Introduction to Finance (Distinction Criteria)

This report covers the calculation of financial ratios, monthly cash flow forecast, and investment appraisal techniques for Sassy Clothing. It includes the significance of considering users of financial statements, additional expenses, break-even point, margin of safety, and evaluation of investment strategies. The report evaluates the efficiency of prospective investment projects using payback period, net present value, and accounting rate of return.

Introduction to
Finance

Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................3
Question 1........................................................................................................................................3
1.Calculation of ratios for year 2019 and year 2018....................................................................3
2.Significance of taking the users of the financial statements into consideration when
analysing the financials................................................................................................................5
Question 2........................................................................................................................................6
1.The Opening financial position at the start of July 20X5.........................................................6
2.Monthly cash flow forecast.......................................................................................................6
3.Explain the various additional expenses which owners of the enterprise should consider for 8
Question 3 .......................................................................................................................................9
1. Figure out the Break even point (BEP) for years 2019 and 2020 both in units and in sales.. .9
2.Calculate Margin of safety (MOS) for years, 2019 and 2020.................................................11
3. Critically measure and evaluate the strategy developed by Jessica.......................................11
Question 4......................................................................................................................................13
1. Calculate the Pay back period, Net present value and Average rate of return for each
prospective investment project for the business and evaluate the one which is most efficient. 13
2. Determine the most efficient investment as per the computations presented above.............15
3. Discuss the various approaches to investment appraisal.......................................................16
CONCLUSION .............................................................................................................................18
REFERENCES..............................................................................................................................19

INTRODUCTION
Finance is defined to be the management of monetary resources and other related
activities which include investing borrowing, lending, budgeting, saving and forecasting. The
fiance related processes involve effective channelling of the financial funds of the business in
several forms such as credit, loans or the capital which is required for investing (Berrou,
Ciampoli and Marini, 2019). In this report, the financial statements along with the accounting
ratios of gross profit margin, assets usage, acid test ratio, inventories holding period, current ratio
and debt to equity ratio are computed in the report. The report also introduces the monthly cash
flow and cash budget of the enterprises which will assist in evaluating the financial strength and
positions of the business and computes and evaluates three different prospective investments that
are available and asses which one to opt for by using the different investment appraisal
techniques.
MAIN BODY
Question 1
1.Calculation of ratios for year 2019 and year 2018.
 Gross profit margin = ( Sales - Cost of goods sold ) * 100 / Sales
=(3495 – 2182 ) *100 / 3495
=(1313 / 3495 ) *100
= 37.5%
Interpretation- The gross profit margin ratio is computed by dividing the difference between the
revenue and cost of goods sold by the net revenue earned by the enterprise. It aids to analyse the
gross profit efficiency of the business organisation. The ideal ratio of gross profit margin is
between 50% to 70% whereas here the ratio is 37.5% which shows that the business lacks in
generating the ideal gross profit against the total revenue earned by business (Bhardwaj, 2018). It
is required that the company works upon increasing its revenues and decrease the cost of the
good sold in the business.
 Asset Usage Ratio= Total Sales / Average Total Assets
= 3495 / [( 3812 + 2503 ) / 2]
= 3495 / 3157.5

