Investment Appraisal Techniques and Cash Flow

This assignment delves into the crucial concepts of investment appraisal and cash flow management within a business context. It examines various techniques used to evaluate potential investments, such as Net Present Value (NPV) and Internal Rate of Return (IRR), emphasizing their application in assessing project profitability and risk. The importance of accurately forecasting and managing cash flows is highlighted, along with strategies for mitigating cash flow problems. The assignment incorporates relevant examples, case studies, and references to academic literature to illustrate these concepts.

BUSINESS FINANCE

Table of Contents
INTRODUCTION......................................................................................................................3
TASK 1 profitability and cash flow...........................................................................................3
Difference between cash and profits.....................................................................................3
Liquidity and profitability characteristics of Event Planner Ltd...........................................3
Cash shortage with having availability of profits..................................................................4
Causes of cash flow problems with necessary illustration....................................................5
Methods for dealing with cash flow problems to ensure effective cash management..........5
TASK 2 Capital budgeting ........................................................................................................6
Capital investment appraisal: meaning and process..............................................................6
Stages of capital investment appraisal process......................................................................6
Four main capital investment appraisal methods with advantageous and disadvantageous. 8
CONCLUSION........................................................................................................................10
REFERENCES.........................................................................................................................10

INTRODUCTION
Finance is the essential element of every organization because none of the business
can survive without adequate availability of funds. It will be require for both the revenue and
capital nature expenditures such as office expenses, purchase payment, investment in fixed
assets and so on. The present report is based on analysing the significance of cash flow and
profitability for Event Planner Ltd. It is a newly established business who specialised in
planning for special events such as weddings, christenings and birthdays etc. as per client
demands. Currently, business is facing liquidity problems because of lack of cash funds.
Thus, the report aims to advise line manager to use effective cash flow management so as to
remove cash problems. Second part of the report will discuss the importance of all the capital
budgeting techniques, its advantageous and disadvantageous to take strategic investment
decisions for Toddlers Ltd. It is a manufacturer of children's furniture, toys and other
accessories and regularly focuses on introducing new products with unique features.
TASK 1 PROFITABILITY AND CASH FLOW
Difference between cash and profits
Cash flow and profitability both the very crucial aspects for Event Planner Ltd. Cash
flow is the difference between the amount of cash that has been received by the Event
Planner and actual cash used. In other words, it is the difference between cash incomes and
the cash application (Cope, 2014). Henceforth, it does not consider all the non-cash related
transactions such as depreciation and profits and loss on sale of fixed assets. On the contrary
to it, profitability is the excess or surplus of Event Planner Ltd's total earnings and payments
whether it has been received or paid in cash or not. Thus, it became clear that cash flow
consider only the cash income and spendings while profitability takes into consideration all
the cash as well as non-cash affecting transactions. Cash flow is necessary to pay to the
creditors, staff, purchase and other expenses. However, profitability is necessary to exist in
highly competitive market otherwise, investors, suppliers, staff member and lenders will not
be interested to give their services to an unprofitable business.
Liquidity and profitability characteristics of Event Planner Ltd
In context to the given scenario, profitability and liquidity characteristics for Event
Planner Ltd, has been described below:
 Liquidity measure the Event Planner's ability to pay off their short term business
obligations effectively and timely. It is greatly depends on the cash because it is

the most liquid assets that the Event Planner have in its business (Brunnermeier,
Gorton and Krishnamurthy, 2014). Large amount of cash availability will
indicates that Event Planner is able to meet out their short term business liabilities
effectively and vice versa. On the contrary to it, profitability shows that how much
Event Planner is earning through its operations. Larger revenues than compare to
expenditures will shows that Event Planner is earning good profitability through
its operating functions and shows that business is performing well in the market. It
is necessary to ensure long term survival and sustainability.
 Liquidity refers to availability of cash funds hence, it is based on the cash inflow
and outflows from in Event Planner Ltd. It includes cash sources and applications
from Event planner's operating, investing and financing activities (Holden and
Jacobsen, 2014). However, its profitability is based on the operational functions
whether it has any impact on cash flows or not. It does not taken into
consideration all the capital nature of revenues and expenditures.
 Liquidity is based on the cash based accounting principle while profitability is
based on the accrual accounting concept. Cash based accounting principle tells
that transactions must be recognised at the time of cash receipts or payments by
Event Planner Ltd. On the other hand, accrual accounting concept demonstrates
that transactions should be recorded when they incur without identifying their
cash impacts on Event Planner Ltd.
Cash shortage with having availability of profits
There are various reasonable available that may cause cash shortage in the firms while
having adequate amount of profits, some of these are explained hereunder: Non-cash revenues: It is one of the reason that may impair cash availability of Event
Planner Ltd while profitability will be increase. It is because non-cash revenues
through Event Planner's operating activities will be reported in profit and loss account
as current year income and results in inclined revenues and profitability as well
(Collins, Hribar and Tian, 2014). On contrary, it will have no impact on Event
Planner's cash sources. This in turn, it may face cash shortage problems with having
profitability. For example, profit on the sale of fixed assets is a non-cash revenue and
recorded as revenues in profit and loss account. Thus, it will increase Event Planner's
revenues and profitability as well.

