Payback Period Analysis

This assignment focuses on the payback period, a financial metric used to evaluate the profitability and risk of an investment. The document provides information about how to calculate the payback period, its strengths and weaknesses as a decision-making tool, and relevant examples. It delves into the concept's application in investment appraisal, emphasizing its role in assessing the time it takes for an investment to recover its initial cost. Additionally, the assignment touches upon other financial metrics used alongside payback period for comprehensive investment analysis.

FINANCE FOR MANAGERS

Finance for managers
Table of Contents
INTRODUCTION...........................................................................................................................1
TASK 1............................................................................................................................................1
1.1 Purpose and need of financial records..............................................................................1
1.2 Methods to record financial data and information...........................................................1
1.3 Analysing need of financial recording in terms of legal and organisation.......................2
1.4 Use of financial statements for stakeholders....................................................................3
1.5 Difference among financial and management accounting...............................................3
1.6 Explanation of process of budgetary control....................................................................4
1.7 Evaluating several kinds of costing techniques................................................................6
TASK 2............................................................................................................................................7
2.1 Calculation as well as interpretation of variances............................................................7
TASK 3............................................................................................................................................8
3.1 Key techniques of project appraisal.................................................................................8
3.2 Evaluation of project appraisal methods........................................................................11
3.3 Ways to obtain fund for business project.......................................................................12
3.4 Elements of working capital (WC).................................................................................13
3.5 Ways to manage working capital effectively.................................................................14
CONCLUSION..............................................................................................................................14
REFERENCES..............................................................................................................................16

Finance for managers
INTRODUCTION
Finance is very important concept of each and every business organisation in order to
exist, run and produce goods within market. Due to this, it is highly necessary for the managers
to have knowledge about basic financial aspect by which they able to manage financial resources
effectively. The present project divides into four parts where first part focuses on methods as
well as requirements in order to keep records of various financial transactions and reporting
them. In the second part, key elements of the working capital along with methods for managing
them effectually are explained. Third part of the report shows about different kinds of
management accounting tools and techniques along with making difference with the financial
accounting. At the end of project, explanation regarding to the appraisal methods and financing
sources is provided.
TASK 1
1.1 Purpose and need of financial records
Very basic need to record all the financial transactions is to determine about financial
health of the company and assess that whether it is profitable or not. The firm records the
financial data in order to know that total cost of production within small business of Malta is
whether enhancing or reducing and on the basis of that further decisions can be made properly.
Value of net profit is also derived through recording financial data which supports the small
business to take generally two financing decisions like dividend and investment. In case, firm
generates more profit, then it will take decision to invest money in several avenues and purchase
business equipments (Cotter, Tarca and Wee, 2012). Along with this, higher net profit leads to
provide more amount of dividend to existing and potential both shareholders. Another
requirement to make record of financial transactions is to compare financial performance of the
small business with previous years and rivals.
1.2 Methods to record financial data and information
When the management is going to record various financial data then different methods
are used which are such as follows: Income statement- In this method mainly three types of financial information are
recorded which are like revenue or net sales, incomes and expenses. It supports to the
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small business in order to assess three kinds of profit at the fiscal year ending which are
such as gross, operating and net income. Balance sheet- Another technique to record financial information is balance sheet under
which majorly two kinds of data involved which are like assets and liabilities. Under both
the sections current and non-current assets and liabilities included which provide liquidity
position to the small business at the end of year (Otley and Emmanuel, 2013).
 Cash flow- The method under which cash receipts as well as outflows both are recorded
which depict framework of net cash position to the management. For assessing cash
balance of every month end such method is one of the best to recording financial data.
In order to record such all the financial transactions in above stated statements there are
some small reports are prepared. After completing the reporting system of accounting final
accounts of the firm are to be prepared. Moreover, the different reports include inventory,
payroll, receivables ageing, cost sheet, sales, production, expenses etc. In addition to this, for
making such all the treatments in books of account accounting standards, theories, principles etc.
used which come under IAS and IFRS.