= 1.10 times
Interpretation- This ratio evaluate the efficiency of an enterprise to utilise its total assets to
generate the business revenue. The higher the ratio, better is the efficiency of the business in
generating sales against company's total assets and ideal ratio is 2.5 or higher (Dixon, Halperin
and Bilokon, 2020). Lower ratio suggests that the business is not utilising the assets of the
enterprise in an efficient manner and lacks effectiveness of its use. The asset usage ratio here is
1.10 times which is lower as compared to the ideal ratio and shows that the company fails to use
its assets efficiently and needs to utilise it more effectively.
 Current ratio = Current Assets / Current Liabilities
= 1687 / 744
= 2.27 times
Interpretation- The current ratio analyses he liquidity of a business enterprise. It assess the
capability of a business organisation to meet the short term obligations of the business and how
effectively the business utilise its current assets to meet all the short term current liabilities of
business. The ideal current ratio is 2:1 and in this case the current ratio of the business is 2.27:1
which is higher than the ideal ratio. This shows that the company is efficiently using all its
current assets to fulfill the current short term obligations of the company which are due within
one year.
 Acid Test Ratio = ( Current Assets – Stock ) / Current Liabilities
= (1687 – 150 ) / 744
= 1537 / 744
= 2.06 times
Interpretation- The acid test ratio is also termed as quick ratio and it analyses the ability of the
enterprise to fulfill all its short term obligations by utilising the quick assets of the business. The
quick assets are the ones which can be promptly converted into cash. It includes all current assets
excluding inventory (Erel and Liebersohn, 2022). The ideal acid test ratio is 1:1 and here the
ratio is 2.06:1 which is higher than the ideal ratio. This explains that the business has enough
quick assets to meet and fulfill all its short term liability obligations.
 Inventory Holding Period = ( Average Inventory / Cost of goods sold )*365
= [( 150 + 102 ) / 2 ] / 2182 * 365
= ( 126 / 2182 ) * 365

= 21.08 Days
Interpretation- The inventory holding period ratio displays the total number of days required for
which the business would hold all the inventory before turning that inventory into sales. It
depicts the number of days required to rotate the inventory in the company. The ideal inventory
holding period is somewhere between 30-60 days and here the ratio is almost 22 days. This
shows that business hold inventory for 21 days before it converts it into cash through business
revenue (Flögel, 2018).
 Debt to Equity Ratio = Total Debts / Total Equity
= 170 / 2898
= 0.058 times
Interpretation- This ratio interprets the amount of debt that the company has against the business
equity. It displays the relationship between the debt and the equity of a business enterprise.
Higher the debt to equity ratio, higher is the dependency of the business organisation on the
company debts and lower the ratio, lower is its dependency on company debts. The ideal debt to
equity ratio stands between 2-2.5 whereas here the D/E ratio is 0.058 which shows that the
business is dependent on its debts in very lower amount and hence has strong equity state.
2.Significance of taking the users of the financial statements into consideration when analysing
the financials.
The financial of a business organisation are of a great assistance when the business aims
to assess and evaluate the financial stability and financial position of an enterprise. This is done
through the different financials that are available which provide the internal insight of the
business to evaluate the business operations, company's profits, its cash flows and the state of
company assets and the liabilities it has. The financial statements are an authentic option which
gives the required information about the business relating to its revenues, expenses, profits,
company's debts and the profits being earned (Mora and et.al., 2019). With the help of different
statements present in the company financials, the operational and enterprise performance and
activity of the business is evaluated thoroughly which can be trusted as all the information
extracted is from the financial statements of the company solely. The financial statement mainly
concern with the Balance sheet, income statement, statement of cash flows, accounting ratios and
the statement of equity of the enterprise. The users of the financial statements are the people who
aim to utilise all the extracted information gained through evaluating theses financial statements.

The users of the financial statements are both external users as well as internal users. The
external users of the financials are the one which are of outside the business and the internal
users are the ones which work in the business and are directly linked to it. The external users are
the governments, tax authorities, investors, banks, suppliers and shareholders of the business.
The internal users of the financial statements are the company owners, business managers,
employees (Hirst, 2020).
Question 2
1.The Opening financial position at the start of July 20X5.
2.Monthly cash flow forecast.

The figures that have been predicted by Sassy Clothing depict that cash balance each
month has a negative balance every month. The sales revenue expected after 6 months tenure is
£1,175,000 but with analysis of cash budget it can be said that the expenditure incurred is higher
compared with sales in August, September, October, November. This lead to the requirement of
obtaining overdraft facility from the financial institutions such as banks (Inekwe, 2021). The
company also needs to amend its internal and external business performance to utilise all its
available resources effectively and obtain maximum operational efficiency. The company needs
to have rigt negotiations with bank managers pertaining to facility of short term loans, approving
of the credit limit desirable to the enterprise for realising benefit of getting loans in short time
durations and at low interest rates. This will surely assist the company to better their sales
revenues and balance the cash amounts with the organization every month. This will be primarily
done when the company achieves higher sales and incurs lesser cost expenses relating to its raw
materials, operational equipments.

