Introduction to Finance: Ratios, Financial Statements, Breakeven Point, Cash Budget, and Expenditures

This assessment covers various financial ratios, importance of financial statements, breakeven point calculation, cash budget preparation, and explanation of additional expenditures. It includes subject matter related to finance and accounting.

Introduction to
Finance

Table of Contents
INTRODUCTION...........................................................................................................................3
QUESTION 1..................................................................................................................................3
QUESTION 2..................................................................................................................................6
(c) Explanation of additional expenditures.............................................................................8
QUESTION 3..................................................................................................................................8
(a) Calculate the breakeven point in units and sales revenue for the year ended 31 March
2019 and the year ended 31 March 2020.................................................................................8
(b) Calculate the margin of safety in units and sales revenue for the year 2019 and 2020.
...................................................................................................................................................10
(c) Discuss the new strategy developed by Jessica................................................................10
QUESTION 4................................................................................................................................10
(a)Payback period....................................................................................................................10
Accounting rate of return.......................................................................................................11
Net present value......................................................................................................................13
(b) Project A should be undertaken.......................................................................................14
(c) Capital appraisal technique: -...........................................................................................14
REFERENCES..............................................................................................................................17

INTRODUCTION
Finance can be defined as the system of exchange amongst the various borrowers, lenders
and investors. It involves various complexities, as it operates at various levels in various
organisations globally. In finance the medium of exchange that are used can be money, credit
and finance. The concept of finance has been there in the global economy for a very long time
that is since 20th century. Earlier the financial function was more inclined towards arranging
funds from the financial institutions through shares and debentures. It transformed and changed
with an emphasis on day to day activities. It came with fund analysis in a very regularised
manner rather than casual basis. Final phase of transition of the financial function involved the
emphasis over growth of business and thus this increased the competition in the economy. In this
particular phase the economy is more inclined towards financing all that needs finance and do
not follow stereotyped financing.(Adegboye, and Iweriebor, 2018)
In the following assessment we will try to study various ratios that are used to study the
health of the business. Importance and working of various financial statements, break even point,
pay back period, various rates of return, etc.
QUESTION 1.
(a) Calculation of the financial ratios
i) Gross profit margin
Gross profit margin = ( Sales – COGS)*100 / Sales
Sales for the year ending 2019= 3,495
COGS for the year ending 2019= 2,182
Gross profit margin for the year ending 2019 = ( 3,495 – 2,182)*100 / 3,495
= 37.56%
Interpretation : Gross profit margin indicates the share of gross profit out of the total revenues
of a company and so for the purpose it considers gross profit over net. The ideal percentage for
the same is 50% - 70% . Liverton Co. is having a gross profit margin of around 37.56% which
shows that it still has the potential to improvise on its profits. This can be done probably by
increasing the selling price of the products and services or by decreasing the cost of goods sold.
ii)Asset usage = ( net sales / average total assets)

Sales = 3,495
Total assets for year ending 31st march 2018 = 2,503
Total assets for year ending 31st march 2019 = 3,812
Average total assets = (2,503 + 3,812)/2
= 3,157.5
Asset usage ratio for the year ending 2018 = 3,495 / 3157.5
= 1.10 times
Interpretation : The asset usage ratio is used to see as to how efficiently an organisation is
utilising its resources. The ideal ratio for the same is above 2.5 times or more % whereas the
ratio for Liverton Co. stands at around 1.10 times which means the assets of the company are
not being utilised efficientlyand has scope for improvement.(Andreeva., and et.al, 2018)
iii) Current ratio = current acid / current liabilities
Current assets (inventory+Trade receivables+short term investments+cash at
bank) for the year ending 2019 = (150+1010+75+452) = 1687
Current liability (trade payable+bank overdraft+Taxation) for the year ending
2019 = (289+143+312) = 744
Current ratio for the year ending 2019 = 1687 / 744 = 2.26
Current assets (inventory+Trade receivables+short term investments+cash at
bank) for the year ending 2018 = (102+315+0+1) = 418
Current liability (trade payable+bank overdraft+Taxation) for the year ending
2018 = (119+98+285) = 502
Current ratio for the year ending 2018 = 418 / 502 = 0.83
Interpretation :The current ratio shows as to what an extent is a firm able to meet its short term
liabilities without compromising the long term assets. The ideal ratio for the same is 2 : 1,
whereas the company's ratio stands at around 2.26 : 1. It stood at around 0.83 : 1 in the previous
year and since then the firm has improvised on its ratios.
iv) Acid test = current asset – inventory / current liability
current asset – inventory for the year ending 2019 = 1687 – 150 =1537
currenrt liablity for the year ending 2019 = 744

