Business Finance Report: RCL Working Capital and Capital Budgeting

This report provides a comprehensive analysis of Root and Cook Ltd.'s (RCL) financial performance, focusing on working capital management and capital budgeting. Part 1 examines the differences between profit and cash flow, emphasizing the impact of receivables, inventory, and payables on cash flow. It also discusses various management concepts and their implications on the company's financial status, offering recommendations for improving working capital management. Part 2 delves into capital budgeting, outlining its purpose, key steps, and the advantages and disadvantages of investment appraisal methods. The report analyzes two potential investment projects, Reading and Bristol, and provides recommendations for decision-making. The report highlights the importance of timely collection of receivables, improved payables, price negotiation, and expense reduction to enhance RCL's financial stability and profitability. The executive summary encapsulates the key findings and emphasizes the need for effective working capital management to avoid insolvency and ensure sufficient cash flow for operational activities.

BUSINESS FINANCE

TABLE OF CONTENTS
PART 1............................................................................................................................................1
i (a) Difference of Profit and Cash flow of RCL........................................................................1
i (b) Theory of working capital, receivables, inventory and payables........................................1
i (c) Impact of Working Capital affect Cash flow.......................................................................1
ii) Various management concepts and their implication on company's financial status.............2
iii) Analysis and recommendations for improving Working Capital Management....................3
PART 2............................................................................................................................................4
i (a)Purpose and Key steps of Capital Budgeting.......................................................................4
i (b) Advantages and disadvantages of Investment Appraisal Methods....................................5
ii Comparison of the alternative investment options..................................................................6
iii Analysis and recommendations..............................................................................................6
..........................................................................................................................................................7
REFERENCES................................................................................................................................8

