Management Accounting and Decision Making - Essay Example

?Task Cash Budget   Months Particulars April May June July August September Revenue 27,000 41,850 67,500 111,600 125,550 81,000 Cash Purchases 5,400.0 8,370.0 13,500.0 22,320.0 25,110.0 16,200.0               Cash Sales 8,100 12,555 20,250 33,480 37,665 24,300 Cash from credit sales - - 18,900.0 29,295.0 47,250.0 78,120.0 Cash Purchases (1,080.0) (1,674.0) (2,700.0) (4,464.0) (5,022.0) (3,240.0) Credit Purchases - (4,320.0) (6,696.0) (10,800.0) (17,856.0) (20,088.0) Labor Cost (5,400) (8,370) (13,500) (22,320) (25,110) (16,200) Overhead Cost - (6,750) (10,463) (16,875) (27,900) (31,388)               Net Cash 1,620 (8,559) 5,792 8,316 9,027 31,505 Opening Cash 125,000 126,620 118,061 123,853 132,169 141,196 Closing Cash 126,620 118,061 123,853 132,169 141,196 172,700 Income Statement In ? For the six months ended September 30,20X0       Revenue 454,500 Cost of Purchases (90,900) China glass and cutlery (10,000) Bed linen and towel (10,000) Miscellaneous items including toiletries (5,000) Labor Cost (90,900) Overhead Cost (113,625) Depreciation (133,167) Losses in inventory (2,000) Net loss (92) Balance Sheet In ? As at September 30, 20X0 Property, Plant and Equipment 1,840,000 Less: Depreciation (133,167) Net Book Value 1,706,833 Inventory 9,000 Receivables 144,585 Cash 172,700 Total Assets 2,033,118 Owner's Capital 2,000,000 Profit for the year (92) Creditors 12,960 Overhead cost payable 20,250 Total capital and liabilities 2,033,118 The above statement presents the cash budget, income statement and the statement of financial position for the six months ended September 30. In the forecasting of the cash budget, the effect of inflation has been ignored. During the six months period the inflation is expected to rise and it will impact all the variables of the projections. In addition, it has been assumed, in the cash flow forecast, that the credit sales will be settled at the end of two months. Same assumption has been applied in the cost of purchases which is being assumed to be settled at the end of the next month in which the sales were made. It has also been assumed that purchases, in order to maintain the inventory level to ? 10,000, are included in the total cost of purchase. In the income statement, it has been assumed that China glass and cutlery, bed linen and towel and miscellaneous items including toiletries are revenue expenditure and will be consumed entirely during the current period. The loss in inventory is proportionately divided between the two half of the years and half of the expected loss is taken. The corresponding impact has been taken in the inventory. Task 2 (a) As per the given scenario, the average spending has decreased by 15% which means that the average spending in actual turned out to be 127.5. If we substitute this figure with the current expected occupancy rate, the revenue is likely to decrease. The following table presents the revised income statement Income Statement In ? For the six months ended September 30,20X0 Revenue 386,325 Cost of Purchases (77,265) China glass and cutlery (10,000) Bed linen and towel (10,000) Miscellaneous items including toiletries (5,000) Labor Cost (77,265) Overhead Cost (96,581) Depreciation (133,167) Losses in inventory (1,000) Net loss (23,953) As apparent from the above table, the net loss has further increased which would adversely affect the financial outlook of the company. In order to maintain the previous less of profitability (in this case net loss of 92) the company is required to maintain the same level of sales. This can only be done by increasing the level of occupancy so that the sales remain the same at ?454,500. In order to maintain the same level of sales the monthly occupancy should be increased by 20% monthly. Since the occupancy rate of august is already 90%, it can only by increased to a perfect 100%. Following is the revised occupancy rate if the previous level of sales is desired Monty Occupancy Rate April 24% May 36% June 61% July 97% August 100% September 73% Average 65% Thus the revise sales would be Daily Rate Average Days in a month No. of months Average Occupancy rate No. of rooms Total Revenue 127.5 30.5 6 65.00% 30 454,984 With the revised level of occupancy, the revised revenue is almost equal to the previous level. (b) As provided in the next scenario, the actual occupancy rate of the hotel for the month of August turned out to be 80% as compared to the expected occupancy rate of 90%. This is likely to reduce the revenue and net profit for the company for the six months ended September 30. The change in the occupancy rate is likely to reduce the revenue by ?13,950 and the net profit by ?4,882. The methods available to the company in order to maintain its previous level of revenue and profit are to curtail the operating cost such as labor cost and the overhead cost. In order to maintain the previous level of profit, the hotel should such costs by ?4,882. Task 3 The shareholder