acid test ratio for the year ending 2019 = 1537 / 744 = 2.06
current asset – inventory for the year ending 2018 = 418 - 102
current liability for the year ending 2018 = 502
acid test ratio for the year ending 2018 = 102 / 502 = 0.20
Interpretation : The acid test ratio is used to analyse the short term liquidity of the company and
for the purpose it considers only highly liquid assets. The ideal ratio for the same is 1 times
whereas the company's ratio stands at 2.06. This ratio has increased since the last year as it stood
at 0.20 in the previous year. Which seems to be a good sign.(Berrou, Ciampoli, and Marini,
2019)
v) Inventories holding period = (Average inventory / cost of goods sold)*365
average inventory for the year ending 2019 = ( 150 + 102 ) / 2 = 126
cost of googs sold for the year ending 2019 = 2182
inventory holding period for the year ending 2019 = (126*365) / 2185 = 21.04
Interpretation : This particular ratio depicts the number of days for which a company is holding
up its inventory. The ideal ratio for the same is 5 – 10 whereas the company stands with a ratio
of around 21 days which is much higher, thus the company should try to reduce this period by
decreasing the production or increasing the sales.
vi) Debt to Equity ratio = Debt / Equity
debt(Trade payables
+Bank overdraft+long term loans) for the year ending 2019 = 289+143+170 =
602
equity for the year ending 2019 = 2898
debt / equity ratio for the year ending 2019 = 602/2989 = 0.20
debt(Trade payables
+Bank overdraft+long term loans) for the year ending 2018 = 119+98+50 =
267
equity for the year ending 2018 =1951
debt / equity ratio for the year ending 2018 =267 / 1951 = 0.13

Interpretation : This particular ratio is used to find the leverage of a company that the ratio
between the debt and equity of a company. The ideal ratio for the same is 2 – 2.5 times whereas
the company's ratio stands at around .20 which is too less than the ideal ratio. Somehow it should
be observed that the ratio has improvised as compared to .13 for the previous year.
(b) Importance of considering audience :-
External Users:-
1. Shareholders- Financial statements depicts the current financial condition of any
company. Since no one wants to lose money by investing in a loss making company, it
becomes imperative to study the financial statements. Statements shows whether a
company is making profit or incurring losses which includes Income statement or P&l
statement.(Dong, Xu, and McIver, 2020)
2. Bank and financial institutions:- Banks provides credit facility to the companies having
good financial records. Therefore, it is necessary for every company to have accurate
financial records audited by an expert while applying for a loan. In case of otherwise,
may cancel the loan process and have legal proceedings.
3. Government:- Governments use financial statements for taxation purposes. To
determine corporation tax, the company's taxable income has to be ascertained. Hence, it
is very necessary to have audit of financial records, otherwise the company may get stuck
in the taxation processes.
Internal Users:-
4. Management:- The financial statements helps the management in analysing the
company’s performance in comparison to the previous years along with other businesses
and sectors. Providing management with accurate information enables them to take
correct decisions as well as forming policies.
5. Employees:- Employees primarily use financial statements with the main objective of a
salary or wage increments. Another key factor is that employees generally feel more
satisfied working with a profit-making company and not a loss-making company.
QUESTION 2.
(a) Opening statement of financial position at the start of July 20X5
Opening Statement of Financial Position

