Capital Budgeting Strategies and Practice Variation

Summary of the provided content: This assignment provides a collection of research articles, books, and online resources related to financial management, budgeting, and cost accounting. The papers cover various topics such as public management, capital budgeting, and beyond budgeting. There are also studies on participatory budgeting, transparent prioritization, and resource allocation using multi-criteria decision analysis. Additionally, the assignment includes online resources from Business Finance and E-Financial Management.

BUSINESS
FINANCE
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Table of Contents
INTRODUCTION ...............................................................................................................................3
TASK 1.................................................................................................................................................3
1) Showing a clear understanding of the difference between profitability and cash flow and how
these are stated in the organization accounts...................................................................................3
2. Explaining the application of the concept of working capital management to the company and
how the present-day condition is a reflection of how the enterprise in managed. ..........................5
3. Analysing the above discussed method and understanding which will be best for making
decision in present case....................................................................................................................6
TASK 2.................................................................................................................................................7
1) Describing the understanding of the stages of the capital budgeting process and of the chief
capital investment appraisal methods..............................................................................................7
2 Application of methods applied to the projects..........................................................................10
3. Analysing the best suitable methods for making decisions......................................................11
CONCLUSION ..................................................................................................................................11
REFERENCES...................................................................................................................................12
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INTRODUCTION
Business finance is a aspect that embrace a broad range of functions and subject area
rotating around the governance of money and other precious assets. It is the fundamental
component for various kinds of the organisation and thus keeps them operative. Each and every
function which executed by the company require finance so it can be stated that they are the lifeline
of the business. Business finance is essential term which help in managing the financial gain and
expenses, profit and loss and various investments of the business enterprise Business finance
therefore regards to wealth and credit made use of in concern (Bierman and Smidt, 2012). It pertain
to procural and use of funds so that company may be competent to execute out their functions in
effective and efficient manner. In this report, various aspect of managing business finance will be
studied in the context of provided case study of Wild Frontier Builders LTD. It is property
maintaining firm providing buy to let market. In this report, a clear understanding of the distinction
between profitability and cash flow will be provided. Also, the steps needed to enhance business
working capital management will be provided. The stages of capital budgeting process will be
discussed.
TASK 1
1) Showing a clear understanding of the difference between profitability and cash flow and how
these are stated in the organization accounts.
In order to maintain financial status of Wild frontier business Ltd, it is important to make
financial gain and assure cash flow availableness in present company. Net profit is the result bring
forth by an
business by managing their business functions . Cash flow is the balance sum of money owned by
company after compensating for all expenditure and financial loss from their present cash. A
variation between net income and cash flow
is developed because of modification that are done in their management which is presented as
follows (Hope and Fraser, 2013).
Cash flow prediction document will evidence all the cash dealings which are performed in
company in actual time period. The accelerative cash can yielded with maximum sales in business
which boost
the productivity and proficiency of business. The entrepreneur of Wild Frontiers Business Ltd
invest significant amount of capital with the objective to earn higher amount of return in future
(Wampler, 2010). The cash created from the sales of idle assets can also be used to meet working
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capital needs of business. The method of computing income and expenditure statements is entirely
different as therein all cash inflows
and outflows are reasoned to show the actual position of company in market. Element which are
well thought out in the computation of actual net income consider diminution, bad debts
, write off, physical resources sold-out at a gain or loss and accessibility of high stock of
merchandise which is not used
(Kilfoyle and Richardson, 2012)
From the critical assessment of present case study of Wild Frontier Ltd. (WFB) it is
identified that firm operates in property business. It provide broad range of services like, plumbing,
roofing, building works and general repairs. The improvement in buildings by WFB will the leading
business areas
of present company (Lee, Johnson and Joyce, 2011 ). There is different grounds which assist in
confirming the present financial position of WFB in regards to the
alteration that happens in income position and cash flow which are presented as follows:
Bank overdraft- It is a facility which permits individual to continue withdrawal of money
from bank account even it has no funds and the present balance slip down below the zero. It is loan
facility where bank increases the credit limit up to a maximum amount. It is significant source of
funding that can be used by entrepreneur to fulfil cash needs of business (Phillips Costa .2007)
Since, its inception from the case study that, the present situation of company is in risk due to the
presence of bank overdraft which exist in company for approximately
9 months. The idle of this high-risk bearing debt liability in the company reduces not only cash
flow as company is required to pay high interest charges on overdrawn amount. Therefore, decrease
in cash position will lead to cut down in the
net income of the Wild Frontier Ltd (Truong, Partington and Peat, 2008).
Calculation of bank overdraft in Profit and Loss statements
Table 1: Extract of P&L statement of Wild Frontier Ltd.
