Approaches to Budget Production for Financial Constraints and Organizational Targets
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This document discusses different approaches to budget production, including the input/output approach, activity-based approach, and incremental budget. It also highlights the issues raised regarding cash flows and legal requirements in the budget.
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FINANCE FOR MANAGERS
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TABLE OF CONTENTS INTRODUCTION..........................................................................................................................1 TASK 1............................................................................................................................................1 TASK 2............................................................................................................................................2 Ratio analysis of Unilever plc......................................................................................................2 TASK 3............................................................................................................................................5 Approaches to production of budget with reference to financial constraints, achievement of the organisational targets, accounting conventions and the legal requirements................................5 TASK 4...........................................................................................................................................6 TASK 5 600.....................................................................................................................................8 REFERENCES..............................................................................................................................10
EXECUTIVE SUMMARY Financial management could be described as function or area in organisation that is concerned with the profits, expenses andfunds so that organisation have required resources for meeting the goals and objectives. The report reveals about the different financial information that is available for users to analyse the performance and position of organisation. The financial information has to be analysed from different sources before establishing trading relationship or making investments. Ratio analysis is an effective tool which is used by the investors and management for assessing profitability, efficiency and liquidity of company. Ratio analysis of Unilever plc has been done for identifying strengths and weaknesses of the organisational processes. Budget which is an important planning tool plays an important role in company. The different approaches enable the company to assess the issues and make allocation of resources accordingly. Report has analysed the budget and provided alternate actions that could be taken by organisation. At the last investment appraisal techniques have been used for analysing the viability of investments before making capital expenditures. TASK 1 Main sources of data available inside and outside of organisation and use of information for reviewing the financial performance. Financial analysis could be defined as the process used for measuring results of the policies and operations of the management. Internal as well as external users could analyse the financial health of the organisation over a period of time. Main sources of data of the organisation There are different sources of data that are used for reviewing financial performance are: Income Statement It is the main source of financial information providing summarised information about the company incomes and expenditures. Users could identify the returns and different costs of the organisation to know the areas from company is earning and also making the spendings. It couldbeevaluatedwhetherthepoliciesandstrategiesofthemanagementareworking effectively for earning profits. It is essential as the if company is not earning adequate profits it represents in inefficient and it will not be able to provide adequate returns. Balance Sheet 1
It provides information about the financial status and wealth of the enterprise. Areas such as capital structure, liquidity and efficiency of the management could be identified using the statement. The in depth analysis of the balance sheet is performed to identify the investments, equity and the obligations of the enterprise (Lin,Hsiao and Yeh,2017). It is also used for assessing the financial risks associated with the company. Different situations in which financial information is used. Entering into trading relationship Before entering into trading relationship, firms have to analyse the cash flow statement and balance sheet to identify the liquidity position and to know the financial obligations. Management has to identify whether the other party will be able to make payments timely for the supplies. If it is having inadequate cash flows or high financial obligation trding with such party could be riskier. However the actual performance and the reasons for the outstanding obligations could not be identified from these statements clearly. Investment decisions Formaking investments in any enterprise it is essential for the investors to assess the performance and position of the enterprise. From the income statement and balance investors assess the returns over equity, capital employed, net profits and return over capital employed for evaluating the performance and management efficiency. It provides whether adequate returns will be earned by making the investments or not. Acquisitions or mergers In the current scenarios mergers and acquisitions are on the top trends through which companies are expanding or growing. It involves considerable amount of investment of the company therefore management has to analyse the target company performance and position using the financial statements of past years. They analyse the profitability of the firms using income statement, liquidity and stakeholders of the firm from balance sheet (Lee and Tweedie, 2020). Also the information about the share prices could be analysed from securities exchange. However the information about internal management efficiency and internal controls could not be identified. TASK 2 Ratio analysis of Unilever plc UNILEVER PLC 2
