Concept of Profit and Cashflow and difference between profit and cashflow

This assignment explains the concept of profit and cashflow, and the difference between the two. It also discusses the concepts of working capital, receivables, inventory, and payables, and the effect of changes in working capital on the cash flow statement.

B10408
BUSINESS
FINANCE

EXECUTIVE SUMMARY
This assignment completed in two parts; first consists of concept of income
statement, financial position indicators, cash flow indicators and various KPI’s.
The report will explain how net profit affected, what are the causes of over
expenditure and measures to control it. The case of Mediterranean Delights Ltd
(‘MDL’) will highlight the main issues related with recording transactions and the
reflective case study of this company will reveal core idea of accounting theories.
The selected company is operated in South of England and have business
objective of expansion over all geographical locations of London.

Table of Contents
PART 1............................................................................................................................................4
1. Explaination:............................................................................................................................4
A. Concept of Profit and Cashflow and difference between profit and cashflow:....................4
B. Concepts of working capital, receivables, inventory and payables:.....................................5
C. Effect of changes in working capital on cash flow statement:.............................................6
2. Affect of Mediterranean Delights Ltd (‘MDL”) management on its financial results.............7
3. Recommendation of steps to improve MDL cash flow through better working capital..........9
PART 2..........................................................................................................................................11
1. Concept of budgeting and its purpose of preparation:...........................................................11
2. Application of traditional and alternative budgeting approach for planning cost of Second
sight plc..........................................................................................................................................13
3. Analysis of best approach.......................................................................................................14
REFERENCES..............................................................................................................................15

PART 1
1. Explaination:
A. Concept of Profit and Cashflow and difference between profit
and cashflow:
Profit: It shows the performance of company recording during a year. It is
used as key performance indicators by firms to analyze whether company
performs well or not as compared to previous year. It is calculated through
deducting all variable and non-variable expenses from net revenues. It is
primary objective for every business to maximize net profit every year for
expanding its business (Bendell and Doyle, 2017).
Cash flow: It is net inflow of cash into organization; it only records cash
transactions which makes it highly liquid statement. Generally it tracks the
movement of cash within organization; managerial accounted get an idea of
key areas where heavy amount of cash is eliminated. After evaluation; finance
accountant able to calculate whether company is capable for controlling its
costs or not. It records transactions in the form of three different activities viz.
operating, financing and investing. These different activities are discussed
below:
Operating activities: These activities includes cash from operations; net profit
is adjustable to non-cash items and changes in working capital to know how
much cash is used or generated from operating activities.
Financing activities: These are all transactions related with issuing share
capital, payment of dividends and any other right issues within its existing
customers.
Investing activities: It includes all potential opportunity taken by business
owners through investing in another business to receive dividend or profit
after selling investments.

Difference between Profit and Cash flow:
Profit Cash flow
It is calculated by preparing Income
statement consists of trading and
profit and loss account at end of
accounting year.
It has separate calculation method
which is through preparing cash flow
statement for ending year.
It records transactions on accrual
base accounting standards; means
recorded when buy, sale or payment
occurs.
It follows real time accounting
standard; which means it only
consider any transactions when
actually paid to business.
It is performance indicator and part
of organizations primary objective.
It is not key indicator of performance
but help financial manger in
controlling extra unwanted expenses.
It is used by external as well as
internal stakeholders such as
mangers, investors, shareholders,
banks and other statuary bodies.
It is not preferred by external users; it
only evaluated by company owner’s
to get real status of movement of fund
within organization. It also supports
in finding out irrelevant or misuse of
fund by different departments.
It is main source for cash flows in a
long run of business.
It just maintains the profit earned by
organization through allocating this
surplus on right place.
It tells profitability of business. It shows liquidity of business
organizations.
B. Concepts of working capital, receivables, inventory and
payables:
Working Capital: It is required fund for running day to day operations of
business. Essentially required by every small and large organizations to
successfully run and survive in long run (Maxwell, 2017). It act like fuel for
any vehicle; for instance a vehicle will not move; if it don’t have fuel;
likewise business also requires working capital to move and run. Calculation
formula:
Working Capital = Current Assets – Current Liabilities
Most of the cases; company has more average collection period compared to
average payable period. For instance; customers take 15 days to return
amount for its purchases; while it has pay its creditors within 10 days. This