Particulars Amount Particulars Amount
Interest cost () Income ()
Bank overdraft ()
Balance Carry forward ()
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Calculation of bank overdraft in cash flow statements
Table 2: Extract of cash flow statement of WFB
Particulars Amount
Cash flow from operating activities ()
Cash flow from investing activities ()
Cash flow from financing ()
Bank overdraft ()
Net increase or decrease ()
Bank overdraft ()
Cash balance ()
Closing stock- The present operations of cited company has high closing
stock that is kept till the closing of the period. This underlying closing stock will increase the
potential of the business as it
impact the company in positive manner. Outcome of higher closing stock is that it cut down the
cost of goods sold
which further enhances the gross sales and profit . The increase of
sales will immediately impact the business that it will intensify the present income of the company.
Furthermore, idle unsold stock available within the company will not make any cash flow for
business. The increase in closing stock will trim down the total cash flow from accessible cash
present in company (Brigham Daves, 2012).
Treatment of closing stock in income statements
Table 3: Extract of trading and profit and loss account
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Particulars Amount Particulars Amount
Purchases () Sales ()
Salary and wages () Closing stock ()
Gross profit ()
*** ***
2. Explaining the application of the concept of working capital management to the company and
how the present-day condition is a reflection of how the enterprise in managed.
The term working capital management regards to organizations management accounting
strategy developed to supervise and manage the main elements of working capital; current assets
and liability. To assure best financial performance of company, it is important to have proper
working capital management. The difference between current liability and current assets is known
as working capital. The main objective of administration of working capital is that company wants
to assure it is competent to continue its functions (Brigham Daves, 2012). There are different
working capital management strategies that can be considered by Wild Frontier Builders LTD.
They are further explained as follows:
 Hedging Strategy: It is important strategy for management of working capital with
moderate risk and profitability. According to this strategy, the physical resources would be
financed by a debt instrument of just about same maturity. This strategy is based on the
concept that long term source for finance must be used for long term resources
 Conservative strategy: This concept help in working capital management with less risk and
profit. Here, other than fixed and permanent current assets a portion of temporary working
capital is financed through long term financial sources. It has less liquidity risk at the price
of extreme interest expenditure (Truong, Partington and Peat, 2008).
 Aggressive strategy:This strategy is based on extreme risk and maximum profit. The prime
focus of this strategy is on improving proficiency. Therefore, to fund fixed assets only long
term funds are used as component of permanent working capital.
3. Analysing the above discussed method and understanding which will be best for making decision
in present case
Working capital is required by any firm when there is any emergency arise to run their day
to day operations smoothly and efficiently. It involves two components that is net current assets and
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current liabilities. Management of working capital is necessary for the an organisation it is life
blood it help in maintaining day to day operational activities (Sintomer, Herzberg and Röcke,,
2008). It is important for an organisation to enhance goodwill, strengthen the solvency, regular
supply of raw material and smooth business operations. Wild Frontier builders limited require
minimum level of stock for emergencies so, it is necessary for company to manage its working
capital. There are some steps taken by an organisation which are discuss below:-
 Increase sales revenue- It is the best source to improve company's funds by increase sales
and generating revenue. This can be increase by an organisation only when if it target new
market and expand their business in a new market channels
 Consider other source of financing- Company can finance its business by taking invoice
factoring and working capital advances that will improve the firms cash flows.
 Good information system- Most business face various issues about account receivable
because the ERP system is not supporting. It is difficult for the staff to operate daily task so,
firm adopt better information system that help in resolving disputes and improved working
capital (Kilfoyle and Richardson, 2012).
 Payment to suppliers on time- It is an another way for an organisation to manage its
working capital by paying due money to its suppliers on right time. It helps in developing
and maintaining a good relationship with them and in return they offer various discount and
special schemes on raw material and equipment that directly affects company's cash flows.
 Manage inventories actively- Company should maintain their stock level in its factory by
purchasing stock in monthly or quarterly basis because customers demand change with time.
So,they do not hold any unnecessary inventory in advance that will create stock problem in
future. Along with that, they review and manage its stock with its clients orders that will
directly improve the working capital.
 Lease equipment- Company can lease equipments rather than buying it that will help in
management of cash. Investing huge amount on such equipment is wasteful because
technology is ever changing so it is better to avoid purchasing (MillerO’leary, 2007.
)
 Collect Outstanding invoices on time- Firms should increase their speed up collection
process that will cover all delay payment of creditors before time frame. The accounting
department reviewing and monitoring all past financial records that help them in collecting
due payments from its creditors and help them in maintaining its operating cash flows.