1.3 Analysing need of financial recording in terms of legal and organisation
The small business organisation requires financial recording system to assess business
performance and take several financing decisions within workplace. At the time of framing profit
and loss account, it is mandatory to follow the tax rate which is charged by the government of
Malta. If taxation rules along with applicable rate are not used in the small business while
preparing income statement then not considered in the legal manner. Further, accounting
principles like prudence, consistency etc. and standards framed by International Financial
Reporting Standards (IFRS) are needs to use by small business. Apart from this, those principles,
accounting theories and standards considered while preparing financial accounts are mandatory
to show at the end of all the statements by following legal rules. When looking at the reporting
aspect then small business record all the financial transactions with the help of international
standards and theories. The reason for using international methods is that, across the world any
person or firm can analyse overall financials of the small entity. Use of IAS which known for
international accounting standards at the time of making accounting treatments is highly
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necessary in legal manner. The reason is that every company can assess business valuation and
financial performance at the end of an accounting period.
1.4 Use of financial statements for stakeholders
Stakeholders like employees, customers, suppliers, investors, government etc. use
financial statements of the firm while making decisions relating to it. Very basic requirement of
the financial accounts is to assess the profitable and liquid position of the company which
currently operates in Malta and on the basis of that different decisions are taken. When enterprise
generates more profit in the books of account then investors will put money into it and purchase
more shares (The purpose of financial statements, 2012). When talking about the suppliers then
they take decision to provide raw materials consistently by considering such position of it.
Moreover, as profitability and liquidity of the small business is higher, then employees will
attract towards it because it leads to provide more salary and other monetary benefits.
The banks also require statements related to financials of the company which are useful at
the time of providing loan or capital. When the small business goes to raise capital through
particular financing source i.e. bank loan then bank firstly determine business valuation. Along
with this, liquidity position, profitability etc. of the firm is mandatory consider while providing
the loan. Hence, it can be said that bank needs financial statements of the firm for various
purposes.
When talking about the public companies then they usually go for merger and acquisition
of those small firms which are generating higher revenue or profit. Such kinds of businesses
when going to acquire small firm then analyse profitability of past years along with the
appropriate value of overall business. In order to determine these all the values and terms of
financial they needed statements which are relied under the financials.
1.5 Difference among financial and management accounting
Financial Accounting Management Accounting
Financial accounting basically focuses on
financial statements that are allocated to
stakeholders, borrowers, financial analysts and
Management accounting basically focuses on
within the company operations, like providing
information and instructing internal stakeholders
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external stakeholders of company. in order to achieve goals within time.
This helps in maintaining balance sheet,
statement for cash flows, income statement and
also statement related to changes in equity.
This helps in calculating production costs and
supports to the firm for deriving pricing
decisions.
It deals with external stakeholders of company
like financial institutions, stockholders, investors
and these all are considered as audience for
financial accounting reports (Otley, 2016).
It deals with internal stakeholders of company
like; manager needs to make decisions on daily
operations of company.
It is a long term process as it needs one time
decision making.
It is a short term process because in this manager
needs to change strategies according to
fluctuating environment.
Auditing is mandatory required in this. In this it is not mandatory required to use
auditing process.
It must follows Generally Accepted Accounting
Principles (GAAP) and International Financial
Reporting Standards (IFRS) and prescribed
formats.
It is not bounded by outside company rules and
regulations.
1.6 Explanation of process of budgetary control
Budget is a statement in which two data of the financial are predetermined for the next
accounting period which are cash inflows and outflows. When the company considers the budget
then able to derive that up to which extent it will be able to generate amount or sales at the end of
year. Along with this;, level of expenses are also easily determined in the present era for the
upcoming fiscal period. It includes different kinds of statements in which type of values also
differ. Further, various budgets involve sales, cash, labour overhead, material purchase,
production etc. After using these all the budget statements, the management of selected small
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business capable to boost up business performance in the future accounting periods. Process of
Budgetary Control Involves various steps which are described as below:
 Revenue Projections: This is based on past projected growth income and financial
performance of the small business which operates in Malta. The projected growth is
connected with planned initiatives which will help business in growing. Further, at the
time of preparing budget of small business, it is identified initially that, revenue will be
up to which level generated. With the help of projecting or predetermining sales for the
next year, management go for further stages.