shows that company requires advance 5 days payment as working capital to
pay its creditors on time.
Receivables: These are treated as current assets for the company because
receivables are the total amount which has to be received from debtors. It is
preferable for every business if average collection period cycle is shorter
because shorter cycle will help company in preventing situations or
circumstances like shortage of fund, risk of bad debts and paying interest on
blocked money by debtors.
Payables: These are the gatherings or providers from whom business has
bought crude materials to encourage creations or to deal it to other. Payables
otherwise called sundry loan bosses, organization are obligated to pay sundry
lenders for their buys. The period wherein organization pays loan bosses or
payables is known as normal records payable period. Organizations attempt to
take shorter period to take care of its lenders to assembled solid altruism in
the market, with the goal that it can purchase using a loan from the market no
problem at all (Haeger, 2017).
Inventory: The significant essential mainstay of assembling organizations is
its inventories. Without stock no business can do exchanging and gain
benefits. It is likewise known by supply of the organization (unique in
relation to share stock). For appropriate stock administration organization
embraces the EOQ (Economic request amount) idea to oversee requests of the
purchaser. Nowadays JIT (Just in time) idea is gotten fundamental goal of
each organization to decrease distribution center expenses (Bouma, Jeucken
and Klinkers, 2017).
C. Effect of changes in working capital on cash flow statement:
There are inverse and positive relations associated with different components
of working capital and cash flows. For instance, increase in current assets
shows inverse relation between both working capital and cash flow, as cash
flow will increase with decrease in current assets and vice-a-versa (Michalski,
2014).

On the other hand increasing in current liabilities shows positive
relation between both; because increasing in current liabilities will
automatically increase over all cash moving towards inside the business.
Some of the affect of changes on cash flow are discussed below:
Increase in current assets and decrease in current liabilities: Increment in
indebted individuals must be decline from money from tasks since increment
in account holder's methods purchasers had not paid the measure of deals
income and this unmerited sum ought to be deducted to get genuine money
earned from activities. Increase in current assets and decrease in current
liability both affects negative cash flows.
Decrease in current assets and increase in current liabilities: It will result in
positive cashflows moving towards organization. As decrease in current
assets means selling of inventories or payment from traders and debtors;
while increase in current liabilities column increase cash due to increase in
short term borrowings and goods purchased on credit from suppliers.
2. Affect of Mediterranean Delights Ltd (‘MDL”) management
on its financial results
MDL deals in both buying and selling of goods and services; management
made strategy to minimize procurement rate and increase sale price to get
more amount of earning. Mediterranean Delight Ltd. management team also
tries to do same but its affect on its financial results varies:
Affect on Income statement: MDL’s financial manager fails in managing cost
of sales of operations; result to which company spend approx 90% on
procurement and production process; which means it only able convert 3.5%
of overall sales into cash item (Sagner, 2010).
Affect on cash flow statement:

MDL’s calculated cash flow is below:
Cash flow statement at the end of the year 2017
Amoun
t (£
Million)
Amoun
t (£
Million)
A Cash from operating activities:
Net profit before tax and interest 5
Advance payment (8)
Working capital adjustments:
Increase in debtors (2)
Increase in creditors 1.5
Bad debts (2)
Net cash from operating activities (5.5)
B Cash from Investing activities:
Investment in stake acquisition (10)
Net cash used in Investing
activities (10)
C Cash from Financing activities:
Net Increase in cash and cash
equivalents (A+B+C) (15.5)
Interpretation: Negative cash flow affects MDL to pay extra income to
manage these expenses; it also required additional borrowings to pay off
liabilities taken for cash outflows on Investment and operating activities.
Affect on receivables: MDL’s total debt increases by £2 million due to bad
policy of cash transactions made by management.
Affect on payables: Organization needs to pay £1.5 million pound to satisfy
its client’s request. As the payables are not as much as receivables
organization has a positive working capital.
Affect on Inventories: Because of question between two gatherings,
organization requires to store extra inventories which increment stockroom
costs.

3. Recommendation of steps to improve MDL cash flow
through better working capital
There are numerous ways through which company can improve its cash flow
by adjusted working capital:
 Minimize wastage of resources: It was noticed that company is not
properly manage its resources such as cash, raw material and vendor;
this raises the issue of wastage of resources in doing unrequited
activities.
 Reduce extra inventory above minimum stock level: Minimum stock
level are the minimum required inventory needed by business to face
any situations like unexpected demand, strike, loss and other
circumstances but maintaining stock above this level increases the
cost of overall operations.
 Minimizing average collection period: Management should focus or
make attractive cash policies to convert credit sales into cash sales to
improve cash inflows.
 Avoid slack: Slacks are hurdles for any project; it increases
unnecessary cost and duration of operations. Strategy to remove slack
can improve cash flow.
 Increase average payable period: This is the duration in which
company pays its dues to creditors. It will be better for company to
have excess of average payable period over average receivables for
improvement in cash flows (Tomkin, 2016).

EXECUTIVE SUMMARY
This part consists of case study of Second Sight Plc which is an international
company produces prescription glasses and sunglasses. Its clients are leading
international brands. Present situation of company states that last year it has
generated £250 million and has market capitalization of £300 million including
debt of £50 million. Company has long term expansion plan in Netherlands and
other project considering is to joint venture with Indian company. This part
consists of various budgeting methods; zero based, traditional, activity based and
rolling budgets.

