Understanding management accounting and financial management - Assignment Example

?  January February March April May June July August September October November December                           Revenue 5,000,000 7,500,000 7,500,000 10,000,000 20,000,000 20,000,000 20,000,000 20,000,000 15,000,000 10,000,000 10,000,000 5,000,000 Production labor 1,000,000 1,500,000 1,500,000 2,000,000 4,000,000 4,000,000 4,000,000 4,000,000 3,000,000 2,000,000 2,000,000 1,000,000                                                     Cash collection: In the same month 500,000 750,000 750,000 1,000,000 2,000,000 2,000,000 2,000,000 2,000,000 1,500,000 1,000,000 1,000,000 500,000 In the next month - 3,000,000 4,500,000 4,500,000 6,000,000 12,000,000 12,000,000 12,000,000 12,000,000 9,000,000 6,000,000 6,000,000 In the second month - - 1,500,000 2,250,000 2,250,000 3,000,000 6,000,000 6,000,000 6,000,000 6,000,000 4,500,000 3,000,000                           Total cash from sales 500,000 3,750,000 6,750,000 7,750,000 10,250,000 17,000,000 20,000,000 20,000,000 19,500,000 16,000,000 11,500,000 9,500,000                           Paid to supplier - (1,500,000) (2,250,000) (2,250,000) (3,000,000) (6,000,000) (6,000,000) (6,000,000) (6,000,000) (4,500,000) (3,000,000) (3,000,000) Production labour - in the same month (700,000) (1,050,000) (1,050,000) (1,400,000) (2,800,000) (2,800,000) (2,800,000) (2,800,000) (2,100,000) (1,400,000) (1,400,000) (700,000) Production labour - in the next month - (300,000) (450,000) (450,000) (600,000) (1,200,000) (1,200,000) (1,200,000) (1,200,000) (900,000) (600,000) (600,000) Other variable production OH (500,000) (750,000) (750,000) (1,000,000) (2,000,000) (2,000,000) (2,000,000) (2,000,000) (1,500,000) (1,000,000) (1,000,000) (500,000) Fixed Cost (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) Rent paid (600,000) - - (600,000) - - (600,000) - - (600,000) - - Total cash paid (1,850,000) (3,650,000) (4,550,000) (5,750,000) (8,450,000) (12,050,000) (12,650,000) (12,050,000) (10,850,000) (8,450,000) (6,050,000) (4,850,000)                           Opening cash flow 0 (1,350,000) (1,250,000) 950,000 2,950,000 4,750,000 9,700,000 17,050,000 25,000,000 33,650,000 41,200,000 46,650,000 Net cash flow (1,350,000) 100,000 2,200,000 2,000,000 1,800,000 4,950,000 7,350,000 7,950,000 8,650,000 7,550,000 5,450,000 4,650,000 Closing cash flow (1,350,000) (1,250,000) 950,000 2,950,000 4,750,000 9,700,000 17,050,000 25,000,000 33,650,000 41,200,000 46,650,000 51,300,000 The cash budget presents the activity of the company over the first 12 months of its operations and assesses how much cash it can generate while working in the due course of business. As it is apparent from the above computation that in the first month the company has negative cash flow as it is the policy of the company to sale goods on credit and majority of the creditor settles claims after the month of the sales. After the first few months, the cash flow of the company has changed from negative to positive and thus it continues to grow for the next months till December. In order to further increase it cash flows, the company should curtail its variable cost of production and should ensure that creditors are approached in order to award the company with discounts. Another method for ensuring that the company has healthy cash flow is that the company should ask the creditors for increasing the settlement period. By doing so, the company would have ample amount of cash available and thus it can invest it in the working capital. Good working capital is essential for better functionality of the business and the company can assess the working capital requirement by looking at its cash budget. For example, since the cash flow is negative in the first two months, the company needs to manage its working capital prudently in these two months so that they can finance the rest of the operations of the year easily. A budget is a financial and a quantitative statement prepared prior to a defined period of time of the policy to be pursued for the purpose of attaining a given objective. Furthermore a budget is an attempt made at the beginning of each financial year to plan the profit and loss account for the year and to aim for a definite balance sheet. This profit planning must be a well thought- out operational plan with its financial implication expressed as both long and short range profit plans. In any organization where budget is used as a means of profit planning many alternative plans have to be considered and the most profitable one will be adopted, because where the plan chosen in great expectations, then the best use has been made of the available resources. On the other hand budgetary control is the establishment of policies and the periodic review or comparison of the actual result with the budgeted performances either to secure approval for individual action or to serve as a remedial course of action. Budgetary control whereby actual state of affairs can be compared with that planned for by the management, so that appropriate action may be taken to correct adverse situation that may occur before it is too late. It is also used to fix responsibility. A budget systems serve the needs of management in respect of the Judgments and decisions it is fruited to make and to provide a basis for the management functions of planning and control. Developing a budget is a critical step in planning any economic activity. This includes business, governmental agencies and individuals. Therefore businesses of all types and governmental units at every level must make financial plans to carry out routine operations, to plan for major expenditures and to help in making financial decisions. On this back ground, every organization no matter nature has a plan for the future, simply because the success of any organization depends on the level of plan that is put into the organization. The main problem with budgeting is that it reflects data from the past and present, and will only enable predictions and forecasts to be made out the future. At the same time, numerous pressures in the job may impose constraints upon managers, which affect the quality of information they collect. The problem can be numerous; clearly, nothing can be forecasted with absolute certainty. No matter what financial