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ParticularsFormula20192018 Profitability Ratios Return on capital employed Net operating profit/Employed Capital18.91%23.90% Employed Capital Total assets – Current liabilities4382840961 (64806-20978)(61111-20150) Net Income82899788 Return on Equity Net Income / Shareholder's Equity59.69%80.78% Net Income82899788 Shareholder's Equity1388612117 Gross profit margin Total Sales – COGS/Total Sales44.01%43.57% COS2910228769 Sales5198050982 Net profit margin Operating Income/ Net Sales27.69%32.38% Net Income82899788 Revenues29929.9930225.68 Assets TurnoverSales / Net assets374.33%420.75% Sales5198050982 Net assets1388612117 Liquidity Ratios Current assets1643015478 Current liabilities2097820150 Inventory41644301 Quick assets1226611177 Current ratio Current assets / current liabilities0.780.77 Quick ratio Current assets - (stock + prepaid expenses)0.580.55 Efficiency Ratios Inventory41644301 Trade Receivables66956482 3
Trade Payables00 Days365365 COS2910228769 Sales5198050982 Inventory daysInventory/COS*36552.22554.568 Debtor daysDebtor/ Sales*36547.0146.41 Creditor daysCreditor / Sales*3650.000.00 Gearing Ratio Long-term debt2356623125 Shareholder's equity + debt3745235242 Gearing Ratio0.630.66 Ratio analysis is an important tool used for analysing the performance and position of the enterprise. It is not possible to analyse the internal performance and position from the direct figures provided in financial statements (Duan and et.al., 2018). Ratio analysis helps the users to analyse profitability, liquidity, efficiency and capital structure of the entity. Gross Profit Margin Gross profit ratio helps to assess the efficiency of companyin generating returns managing the direct costs and expenditures. Company had gross profit of 44.01% in 2019 where it was 43.57% last year. It has shown slight increase in the ratio representing new policies and strategies are working effectively. Net Profit Margin It represents the profits earned by the company as against the sales. The net profit margin of company in 2019 showed 27.69% return where last year it was 32.28%. It has declined from last year due to increasing costs in proportion to the sales (Williams and Dobelman,2017). It could be seen that profitability of company has declined from last year however it has to control falling margin as profit margin is strength of company. Asset Turnover Ratio The ratio is used for assessing management efficiency in generating sales against the assets. It could be seen that turnover of company is significantly high against the sales. The ratio of company has declined from 420.75% to 374.33% in 2019 which shows existing strategies are 4
not effective and management is required to take actions for increasing turnover. However as per the industry trends asset turnover is high which is strength of management. Current Ratio The ability of company in meeting the short term obligations is assessed using current ratio. Current ratio is 0.78 in 2019 where it was 0.77 in 2018. It could be analysed that current ratio is below 1 which means it will not be meet the short term liabilities from the current assets. The liquidity position is significantly lower that could lead the company to borrow high loans to meet working capital requirements. Gearing Ratio Company is having gearing ratio of 0.63 in 2019 which represents company is having 63% of debt in total capital structure which is higher. Company needs to control the increasing debt by taking corrective measures to reduce the financial risks. Debtor Days Debtor days of company are adequate at 47 days which shows that collection from the debtors is made quickly for managing the cash cycle (Monahan, 2018). The management is efficient in managing the operating cycle for meeting the working capital requirements. It could be analysed that company has highly adequate profitability, efficiency ratios are also adequate however the liquidity position is very weak that could impact the long term growth of business if not fixed on immediate basis. Limitations of ratio analysis are that it only uses quantitative data and does not consider qualitative aspects that are influencing the organisation. TASK 3 Approaches to production of budget with reference to financial constraints, achievement of the organisational targets, accounting conventions and the legal requirements. Financial plan of the company is known as the budget. It is an effective tool used by the organisationsforplanningandcontrolling.Budgetispreparedintheplanningstageby management for properly allocating the resources after analysing the previous budgets and trends that will best meet the goals and objectives. Management have different approaches to budget considering different factors. Unilever uses the below stated production approaches for preparing budgets to effectively all the requirements of the budgets including meeting organisational targets, meeting the legal requirements and accounting conventions. 5