PART 2
1. Concept of budgeting and its purpose of preparation:
Budgeting: It is the process of forecasting future sales and costs associated
with each activity through past analysis of Income statement, balance sheet
and other attached documents (Wildavsky, 2017).
Purpose: The main purpose for preparing budget is to identify the alternatives
and proper allocation of funds on product centric activities. It functions like
key performance indicators for every firm. Budgeting always matches with
actual performance to know whether it performed well during the year or not.
Various approaches used by management in preparing budgeting are
discussed below:
(a) Traditional budget approach: In this method, budget is made for current
year by changing in the earlier year's budget reports. For getting ready
spending plan by conventional methodology, earlier year's information or
data of accounting report and pay explanation is taken as a base and the
figures given in budget summary is changed by assessing expansion rate,
future buyer request, and so forth.
Strength Weakness
It provides key performance indicator
for company.
This method uses spreadsheet which
is not efficient in handling big data’s
and storing in local drives.
Focus on decentralization of structure
of governance to meet assigned target.
It’s not possible to modify any
policy once budget is prepared
(Drury, 2013).
(b) Alternative budget approach: All budgets not belonging to traditional
approach lies under alternative method of budgeting. Some of these
methods are discussed below:

 Rolling budget: It is never ended process for a business. Because in this
approach engages in replacing old budget with new budget policies before
ending of previous budget. It supports management in preparing accurate
budgets and fixes any bug found in the project.
Strength Weakness
It helps in building responsive
towards change in trending
economies (Ward, 2012).
It is expensive process because it
never ends at a point and requires
spending huge amount on its
continuation.
As this approach involves regular
preparing of budget; it builds strong
intuition in managers mind and he
able to take accurate decisions on
time.
It also raises the costs of business due
to hiring professionals or experts of
rolling budget; sometimes company
requires consulting third party to
make auto preparation.
 Zero based budgeting: This budget approach makes the budget from base
level or put all the values to zero. It helps in situation where firm is looking
for starting a new venture at new location and zero estimation. The purpose of
this approach is to remove any unnecessary cost expenses attached with
production process.
Strength Weakness
It gives advantage towards other
budgeting approach; as it evaluates
data from its base while in other
approach simply increase in
percentage of previous value done.
It is time consuming process; as
evaluation of actual value of each
item separately requires lots of
evaluation and analyses over
longer duration (Guilding, 2007).
It helps company in taking make or
buys decisions easily through
evaluation actual value of both
alternatives.
Time consuming nature makes
this project most expensive as
compare with other alternative
methods.
 Activity based budget: This methodology takes action based costing to plan
spending plans. Like zero based planning, it likewise not takes base year for
making spending plan. Other than this it center on different expenses and
partitions it into various exercises after legitimate examinations (Scapens,
1991).
Strength Weakness
It wipes out pointless exercises and It is intricate procedure, requires

considers just important or center
exercises required for maintaining
a business.
heaps of profound investigations
of expenses. As expenses are of
three kinds fixed, variable and
blended. Blended expenses
incorporate both fixed and variable
and requires heaps of studies to
isolate it.
It accepts entire association as
single units which help an
organization to keep away from
struggle circumstances between
various divisions.
This spending limit must be set up
for present moment and not helpful
for long haul field-tested strategy.
2. Application of traditional and alternative budgeting
approach for planning cost of Second sight plc
1. Traditional approach: Organization needs to take base year for current
year's financial limit. £250 million income followed a year ago, it is
intending to open a branch where 800 representatives will work. In India
work are less expensive, in this way to representative in any event 500
staff it requires to expand its expenses by 25% from past one. As per this
methodology organization should expand its income by 20%.
2. Rolling budget: Organization requires making spending plan before the
finish of this present month for next a half year. Association's present
obligations are around £50 million and promoted share is £300 million
pounds.
3. Zero based budgeting: Second sigh plc prepared to joint wandered in India
which is new and better place for the organization. It can begin all
expenses from level zero.
4. Activity based budgeting: Organization's center business is producing
glasses and shades which it supplies to different organizations. So it should
concentrate more on activities and transportations, different expenses and
overheads ought to limit.

3. Analysis of best approach
On the basis of evaluation of different approaches done above; it was found
that Second Sign is going to open new venture in India. The activities and
cost structure will be totally different. Overall company has to start from the
scratch and on the basis of this requirement it is recommended that should go
with zero based budgeting process; because this budget approach do not
requires any previous associated cost and revenue figures. Zero based budget
works independently by assuming all values at zero. But after starting
business it can prefer other approaches such as rolling budget and activity
based budget to remove any bug affecting actual performance. No single
approach is best; hence it suggested that company should adopt mix of
strategies and budgeting methods to better suit to available situations.

REFERENCES