 Cost Projections: This involves both the cost that is fixed and variable cost. Fixed cost
doest not change and should be involved in budget like utility costs, facility expenses,
mortgage or rent payments, insurance etc. While variable cost keeps on fluctuating and
should be controlled in budget like supply costs, overtime cost etc. Moreover, in the
second step, such both kinds of the expenses estimated for the small business for
upcoming year. After projections of the sales and revenue, cost as well as total expenses
which will be incurred are estimated by the managers of small business.
 Profit Margin: Every company should have profit margins because it will help
management in making further investments, improving facilities and also it shows
strength of organisation (Elhamma and Taouab, 2015). In the cited small business firm, if
margin of the income generated is in the positive or favourable condition then helps to
control on the budgets. Due to this, the small entity will able to meet with the budgeted
values. By considering above projections of both the values like cost and revenue, level
of profit is to be predetermined at this current stage.
 Board Approval: The president or head of the organisation provides approval of budget
who will also keep report of budget performance, will be familiar with expenses. Once
above stated all the steps completed in the small business then presented to the authorised
managers. The reason for present in front of them is to take approval for further process.
The estimated values and profit is known as raw budget which is presented in front of
authorised manager for taking approval.
 Budget Review: Committee sets for keeping a check over budget, review budget
performance against goals & will also make changes if needed in any case of
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overspending or wastage. In this last stage of budgetary control, reviews are taken that
whether it is going on track and as per the estimated. It is the position, where small
business able to make changes in budget after considering the evaluation. At this specific
step, budget is evaluated that whether any problem or issue is remained or not. After
completion of reviewing procedure it is implemented within workplace of small business.
 Dealing with Budget Variances: In case of variance in actual budget and planned
budget, responsible department manager is answerable for changes. At the end, both
actual data generated and estimated data of the budget are compared. Further, outcome of
both the values is considered as the budget variance. At the last and after completion of
next year, estimated data are compared with the actual generated facts and figures.
1.7 Evaluating several kinds of costing techniques
In the cost accounting, various number of methods are available which helps to the small
business in order to derive net profit and then make pricing decisions. The methods are such as
standard, marginal, historical, absorption etc. among them two are widely used which described
as below: Marginal costing- In this type of costing method only two types of costs used by
manager which are such as direct and variables. Such technique does not involve any
kind of fixed expenses at the time of making calculation of net profit. Moreover, by
considering the final outcome company take decision for charging prices of products and
services (Pope, 2010). Apart from this, when the small business enterprise considers
marginal costing method, then not able to cover all the expenses incurred at the
workplace. Moreover, all the fixed costs will be paid by the small firm from revenue
generated at the price of marginal method. Therefore, level of net profit at the end of year
will be lower in the industry. Absorption costing- Other costing method is absorption which involves full and all
expenses associated with the small business and then determine profit. On the basis of the
respective tool actual business performance is assessed which supports to make effective
pricing decisions to sales products and services in market. When comparing to the
marginal method, then it is profitable for the small business. The reason is that,
absorption method helps to the firm in order to cover all the costs or expenditures
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incurred at the workplace. Henceforth, net profit and business performance will be higher
in this situation as compare to marginal costing. Standard costing: Method of costing in which expense level is estimated before
completion of the production process is known as standard costing. Base of
predetermining expenditures is standards which are mentioned in the situations of
operation department. In this costing is considered as outdated in which chances of
incurring losses are there. Further, in order to avoid the loss standard expenses are to be
compared with the actual data within specific period.
 Historical costing: This technique of costing is totally opposite from the above explained
standard costing, under this, once total expenses incurred within workplace then used for
determining pricing level. Moreover, chances of incurring profit are high in the historical
method of costing.