and marking researches take place every organization has to take risks. A cash budget involves detailed estimate of anticipated cash receipts and payments for the fourth coming year or period. This is because while it may be possible for an organization to exist and continue to survive without profit, the existence of an organization is doubtful without liquidity. This organization will therefore assist the adverse effect of cash squeeze(lack of cash) by arranging for an overdraft facility or to maximize the benefit associated with surplus fund through short-term investment. The preparation of sales budget is one of the most important aspect in budgetary control system. The sales forecast in this respect must be sound and accurate. In most of the businesses, the sales forecast is based on the past sales, market and sales analysis. The preparation of sales budget is approached in two different ways, 1. Judging and evaluating external influence- 2. Considering internal influence. The two influences have to be considered when forecasting sales. The external influences are made up of general trend of Industrial activity, government policies, cyclical phase of the nation economy, purchasing power of the population, population shift and changes in the buying habits. In the case of internal influences, sales trends, factory capacity, new products, plant expansion, seasonal products, sales force estimates, and the establishment of sales quotas for salesmen and sales territories must be given adequate consideration with the company’s profit desired. The top management must communicate the policy effects of the long term plan to those responsible for preparing the current years budgets. Policy effects might include planned changes in sales mix or the expansion or contraction of certain activities. In addition, other important guidelines that are to govern the preparation of the budgets should be specified. E.g. the allowances that are to be made for price and wage increase, and the expected changes in productivity. Also any expected changes in industry demand and output should be communicated by top management to the managers responsible for budget preparation. It is essential that all managers be made aware of the policy of top management for implementing the long term plan in the current year’s budget so that common guide liens can be established. Site A                                                                   Particulars Years   0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Net Cash - 2,000 3,000 4,000 4,400 4,900 5,400 5,500 5,525 5,545 5,550 5,575 5,590 6,000 6,000 6,000 Total investment (23,100) - - - - - - - - - - - - - - -                                   Net cash flow (23,100) 2,000 3,000 4,000 4,400 4,900 5,400 5,500 5,525 5,545 5,550 5,575 5,590 6,000 6,000 6,000 Present Value Factor 1.000 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 Present Value (23,100) 1,754 2,308 2,700 2,605 2,545 2,460 2,198 1,937 1,705 1,497 1,319 1,160 1,092 958 841                                   Net present value 3,981                               IRR 16.80%                               Payback period 5 years and 10 months approx                               ARR 16.16%                               Site B                                                                   Particulars Years   0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Net Cash - 2,100 3,150 4,200 4,620 5,145 5,670 5,775 5,801 5,822 5,828 5,854 5,870 6,300 6,300 6,300 Total investment (25,800) - - - - - - - - - - - - - - -                                   Net cash flow (25,800) 2,100 3,150 4,200 4,620 5,145 5,670 5,775 5,801 5,822 5,828 5,854 5,870 6,300 6,300 6,300 Present Value Factor 1.000 0.877 0.769 0.675 0.592 0.519 0.456 0.400 0.351 0.308 0.270 0.237 0.208 0.182 0.160 0.140 Present Value (25,800) 1,842 2,424 2,835 2,735 2,672 2,583 2,308 2,034 1,790 1,572 1,385 1,218 1,147 1,006 883                                   Net present value 2,635                               IRR 15.69%                               Payback period 6 years and 1 months approx                               ARR 14.47%                               The above investment appraisal tells us the fact that the company should go with the site A as it has higher NPV and higher IRR. Also the payback period of Site A is less and it has higher ARR also. Thus, it would be financially viable for the company to choose the Site A for expanding their operations. Investment appraisal through NPV method and IRR method are both very helpful in order to create financially attractive prospective of any investment decision. A good financial analysis is based on the tradeoff between these two methods. However, practically, the IRR method is used widely in investment appraisal decision. The prime reason behind selecting the IRR method of appraisal is that it is comparatively straightforward and can be used without having a prior experience in capital budgeting. NPV method has certain drawbacks and limitations. Different projects must be assessed at different discount rates because the risk for each project is generally different. The reliability of the NPV based investment appraisal can be as reliable as the discount rate itself. However, in practice, it is very unrealistic to determine different discount rate for different investment proposals. On the other hand, IRR uses a single discount rate to evaluate every investment, due to which it is used extensively among the financial analysts. With certain disadvantages, the NPV method comes with several attributes due to which it is considered superior to the IRR method. IRR method of appraisal is for evaluating the financial result of an investment over a short period of time. Moreover, IRR is also ineffective for investments proposals which are a mixture of positive and negative cash flow. For these types of investments, the IRR can be more than one. Another factor which makes the NPV method more reliable than the IRR method is the fact that the discount rate changes several time over the period. The IRR method does not incorporate this fact into calculation and, thus, is not suitable for long term investment appraisal. [Stulz, R. 1999] In NPV method, the discount rate is known and is singular which makes it easier to evaluate the feasibility of