Advanced Finance for Business Managers

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Advanced Finance for Business Managers

Name Kingsley Ibe Uche
Task 1 Examining reasons and problems associated with the forecasting future of cash requirements

Explain how the cash budget is created and adjusted
Task 2 Evaluate the impact of expected cash flow on management decision making
Task 3 Analyse the financial consequences of capital investments decisions

Evaluation of the outcomes of your investment appraisal in relation to the company’s expected rate of return

Qualitative factors in a business that could affect a decision about investment
Task 4 Assessing financial performance and stability

Analysis of published accounts – future performances.

An explanation of why businesses need to manage financial information and systems to gain strategic advantage.
Word Count

5136
Date

28th June 2021

 

Advanced Finance for Business Managers

Content

S. No. Description Page No

Understanding How to Assess the future cash Flow Position of a Business 3

examine the reasons for and problems with forecasting future cash requirements 3

explain how the cash budget is created and adjusted 4

 

Understanding the impact of cash flow forecasts on decision making 5

Evaluate the impact of expected cash flow on management decision making. 5

 

Understand how costing techniques contribute to decision making. 6

Explain how suitable costing techniques can be used to assess the financial implications

of short run decisions. 6

 

Understand the financial implications of capital investment decisions 7

Analyse the financial consequences of capital investments decisions 7

Evaluation of the outcomes of your investment appraisal in relation to the company’s

expected rate of return. 9

Evaluation of qualitative factors in a business that could affect a decision about investment 9

 

Be able to assess the financial performance and stability of a business 10

Assessing financial performance and stability 10

Analysis of published accounts – future performances. 12

An explanation of why businesses need to manage financial information and systems to

gain strategic advantage. 13

 

References 17

Understanding How to Assess the future cash Flow Position of a Business

A cash flow statement explains in the cash movement of a business organization. Cash flow statement demonstrate the manner at which cash move in and out of a business organization. Cash flow statement is classified into three main activities, which are operating, financing, and investing.

1.1 Understanding How to Assess the Future of Cash Flow Position of a Business

Forecasting of cash flow is very vital to any enterprise organization. If there is no forecast of money flow, then it receives very challenging for any commercial enterprise to discover out how tons money will be easily accessible at a precise time. The below is detail explanation of importance of forecasting cash flow:

Forecasting of cash requirements is the only way to find out how much money will be available for a particular project, using cash flow forecasting you will be able to know if the organization will be requiring more funding and the timing at which the fund will be needed

Business cycles always have fluctuations, and these fluctuations can affect the cash requirements, hence forecasting them will help avoid any losses and safe the company from having a difficult finance time.

Cash flow forecasting also enable the business in financing and funding of its business projects. In a situation where the business organization is considering borrowing by taking loan from the in that case, is a good idea that the business present the cash flow projection of the company or that project because this will show details of all the necessary particulars which gives you an advantage over others and make you a perfect candidate for the loan. It indicates the capacity of the enterprise to repay the loan, and the reality that you are in manipulate of the business’ price range and are proactive.

It additionally helps in planning the increase of the business, especially in startup business that might want to invest its earnings to grow, so the cash flow statement will assist in inspecting how much of it can be invested and is it prudent to spend or not. (Farshadfar and Monem, 2013, p113)

Difficulties Business Organizations faces in forecasting cash forecasting

As beneficial as cash forecasting is for a business, it does come with a range of issues in the procedure. The issues in forecasting cash requirements are as follows:

In foretelling the exact fund required for a business the creators of the forecast must be aware of every unit of the business, many times it happens that a few subsidiaries or business units might have local accounts that may not relate to the business, so in this case, the accuracy cannot be achieved.

Cash flow projection will solely be correct if the info is given to them accurately and promptly. Sometimes the subsidiaries can also no longer be totally conscious of the gain of sending in the crash statistics to the forecasters. There is need for a good functioning rapport with all key units of the business, this allows the sharing of records promptly. Hence these become another issue in the forecasting of cash requirements.

