Business Finance: Profit, Cashflow, Working Capital, Budgeting Methods

This report provides an introduction to financial terms such as profit, cashflow, and working capital. It explains the impact of changes in working capital on cashflow and recommends steps to improve cashflow through working capital management. The report also discusses the purpose of budgeting and different types of budgets, with a focus on the activity-based budgeting method. It demonstrates the applicability of budgeting methods to plan future cost management for Second Sight Plc.

Business finance

TABLE OF CONTENTS
EXECUTIVE SUMMARY........................................................................................................3
Part 1..........................................................................................................................................4
a. Meaning of profit and cashflow.........................................................................................4
b. Working capital, receivables, inventory and payables.......................................................4
c. How changes in working capital affect the cashflow.........................................................5
How the MDL is managed which might affect its financial results.......................................5
Ways to improve the company's cashflow through working capital management................6
EXECUTIVE SUMMARY........................................................................................................8
Part-2..........................................................................................................................................9
Purpose of preparing the budget and its different types.........................................................9
Demonstrating the applicability of budgeting methods to plan future cost management....11
Analysing which method is appropriate for Second Sight Plc.............................................12
REFERENCES.........................................................................................................................13

EXECUTIVE SUMMARY
In this report, an introduction is provided in respect to the few financial terms and
their usefulness in the business such as profit, cashflow, working capital etc. it also presents
about the impact of change in working capital over the cash flow of the business. Based on
findings, the key steps that can be taken by Mediterranean Delights Ltd (MDL) were
recommended to improve its cash flow.

Part 1
i.
a. Meaning of profit and cashflow
Profit: It is the amount of money earned by the businesses after meeting all the relevant
business expenses for a particular period. Profit is derived by deducting total expenses from
the revenue of business. There are situations when the business is incurring profits but still it
may not be having sufficient amount of cash. For example, the deduction of depreciation
leads to reduction in profits.
Cashflow: It refers to the cash flow of the business. Cash-flow states the amount that
company been received and spent during a particular time period (Atrill, 2014). There are
three sources of cash flow in a business which includes activities related to operating,
investing and financing. Cash flow is highly significant which helps business unit in
determining the liquidity position of the business as well as business earning ability from its
operating activities.
Difference between cash flow and profits enumerated below:
Profit Cashflow
It refers to the gain that is earned by the
company after meeting all the business-related
expenditure.
It is about cash inflow and outflow in the
business at a specific period.
It is calculated by subtracting all the expenses
incurred from the total revenue for the
particular period.
By combining all the three sources which are,
operating, investing and financing activities
cash flows can be determined.
It is derived on the basis of accrual basis of
accounting.
It is uses cash basis of accounting.
b. Working capital, receivables, inventory and payables
Working capital: It is the amount which determined by subtracting current assets
from the current liabilities (Watson Head, 2016). Working capital is calculated to know the
liquidity position of business and also operational efficiency in managing its current assets
and current liabilities. It is desirable to have a positive working capital as it reduces the
situation of cash crunch.
Elements of working capital mainly includes the following:

Receivables: It is the amount of money which is owed by the customers to be paid to
the company in lieu of the goods purchased by them on credit. It is shown in the balance
sheet on the asset side as receivables.
Inventory: It refers to the raw material and finished goods which is used by the
businesses for production and selling of the same and any unsold good is remained in the
inventory and shown on the balance sheet. It is important for businesses to maintain the
certain amount of inventory in order to meet the uncertain circumstances like increase in
demand. It is the most important asset to the business as it drives profit to the business.
Payables: It is also known as accounts payables which represents the obligation of the
company to pay its debts. These are the payments to be made by the businesses to its
suppliers. The large organization, often have a separate department for it which manages the
timely payment of its suppliers.
c. How changes in working capital affect the cashflow
The effect of working capital can be seen in the cash flow statement of the company.
Specially. The operating cash flow section details about the short-term changes in the
working capital needs (Aktas, Croci and Petmezas, 2015). It is also recommended to have
positive working capital which states that the cash inflow for the period is higher than the
cash out flow. The negative working capital depicts that the company has incurred more
expenditure in the specific period. For example, company purchases the fixed asset which
leads to increase in cash outflow for the amount of asset purchased which will reduce the
cash, making working capital to decrease. Analysing the working capital is essential is very
important for all types of businesses especially the firms with seasonal cash flows.
ii.
How the MDL is managed which might affect its financial results
Currently, Mediterranean Delights Ltd (MDL) is operating 30 delicatessens in South
of England. In the previous year, the company had the turnover of over £50 million along
with operating profit of £5 million and the company is managed by Wade having 25% stake
in the company while remaining stake is spread with other family members. Apart from this,
the company’s debt has increased from £16 million to £18 million. MDL has acquired the
40% stake in the Italian company and has paid 10 million to acquire its shares and paid
additional amount of £8 million in advance for supply of the products. The company also
owes £1.5 million to Delios and is facing a legal dispute of £2 million delivery to San Pedro
in the year 2017. There are chances of getting involved in another legal dispute which may