PART 1
i (a) Difference of Profit and Cash flow of RCL
The term profit is defined as financial gain which is distributed at end of the year to
shareholders. On other hand, cash refers to physical money. A business may have a profit but
cannot have cash because profit is calculated by using revenues and expenses which is different
from company's cash receipts and cash payments. Cash flow is termed as the difference of cash
amount that a company receives and pays whereas, profit is determined by the evaluation of
revenues and expenses in a given year. Profitability is a concept which cannot be measured in
terms of cash rather depends on the results of accumulated cash (Bierman and Smidt, 2012).
The 2 prime customers of RCL are D&R DIY and BricoFrance. The company generated
its major operating profit as a result of an order placed by D&R last year of 12 million pounds.
It's major revenue was stuck as a result of the increasing debts and the irregularity of payments
from its customers. Most of the company's amount is also involved in disputes with
BricoFinance which has stopped payment of 20 million pounds and Robocut had an 8 million
pound advance payment for manufacturing automatic grass cut machines.
i (b) Theory of working capital, receivables, inventory and payables
Working capital is a broader concept which includes receivable’s inventory and payables.
The working capital of a company is calculated by subtracting current liabilities from its current
assets. A deficit in working capital implies that company has less value of current assets as
compared to its current liabilities. It measures the ability of a company to repay its short term
loans and debts as well as provide funds for company's operations (Gervais, 2010).
RCL has a deficit in net working capital as an inventory is lined up in the warehouses and
payables are generating with no cash receivables. Steve, the owner of RCL, is pushing up
customers for making immediate payments as the shareholders are worried about company's
operations. Steve is showing concern for other shareholders to invest in company as it's debts
have increased from last year to 157 million pounds.
i (c) Impact of Working Capital affect Cash flow
The impact of inventory, receivables and payables have an effect on company's cash
flow. The operating cash flow includes all those transactions which are occurring irrespective of
generating any cash transactions for company. The deficit in working capital implies that
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company has more cash liquidity which could be used to fund other operational projects. On the
other hand, an increase in working capital shows that company is financing its resources for
shorter period of time. Thus, expressing a reduction in the accessible cash flow from the
financing, investment and operating activities.
Root and Cook Ltd. in the current year at the Manchester site is experiencing an increase
in working capital as cash receivables are late, inventory is held in go-downs and payments are
done in advance. Such activities of company put a direct impact on its share value in the market
which is a major concern for it's shareholders who might withdraw their money. Steve needs to
take decisions to contemplate the company's position (Bierman and Smidt, 2012).
ii) Various management concepts and their implication on company's financial status
The availability of short term assets for meeting its financial operations is an important
factor for any company. Most of the manufacturing units face challenges of low cash availability
as it requires future payments for acquiring various machineries for producing goods. The deficit
in working capital implies that company has more cash liquidity which could be used to fund
other operational projects. On the other hand, an increase in working capital shows that company
is financing its resources for shorter period. For instance: a company buy reams for 100 x 10
pounds (1000 pounds) and uses only 50 reams in a year. The company pays 1000 pounds in cash
though had only made an expense of 500 pounds implies a negative cash outflow of 500 pounds.
On the other hand, same company generates a sales revenue of 1000 pounds out of which 50 %
of its customers take goods on credit which implies earnings of 500 pounds. Thus, the profit and
cash flow figures are:
 Cash flow: = Cash inflow (500 pounds of cash sales) minus cash outflow (1,000 pounds
reams) => - 500 pounds cash flow
 Profit = Income earned (1,000 pounds of sales) minus cost incurred (500 pounds utilized
for reams) => +500 pounds of total profit
Root and Cook Ltd is experiencing a good profitability figure in current year though the
cash amount is nil as company's cash receivables and payables have a huge difference. Both;
cash and profit are the measures of accounting. The profit is measured in terms of company's
prolong ability while cash depends on its receiving and paying ability. Steve is working on how
to increase firm’s liquidity by maintaining profitability position. The inventory of raw materials
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is lined up and slow payments from customers are key points to be look into to improve the
overall cash generation of company (Nazir and Afza, 2009).
iii) Analysis and recommendations for improving Working Capital Management.
Various practices are adopted by companies to manage their working capital efficiently.
The working capital is calculated as current assets minus current liabilities. The ideal ratio in
between the two is 2:1 which implies 2 portion of assets while 1 portion of liabilities must be
preserved in a business enterprise. To ensure that company has sufficient monetary value to
execute its regular financial activities as well as to fund daily business activities, it should
manage its working capital both efficiently and effectively. Too much of working capital leads to
decreased profits and shareholder’s value as well as little working capital may lead to insolvency
of company (Bierman and Smidt, 2012). The various methods that could be used to bring
stability in working capital are:
 Timely collection of receivables: Company should have a check on timely collection of
payments from its customers. It could be done by motivating collection teams by
providing incentives for early collection of payments. RCL’s major issue was lack of
collection of payments which has reduced company's liquidity and thereby, preventing it
to fund other financial operations.
 Improved account payables: This will lock up cash in company for funding other
projects. There should always be a balance in between cash receivables and cash payables
of a company. Procuring of raw materials from suppliers on credit basis also help
companies in locking up cash.
 Price negotiation: Procurement of raw materials should always be done by evaluating
prices of various suppliers and negotiating with them. Suppliers could be changed
keeping the cost incurred on the company. Best type of raw material should be bought so
as to gain maximum profitability(Bierman and Smidt, 2012).
 Less expenses: Company should curtail its expenses both fixed and variable to improve
its overall cash flow. RCL has a major task of decreasing its expenses for the firm to gain
cash accessibility for meeting its short term debts and operational projects.
EXECUTIVE SUMMARY
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The above report incorporates how different accounting factors affect working of a
company. Steve, one of the shareholders of company, is engaged in taking crucial decisions so as
to bring stability in the inflow and outflow of cash. Insufficiency of working capital may have an
impact on company's liquidity status. To ensure that company has sufficient monetary value to
execute its regular financial activities as well as to fund daily business activities, it should
manage the working capital both efficiently and effectively. Too much of working capital leads
to decreased profits and shareholder’s value as well as little working capital may lead to
insolvency of company.
PART 2
i (a)Purpose and Key steps of Capital Budgeting.
The term capital budgeting is known as the investment of capital in long term projects
which will generate cash in a period of one year. It incorporates decisions to make investment in
buildings, plants, heavy machines etc. It is an aspect of financial management. Financial
managers should see capital budgeting methods if they want to plan long term investment of its
profits. The process of capital budgeting involves three crucial steps to be undertaken. Capital
budgeting enhances company's competitive position thereby accumulating profits and allocation
of excess profits to shareholders (Storey and Greene, 2010).
 To decide the amount of expenditure needed to make an investment: It involves
taking vital decisions as to how much an investment will cost and how much the
company will earn in the coming years.
 Determine the possible sources of capital availability: This step involves searching for
various possible sources of inflow and making the best possible use of it. Ascertaining
the sources from which capital could be raised for funding the investments.
 Allocate the capital available in different investment aspects: This aspect focuses on
which projects among the ones shortlisted should be preferred for funding and why. The
why concept is an important question every manger should look into before investing.
Steve at RCL is concerned about investing in two new manufacturing projects with
Reading or Bristol. Both the projects involves huge investment to be undertaken. The Reading
venture involves construction on an abandoned site which will cost £20 million and would
operate for 9-10 years. The other project with Bristol involves £16 million investment and will
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have an expected useful life of 5-6 years. Steve need to undertake a crucial capital budgeting
process and decide which project will benefit the company in the long run by generating profit as
well as maintaining sufficient cash for the short term operations.
(Source: The capital budgeting, 2017)
i (b) Advantages and disadvantages of Investment Appraisal Methods
The Investment appraisal of new projects involves deciding whether the new machines,
set up new plant, procuring of buildings or replacement of tools are worth to fund or not. These
methods incorporates payback period, net present value and internal rate of return which is
calculated to decide whether the investment decision should be taken or not (Preve and Allende,
2010).
b. i Net present value: The term NPV is a method used for calculating the investment
appraisal which focuses on surplus or shortage of cash inflow. A positive NPV states that
the investment will have a good impact on the company. There is an inverse relationship
between NPV and the discount rate. It states that a low discount increases the NPV result
whereas the high rate of discount reduces the capital's net present value.
b. ii. Internal rate of return: The internal rate of return or the discount rate which is
used in NPV is another method of calculating the appraisal of capital budgeting. The IRR
is responsible for measuring the efficiency of the capital investment in a project. If the
cost of capital invested is lower than the IRR the project is accepted whereas if the capital
invested cost is more than IRR the project has more possibility to get rejected.
b. iii. Payback period: It is measured to calculate the time taken to get the principal
investment amount back.
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Illustration 1: Capital Budgeting