TASK 2
2.1 Calculation as well as interpretation of variances
Variance is one of the best tool to measure business performance in which two data are
used which are budgeted or standard and actual. Difference of such both the values is considered
to make interpretation of business performance. Further, calculation as well as interpretation of
variances is such as follows:
Particulars Budgeted data Actual data Variance
Output units 1000 1100 100 (Favourable)
Sales revenue 62000 69900 7900 (Favourable)
Direct labour 22000 24420 -2420 (Adverse)
Direct materials 20000 23260 -3260 (Adverse)
Fixed overheads 6000 6400 -400 (Adverse)
Profit 14000 15820 1820 (Favourable)
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Interpretation
It can be interpreted from above mentioned variance analysis is that; output units are in
the favourable condition with the 100 units. The firm predetermined that at the end of year 1000
units must be produce but instead of that it manufactures 1100 units with same raw materials
which are profitable for it. When looking at the sales and revenue digits then it can be found that
it generates 7900 GBP more amounts compare to budget. Because of this it can be said that
management utilise resources in optimum ways and reduce total costs (Elhamma, 2015). Along
with this, profit variance is also favourable for the entity in which it generates 1820 GBP more.
In the budget it determined that 14000 GBP profit required to generate where actual value comes
at 15820 GBP which is highly beneficial for it.
Apart from this, all the expense variances are in the adverse situation which shows that
management not able to control on costing aspect. Direct labour and materials variance in the
current case are -2420 GBP and -3260 GBP respectively which both are at the adverse condition.
When talking about the fixed overhead expenses variance then also it is in unfavourable situation
where value of variance is worth of -400 GBP.
TASK 3
3.1 Key techniques of project appraisal
Accounting rate of return (ARR)-
Formula of ARR = Total profit / Average investment * 100
Years Profit of project 1 (in €) Profit of project 2 (in €)
Cost or initial investment -200000 -120000
Year 1 58000 36000
Year 2 2000 4000
Year 3 4000 8000
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Scrape value 14000 12000
Total profit 64000 48000
Average investment 107000 66000
ARR
= 64000 / 107000 * 100
59.81%
= 48000 / 66000 * 100
72.73%
Payback period-
Years
Cash flow of
project 1 (in €)
Cumulative
cash flow of
project 1
Cash flow of
project 2 (in €)
Cumulative
cash flow of
project 2
Cost or initial
investment -200000 -120000
Year 1 120000 120000 72000 72000
Year 2 64000 184000 40000 112000
Year 3 66000 250000 44000 156000
Payback
period 2.9 years 2.1 years
Net present value (NPV) for Project 1-
Cost or initial
investment
200000 Depreciation Cash flow of
project 1 (in
Discounting
factor @ 10%
Present value
of project 1
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€) (in €)
Year 1 58000 62000 120000 0.909 109091
Year 2 2000 62000 64000 0.826 52893
Year 3 4000 62000 66000 0.751 49587
Scrape value 14000 14000 0.751 10518
Total 222089
Less initial
cost 200000
NPV €22089
Net present value (NPV) for Project 2-
Cost or initial
investment 120000 Depreciation
Cash flow of
project 2 (in
€)
Discounting
factor @ 10%
Present value
of project 2
(in €)
Year 1 36000 36000 72000 0.909 65455
Year 2 4000 36000 40000 0.826 33058
Year 3 8000 36000 44000 0.751 33058
Scrape value 12000 12000 0.751 9016
Total 140586
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Less:initial
cost 120000
NPV €20586
IRR of Project 1:
Cost or initial
investment
Cash flow of
project 1 (in
€)
Discounting
factor @10%
Present value
of project 1
(in €) @ 10%
Discounting
factor @12%
Present value
of project 1
(in €) @ 12%
Year 1 120000 0.909 109091 0.893 107143
Year 2 64000 0.826 52893 0.797 51020
Year 3 66000 0.751 49587 0.712 46977
Scrape value 14000 0.751 10518 0.712 9965
Total 222089 215106
Less:initial
cost 200000 200000
NPV @ 10% 22089 @ 12% 15106
IRR: 10% + (22089 / 22089 – 15106) * 12%-10%
= 10% + 3.16 * 2%
= 10% + 6.32%
IRR OF Project 1 = 16.32%
IRR of Project 2:
Cost or initial
investment
Cash flow of
project 2 (in
Discounting
factor @10%
Present value
of project 2
Discounting
factor @12%