Another challenge that is involved in this process is the manual process of inputting all the cash payments into the system. The forecast is solely as correct as the statistics entered. So, it should be properly maintained to avoid the error and improve accuracy. (DeFond and Hung, 2003, p74) 6

1.2. Preparation and adjustment of cash budget

The cash budget is organized to recognize the cash necessities in the future so that essential business and cash decisions can be made correctly and accordingly. The cash budgets can be created in three different methods, as stated below:

Projected balance sheet method.

Receipts and payments method.

The cash flow method.

In the above example the business organization decided to prepare the budget using the receipts and payments method. It is the easier and mostly used cash budget method. The method is done in a columnar fashion where the first column has all the particulars, which is all the receipts and payments made and the other columns represent the money indemnified against the same receipts and payments. The amount column will be divided as per to the number of the budget created. It is usually created every three months. In the example given it is created on a 3-months frequency which means four quarters. The cash budget started out with the opening balance of $25200 in the first quarter, all the receipts received by the company has been recorded and added to the available cash balance of the company. In this case the business has only one source of receipts and for the first quarter it was summed up to be $31740, when added to cash balance, which indicates the total available cash as $56940. After this, all payments such as direct materials, labor, factory overheads, selling and administration expenses and equipment purchases of that quarter are subtracted from the total cash available, which gives the ending cash balance of that quarter which is $15400. This ending balance will become the opening cash balance for the next quarter and the process will continue. The ending balance of the last quarter will be the final cash balance of the business in that particular year.

All the necessary adjustments like adding the receipts and subtracting payments such as direct material, direct labor, factory overhead, selling and administration expenses, and the purchase of equipment were done. Since the receipts and payment method is cash based it doesn’t adjust outstanding amounts on receipts or payments. (DeFranco and Schmidgall, 2017, p117)

For example in the given example below, the cash budget is prepared with receipts and payment method and it is created for half yearly.

Particulars

First half

Second half

Total

Cash at the beginning

$50000

$16500

$66500

Add: receipts

Sales

$20000

$40000

$60000

Total cash available A

$70000

$56500

$126500

Less: payments

Rent

$5000

$5000

$10000

Administration expenses

$20000

$20000

$40000

Advertising expenses

$5000

–

$5000

Purchase of tools

$3000

–

$3000

Purchase of machinery

$20000

–

$20000

Telephone expenses

$500

$700

$1200

Total payments B

$53500

$25700

$79200

Budgeted end cash balance (A-B)

$16500

$30800

$47300

In the above cash budget all the adjustments needed according to the receipts and payment method is done. Adjustments such as expenses like rent, administrative expenses, advertising expenses, tools and machinery purchase and telephone expenses are subtracted and the revenue from sales is added to the cash available. This adjustment is done in the first half of the year. Whereas the second half of the year doesn’t have same adjustments since there has been no advertising expense or purchase of tools and machinery. The only adjustments done in the second half are adding the sales revenue and subtracting expenses like rent, administrative expenses, and telephone expenses.

2.1. Cash flow impact on management decision

As explained above the cash flow has a huge role and help in the decisions taken by the management. The following are the impact that the cash flow projections have on management decision:

The cash flows typically show the amount available to the company after all the expenses, so this will help the management take investment decisions accordingly. Also, it helps them find out any inefficiency in the organization and act accordingly.

The cash flow helps in helping the investors see if the company has enough money to pay back them in the form of dividends after all the expenses are paid off.

It helps the management to know if they need to purchase an asset or anything with cash or will they need to ask for credit.

It also helps the management in predicting if the company is in the position to pay of the debts or does it require refinancing for the same. (Bergmann, Kamarás, Gleißner and Guenther, 2020, p10-14)

Section -2

3. Understand how costing techniques contribute to decision making

Cost techniques

Cost techniques are used to calculate the cost of a product or service provided by an organization to achieve maximum profit keeping in mind all the expenses that went into producing the same.

3.1. How suitable costing techniques can be used to assess the financial implications of short run decisions.

Product mix

Product mix consults to the diverse range of products or services offered by an organization. It is also called the product portfolio. The range and number of each product that needs to be produced are very important for a company’s profit maximization. Here the company needs to decide on how much of the three dinosaur toys need to be made to make a maximum profit at the same time using the resources efficiently. These four things that need to be kept in mind while collecting information to calculate the product mix and are as follows-

Width –this refers to the product line, it is several different types of products manufactured or services provided by the company. In the example given the company offers dinosaur toys and hence there product mix width is one.