 Capital nature transactions: Event Planner's business expenses that are not of
revenue nature will not be recognised in profit and loss account and does not impact
profitability. For instance, cash outflow for purchase of assets, repayment of debt and
redemption of share capital will have no effect on Event Planner's profits. On the
other side, this functions will reduce cash funds and results in cash shortage (Brooks
and Mukherjee, 2013). Thus, it can be said that non-operating cash outflow is the
another reason for cash shortage with having good amount of profitability. For
example, if Event Planner purchase any fixed assets than it will decline cash funds
while profitability will be unaffected.
Causes of cash flow problems with necessary illustration
As per the scenario, Event Planner Ltd, is facing some liquidity problem due to lack
of sufficient cash sources. Moreover, it has been stated that Event Planner's first year was
unprofitable and its bank account has overdraft balance from the last 9 months which embark
an negative image in the mind of stakeholders.
In the present scenario, loss is first and foremost reason for arisen cash flow problems.
Moreover, Event Planner's directors has insisted to purchase very luxurious car for showing
clients the various party venues. Thus, over-investment is the another important reason
because Event Planner has incurred a great amount of expenditures on car purchases resulted
in lack of adequate cash funds (Causes of cash flow problems, n.d.). Moreover, heavy
entertainment bill is the another reasons for not only the cash flow problems but also for the
adverse business performance. It is because it is an revenue nature transaction thus, it has
been recognised as expenses and resulted in unprofitable business and cash flow problems.
Moreover, Event Planner is offering services of most expensive restaurants of the town thus,
it will results in higher cash outflow and declined cash availability and profitability as well.
Due to lack of funds, Event Planner took a heavy overdraft to meet out their obligations.
Thus, firm has to pay interest on this overdraft facility resulted in increasing cash outflow and
arise cash problems. Thus, it has been clear that all of the reasons are responsible for the cash
flow problems in Event Planner Ltd.
Methods for dealing with cash flow problems to ensure effective cash management
Cash flow forecasting through budget: The best way to improve cash flow is
forecasting. Event Planner's line manager can prepare projected budget through estimation of
cash revenues and transactions so as to predict net cash flow after covering all the cash
payments and ending cash balance (6 ways to avoid cash flow in your business, 2006). It

provides advantage to cut non-essential expenditures such as luxurious car and other
transactions that contributed to arisen high entertainment bill. Moreover, through delaying
supplier payment and prompt receipts from the clients helps to enhance Event Planner's cash
inflows and reduce outflows resulted in handling cash flow problems.
It helps to gain a lot of insight into future and compare it with the actual so as to take
corrective actions to mitigate adverse existed cash flows. Save energy through switching off
lights, optimum uses of resources and competitive service prices assist manager to enlarge
their revenues and lower expenses resulted in removing liquidity problems effectively
(Whited, 2014). Furthermore, early settlement discounts helps to generate earlier from the
current debtors and remove hurdles to pay for the suppliers services. In addition, Event
Planner Ltd, can reinvest its previous net cash flow further and may earn some return on this
results in improving business cash sources. This in turn, it will be able to discharge their
creditors timely and assure long-run survival, growth and sustainable business.
TASK 2 CAPITAL BUDGETING
Toodlers Ltd, is a manufacturer of children's furniture, toys and other accessories and
its success is greatly depends upon new product development with new features. Recently,
Toodler introduced its latest product child's car seat which converts into a buggy. This design
enable quick and easy conversion of car seat into a buggy and extremely lightweight with yet
durability.
Capital investment appraisal: meaning and process
It is also known as capital budgeting helps to examine and evaluate the attractiveness
of each project and find out the most suitable project for Toodlers Ltd. This techniques
demonstrates the profitability of all the available investment proposals to determine most
viable project in which funds can be invested (Baum and Crosby, 2014). Toodlers Ltd, can
use this process in order to take decisions for new product development that will provide
huge benefits in future. Through this process, Toodlers Ltd, can assess risk and uncertainty
associated with all the proposal available and identify most beneficial among these.
Stages of capital investment appraisal process
This process consists of various stages, that involves initial investigation, detailed
explanation, sources of finance, authorization, consistency with the organization's strategy,
implementations, project monitoring and post completion audit, described below:

Initial investigation: Before accepting any new project, Toodlers Ltd, has to
investigate all the available proposals. It has to recognise that organization have enough
resources or not to invest. They has to assess risk involved, strengths and weaknesses of all
the projects through competitors actions and industrial analysis as well. Moreover, they
should identify the impact of each proposal on the stakeholders and determine that they will
be ready or not to accept the project.
Detailed explanation: In this, Toodlers Ltd, has to estimate the cash inflows during
the project life time and determine relative profitability through various techniques
(Stevanović and Pucar, 2012). Moreover, directors has to assess sensitivity analysis and look
at the key variables in a particular project. Under the sensitivity analysis, managers can detect
the impact of uncertainty associated with the cash flows on the project's outcome helps to
evaluate project feasibility and select most profitable project.
Sources of finance: Thereafter, Toodlers Plc needs to identify sources of finance
through which funds can be generated for the initial investment. It may go through personal
savings, retained earnings, bank loan, debts, overdraft and so on.
Authorization: After the project evaluation, it must be presented to highest managerial
authority of Toodlers Ltd. This decision maker will have authority to approve, modify or
reject the project. In most of the organization, it is the duty of certified finance manager
(CFO) and proposal should be signed by relevant authority to increase accountability
(Carrying out investment appraisal, n.d.).
Contribution to the organization's strategy: Toodlers Ltd, has to determine that how
the proposal will contribute to overall strategic goals of the organization. CFO need to assess
the risk and likely impact of the proposal on its business.
Implementations: Investment plan should be implemented effectively and on right
time so that opportunities can be gained. It helps to enhance Toodler's strategic capabilities
and compete effectively (Kaplan and Atkinson, 2015).
Project monitoring: After project implementations, it's progress should be reviewed
on an regular basis. It will helps to assess that how well the project is going on and take
corrective and remedial actions in order to remove any deviances between plans and its
execution with the reassess forecasts (Pozzi and et.al., 2015).
Post completion audit: After completion of the project, post completion audit should
be done in order to determine that targeted goals of the investment plan has been achieved or

not by Toodlers Ltd. So that, managers will be able to determine the limitations or drawbacks
of the project and eliminate it in future period. This in turn, more effective decisions can be
taken which significantly contributes to the high growth and success.
Four main capital investment appraisal methods with advantageous and disadvantageous
There are variety of capital investment appraisal techniques available to Toodlers Ltd,
for taking decisions for any new capital project. It employs both the discounted and non-
discounted methods that can be used by Toodlers Ltd. Out of these, four most important
methods are described hereunder:
Non- discounted cash flow methods: It includes pay-back period and accounting rate of
return method.
Pay-back period (PP): The time period in which project's initial investment can be re-
earn by the Toodlers Ltd, is called PP. In other words, the time length in which project cost
will be recover is known as PP, also called recovery period (Beck, Raj and Britzelmaier,
2013). With reference ton Toodlers Ltd, director can make use of this investment appraisal
technique to determine the time period in which project's initial cash outflow will be re-
generated.
Selection rule:
Toodler Plc, should select project that takes lower time period to recover its project
cost than compare to other available proposals.
Advantageous:
 Its one of the most important advantage is it is very easier method as year, in which
cumulative cash flows is equal to the project's initial outflow is known as PP.
 It helps to identify the time length to recover invested funds in the associated project. In rapidly changing business environment, it is most often use technique by the
organizations.
Disadvantageous:
 Its limitation is it does not take into consideration the time value of money.
 It ignore post pay back profitability beyond the PP.
 It seems to be very difficult to set an target pay back period. Hence, in only one
project, PP can not be use to take investment decisions.