arose because of supply of sub-standard material by Maltese agricultural group. MDL has
refused to pay money to the group which is now threatening for legal action. MDL is
currently having large stock of inventory which company thinks to be useful after resolving
these issues. So, after analysing the current situation of the company it can be said that MDL
should put a pause on further investment plans and should come up with the plan to pay off
its debt. The company should sell of its inventory as soon as possible otherwise, the cost
associated with storing and handling the stock will exceed the revenue associated to it.
All these things will have a direct impact on the working capital and cash flow
position of the business. MDL is required to work hard in recovering the amount from its
customers which can be used in repaying its debt.
iii.
Ways to improve the company's cashflow through working capital management
Following are the recommended steps that can be taken by the company for
improving its cash flow by effectively managing its working capital.
 MDL should use electronic payment system which helps in ensuring that timely
payment of the debt obligation is made by the company which help in avoiding any
delay and penalty.
 The company should contact multiple suppliers and then select the one who is
offering the required material with a heavy discount. This will result in reduction in
the cash out flow.
 It is very essential for the company to maintain a good relationship with its suppliers
and vendors which will be very helpful at the time of financial crisis.
 MDL should look at the terms of loan and interest payment and carefully examine
whether it is eligible for any modification in respect to interest rate and lower the
fixed amount every month. Settling the loan in an effective manner will help in
reducing the cost of future instalments and savings can be included in the working
capital.
 The company should not overstock its inventory and find ways to sell out its
inventory very soon as it will help in managing the cost associated with inventory and
helps in cutting the cost of product and services which are not working.
 The company should implement the automating system for accounts receivables and
payables. It will help in tracking the inflows and outflows associated with it. It should
make sure that it has a strong collection team who are effective enough in recovering

the amount from the customers and for making this possible the company should offer
attractive incentives and rewards to its employees.
 Another way to improve cash flow is to increasing the profits of the business by
timely reviewing the expenses of the business and taking corrective actions to reduce
it.
 MDL should resolve its legal issues as soon as possible which helps in avoiding
unnecessary legal expenses and reduces impact on company’s goodwill.

EXECUTIVE SUMMARY
This report presents the different methods of budgeting along with their strengths and
weaknesses like activity and zero-based budgeting, rolling budget etc. Based on the findings,
the activity-based budgeting method seems to be the best method suited to the Second Sight
Plc for its new facility planning.

Part-2
I.
Purpose of preparing the budget and its different types
Budget can be termed as the financial plan for the specific period. It provides the
direction based on which complete planning and controlling process is carried out. It is
prepared taking into consideration previous year’s budget with an increment in the amount
with respect to inflation, increase in sales etc. it is also known as incremental budget. The
different types of budgets are discussed below.
Traditional budgeting approach
In this method of budgeting, the next year’s budget is prepared taking previous year
as the base (Atrill, 2015). Budget is completely dependent upon on the previous year’s data
and then adding and subtracting the relevant changes such as inflation, market situations etc.
The budget can be easily made by the company. In this, only changes in the budgets are
justified and keeping everything constant, which means there is no need to rethink about the
each and every item in the list.
Strengths:
 It provides references point which makes it easy to manage the activities.
 This method encourages decentralization as everyone can look at the budget.
 It can be easily prepared using past year’s data.
Weaknesses:
 Excessive reliance has been placed on previous year data which can prove to be fatal
at times.
 Budget slacks as manager can make changes in the business as per the need.
 This budget is prepared by the top-level management which makes other people in the
organization fell ignored.
Other alternative budget reports
Rolling budgets
It is the new set of plans for the next year which replaces the previous year on a
continuous basis. It means the budget is regularly updated when the previous budget ends. It
can be prepared at different interval of times such as quarterly. half yearly etc. this method
requires a lot of time for preparing for the first time but one’s it is prepared it can be easily
extended.
Strengths:

 This budget is very flexible which can be easily changed with the change the
unexpected events.
 It brings better understanding and responsibilities among the employees.
 It also helps in finding the strength and weaknesses of the business so that actions can
be taken to remove the weakness.
Weaknesses:
 This method is robust in nature and requires skilled personnel for carrying out the job.
 If the target sets in the budget are difficult to achieve then it will demotivate the
employees of the organization.
 This method is very costly as it requires additional manpower for updating the budget
from time to time.
Zero based budgets
It is a budgeting approach in which a budget is prepared from the scratch. It starts
from the zero and does not uses previous years data and information. In this approach, before
adding any expenses in the budget a proper justification of each and every expense is carried
out. The main objective of using this approach is to identify the unnecessary cost and
reducing it.
Strengths:
 It helps in effective allocation of resources department wise as it is based on actual
numbers.
 This method helps in cost reduction by eliminating unnecessary cost.
 It establishes better communication and coordination among the departments and
motivates employees by involving them in decision making process.
Weaknesses:
 It requires high involvement of employees with adequate time.
 It is a very time taking process.
 Providing justification for each and every cost is problematic and may require proper
training to the managers.
Activity based budget
In this method, budgeting is done by identifying the cost drivers. It analyses the
different cost to be incurred and based on which resources are allocated to the respective
activities (Drury, 2016). It separately evaluates different activities and processes undertaken.
The objective is to bring efficiency in the business. It is activity-oriented approach.
Strengths:

 It eliminates unnecessary activities which results in cost saving.
 It evaluates each cost separately with its driver and only important activities becomes
part of business. It improves the relationship with customers by serving them with the best quality.
Weaknesses:
 It requires research with regards to different factors which makes it complex.
 It needs highly professionals to prepare budget,
 This method focusses on short term needs of the business.
ii.
Demonstrating the applicability of budgeting methods to plan future cost management
Traditional method
This method of budgeting is currently used by the Second Sight Plc. This method uses
previous year’s budget for preparing the current year’s budget. This method is most suitable
for businesses having no major changes in the working conditions. It is most suitable because
it helps in forming coordination across of the functional units. For example, if there is any
error in the actual performance then it can be easily identified from the budget as only
necessary changes are done. It has other benefits as well which the Second Sight Plc is taking
advantage of it like better decision-making process.
Rolling budgets
If the Second Sight Plc uses rolling budget then it will be very beneficial for the
company in terms of effective planning and controlling (Weetman, 2010). This budget is very
flexible so the company can make changes in the between. For instance, on the starting of
accounting year company prepares the budget month wise till December. After the
completion of January, the budget will be extended to January of the following year. The
major benefit is that the company will always have budget ready for the next accounting year.
Zero based budgets
Using zero based budgeting, Second Sight Plc will gain the benefit of effective
allocation of resources as budget is prepared from the scratch and every department evaluates
the resources required by it in carrying out its business activities. The major problem
associated with it is the that it is very time consuming.
Activity based budget
This budget method, will help Second Sight Plc in evaluating the cost separately for
each and every activity carried out by it. This method will assist the company in determining

the cost with respect to various activities undertaken by it. This method will also help in
identifying the unnecessary cost which can be eliminated. For example, the estimated sales is
10000 units at the cost of £5 in the coming year, based on this the estimated budget of
expense is £50000. But if it is compared to previous year’s budget of £30000 which is
expected to grow at 10% then the budget would be £33000.
iii.
Analysing which method is appropriate for Second Sight Plc
The traditional method of budgeting is not appropriate for the company as it is only an
adjustment to the previous year budget which can be in respect to inflation or increase in
revenue. On the other hand, the other alternative methods of budgeting such as activity based,
zero based and rolling budget takes a deeper look into the various business prospects. These
methods can be implemented by the organization in case of any material changes like
business location, products etc. Second Sight Plc should implement activity-based budgeting
approach in its business. This method has various advantages which will turn out to be very
beneficial for the business. It will help in making changes in the budget very smoothly so that
any uncertain event can be taken into account which will result into reducing losses of the
business. As the Second Sight Plc is looking for expanding its business in other nation this
method will be useful as it will result into better forecasting. A separate cost based on
different activities and processes can be evaluated and all this will lead to identifying the
unnecessary cost so that actions can be taken to reduce it which results into increase in
profits.

REFERENCES
Books and Journals
Aktas, N., Croci, E. and Petmezas, D., 2015. Is working capital management value-
enhancing? Evidence from firm performance and investments. Journal of Corporate
Finance,.30. pp.98-113.
Atrill, 2014. Financial Management for Decision Makers. 7 ed. London FT Prentice Hall.
Atrill, 2015. Management accounting for Decision Makers. 8th ed. London Pearson.
Drury, 2016. Management Accounting for Business. 6th ed. London Cengage.
Watson Head, 2016. Corporate Finance. 7th ed. London Pearson.
Weetman, 2010. Management Accounting. 2nd ed. London FT Prentice Hall.