Managing Financial Resources and Decisions Assigment 2

This report provides the analysis and evaluation of the budgets, costs in F05 Ltd, investment and project appraisal; the financial statements and many kinds of ratios of Associated British Foods. This finding uses some methods like budgetary control, breakeven analysis; several formulas about accounting like accounting rate of return, present value and net present value. Results of this analysis help evaluate the business performance and making right decisions.

Managing Financial Resources and

DecisionsTitle page

Prepared for: Mr JUN ALEJO BATHAN (Professor)Financial Decisions and Financial Performance Analysis

Banking Academy, HanoiBTEC HND in Business (Finance)Prepared by: A2TV group Class: F05B

Number of words: 3,351 (not include the table)

Submit day: 10th, January 2013

Managing Financial Resources and

DecisionsExecutive summary This report provides the analysis and evaluation of the budgets, costs in F05 Ltd, investment andproject appraisal; the financial statements and many kinds of ratios of Associated British Foods.This finding uses some methods like budgetary control, breakeven analysis; several formulasabout accounting like accounting rate of return, present value and net present value Results ofthis analysis help evaluate the business performance and making right decisions

This report finds the difference between flexible budget and actual budget in F05 Ltd is quitehigh and it is not good for the future decisions of the company Besides, the contents and thefunctions of the main financial statements Associated British Foods of are discussed This bringsmany useful data for the investors and debtors

Recommendations discussed include:

- Evaluate the costs carefully to have the most reasonable flexible budgets

- Use several analysis to have the right price

- Use more investment appraisal methods to judge the viability of the projects

However, in this report, there are several limitations:

- Because of time’s limitation, some parts cannot be more deepened in content

- The limitation of public company’s data

Table of Contents

Title page i

Executive summary ii

Introduction 1

3.1: The analysis budgets and apposite decision-making 1

3.1.1 The flexible budgets and budgetary control: variance analysis 1

3.1.2 Summary of the possible causes of variance 3

3.2: Explanation the calculation unit costs and pricing decision- making using pertinent information 3

3.2.1 Classifications the different costs 3

3.2.2 Pricing decision making 4

3.2.3 Cost should be used for decision making 5

3.3: The viability of a project using investment appraisal methods 5

3.3.1 Accounting rate of return (ARR) method 6

3.3.2 The net present value (NPV) method 6

4.1: The discussion of the primary financial statements 8

4.2: The comparison of appropriate formats of financial statements for different types of business .9

4.3: Interpretation of financial statements using applicable ratios and comparisons both internal and external 12

4.3.1 Profitability and return on capital (ROCE) 13

4.3.2 Borrowings ratios 14

4.3.3 Liquidity and working capital ratios 15

4.3.4 Shareholders’ investment ratios 16

Conclusion 17

Reference 18

Appendix 1 – The ABF balance sheet 19

Appendix 2 – The ABF income statement 20

Appendix 3 – The ABF cash flow statement 21

Table 1: The budgetary control (variance) analysis of F05 Ltd 2

Table 2: Summary of the possible cause of variance 3

Table 3: A cost center and some examples 4

Table 4: The data about two projects 5

Table 5: The data for calculating ARR 6

Table 6: The PV & NPV 7

Table 7: The ratios 13

Introduction

The report aims to provide the information obtained through the analysis about budgets, costs ofF05 Ltd and investment and project appraisal Additionally, the financial statements ofAssociated British Foods (ABF) are presented The scope of this report includes:

- Analyze budgets and make appropriate decisions of F05 Ltd

- Explain the calculation unit costs and make pricing decisions using relevant information

of F05 Ltd

- Assess the viability of a project using investment appraisal techniques for two projects

- Discuss the main financial statements of ABF

- Compare appropriate formats of financial statements for different types of business of ABF

- Interpret financial statements using appropriate ratios and comparisons both internal and external

3.1: The analysis budgets and apposite decision-making

3.1.1 The flexible budgets and budgetary control: variance analysis

A budget is defined as a ‘comprehensive and coordinated plan, expressed in financial terms, forthe operations and resources of an enterprise for some specific period in the future (Khan &Jain, 2007, p8-2)

The table below will show the budgetary control (variance) analysis of F05 Ltd:

Standard costsunits

Fixedbudget(a)

Flexiblebudget(b)

Actualresults(c)

Budgetvariance(b)-(c)

Variable costs

Notes The formula to calculate the flexible budget

(1) Direct material = £3(standard cost units of direct material) * production (units) (2) Maintenance = (£2000/4000 units) * production (units)

(3) Direct labor = £2 (standard cost units of direct labor) * production (units)