Length – this refers to the types of products offered, or services provided in a particular product line by a company. In the company given, it offers one product and nothing under it hence the product mix length is one here.

Depth – refers to the difference in flavor, size, color, etc for each product. Now in the firm, they have three diverse dinosaur toys so the product mix depth will be three here.

Consistency – It shows the relationship between the products and how close and similar are they. The case study here explains that the company are marketing three different dinosaur toys for sell and all the same use, therefore the product mix is consistent.

This company has limited width, length, and depth and has high consistency in its products. These are things to keep in intellect while summing up(calculating) an optimum product mix. So, to be able to effectively calculate the optimum product mix all the labor hours required manufacturing and contribution margin per hour are calculated. As per the demand of the product type which has more contribution per hour, the product will be manufactured as much as possible, afterwards then the rest will be manufactured. Adding up the total hours available, use the time to manufacture the toy with higher contribution, and once all of them have been manufactured they move on to the next and so on. (Zhuang and Chang, 2015, p963)

Make or buy decision

This refers to the decision a company makes either to manufacture the products by its self(in-house) or purchasing already made and selling them to the customers as per demands. In this case the company has found that a component manufactured by them is available in China and are considering buying from them or manufacture it themselves. In such case the company needs to consider some factors like in-house space and expertise, production cost, better quality control, etc. In other to take the right decision, the company needs to find the cost of production of the component. For that, the company needs to collect the relevant costs such as direct labor, direct material, overhead expenses, annual tolling, equipment cost, rent paid, fuel, lighting, electricity, and other expenses related to the production. Upon having gathered all the cost involve, all of this will then be added to find the total cost of production for one component. The company finds out that the rate for single component from another country (China) is more, then the decision will be to manufacture the product themselves and if the rate of the production in abroad by a Chinese company is less then they will but form the company instead of manufacturing. ( As put together by Fernandes, Silva, and Andrade,).

Section – 3

4. Capital investment decision

4.1. Analyses of the financial consequences of capital investments decisions

Payback period, NPV and IRR

The payback length refers to the cash given back to the enterprise from an asset after investing in it in this case, the company has decided to invest $60000 while expected to get returns of $40000 yearly and having budget expenses set at $17000 yearly, based on this the net cash flow will be $40000 – $17000 = $23000. Since the net cash flow is constant throughout the payback period can be calculated as $40000/$23000 = 1.7, that is 1.7 years. (Imteaz and Ahsan, 2018,p125)

The IRR of the asset can be calculated as follows

The IRR of the project is calculated to be 23%

NPV

Total current value of the asset is calculated as per the below table.

The NPV has been calculated to be $13,869.02

Financial consequences of capital investment decisions

Capital investment decisions are important decisions to be made by a company while making any decision on capital investment. Capital investments are usually investments that have long term effects on the company and a wrong decision can lead to huge losses for the company. Hence the company needs to be extremely careful in analyzing the consequences when it comes to making a capital investment decision. In the given example above is a company which wants to invest in new equipment and the analysis for the investment has been taken using payback method, NPV and the IRR method, the following can be assessed.

Here the payback period is been calculated to be 1.7 years which is relatively small and the company earn back the money quickly invested. This is a positive sign for the company.

The NPV is calculated to be $ 13869.02, which is a positive value, this means that the equipment has more revenue than cost incurred by it. This way the investor makes a profit and is advisable to make the investment as it is a positive outcome.

The IRR is calculated to be 23% and the expected return is calculated at 12%, which is less than the IRR. The IRR usually measures the profitability of a project and here the profitability is more than the expected rate. This was the company is sure of the profitability of the company hence it is a positive sign.

Thorough analysis has been made for the project through these methods and in every method the investments seem to be giving good financial results.

The money spent will be paid back within 1.7 years along with being more profitable than the expected rate and the investments revenue outrun the cost. Hence this project has good financial consequences to the company.

As mentioned above the purchase of new equipment only possess as a strength to the company and hence the company can invest in the new equipment for a new line in soft toys that have interactive chips.