 Limit unnecessary Expenses- Company should set clear rules and restriction on investing
on its business. They should make quarterly budget that is transparency which help them in
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maintaining cash and inventories that direct affect the working capital. They spend on those
area where it required not spend unnecessary expenses (Brown, Evans and Moser, 2009).
TASK 2
1) Describing the understanding of the stages of the capital budgeting process and of the chief
capital investment appraisal methods
The capital budgeting is one of the crucial concept used by the organization to evaluate the
skilfulness and lucrativeness of various business projects adopted so as to acquire maximum
fruitful opportunities. The capital budgeting procedure have different stages which are presented as
below:
 Idea generation- It is important for business to generate new ideas and concept for effective
management of finance. With the interaction of top executives, experienced and senior
employees the unique idea can be ascertained. The business proposals are known from
various sources which are examined effectively so as to acquire high profit in the coming time
(Sintomer, Herzberg and Röcke,, 2008)
 Investigation of proposals- The cash flows are predicted by the entrepreneur of Eye
Watering Inc. for the different business project adopted by it for particular time. The
prediction of the cash flow is an inbuilt feature in estimating the
total performance of a project (LibbyLindsay 2010)
 Corporate capital budget- The entrepreneur will choose the top-grade and right projects
according to the initial investment employed on all of them. The
present projects are analysed in accordance to the initial investment and the cash flows
bring forth by the program at a specific period.
 Post audit- During this phase company will concern reassessment of the present business
proposals according to
the standardized benchmarks developed the company. The post audit methods will be utilized to
analyse the
execution of the presented projects with the budgeted frameworks (Gervais, Heato and Odean,,
2011).
There are different capital budgeting method utilized by the company so as to measure the
income generating capacity of the two projects. As inception, the project planned by Eye Watering
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Inc are call of assassins part XXIII and coal mining and oil extract whose calculation is as follows:
Time period (in years) Call of assassins Cumulative
0 10
1 0 0
2 0 0
3 0 0
4 8 8
5 13 21
Computation of pay back period for Call of Assassins
4+13/10
= 4+1.3 =5.3 years
Time period (in years) Coal mining and extract oil Cumulative
0 6
1 0 0
2 0 0
3 0 0
4 5 5
5 8 13
Computation of pay back period
= 4+8/6
= 4+ 1.33
= 5.33 years
Calculating net present value for project Call of Assassins
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Time period (in years) Call of assassins Present value @ 12%.
0 10
1 0 0.8928571429 0
2 0 0.7971938776 0
3 0 0.8928571429 0
4 8 0.6355180784 5.0841446272
5 13 0.5674268557 7.3765491243
Sum 12.4606937516
NPV 2.4606937516
Calculating net present value for project Coal mining and oil extract
Time period (in years) Coal mining and extract
oil
Present value @ 12%.
0 6
1 0 0.8928571429
2 0 0.7971938776
3 0 0.8928571429
4 5 0.6355180784 3.177590392
5 8 0.5674268557 4.5394148457
Sum 7.7170052378
NPV 1.7170052378
Internal Rate of Return (IRR)
Time period (in years) Coal mining and extract oil Call of assassins
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0 6 10
1 0 0
2 0 0
3 0 0
4 5 8
5 8 13
IRR 18.32% 17.50%
Average Rate of Return
Time period (in years) Coal mining and extract oil Call of assassins
0 6 10
1 0 0
2 0 0
3 0 0
4 5 8
5 8 13
Sum 13 21
Average 2.6 4.2
ARR 43.33% 42.00%
2 Application of methods applied to the projects
Capital budgeting is a technique help the firm to determine that which project is provide better
returns in an applicable given period of time. There are various methods of these techniques that are
discussed below-
NPV( Net present value methods)- Net present value is a different between discounted cash
inflow and cash outflows. It helps the firm to analyse the profitable return of project in which they
investing. A positive NPV shows that the project give better return and generate large revenue and
negative NPV indicate them there is net loss in future. It help them to take decision regarding
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investment whether to invest in these project or not in future.
IRR( Internal rate of return)- It is an another method of capital budgeting it is used to know the
profitability of projection. IRR calculation method is almost same as NPV method it measure with
the help of discounted rate this help in making net present value of net cash flow of that particular
potential project is zero and equal to NPV so the investment decision on project for future can be
taken on that basis. Along with this, decision can also be taken on that basis if IRR is greater than
cost of capital that shows that project is a profitable and company should taken that project further.
Average rate of return – It is also known as accounting rate of return it is that return that an
investor expect when they invest on projection. These technique is used generally when there is a
comparison on multiple projects.
PBP ( Pay back period method)- It shows length of time to compete project it also help in take
decision regarding investment whether to undertake project or not. It is not suitable for longer pay
back period because it ignore time value of money.