(4) Other costs = £1,500 + £2 * production (units)

(5) x: production (units)

It can be seen clearly that actual cost are lower than expected While predictable costs are

£53,500; the actual costs are only £34,000 As the result, this is favorable - less than expected

£19,000

Variable costs should have been greater than the £22,000 in the fixed budget because the

company produced 6,000 units instead of 4,000 units Costs should have been increased by 2000*(3 + 2 + 0.5) = £11,000 However, actual variable costs (£21,500) are less than expected costs(£33,000) It means that this is favorable with £11,500 less

Actual semi-variable costs are much lower than what F05 Ltd expected While it predicted that

semi-variable costs are £13,500; actually it only stood in £5,000 This is also favorable when less

than expected £8,500

Finally, actual fixed costs (£8,000) are higher than expected costs (£7,000) Therefore, it is

adverse with £1,000

3.1.2 Summary of the possible causes of variance

Material Price Substitute the old materials by

another different material The price reduces

High inflation rate Restrict laws of governmentsFailure to purchase the anticipated quantity materialUsage Use higher quality than

standard

Unsuitable quality of materials

Labor Rate The number of experience

workers go up

A number of worker increase

Workers sickness or vacation time

Labor strike Efficiency Sufficient training of workers

Good working condition High retained workers rate

Machines break out or use of not working equipment Poor workers performanceFixed overhead price Sale orders increase

Efficient utilization of existingcapacity

Failure to utilize normal capacity

Improve quality of machines

3.2.1 Classifications the different costs

Functional classification system under which costs are classified according to the function they perform within the business; for example, manufacturing, selling, general and administrative or financial costs (G Siegel & K Shim, 2006, p.476)

Assuming that F05 Ltd is a car manufacturing company:

 Production cost: steel, assembly line wages

 Administration cost: salaries, personnel department

 Marketing, selling, distribution: advertising, transporting costs

A cost center is a business’s section to which cost can be charged It may be a location, a person

or an item of equipment Each business will choose cost centers relevant to its particularcircumstances (Lzhar & Hontoir, 2001, p.190) This table below shows some examples aboutcost center:

Labor Supervisors, cleaners, salespeopleExpense Advertising, administrative costs

Table 3: A cost center and some examples

3.2.2 Pricing decision making

a) The Terminology of CIMA defines cost unit as ‘a quantitative unit of product or service inrelation to which costs are ascertained (Dutta, 2003, p.1-7)

Following the data of F05 Ltd:

An expected cost unit: £53,500/6000units ≈ £8.92/unit

An actual cost unit: £34,500/6000units = £5.75/unit

Based on this result, F05 Ltd will set higher price than actual so it will lose competitive price in

the market Consequently, F05 Ltd.’s market share and sale revenue can be cut down and thecompany will have loss

b) Breakeven analysis: is a method identifying the relationship between costs, volume of output and profit It indicates the breakeven point, the point where sales revenue equals total cost

(the sum of fixed and variable costs) and there is neither profit nor loss (Armstrong, 2006,p.391)

The formula for using breakeven analysis to set the price is:

Breakeven Price = (Total Fixed Costs + [Variable Costs Per Unit × Volume]) ÷ Volume

(J Penner, 2004, p.157)

Apply this formula for F05 Ltd:

Total Fixed Costs: £8,000

Variable Costs per Unit: £21,500 ÷ 6000units ≈ £3.58

Volume: 6000 units

 Breakeven price ≈ £4.91

Based on this, a product must be sold at least £4.91 without generating profit

3.2.3 Cost should be used for decision making

So far economically relevant costs for decision-making have been defined as future, avoidable costs but in economic theory the correct cost for evaluating a decision is termed opportunity

cost Opportunity cost can be defined as accepting the value of the next best alternative (Lucey,

£

Net Cash Flow

£

Income fromOperations

3 10,000 26,000 8,000 24,000

Table 4: The data about two projects

3.3.1 Accounting rate of return (ARR) method

ARR = Estimated average profits

Estimated average investment × 100% (Röhrich, 2007, p.29)

Table 5: The data for calculating ARR

The accounting rate of return is:

Otherwise, this technology also has some disadvantages like the timing of profit flows is ignored

and it takes no account of time value of money According to Needles, et al (2010, p.1167), this

method is unreliable if estimated annual net incomes differ from year to year

3.3.2 The net present value (NPV) method

3.3.3. The present value formula:

PV: present valueA: annual cash flowR: discount rate

PV =

A r

(R n−1)+r

1

r1: risk raten: number of years R: (1+r)

The net present value formula:

(A.Kennedy, 1990, p.412)This table below shows the result:

Year Present value of

£1 at 15%

Net cash flow Present value of net

cash flow Project 1 Project 2 Project 1 Project 2

Table 6: The PV & NPV

One of the advantages of NPV is to provide the better forecast about the activities of the companies in the future Differ with ARR; this method recognizes the time value of money.