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Input/Output Approach The approach is used for budgeting physical costs and inputs as function of the planned activities at unit level. The approach is also used for merchandising, service, distribution and manufacturingactivitieswhicharehavingdefinedrelationshipbetweeneffortsand accomplishment. Budget inputs are function of planned output (Das and Pandit,2020). The approach starts with planned output and work backward to budget inputs. Drawback of approach is that there is difficulty in using approach for the costs not responding to the changes in the unit level drivers of cost. The method is used by Unilever in distribution activities by analysing the supplies and demand of the previous years and of different regions. Activity Based Approach It is similar to input/output method but reduces distortion in transformation by emphasis on expected costs planned activities that are consumed for the processes, products, services or budget objective. Amount of every activity cost driver which is used by budget objective is multiplied and determined by cost per unit of activity cost drivers like assembly line set-ups or inspections. The approach is used by Unilever for estimating cost of products and services based over cost drivers. It also sometimes uses traditional volume based drivers like like labour hours or direct material consumption (Karaömer and Özbirecikli,2019).Company is performing number of activities and operations and activity based budgeting plays critical role in allocating the resources of organisation. Incremental Budget It costs for coming period as pound change or percentage change from amount budgeted for the previous period. The approach is used often when relationship between the outputs and inputs are non-existent or weak. For instance, when it is difficult for Unilever to setup clear relationbetweenthesalesandadvertisingexpenses.Consequentlybudgetamountfor advertisement in future period is based over actual or budgeted expenses in previous period. Suppose expenditure for last year were 20000 the budgeted expense for next year will be with some increment percentage. Management will take 20000 as base and pay attention over justifying the increment. The approach is used where there is no or very slight fluctuations in the items from previous year (Talmon and Faliszewski, 2019). However the approach considers all the expenditures and items such as taxes or other expenditures and also helps company in tracking the variances between budgeted and actuals outcomes. 6
TASK 4 Discussing issues raised regarding the cash flows and legal requirements Budget refers to spending plan of the organisation that is prepared for allocating the resources of organisation. Budgets are prepared using the previous budgets and evaluating the current trends and other adjustments of organisations. The given budget shows increasing sales trends from January to June and it has raised loan of 4000 for the business. Total receipts are highest in month of January. The cash outflows are for material purchases showing increasing trend, wages are showing declining trend though the sales are increasing. It is making fixed cost and payment for lease on new building monthly of 200. It had made expenditures on advertising in four months only. The corporation tax has been provided by the company only in June at the year end. Company has also made capital expenditure of 2750 in March for purchasing new equipment. The loan repayments are started from April where the loan was availed in January. The budget shows that company had negative balance throughout the budget except in January when company availed loan (Chohan, 2019). The closing bank balance of the budget has shown constantly declining trend. It could be analysed that the that the management has not efficiently allocated the resources and expenditures due to which the cash budget is showing declining tren even after the increase in sales receipts. Issues in the budget Company is having negative cash flows throughout the budget and negative closing balance in May and June. Negative cash balance could affect the business significantly as company would not be able to run the operations of business without having adequate cash flows. The payment for capital expenditure is made by single payment that has affected the budget. Courses of action that company could take for overcoming the issues Main motive of company is to have adequate positive cash flows for running the operations of business. 1) Company could make partial payments for the materials like 50% in current month and remaining 50% in next month this would have allowed the company to have time for collecting the dues for making payments. 2) The capital expenditure payment could be made in two months by negotiating with the vendor (Ostaev and et.al., 2019). It will help company in reducing the burden of tax in single month. 7
3) It could reduce the advertisement expenditure for continuous month and can make expenses in alternate months in February and April for reducing the negative cash balance. The below budget shows the manner in which company could adjust the budgets for reducing the negative balance. Task 4 exercise:JanFebMarchAprilMayJune Receipts:£0.00£0.00£0.00£0.00£0.00£0.00 Sales Receipts211021562164221922842444 Proceeds from Loan4000 Total Receipts611021562164221922842444 Payments:£0.00£0.00£0.00£0.00£0.00£0.00 Material Purchases359366.5378.5388.5411440 50% in next month359366.5378.5388.5411 Wages600600550550550450 Fixed Costs700700710710715715 Lease of New Building200200200200200 Advertising Fees120120 Corporation Tax650 Capital Expenditure13751375 Loan Repayment450450450 Total Payments16592345.5358027974089.53316 Net Cash Flow4451-189.5-1416-578-1805.5-872 8
