revenue and

expenses corresponding to actual level of output It show differences between actualperformance and budgeted performance based on actual volume or other level of activity toidentify reasons for any differences (John, 2009)

My F05 Ltd manufactures a distinction product Budget results and actual results for June 2011are shown below

Budget Actual results Variance

b) Actual results

According to data from scenario: Production units - £6,000; Direct Materials - £10,500; Direct

Labor - £8,500; Maintenance - £2,500; Depreciation - £4,500; Rent and rates - £3,500; Othercosts - £5,000

c) Variance

Variance is calculated by formula: Variance = Actual result - Budget

As can be seen, the difference between the projected budget and the actual performance In thiscase variance is negative, meaning the budgeted amount was greater than the actual amountspent

Budgetary control is the practice of establishing budgets which identify areas of responsibility

for individual managers (for example production managers, purchasing managers and so on) and

of regularly comparing actual results against expected results, the differences being variances(John, 2009)

The budgetary control (variance) analysis should be as follows

Fixedbudget(a)

Flexiblebudget(b)

Actualresult(c)

Budgetvariance(b) – (c)

a) Flexible budget: (Actual production / Expected production) x variable (semi-variable)

cost in fixed budget

Direct material: (6,000/4,000) x 12,000 = 18,000

Actual cost for 6000 units is £34,500

Fixed budget for 4000 units is £38,500

 Budget and actual costs is differ from each other too large  it is good for setting upestimation

If flexible is too high, it will make to decrease competitiveness of business

 The company should consider again about production unit cost

 Give right prices for buying products into market to increase competitive advantages

Other costs of the company is not good, standard is not correct, difference of 7,500  it is notgood for price decisions  The company also need consider again them

The most important method of budgetary control is variance analysis, which in this context

involves the comparison of actual results achieved during a control period with a flexible budget

Variance analysis

In producing 6000 units the expected costs should have been, not the fixed budget costs

of £38,500 but the flexible budget costs of £53,500 Instead, the actual costs were 34,500 and

£4,000 less than company’s expectation The reason for improvement is when produce 6,000units the cost were lower than what we expected (BPP, 2004)

Variable cost should have been greater than the £22,000 in the fixed budget because thecompany produced 6,000 units instead of 4,000 units Costs should have increase by ½ (12,000 +8,000 + 2,000) = £11,000 which can budgeted as the variable cost of 2,000 units This isdifference between the fixed and flexible budgets Semi-variable costs should have risen by

£4,000 for the increase of production (BPP, 2004)

A full variance analysis statement would be as follow

Budgeted difference due to increased production

Variances

3.1b The summary of the possible cause of variance

- Changing material standard such as: add some new material

- Changes in transportation costs lead to the material price increase

b) Material usage

- Material usage rate increase, for example the firm has some problem about themachinery lead to large qualities of product is destroy totally

- Material is defective so the firms need other material sources instead

- The firm needs many materials in order to produce large products for the partners.c) Labor rate

- The company must pay more salary, have welfare policies such as bonus, reward fortheir worker to motivate and encourage them contribute their best for the company’sobjective

- Rate increased resulted in increase of actual direct labor cost, for example, excessovertime, the worker is pay more money for their efforts

d) Idle time

- All operation of firms is stopped due to machine breakdown or non-available ofmaterial

- Worker is injury in work process lead to the shortage of labor resources

Outcome 3.2 Unit costs and makes pricing decisions using relevant information

3.2a Specification of F05 Ltd items

Specify items for My F05 Ltd items of expenditure which are classified as direct material cost,direct labor, and production overhead and so on (Scenario, 2012)

a) Direct costs

• Direct material costs: timber, bamboo (raw material); and cartons, boxes (primarymaterial)

• Direct labor costs: salary, bonus, reward for carpenter, designer and employees

• Direct expenses: salaries expenses, factory expenses…

b) Indirect cots

• Production overheads

- Indirect material: glues, screws, glasses…

- Indirect wages: wage for stores staff, and foreman

- Indirect expenses: rent, rate and insurances

• Administration overheads: telephone, internet, legal charges, and audit fee…

• Selling overheads: advertising costs, and market research, website maintains costs