4.2. The IRR in the project is at 23% whereas the expected rate is 12%, this means that the project is viable, and the company can continue to invest. IRR is calculated with NPV at zero because IRR is at its peak whilst the NPV is zero.The NPV has a net positive value and an asset with a net positive value is acceptable. (Arjunan, 2017,p3)

In both the measurements, NOV and IRR, the investment has been justifiable and hence the company can buy the asset.

4.3. Qualitative factors affecting business decisions.

Investment decisions are one of the most crucial decisions made by a company, and a lot of factors are involved in this decision making and a lot of factors need to be kept in mind for the same. Qualitative factors are those factors that cannot be expressed in the form of numbers, which is they cannot be quantified. In this case,SFT ltd has considered the quantitative aspect of the factors, which is the NPV, IRR, and discount payback, and the company also needs to consider certain qualitative factors such as the following before making an investment decision-

Social trends – this refers to how people would respond to the new investment made. Even though the asset shows a good return to the company, the product manufactured or offered through that asset should be something the customers should be interested in. for example the people might prefer sustainable products and maybe this asset might satisfy that, in that case however productive the asset is there might not be many consumers available.

Political factors – sometimes they might be political influence such as a new rule or tax payments, on the business and with uncertainty in the political environment and the fact that new government brings policy changes, so this should be considered always as a factor to have in mind.

Corporate culture – it is also important to see how the company and its employees will react to new investments and how they can learn to operate. The new investment can be difficult to operate, and the proper training must also be given to the employees. (Happ, Schnitzer and Peters, 2021, p22)

Both quantitative and qualitative factors are important for a business in making investment decisions, because if one satisfies and the other does not then the investment is of no use and hence the SFT ltd needs to keep both quantitative and qualitative factors in mind before taking any decision. Both the factors give recommendations to businesses in different ways. Like for example from the quantitative aspect if the IRR of an asset is below WACC then the investment is not the right investment and will not give the right return as expected. In the qualitative aspect if most of the customers only favor sustainable projects or products and if the said investment does not satisfy it then the investment is of no use and would not give the required return.

Based on measurable aspect, the capital invested will give valuable profit and the business organization can go for the investment and since there is not much information regarding the measurable aspect of the business so not much can be commented on the performance of the asset in this front.

Section -4

5.Be able to assess the financial performance and stability of a business

5.1. Assessing financial performance and stability – Mattel Inc.

In this case study the Business organization SFT ltd has set a plan to add another toy manufacturer to their business and has chosen Mattel Inc. In other to be successful with this decision a financial analysis needs to be carried out to allow the company to make the rightful decision. For the same, the following are discussed.

Financial performance and stability of the company

Financially the company performance has been impressive and the company in a good standing financially, the company exceeds expectations and have made profits more beyond the set target. The company has two-year program in which were expected to receive a profit of $650 million but ended up with a profit of $875 million which is above the original set target by $225 million. While looking at the consolidated report, all the funds spent on expenses by the company documented which also shows that the company have avoid unnecessary spend which keep the expenses on the low level. The gross profit of the company has increased from 39.8% to 44%. The additional gains made in gross profit are due to incremental structural simplification savings. The same gave the decrease in other selling expenditures. The selling expenditure decreased from 33.4% to 30.9% of the net sales. (Source : figure 1)

Profit and loss statement

While analyzing the profit and loss statement the revenue growth from previous years has been comparatively the same and has not seen much change in that area. The total profit margin has positively increased by $200 million from the last year. But the last year and the present year have seen losses, on the bright side the company has managed to reduce the loss in the current year to $213 million from $533 million. Since the total income rate is higher than the last year, this is a sign that the company has growth potential which makes it a prefer candidate for investment purposes. Generally, the financial performance of the income statement has been better than formal and there is room for growth and hence this business makes for a big investment. (Source : figure 2)

Balance sheet

From the balance sheet of the company, it has arranged the company’s assets from the most liquid to the least liquid assets and the liabilities starting from short term to long term. Getting the efficiency of financial performance from the balance sheet, some ratios should be calculated. The ratios are calculated as follows-

Debt equity ratio – this ratio shows the shareholders’ funds used to finance the company and it is calculated as debt/ equity = 4833512/491714 =9.8.