3.Explain the various additional expenses which owners of the enterprise should consider for
The business enterprise needs to consider all such expenses which it has incurred during
the months of July top December with regards to the utility bills, operating expenses and supplier
payments. The facility of overdraft will definitely assist the enterprise to have an instant access
to additional cash resources. With this, the business will be able to deal with mismatches that
may occur in situations where the company faces the problem of cash unavailability for
continuing the operations of the enterprise (Mohsin and et.al., 2021). Therefore maintenance of
additional cash is a necessity to avoid occurrence of all such problems in normal business
operations. With effectively utilising the bank overdraft facility, the company will be able to
settle all the necessary enterprise payments and indispensable expenditures at right time avoiding
any extra costs or payment defaults.

Question 3
1. Figure out the Break even point (BEP) for years 2019 and 2020 both in units and in sales.
For 2020, Income statement of the enterprise Sassy Clothing will incur some alterations
and changes that are presented beneath:

2.Calculate Margin of safety (MOS) for years, 2019 and 2020.
3. Critically measure and evaluate the strategy developed by Jessica.
The two strategies presented are analysed and measured and it can be assessed that the
new strategy involved higher risk financially as compared to the other strategy available. The
break even point of the last strategy of year 2019 is 53541 whereas the break even of new
strategy is 53541 when computed in units (Lewin and Cachanosky, 2020). The margin of safety
(MOS) which represents the amount sales can fall ahead of the BEP is realised and the enterprise
makes no profit. The MOS in terms of sales as computed above of the strategy in 2019 is -
£665275 and of strategy in 2020 is -£26388550. The two strategies both display very low and
negative margin of safety displaying that although both re nowhere near to the safety margin but
the strategy formulated in year 2019 is better as compared to the new strategy of 2020. from such
analysis, it is advised that the business should apply some growth formula, effectively increase
the business revenues and work upon lowering the costs incurred in the process. Top obtain the

targeted additional sales growth, the company has already spent £1,450,000 on the fixed costs
which also adds up to the reason the enterprise is dealing with such higher costs and losses.

Question 4
1. Calculate the Pay back period, Net present value and Average rate of return for each
prospective investment project for the business and evaluate the one which is most
efficient.
1. Payback Period-

2. Net Present Value-
Net Present Value= [Cash Flows/ (1+ i)*t – Initial Investment]
 Investment A
Net Present Value= 194780- 175000 = 19780
 Investment B
Net Present Value= 193929- 195000 = -1071
 Investment C
Net Present Value= 182232 – 190000 = -7768
3. Accounting Rate of Return-
ARR= (Average Annual Profit / Average Initial Investment)* 100

Investment A
= (61000/90000)*100 = 67.77%
Investment B
= (59000/101500)*100 = 58.12%
Investment C
= (59600/97000)*100 = 64.44%
Working Note:
 Calculation of Average Cash Inflow= Total Cash Inflows/ Total number of years
Investment A
= (75000+65000+60000+55000+50000)/5
= 61000
Investment B
= (95000+65000+45000+45000+45000)/5
= 59000
Investment C
= (50000+60000+65000+66000+57000)/5
= 59600
 Calculation of Average Investment= (Initial Investment + Scrap Value)*2
For Investment A
= (175000+5000)/2 = 90000
For Investment B
= (195000+8000)/2 = 101500
For Investment C
= (190000+4000)/2 = 97000
2. Determine the most efficient investment as per the computations presented above.
With the help of all the respective calculations made above with respect to the three
prospective investments given above, it can be interpreted and analysed that the organisation
should prefer the Investment A over the other two investments that are available (Taghizadeh-
Hesary and Yoshino, 2019). This is due to the reason that with the computations made above
with all three investment appraisal techniques, Investment A stands to be the one which is the
most efficient and effectively profitable for the business. The reasons behind are primarily