3. Analysing the best suitable methods for making decisions
There are various capital budgeting techniques that are discussed above the best suitable method
should company choose for make investment decision for the project whether to invest or not. There
are mainly two methods which are suitable for the company are net present value and internal rate
of return but the best among both is NPV due to its various advantage and limitation of IRR. NPV is
an effective tool to measuring number of projects as it use single rate to discount cash flows and on
the other side the IRR is not highly effective for all project as compared to NPV. Furthermore, IRR
is not suitable for long term projects and when the project indicate multiple cash flow negative as
well as positive. Along with that NPV is effective more in as it handle several rate of discount with
several problems than IRR. As we compare pay back period with other NPV, ARR and IRR. This
methods can be suitable for taking investment decision for projects it is suitable for whose pay
back period is shorter and the disadvantages of this is that it highly ignore time value of money so
these method of capital budgeting cannot be used in investment decision for project.
CONCLUSION
Summing up the entire report it can be stated that finance is the life blood of business. The
business cannot function properly in case of lack of proper funds. Further it is ascertained that idle
funds add cost to business. Therefore, the proper planning of funds must be done to assure optimum
utilization of resources. The working capital management helps in ensuring that there is proper
finance available in company to execute various activities smoothly. Thereafter, with the help of
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capital budgeting methods, company will be able to determine whether it is correct to invest
significant amount of funds in specific project or not. Therefore, capital budgeting models include
calculation of pay back period, accounting rate of return, net present value and internal rate of
return.
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REFERENCES
Books and Journals
Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of
investment projects. Routledge.
Bodie, Z., Merton, R. C. and Cleeton, D. L., 2009. Financial economics.
Brigham, E. and Daves, P., 2012. Intermediate financial management. Cengage Learning.
Brigham, E. and Ehrhardt, M., 2013. Financial management: theory and practice. Cengage
Learning.
Brown, J.L., Evans III, J.H. and Moser, D.V., 2009. Agency theory and participative budgeting
experiments. Journal of Management Accounting Research. 21(1). pp.317-345.
Chandra, P., 2011. Financial management. Tata McGraw-Hill Education.
De Boer, H., Enders, J. and Schimank, U., 2007. On the way towards new public management? The
governance of university systems in England, the Netherlands, Austria, and Germany.
Springer Netherland
DRURY, C. M., 2013. Management and cost accounting. Springer.
Ezzamel, M., Robson, K. and Stapleton, P., 2012. The logics of budgeting: Theorization and
practice variation in the educational field. Accounting, organizations and society. 37(5).
pp.281-303.
Gervais, S., Heaton, J.B. and Odean, T., 2011. Overconfidence, compensation contracts, and capital
budgeting. The Journal of Finance. 66(5). pp.1735-1777.
Hope, J. and Fraser, R., 2013. Beyond budgeting: how managers can break free from the annual
performance trap. Harvard Business Press.
Joyce, P.G., 2011. The Obama Administration and PBB: Building on the Legacy of Federal
Performance-Informed Budgeting?. Public Administration Review. 71(3). pp.356-367.
Kilfoyle, E. and Richardson, A.J., 2011. Agency and structure in budgeting: thesis, antithesis and
synthesis. Critical Perspectives on Accounting. 22(2). pp.183-199.
Lee Jr, R.D., Johnson, R.W. and Joyce, P.G., 2012. Public budgeting systems. Jones & Bartlett
Publishers.
Libby, T. and Lindsay, R.M., 2010. Beyond budgeting or budgeting reconsidered? A survey of
North-American budgeting practice. Management Accounting Research. 21(1). pp.56-75.
Miller, P. and O’leary, T., 2007. Mediating instruments and making markets: Capital budgeting,
science and the economy. Accounting, organizations and society. 32(7). pp.701-734.
Moyer, R. C. and et.al., 2011. Contemporary financial management. Cengage Learning.
Phillips, L.D. and e Costa, C.A.B., 2007. Transparent prioritisation, budgeting and resource
allocation with multi-criteria decision analysis and decision conferencing. Annals of
Operations Research. 154(1). pp.51-68.
Sintomer, Y., Herzberg, C. and Röcke, A., 2008. Participatory budgeting in Europe: potentials and
challenges. International Journal of Urban and Regional Research. 32(1). pp.164-178.
Truong, G., Partington, G. and Peat, M., 2008. Cost-of-capital estimation and capital-budgeting
practice in Australia. Australian journal of management. 33(1). pp.95-121.
Wampler, B., 2010. Participatory budgeting in Brazil: Contestation, cooperation, and
accountability. Penn State Press.
Online
Business Finance. 2002. [online]. Available through <http://download.nos.org/srsec319/319-
17.pdf>. [Accessed on 29th December 2016].
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