• Distribution overheads: warehousing, and delivery vehicles…

3.2b Decision making

In the case of F05 Ltd, it has many costs affect the decision making of company but below

is some kinds of cost that may be used in the decision making of F05 Ltd

Pricing per unit = 54,500/6,000 = 9.083

Cost payment = 34,500/6,000 = 5.75

Cost according to budget = 38,500/4,000 = 9.625

If company has large different between budget and actual, it will not good for company.But if budget similar to actual, company will prepare good sources for produce such as humansources, financial sources, material sources and so on It helps company save money andavoidable the waste of sources in company

In addition, company should care about standard unit cost to have the best decision making

If the budget is too high, products of company will have high price in market As a result, itmake product of company decrease competitive advantages when compare with othercompetitors and company will not sell product

TASK 2: INVESTMENT AND PROJECT APPRAISAL

Outcome 3.3 Assess the viability of a project using investment appraisal techniques

3.3a The average rate of return for each project

Estimated average profit x 100%

£

Net Cash Flow

£

The total profit of project A in 5 year is total income from operations so the profit of project A in

5 year is £44,000 Therefore the Estimated average profit = total profit/5 = 44,000/5 = £8,800.Investment of project A in the start of project is £80,000 and they use straight-line depreciationwill be used and no residual value is expected so the investment in the end of project is £0.Therefore, Investment = (80,000 + 0)/2 = £40,000

Project B

ARR B = 42,000/5 = 0.21

40,000

The total profit of project B in 5 year is total income from operations so the profit of project A in

5 year is £42,000 Therefore the Estimated average profit = total profit/5 = 42,000/5 = £8,400

Investment of project B in the start of project is £80,000 and they use straight-line depreciationwill be used and no residual value is expected so the investment in the end of project is £0.Therefore, Investment = (80,000 + 0)/2 = £40,000

Compare the average rate of return of project A and project B:

ARR A = 0.22

ARR B = 0.21

 ARR A > ARR B

 Company should choose project A

3.3b The net present value for each project

The value of money in the future

FV t = PV

FV t: the value of money in year tPV: the value of money in presentr: the interest

 PV = Present value of cash flow in the future

Both projects have Net PV > 0 so company can accept both two projects

TASK 3: FINANCIAL PERFORMACE OF A BUSINESS

Outcome 4.1 Main financial statements

Financial statements are a collection of reports about an organization's financial resultsand condition (Accoutingtools, 2012) There are 3 main financial statements: balance sheet,income statement, and cash flow

a) Balance sheet:

• Purpose: A balance sheet prepares to show assets, liabilities, and owners’ orstockholders’ equity A balance sheet is a snapshot of a business’ financialcondition at a specific moment in time, usually at the close of an accountingperiod

• The balance sheet is based on the following fundamental accounting model:

Assets = Liabilities + Equity

- Assets and liabilities are divided into short-term and long-term obligation including cash accounts such as checking, money market, or government securities

+ Assets will be land and buildings, fixtures and fittings, property

+ Liabilities are loans from bank or other sources

- Equity is retained earnings from past contract to provide carpet

b) Income statement

• Purpose: An income statement is a summary of a company’s profit or loss duringany one given period of time, such as a month, three months, or one year Theincome statement records all revenues for a business during this given period, aswell as the operating expenses for the business

• The simplest equation to describe income is:

Net Income = Revenue - Expenses

- Revenue is all money that received from business contracts of organization

- Expenses include outflows incurred to produce revenue, such as salaries expenses, water expenses, electricity expenses…

c) Statement of cash flows:

• Purpose: Cash flow statements explains differences between profit and cash andalso show where a business gets its capital from and what uses it puts the capital

to Only large companies are required to produce a cash flow statement, thoughsmaller companies can do so if they wish

• The statement of cash flow is separate into three sections:

- Cash Flows from operating activities: is a section of the cash flow statement that

provides information regarding the cash-generating abilities of a company's coreactivities

- Cash Flows from Investing Activities: represent the net change in cash from the

use or sale of income-generating assets

- Cash Flows from Financing Activities: reported on the statement of cash flows

(SCF) involve changes to the long-term liabilities and stockholders’ equity(sections of the balance sheet) during the period shown in the heading of SCF