because investment A provides the business with relatively higher returns as compared to the
other two prospective investments available to the company. The Payback period of the three
Investments A, B and C are 2.58 years, 2.77 years and 3.22 years respectively. This determines
that the Investment A requires the lowest time period to recover the initial cash outflow of the
investment project (Zhang, Zhang and Managi, 2019). When the net present value of the three
investment projects are compared, it is seen that Investment A has present value of 24150 with
Investment B having NPV of 5921 followed by Investment C with net present value of 4272. It
can be said that Investment A definitely has the highest present value of the cash inflows and
hence higher profits. By analysing the average rate of return of the prospective investment
projects, Investment A surely has the highest average return rate with 28.89% with other two
investments B and C having an ARR of 19.70% and 22.27% respectively.
3. Discuss the various approaches to investment appraisal.
Investment appraisal techniques
1. Payback Period- Payback period refers to the total number of years which are needed to
recover the original amount of the cash investment made. In other words, it is defined as
the total time period required at the end of which the investment will generate the
requisite sufficient net revenues which will cove the initial cash investment made on that
asset. Shorter the time of the payback period, more attractive is the investment made. The
higher the payback period, less desirable the investment is (Liu, 2020).
Advantage:
 The computation of this appraisal technique is very simple to calculate and interpret. The
results evaluated through this methods can be interpreted by the users of the data.
Disadvantage
 It doesn't takes into consideration the time value of money and doesn't considers the
changes which can take place in the monetary value with change in time.
2. Net Present Value- This refers to the difference between the present value of all the cash
inflows of the business and the present value of cash outflows of the business. The NPV
method of computing the profitability of the investments made is utilised to effective
analyse the profitability of the investments already made or prospective investments to be
made. When the net present value of an investment is positive, it shows that the rate of
return of the investment will be higher than the discounting rate.

Advantage:
 It considers the time value of the money and all the cash inflows of the project along with
the maximization of shareholders wealth.
Disadvantage
 The accuracy of this method is primarily dependent on the fact that how accurately the
business has computed and recorded the business cash flows.
3. Average Rate Of Return- The average rate of return of investment assists to display the
percentage rate of return which is expected on an investment or an asset an comparison
with the initial cost of the investment. It is utilised when the business has to evaluate
multiple projects due to the reason that it assists to provide the expected rate of return
from each project (Schelkle and Bohle, 2021).
Advantage
 It uses data that is available easily therefore does not requires any specific methods of
extracting data. It helps to evaluate the exact financial performance and viability of the
prospective investments therefore aids in picking impelling business conclusions.
Disadvantage
 This technique calculates the profitability of prospective investments as per the net profits
of the projects and not based on the cash inflows rendered by the enterprise.

CONCLUSION
From the report prepared above, it can be concluded that the computation of ratios which
have been presented in the report will help the Liverton co. in effectively analysing and assessing
the financial statements and its position with the help of the accounting ratios of the business
enterprise. The report also assists the company to evaluate and determine the most efficient
source of financial funding which they can utilise to fund the operations of the enterprise and use
them effectively. This report includes conclusion made with respect to the enterprise of Sassy
Clothing as the cash budget of the business to help them evaluate all business cash receipts and
expenditures for a specified time which will then assist to attain the overdraft facility from a
bank. It also involves the Break-even Point and the Margin of safety of the company Free Air
Ltd for last two years 2019 and 2020 respectively. This measured the business revenues at a
point where the business has no profit and no loss along with a safety margin of revenue. The
last part includes conclusions made for different investment appraisal methods and investment
decisions to help evaluate three investment options available with Scrappit plc. and choose the
best one.

REFERENCES
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