Additionally, by accepting only projects with positive NPVs, the company will also increase itsvalue (A.Groppelli & Nikbakht, 2006, p.160)

Otherwise, a disadvantage of it is based on future cash flow and discount rate which are difficult

to estimate Moreover, NPV usually assume that the discount rate is the same over project’s life;

therefore, any change can make it wrong Another disadvantage is requiring calculation of future

cash flows of the investment proposal The cash flow estimations are used to calculate the NPV

of the investment Any error in these results will make mistake

Actually, based on ARR results, the project 1 should be chosen because its ARR is higher than

project 1 However, through NPV table, the project 2 has higher positive result so it should be

chosen Two results are conflict; it means this company should do more methods to have the

most suitable decision-making

4.1: The discussion of the primary financial statements

Associated British Foods (ABF) has three primary financial statements One of them is balance sheet statement It has this name because there are two parts needed equaling to each other

(Albrecht et al., 2007).

Assets = Liabilities + Owner’s equity

Firstly, through AFB’s balance sheet (Appendix1), the assets can be shown clearly There are two types of assets are current and non-current assets including cash, inventories, biological

assets, receivables, property, plants, equipment, and investments in joint venture and associated

Furthermore, the total liabilities also are presented in the balance sheet Liabilities also have

current and non-current liabilities ABF has some liabilities like loans and overdrafts, payables,

provisions, employee profit liabilities Finally, the balance sheet represents the equity of the

business

In general, the purpose of a balance sheet is reporting the financial position of ABF at a certain

point in time help the investors or debtors have the right decisions about the abilities for solvency

of ABF

The income statement (also known as profit and loss statement) (Appendix2) is one of the three

primary financial statements used to assess a company’s performance and financial position The

income statement summarizes the revenues and expenses for a fiscal period (Ingram and

Albright, 2006)

The basic equation an income statement based on is:

Revenues – Expenses = Net Income

Expenses are used to pay interest on debt, taxes and other incurred costs After the costs of doing

business are paid, the amount left over is called net income Net income is theoretically available

to shareholders, though instead of paying out dividends, the firm’s management often chooses to

retain earnings for future investment in the business It is useful to evaluate management

decision influencing payments to stockholders and stock value

A cash flow statement (Appendix3) explains difference between profit and cash and shows where a business gets and uses its capital Only large companies like ABF are required to make a cash flow statement, though smaller companies it is optional It supports the company to meet

scheduled financial obligations by helping owner plans and control the flow of income It also

helps investors and lenders evaluate a company's financial condition (Heisinger, 2009).

The main items in a typical cash flow statement of ABF are:

- Cash flow from operating activities

- Cash flow from investing activities

- Cash flow from financing activities

- Capital expenditure and financial investments

The cash flow statement should be prepared on a monthly basis during the first year, on a

quarterly basis for the second year, and annually for the third year.

4.2: The comparison of appropriate formats of financial statements for different types of business

There are various formats of financial statements harnessed at the moment The moreappropriately formats the companies choose, the more successful they will get With the diverse

patterns, the firms can elect suitable approaches to functionally and naturally show itsexpenditures, investments, profits…

There are accounting criteria such as GAAP (Generally Accepted Accounting Principles) and

IFRS (International Financial Reporting Standards) that are internationally used and asserted.

Simply speaking, there are three types of business including sole traders, partnerships,

corporations (public limited liability companies, PLC) The different kinds of businesses indivergent sectors practice different formats

Firstly, take a sole proprietor for example, he/she would prepare a plain profit and loss account

contrast to a public limited liability company arranging depend on IFRS or GAAP because the

report is only provided to firm’s owner who is personally liable for all the firm’s obligations

covering all the debts and other liabilities Therefore, it is not too intricate; it might not have the

balance sheet or income statement, cash flow statement That is why hardly it collates with theothers Merely, the bottom of the balance sheet would have one-line form:

Capital £ 500,000

Otherwise, it may express profits earned or losses in certain periods, also at the end of the year asfollows:

Concerning partnerships, it has many professional businesses They contain the large

accounting, legal, and management consulting firms Most enormous investment banks likeMorgan Stanley, Smith Barney, and Citibank began life as partnerships or renowned companies,

Profit for the year end 30 April 2012 £ 5,000Ending capital 30 April 2012 £ 35,000