Outcome 4.2 Financial statements for different types of business

There are 3 type of business: sole trade, partnership and company; the table below showsthe differentiation of financial statement in different type of business

Sole trader Partnership Limited liability company

The owner areshareholder, whoseinitial stake is shown

as share capital andsubsequent profitsearned shown as abalance on the profit

on loss account

statement

A sole trader wouldprepare a simpleprofit and lossaccount

The interest must be paidbefore profit and dividedamong the partner and isincluded in the incomestatement as allocation ofnet income

Company will have toprepare based onInternational FinancialReporting Standards

or Generally acceptedaccounting principles

Statement of

cash flow

Cash flows fromoperating activities,from tradingactivities of abusiness

Cash received frominvestment activities such

as capital and paid onloans

Same as sole trader,cash flow from alloperating activities

a) Balance sheet

Sole trader: The profits (or losses) each year are often transferred into the capital

account

Partnership: The partners’ individual stake in the business is represented by capital

account (use for their long-term investment) and sometime, currentaccount (use to record profit share, drawing, salaries, interest on capitalaccount)

Limited liability company: The owners are shareholder, whose initial stake is shown as

share capital and subsequent profits earned shown as a balance on theprofit on loss account

b) Income statement

Sole trader: A sole trader would prepare a simple profit and loss account

Personal income taxPartnership: The interest must be paid before profit and divided among the partner and is

included in the income statement as allocation of net income

Interest on capital and Life-Policy PremiumsLimited liability: Company will have to prepare based on International Financial

Reporting Standards or generally accepted accounting principles

Salary expenses, corporation tax, and insurance.

c) Statement of cash flow

Sole trader: Cash flows from operating activities, from trading activities of a business.Partnership: Cash received from investment activities such as capital and paid on loansLimited liability: Same as sole trader, cash flow from all operating activities

Outcome 4.3 Financial statements using appropriate ratios and comparisons both internal and external

Financial ratios are useful indicators of a firm’s performance and financial situation Most ratios

can be calculated from information provided by the financial statements Financial ratios can be used to analyze trends and to compare the firm’s financials to those of other firms In some

cases, ratio analysis can predict future bankruptcy (John, 2009).

4.3a Profitability and return on capital

Capital employed = Share capital + Reserves + Non - current liabilities

According to income statement of BAT:

• Profit before interest: £4,931 (2011), £4,388 (2010), £4,080 (2009)

As can be seen, ROCE of the company is quite high, and increased steadily in 3 years from 2009

to 2011 It proved that the company is operating very well and earned more profits

2) Profit margin and asset turnover:

PBIT

Profit margin =

Sales SalesAsset turnover =

Capital employed3) Gross profit margin

4.3b Borrowing

1) Liabilities ratio

The liabilities ratio is the ratio of a company’s total liabilities to its total assets

- Assets consists of fixed assets at their balance sheet value, plus current assets

- Liabilities consist of all creditors, whether amounts falling due within one year or after morethan one year (Anon, 2004)

Total debts Current liabilities + non-current liabilities

Liabilities ratio = =

Total assets Total assets

According to Balance Sheet in annual report of British American Tobacco 2011, the currentliabilities of company are £7,847, including borrowings, income tax payable, other provisions forliabilities and charges…The non-current liabilities are £10,798, including borrowings, retirement

benefit liabilities, deferred tax liabilities…Therefore, the total debts are £18,645 In addition, the

total assets are £27,119 (including the current assets are £8,495 and non-current assets are

£18,624)

Similar to 2011, the total debts of 2010 are £18,312 (including current liabilities are £7,645 and non-current liabilities are £10,667), and the total assets are £27,860 (including current assets -

£8,657 and non-current assets - £19,203)

Accordingly, in 2009 the total debts are £18,702 (including current liabilities - £6,916 and current liabilities - £11,786), and the total assets are £26,614 (including current assets - £8,106

non-and non-current assets - £18,508)

From the data above, in the case of BAT the liabilities ratio is as follows

=68,75%

=68,18%

=70,27%

In this case, the liabilities ratio is quite high, mainly because of the large amount of currentliabilities The ratio has fallen from 70,27% to 65,86% between 2009 and 2010 despite of havingincreased but slightly only about 0,57% in 2011 Therefore, the company appears to beimproving its positions