has analyzed the feasibility of the investment by using the payback method. In the payback method, the analyst identifies the time taken by the investment venture to return the initial investment outlay. In other words, payback period is another method utilized in investment appraisal which calculates the time taken by the investment to generate enough cash inflows to recover the initial cost of the investment. As mentioned in the given scenario, the business is expected to last for about 10 years which means that the payback period is supposed to be less than 10 years in order for the investment to be financially viable. Thus the shareholder point of view that the investment would not be financially viable if it does not payback the investment within 5 years is not justified. The importance of capital investment decision cannot be ignored in today’s dynamic economy where every company is striving to earn the best return on its investments. Capital investment can be interpreted as an investment venture of considerable larger amount which is on long term basis and is likely to generate revenue for the company over that particular term. In today’s world, a brief analysis will present the fact that companies have separate departments equipped with experts in the fields of financial appraisal and decision making. The sole job of these financial analysts is to identify whether a particular investment is likely to bring inflow or outflow of benefit to the company. Investment appraisal through NPV method and IRR method are both very useful in order to 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 it is comparatively straight forward 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. Whereas, 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 which makes it 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. 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 represent an unattractive investment where as 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. While making an investment appraisal decision, it is imperative to consider the impact of inflation in the future cash flow. The case study does not include any relevant information about the price inflation over the five year period which can significantly impact the expected rate of return. The director 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 flows in the future for the payment of these finance charges. In order to commence any investment venture, the director must take approval of the shareholders. Although certain investment might appear to be rewarding and worthwhile to invest, do not get 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 investment will weaken the financial outlook of the organization in the year of the investment. The director while making the investment decision must keep into consideration whether it is of a capital nature or would be reflected in the profit and loss of the company as an expense. Other factors which the directors need to put into consideration are the source of funding for the capital expenditure. 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 o 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 pre defined 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. Whereas, in the case of loan, the financer usually communicates to the organization about the sanctioning of the loan. 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. Particulars Year 0 1 2 3 4 5 6 7 8 9 10 Net cash Inflow / (outflow) (2,000,000) 250,000 257,500 265,225 273,182 281,377 289,819 298,513 307,468 316,693 326,193 Sale proceed from sale - - - - - - - - - - 3,000,000 Total (2,000,000) 250,000 257,500 265,225 273,182 281,377 289,819 298,513 307,468 316,693 3,326,193 Present Value Factor 1 0.91 0.83 0.75 0.68 0.62 0.56 0.51 0.47 0.42 0.39 Present Value (2,000,000) 227,273 212,810 199,267 186,587 174,713 163,595 153,184 143,436 134,309 1,282,392 Net Present Value 877,566 References Abeysinghe, R. L., 2010. Nature and introduction of investment decision. [Online] Available at [Accessed 10 Mar 2013]. Berkovitch, E., 2010. Why the NPV criterion does not maximize NPV. [Online] Available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=138643> [Accessed 10 Mar 2013]. Financial Modelling Guide, 2010. Capital Budgeting and pros and cons of IRR and NPV. [Online] Available at < http://www.financialmodelingguide.com/valuation-concepts/capital-budgeting-irr-npv/> [Accessed 10 Mar 2013]. Grayson, G., 2010. Internal rate of return: An inside Look. [Online] Available at [Accessed 10 Mar 2013]. Investopedia, 2010a. Net Present Value - NPV. [Online] Available at [Accessed 10 Mar 2013]. Investopedia, 2010b. Which is a better measure for capital budgeting, IRR or NPV. [Online] Available at [Accessed 10 Mar 2013]. Saching, 2010. What influences investment decision. [Online] Available at [Accessed 10 Mar 2013]. Smith, F., 2010. Investment appraisal and capital budgeting: NPV and IRR. [Online] Available at [Accessed 10 Mar 2013]. Read More