Current ratio – it measures the company’s ability to pay their dues as and when they arise, and it is calculated as current assets/current liabilities = 2247974/1276907 =1.76

Quick ratio – this shows the company’s ability to pay its liabilities without selling its inventories and is calculated as follows – (current assets –inventories)/current liabilities = (2247974-495504)/ 1276907 = 1.37

From the balance perusal, the company is in good financial health and maintains positive efficiency as the debt-equity ratio is 9.8 this is seen as very good. Based on the current ratio which shows company’s ability to meet its payment obligation is at 1.76 this shows the equity power of the company. The fast ratio of the company is 1.37 that is a good sign that the business organization can pay off its liabilities easily. Even though the company has had a loss in the years, the financial strength of the company seems good with the ratios calculated, and the losses are being reduced in the past and current years which show positive nature of the company. It is a good sign. (Source : figure 3)

Cash flow

The income (cash) flow shows the inflow and outflow of the company’s cash. The income statement which is known as cash flow statement can be analyzed with several ratios which are shown as follow-

Operating income – this calculates the cash earned for each dollar of sales and is calculated as operating income / nets sales = (180977/4504571) * 100 = 4%

Free cash flow – this ratio calculates the efficiency of the corporate to get cash and that i am calculated as operating cash flow – cost = 180977-48335 = 132642.

Calculating ratios, it is seen that the operating cash flow is 4%, even though there is not any fixed percentage to define the best ratio, the higher the percentage the better it is, since the percentage is very low it is not a positive sign for the company. The free income shows a positive number and hence it is a positive sign. Overall, when a corporation features a positive income then it is in good financial health. This company features a positive income and therefore runs its operations without much need for borrowing; the company can expand business and gets through bad times. (Source: figure 4)

The financial performance of the corporate has been good for the corporate within the past two years. After five years of revenue decline, the company regained the position in just two years and that shows the stability and ability of the company to pull back from losses quickly. The company made strategic changes in the areas of brand transformation on a few of their product line to come back from revenue losses. The various ratios calculated suggest the same and have a positive effect on the company’s financial strength. Even though the company has occurred losses in the past and now, the company has worked towards reducing the loss and will soon start making profits.The company’s financial position has been stable and good and hence SFT ltd can investigate this company as an investment.

5.2. Analysis of published accounts – future performances.

The analysis of the published financial statements of a company can help in the projection of its future performances. This is because the financial statement helps in analyzing the company’s trend on how they conduct the business, this helps in the projection of future performances. A few of the reasons why analyzing the financial statement is important for projected performance are as follows –

This analysis also helps in seeing the growing trend of the business, if there is any inconsistency or any. It helps in analyzing the steadiness of the firm.

The growth rate is calculated and gets easier to use that trend to find out future growth.

The cash flow analysis will help in knowing the amount of cash the business has or the future pay back its obligations without much financing or borrowing for the future.

The rates of return are calculated, and this helps the investors in calculating the future rates and helps them in investing decisions. (Cassar, 2009,p33-35)

5.3. Why businesses need to manage the financial system in order.

Businesses need to manage the financial systems and information to gain a strategic advantage over others. The financial information has all the details as to how the business is run and how, and what is being done to change any inefficiency and what type of financing they are using, etc. the following are some of the reasons why maintain financial information gives a strategic advantage –

It helps in knowing your financial obligation and helps in meeting them from time to time without any delay.

It is easier to know where a company stands at a particular time, or if any action is required to change that position.

It calculates the quantity of inventory you’ve got in order that there’s no shortage of products or overproduction that results in idle inventory which successively could cost the corporate tons .

It helps keep track of all the people to whom the business owes and at an equivalent time all the folks that owe to the business.

It also helps in knowing that the corporate is following all the statutory laws and are complying with them without fail.

It calculates the business income and helps in fixing prices for its products or services offered.

It also helps in complying with the tax regulations of the corporate and avoids over-tax or under-tax payments.

It makes it easier to distribute profits and dividends to shareholders.

Marinating records helps in getting loans to finance the business and at the same bringing investors on board who otherwise would not invest without studying the financial reports. (Collins, Kansiime, Mugambe and Asiimwe, 2021, p2)

Appendix

Figure 1

Figure 2

Figure 3

Figure 4

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