Accounting rate of return (ARR): It demonstrates the average rate of return that can be
earned by Toodlers Ltd, on its capital projects. It is highly used to meet the shareholders'
expectation through deciding an target rate of return. The formula to compute ARR is as
under:
ARR = Annual profit/(Initial project investment+scrap value/project life)*100
Selection rule:
 Toodlers Ltd, has to select project whose ARR is higher than others. In case of only a single project, Toodler Ltd, should approach for the project whose
ARR is higher than set target rate.
Advantageous: It measure profit potential of the projects in percentage hence, comparison is more
easy (Lewellen and Lewellen, 2014).
Disadvantageous:
 It takes into consideration yearly profits rather than project's estimated cash flows. It does not consider the time value of money because it takes does not take discounted
profits.
Discounted cash flow methods: This methods are comparatively more superior than
non-discounted cash flow techniques because it is a time based approach. Hence, overcomes
the one of the greatest limitation of non-discounted cash flow comprises net present value and
internal rate of return (IRR).
Net present value (NPV): This method determine future values of all the estimated
cash flows and compare it with the actual investment to compute net present value (DeFusco
and et.al., 2015). Future values will be determine through taking an appropriate discount rate.
Selection rule:
 Toodlers Ltd, should go for the project that has higher NPV as compare to others. In case of one project, Toodlers Ltd, should select project if it has positive NPV.
Advantageous:
 This method employs discount rate to consider the time value concept of money.

 It shows more realistic and accurate profitability through predicting future values and
compare it with the project cost.
Disadvantageous:
 It is a time consuming approach, also very difficult to understand. Deciding an appropriate discount rate is very difficult task due to market uncertainty
such as fluctuation in interest rate.
Internal rate of return (IRR): It is the rate at which Toodlers Ltd, project's future
values and project cost will equal hence, NPV will be zero (García-Suaza and et.al., 2014).
Selection rule: Toodlers Ltd, should select project which IRR is higher than cost of capital.
Advantageous:
 It takes into account the time value of money. It is simple to understand because expressed in percentage.
Disadvantageous:
 It fails to assess the risk and uncertainty involved in the project.
CONCLUSION
Presented project report concluded that Event Planner Ltd, should focus on cash flow
management through budget. With the help of this, it can enhance its cash revenues and cut
spendings so that Event Planner will be able to remove liquidity problems. Further, rising
revenues and curtailment of expenditures also provide benefits of rising profitability and
ensure long run business survival. This in turn, it will be able to improve its performance and
highly able to pay off their short term liabilities on time. However, next part of the report
recommended that Toodlers Ltd, should take benefits of capital budgeting techniques such as
NPV, PP, ARR and IRR. It will helps to determine most viable project so as to take strategic
investment decisions and enjoy high growth and success.
REFERENCES
Books and Journals
Baum, A.E. and Crosby, N., 2014. Property investment appraisal. John Wiley & Sons.

Beck, V., Raj, R. and Britzelmaier, B., 2013. The effects of capital investment appraisal
methods in automotive companies. International Journal of Sales, Retailing and
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Brooks, R. and Mukherjee, A.K., 2013. Financial management: core concepts. Pearson.
Brunnermeier, M.K., Gorton, G.B. and Krishnamurthy, A., 2014. Liquidity mismatch
measurement. Available at SSRN.
Collins, D.W., Hribar, P. and Tian, X.S., 2014. Cash flow asymmetry: Causes and
implications for conditional conservatism research. Journal of Accounting and
Economics. 58(2). pp. 173-200.
DeFusco, R.A. and et.al., 2015. Quantitative investment analysis. John Wiley & Sons.
García-Suaza, A.F. and et.al., 2014. Beyond the Mincer equation: the internal rate of return
to higher education in Colombia. Education Economics. 22(3). pp.328-344.
Holden, C.W. and Jacobsen, S., 2014. Liquidity measurement problems in fast, competitive
markets: expensive and cheap solutions. The Journal of Finance. 69(4). pp. 1747-
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Kaplan, R.S. and Atkinson, A.A., 2015. Advanced management accounting. PHI Learning.
Lewellen, J. and Lewellen, K., 2014. Investment and cash flow: New evidence. Tuck School
of Business Working Paper, (2010-77).
Pozzi, R. and et.al., 2015. Using simulation for reliable investment appraisal: evidence from
a case study. International Journal of Operational Research. 23(1). pp. 45-62.
Stevanović, S. and Pucar, M., 2012. Investment appraisal of a small, grid-connected
photovoltaic plant under the Serbian feed-in tariff framework.Renewable and
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Whited, H.H.I., 2014. Constructing a Cash Budget and Projecting Financial Statements: An
Exercise of Short-Term Financial Planning for Entrepreneurs: Teaching Notes. Review
of Business & Finance Studies. 5(1). p. 102.
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