Present value
of project 2
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€) (in €) @ 10% (in €) @ 12%
Year 1 72000 0.909 65455 0.893 64286
Year 2 40000 0.826 33058 0.797 31888
Year 3 44000 0.751 33058 0.712 31318
Scrape value 12000 0.751 9016 0.712 8541
Total 140586 136033
Less:initial
cost 120000 120000
NPV @ 10% 20586 @ 12% 16033
IRR: 10% + (20586 / 20586 – 16033) * 12%-10%
= 10% + 4.52 * 2%
= 10% + 9.04%
IRR of Project 2 = 19.04%
By looking at all the tools of project appraisal it can be said that, project 1 is beneficial in
terms of NPV where amount is worth of €22089 which is lower than project 2. Along with this,
as per the IRR, payback and ARR the project 2 is more profitable in which values are such as
19.04%, 2.1 years and 72.73% respectively. Hence, it can be said that project 2 is viable and
highly profitable at the end of 3 years in comparison to project 1.
3.2 Evaluation of project appraisal methods
NPV:
Very basic benefit of this tool is that, while making calculation it includes all the
components associated with a project like number of years, cost of capital, cash flows of every
period, time value of money etc. Further, NPV gives clear framework and provide better
decisions to the management in order to undertake one project.
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However, cost of capital remains same in every year but in case situation of inflation or
recession arise in the market then project cannot provide computed present value at the end of
project completion (Götze, Northcott and Schuster, 2015).
IRR:
One of the most important things of IRR is that it always undertakes time value of money
and cash flow of each and every project year to measure internal return of the investment
amount. It is very simple and easy method compares to other all the tools of project appraisal.
In contrary, it is typical to understand as well as assumptions made in IRR are unrealistic
by which better value cannot determine. Moreover, IRR is not supportive to compare two or
more projects which are mutually exclusive.
Payback period:
It supports to the manager in order to measure level of risk and able to give rank to all the
projects. It is one of the best tools to make decisions of undertaking a project within firm (Harris,
2017).
However, at the time of computing payback years, it does not include cash flows of all
the years of project by which effective time cannot calculate.
ARR:
Benefit of this method is that, it shows average return of the initial investment at the end
of completing a project. Along with this, it is very easy to calculate and simple to interpret as
well as provides profitability of the cost of project.
In opposite to benefits, it does not involve time value of the money as well as cash flow
of the investment or project. In addition to this, not use terminal value of the initial cost
(Leviäkangas and Michaelides, 2014).
3.3 Ways to obtain fund for business project
When the small business entity is going to undertake new project then it requires fund
which can be obtained or raised from several sources. Further, such kinds of sources which allow
to the small business to raise capital are explained below:
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 Equity shares- Mostly used external source is equity shares under which firm issues
shares in the market with the help of stock market. The issued shares by the small
business are purchased by the stakeholders and whatever amount comes is used as capital
of the project. Financing cost of such source is dividend amount which given from net
profit.
 Bank loan- Other source is bank loan where small business approach to the bank and
take money from it which is used by firms at majority level (Allen and Faff, 2012).
Behind raising fund management of the small business has to give interest amount to the
bank which is cost of finance.
 Retained earnings- It is one kind of internal financing source where amount which
remains after deducting all the costs and dividend amount is used. Sum of money which
remains from net profit within workplace after allowing dividend to shareholders is
considered as retained earnings. Hence, it can be said that, higher the retained earnings is
taken into account for undertaking the project in the small business .