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Opening Bank Balance18546364446.53030.52452.5647 Closing Bank Balance46364446.53030.52452.5647-225 TASK 5 Methods of capital investments and reasons why it is essential for organisation to develop capital expenditure policies. There are different techniques that are used in the capital budgeting. Net Present Value This is a metric used in capital budgeting for evaluating the profitability of proposed capital expenditures. It assess whether the estimated future cash flows would be enough for meeting the cost of project or not. Payback Period It is the metric used for evaluating the time period within which the costs will be recovered of the project. It is also used for evaluating the break even point of the project after which it will be able to earn profits. Importance of capital expenditure policies The policies regarding capital expenditures is essential as companies are required to maintain the existing equipments and property while investing in the new technology and assets for growth. Policies provide frameworks about the procedure to be followed for making capital expenditures (Kengatharan and Clamenthu,2017). As it involves considerable investments companies make investments after properly analysing the viability of expenditure. Investment proposals Unilever is planning to purchase new production equipment for increasing the outputs for which it is having two proposals for two machine A and machine B as stated below Machine AMachine B Cost250000300000 Cash Flows 12000040000 9
24500065000 36000090000 485000125000 595000160000 WACC :10% Analysis Analysing the viability of investments using investment appraisal techniques of the two machines. Net Present Value Computation of NPVComputation of NPV MACHINE AMACHINE B Year Cash inflows PV factor @ 10% Discounte d cash inflowsYear Cash inflows PV factor @ 10% Discounte d cash inflows 1200000.90918181.821400000.90936363.64 2450000.826371902650000.82653719 3600000.751450793900000.75167618 4850000.6835805641250000.68385377 5950000.6215898851600000.62199347 Total discounted cash inflow217494 Total discounted cash inflow342425 Initial investment250000 Initial investment300000 NPV (Total discounted cash inflows - initial investmen t)-32506 NPV (Total discounted cash inflows - initial investment)42425 10
Payback Period Computation of Payback periodComputation of Payback period MACHINEAMACHINEB Year Cash inflows Cumulativ e cash inflowsYearCash inflows Cumulativ e cash inflows 1200002000014000040000 24500065000265000105000 360000125000390000195000 4850002100004125000320000 5950003050005160000480000 Initial investment250000 Initial investment300000 Payback period4 Payback period4 0.5-0.2 Payback period 4 years and 6 months Payback period 3 year and 8 months Recommendation It could be evaluated from the above capital investment techniques that machine B is more beneficial for the company as compared with machine A though it is having higher cost. The outcomes of the investment appraisal investment techniques shows machine A to be more viable. The net present value of the machine B is positive and adequate where of A is negative which means project will not be able to cover the cost from cash flow which will result in loss (Adebimpe and Bashir,2018). Payback period which is used for evaluating the time length of investments shows that machine A will take 4 years and 6 months to cover the cost on the other machine B will take 3 years and 8 months to cover cost. Machine is having positive NPV and shorter payback period but the cost is higher than A. On the other cost of MachineA is low which is strength but is having negative NPV and very long payback period. Due to which it will not be able to earn adequate returns. Therefore, company is suggested to adopt Machine B as it will bring higher economic benefits to 11
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organisation. Accepting proposal A due to lower cost will lead company to suffer losses and his will also impact the efficiency and other sectors of the organisation. Investment decision plays an important role in the organisation as it is made with the motive of increasing the efficiency and productivity of the process and organisation. Adopting Machine B will increase the efficiency and enable the company to meet its strategic goals and objectives (Ndanyenbah and Zakaria,2019). Effective monitoring and control of the machine will enable company to increase the profitability. 12
REFERENCES Books and Journals Lin, C., Hsiao, Y.J. and Yeh, C.Y., 2017. Financial literacy, financial advisors, and information sources on demand for life insurance.Pacific-Basin Finance Journal.43.pp.218-237. Lee,T.A.andTweedie,D.P.,2020.ShareholderUseandUnderstandingofFinancial Information(Vol. 38). Routledge. Duan, J., and et.al., 2018, August. Learning target-specific representations of financial news documentsforcumulativeabnormalreturnprediction.InProceedingsofthe27th International Conference on Computational Linguistics(pp. 2823-2833). Williams, E.E. and Dobelman, J.A., 2017. Financial statement analysis.World Scientific Book Chapters, pp.109-169. Monahan, S.J., 2018. Financial Statement Analysis and Earnings Forecasting.Foundations and Trends® in Accounting.12(2). pp.105-215. Das, S. and Pandit, S., 2020. Financial Statement Analysis and Forecasting.Equity Markets, Valuation, and Analysis. Karaömer, Y. and Özbirecikli, M., 2019. Effects Of Financial Reporting Differences In Between BOBI FRS And MSUGT On Financial Statement Analysis: An Investigation On Financial StructureRatios.MuhasebeveVergiUygulamalariDergisi(MUVU)/Journalof Accounting & Taxation Studies (JATS). Talmon, N. and Faliszewski, P., 2019, July. A framework for approval-based budgeting methods. InProceedings of the AAAI Conference on Artificial Intelligence(Vol. 33, pp. 2181- 2188). Chohan,U.W.,2019.PublicValueTheoryandBudgeting:InternationalPerspectives. Routledge. Ostaev, and et.al., 2019. Strategic budgeting in the accounting and management system of agriculturalenterprises.IndoAmericanJournalofPharmaceuticalSciences.6(4). pp.8180-8186. Kengatharan, L. and Clamenthu, D.P., 2017. Use of capital investment appraisal practices and effectiveness of investment decisions: a study on listed manufacturing companies in Sri Lanka.University of Jaffna. Adebimpe,O.A.andBashir,O.,2018.ModernApproachtoPropertyDevelopment Appraisal.Covenant Journal of Research in the Built Environment. Ndanyenbah, T.Y. and Zakaria, A., 2019. Application of Investment Appraisal Techniques by Small and Medium Enterprises (SMEs) Operators in the Tamale Metropolis, Ghana. 13