ii Comparison of the alternative investment options.
Steve has to make decision regarding the investment in any of the two project. The
Reading venture involves construction on an abandoned site which will cost £20 million and
would operate for 9-10 years. The other project with Bristol involves £16 million investment and
will have an expected useful life of 5-6 years. By using the three investment appraisal techniques
lets find out which project is suitable for the company (Storey and Greene, 2010).
For instance, let us assume the discount rate to be 12 %, (amount in pounds)
Project A yield 10000, 27000, 19000 for three years with initial investment of 35000
Project B yield 27000 for two years with initial investment of 35000
NPV A = 8977
NPV B = 10631
Thus project B has an higher NPV implies investment should be made in project B.
iii Analysis and recommendations
From the critical evaluation of the investment techniques using the NPV, IRR and
payback period which investment to be made is figure out. The tables below clearly depicts that
project Reading should be considered as both NPV and IRR is in favour it Though the payback
period implies taking the project Bristol will be profitable for the company.
Payback period
Cumulative cash inflow
Year Reading Bristol Reading Bristol
1 5600 4000 5600 4000
2 6800 5500 12400 9500
3 7200 7000 19600 16500
4 10600 8200 30200 24700
5 13800 9000 44000 33700
6 16000 9600 60000 43300
7 17600 77600
8 18000 95600
9 18300 113900
10 19000 132900
Reading = 3+(20000-19600)/10600 = 3.04
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Bristol= 2+(16000-9500)/7000 =2.93
Project Bristol should be adopted.
Net present value
Discounted
cash flows
Year A B
Discounting
factor @ 10% A B
1 5600 4000 0.9091 5090.91 3636.36
2 6800 5500 0.8264 5619.83 4545.45
3 7200 7000 0.7513 5409.47 5259.20
4 10600 8200 0.6830 7239.94 5600.71
5 13800 9000 0.6209 8568.71 5588.29
6 16000 9600 0.5645 9031.58 5418.95
7 17600 0.5132 9031.58
8 18000 0.4665 8397.13
9 18300 0.4241 7760.99
10 19000 0.3855 7325.32
66150.15 30048.97
Less: Initial investment 20000 16000
Net present Value 46150.15 14048.97
According to NPV project Reading should be adopted
Internal rate of return
Year A B
Initial investment -20000 -16000
1 5600 4000
2 6800 5500
3 7200 7000
4 10600 8200
5 13800 9000
6 16000 9600
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7 17600
8 18000
9 18300
10 19000
IRR 43.27% 31.98%
According to IRR project Reading should be adopted
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