3.4 Elements of working capital (WC)
Working capital is determined by making difference between current assets and current
liabilities available within workplace. Some of important components of the working capital are
such as follows:
Cash- It is one of the major components of the working capital which supports to determine
value of WC of an entity. There is no need to convert this into cash because as the name
represents that it is already in the liquid position. Moreover, effective management of cash
position is utmost significant within Evert company (Shenoy, 2015).
Marketable securities- In this, shares or stock which are available of the firm in market are
included. When company not having liquid position then use such component due to having
nature of easily cash convertible. Hence, these act in firm as the substitute of liquid as well as
used as non fixed investment.
Accounts Receivables- Another basic factor of working capital is accounts receivables which
generated within firm from debtors and credit sales. At the initial when firm sale products and
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services on credit in higher quantity, then receivables amount also high. It considers as the
current assets of the firm because up to some extent it easily converts in cash position.
Inventory- It considers in the books of balance sheet as current assets which can be easily
converts into cash form (Pope, 2010). Due to this kind of reasons, it taken into account in the
working capital. Moreover, it is highly necessary to manage and optimum utilisation of stock
level to improve WC of the firm.
3.5 Ways to manage working capital effectively
There are different techniques which support to the manager in order to manage and
improve WC which are stated below:
 By reducing level of stock of several items the firm able to manage WC and enhance its
performance within industry.
 Firm should shift burden of carrying cost of stock towards suppliers which lead to
manage such capital at the workplace (Mitchell, 2013.).
 Along with this, it is necessary to record all the cash transactions properly for managing
WC.
 The management needs to allow several discounts and schemes to customers carefully.
 With the help of securing credit terms as well reducing the sales on credit an enterprise
able to maximise the WC effectively.
 In addition to this, manager needs to frame effective strategies for optimum utilisation of
stock to generate sales. Due to this cash positions improves and lead to enhance WC in
fruitful ways.
CONCLUSION
It can be articulated from the current study that, through financial recording the firm able
to determine business performance in form of profit, cost and other financial values in proper
way. It helps to take decisions of business in proper and fruitful ways. As per the variance
analysis it can be said that, firm is in favourable condition in terms of output, revenue generation
and profit. Further, in accordance to all the costs and expenditures it is in adverse situation. It can
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be concluded on the basis of project appraisal methods that project 2 is beneficial compare to
project 1 because it provides profitable value in terms of IRR, ARR and payback period.
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REFERENCES
Journals and Books
Allen, D. and Faff, R., 2012. The Global Financial Crisis: some attributes and responses.
Accounting & Finance. 52(1). pp.1-7.
Cotter, J., Tarca, A. and Wee, M., 2012. IFRS adoption and analysts’ earnings forecasts:
Australian evidence. Accounting & Finance. 52(2). pp.395-419.
Elhamma, A. and Taouab, O., 2015. Budgetary evaluation, environmental uncertainty and
performance: case of Moroccan firms. American Journal of Service Science and
Management. 2(1). pp. 1.
Elhamma, A., 2015. The relationship between budgetary evaluation, firm size and performance.
Journal of Management Development. 34(8). pp. 973-986.
Götze, U., Northcott, D. and Schuster, P., 2015. Investment appraisal: methods and models.
Springer.
Harris, E., 2017. Strategic project risk appraisal and management. Routledge.
Leviäkangas, P. and Michaelides, S., 2014. Transport system management under extreme
weather risks: views to project appraisal, asset value protection and risk-aware system
management. Natural hazards. 72(1). pp. 263-286.
Otley, D. and Emmanuel, K. M. C., 2013. Readings in accounting for management control.
Springer.
Otley, D., 2016. The contingency theory of management accounting and control: 1980–2014.
Management accounting research. 31. pp. 45-62.
Pope, P. F., 2010. Bridging the gap between accounting and finance. The British Accounting
Review. 42(2). pp.88-102.
Online
Mitchell, M., 2013. How to manage working capital. [Online]. Available through:
<http://startups.co.uk/how-to-manage-working-capital/> [Accessed on 17th June 2017].
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