the investment. An investment with a negative value represents an unattractive investment whereas a positive value represents otherwise. In IRR method, the rate must be compared to a specified risk rate in order to declare the investment proposal effective or ineffective. In the absence of the predetermined risk rate, the IRR method is of no use. Based on the discussed fact, NPV method of appraising investment is more practical and precise. The initial capital expenditure must be carefully projected. In order to do so, it is of prime importance that the company obtains quotations from several companies in order to project the current market value of the machines. An artificially higher price will put a declining effect on the net present value of the project, and an artificially lower price will cause the opposite. Another risk that is present in the financial appraisal of the project is that the company might not have estimated the correct useful life of the equipment. The aircraft related hardware and equipment are subject to becoming obsolete at a greater pace as compared to the other kinds, so this risk is present. While making an investment appraisal decision, it is imperative to consider the impact of inflation in the future cash flow. The information provided does not include any relevant information about the price inflation over the three year period, which can significantly impact the expected NPV. The director of the company must also consider the sources from which the financing will be obtained for the investment. Financing decision is significant, as the company would have to pay finance charge to the bank or any other financial institution, and the company must have enough cash flow in the future for the payment of these finance charge. In order to commence any investment venture, the director must receive the approval of the shareholders. Although certain investments might appear to be rewarding and worthwhile to do, they do not receive shareholders’ attention that easily. Shareholders, who are often short-sighted and tend to ignore the long-term feasibility, disapprove the decision of the board based on the fact that the cost of the investment will weaken the financial outlook of the organization in the year of the investment. The directors, while making the investment decision, must consider whether it is of a capital nature or will be reflected in the profit and loss of the company as an expense. In order to finance any project, a company needs to raise capital in the form of revenue funds, short term finance, long term finance, running finance etc. Raising capital can be a significant and crucial task for any company as several technicalities and procedures are involved. It is generally observed in an economic scenario that the company with a good credit history and uplifted financial outlook is likely to raise funds easily as compared to the otherwise. Raising capital significantly affect the gearing of a company. Both modes of financing i.e. equity and debt, comes with their advantages and disadvantages. Several factors, such as statutory rules and requirements, terms and conditions imposed by the counter party and general economic conditions are analyzed before selecting one of the options. The downside of acquiring financing through issuance of equity is that the procedure is quite complicated as compared to acquiring funds by approaching any bank. In most cases, a loan is acquired from any bank or financial institution by filing an application for the sanctioning of the loan. The bank or any other financial institution, after evaluating the necessary details such as credit history, financial outlook for assessing the ability of the entity to repay the loans in future, and the purpose of the project for which the loan application was filed, sanctions the loan. Whereas in the case of raising finances through issuance of equity shares, the company has to fulfill several requirements such as issuing a predefined number of shares, issuing shares to the existing shareholder in proportion to their existing shares and appointing a financial advisor for conducting a due diligence of the entity’s operations. Although these statutory rules and requirements are enforced by the relevant authorities in order to safeguard the interest of the organization and general public, complying with them can be quite troublesome when the requirement of the fund is urgent. There is another drawback of raising finances through issuance of equity. There is always an uncertainty that the shares will not be completely subscribed by the public, whenever they are floated in the market, and thus the company would not be able to raise the required funds. In contrast, in equity financing, the company has to wait for a considerable longer period of time for the funds to become available for their utilization. References [1] Grayson, L. 2010. Internal Rate Of Return: An Inside Look. [online] Available at: http://www.investopedia.com/articles/07/internal_rate_return.asp [Accessed: 2 Dec 2013]. [2] Investopedia. 2009. Net Present Value (NPV) Definition | Investopedia. [online] Available at: http://www.investopedia.com/terms/n/npv.asp [Accessed: 2 Dec 2013]. [3] Peavler, R. 2013. Debt and Equity Financing - Advantages and Disadvantages. [online] Available at: http://bizfinance.about.com/od/generalinformatio1/a/debtequityfin.htm [Accessed: 2 Dec 2013]. [5] Investopedia.com (2013) Modigliani-Miller Theorem (M&M) Definition | Investopedia. [online] Available at: http://www.investopedia.com/terms/m/modigliani-millertheorem.asp [Accessed: 17 Apr 2013]. [6] Investopedia.com (2012) Understanding Financial Liquidity. [online] Available at: http://www.investopedia.com/articles/basics/07/liquidity.asp [Accessed: 17 Apr 2013]. [7] Investopedia.com (2013) Effects of Debt on the Capital Structure – CFA Level 1 | Investopedia. [online] Available at: http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/debt-effects-capital-structure.asp [Accessed: 17 Apr 2013]. [8] Michael T. Jacobs and Anil Shivdasani. Do You Know Your Cost of Capital?. [online] Available at: http://hbr.org/2012/07/do-you-know-your-cost-of-capital/ar/1 [Accessed: 1 Dec 2013]. [9] Stulz, R. 1999. What's wrong with modern capital budgeting?. Financial Practice and Education, 9 pp. 7--11. Read More