Assets
Non-current assets
Tangible assets
£
150,000
Current assets
Cash at bank
£
50,000
Total assets
£
200,000
Liabilities
Capital
£
200,000
Total
£
200,000
(b) cash budget for 6 months
Particulars July August September October November December
Opening
balance
-55000 -170000 -215000 -200000 -135000
Receipts
Initial
investment
200000
Sales receipts 150000 120000 150000 210000 260000 285000
Total receipts 350000 65000 -20000 -5000 60000 150000
Payments
Purchase of
non-current
assets
150000
Material 120000 100000 60000 60000 60000 60000
Other
expenditure
55000 55000 55000 55000 55000 55000
Wages expenses 80000 80000 80000 80000 80000 80000
Tax bill 20000

Total payments 405000 235000 195000 195000 195000 215000
Closing balance -55000 -170000 -215000 -200000 -135000 -65000
As per the question, the new business of Sassy Clothing which is an online clothing
business and mail order business.(Gong, and Cullinane, eds., 2018)The opening balances of cash
budgets already has a negative cash balance of months August to December. The expected sales
for upcoming six months are £1,175,000. The Sassy clothing business needs work upon its
internal as well as external resources to fully utilise the strength to increase its revenue and to
maintain surplus cash balances instead of having negative at the end of each month. This can be
effectively done by the increasing the sales and lowering the other expenses which are
responsible for the increase in manufacturing cost. (Hofmann, Strewe, and Bosia, 2018)
Instead of outsourcing the raw material the best option is in house production.
(c) Explanation of additional expenditures
There is various expenditure that need to be compressed by the Sassy Clothing business
for positive balance. The cost of the month of July and December which basically include
software bills, rent, running fees and charge to the suppliers. Overdraft mortgage is the business
enterprise on the spot admittance to more price range after they do now no longer have any
remain. It lets in dealing with the accurate mismatch of price range draft and supports in keeping
the good track record. With the support of the financial institution overdraft the Sassy business is
capable of do the bills in their costs on time.
QUESTION 3
(a) Calculate the breakeven point in units and sales revenue for the year ended 31 March
2019 and the year ended 31 March 2020.
Break Even Point = fixed cost / contribution per unit
So, Total fixed cost = 1,650,000 + 2,850,000 + 930,000
= £ 5,430,000
And contribution per unit = £ 300 – 125 - 15 - 20 - 15 – 10
= £ 115
So, Breakeven point of year 2019 is = £ 5,430,000 / £ 115

= 47217.39 equivalent
= 47218 units
Break Even profit as per sales revenue (year 2019) = (P/V) fixed cost / profit volume ratio
= 5,430,000 / 38.33 %
= £ 14,166,449
There are few changes in Income Statement of year 2020 as per the Chief Executive-
Particulars Price per unit Amount ( £ )
Sales 309 13905000
Less : variable cost
Direct material 125 5625000
Direct labour 13 585000
Manufacturing overhead 19.5 877500
Selling expenses 15 675000
Administration expenses 8 360000
CONTRIBUTION 128.5 5782500
Less : fixed cost
Manufacturing overhead 1650000
Selling and distribution overhead 2850000
Administration overhead 930000
New manufacturing facility 1450000
PROFIT -1097500
Break Even Point of 2020 = 6880000 / 128.5
= 53540.8
= 53541 units
Break Even Point as per Sales revenue of year 2020 = fixed cost / Profit volume ratio (p/v)
= 6880000 / 41.59 %

= £ 16542438.09
(b) Calculate the margin of safety in units and sales revenue for the year 2019 and 2020.
Margin of safety in units (2019) = profit / contribution per unit (Newell, 2022)
= -255000 / 115
= -2217
For 2020 –
= -1097500 / 128.5
= -8541
Now, as per Sales revenue
Margin of Safety of year 2019 = p/v
= profit/contribution per unit
= -1097500 / 41.59 %
= £-2638855.49
(c) Discuss the new strategy developed by Jessica
The above computations were aimed at analyzing two strategies namely BEP and MOS for 2
years, that is for the year 2019 and 2020. The BEP for the old and new strategy respectively was
47218 units and 53541 units approximately(Rethel, and Thurbon, 2020). Whereas talking about
the MOS for the 2 years that is for 2019 and 2020 in terms of output was -2217 units and -8541
units respectively.
In terms of sales revenue the BEP is going to be £14,166,449.26 and £16542438.09 respectively.
Thus looking at the above calculations it can be suggested that they should try to boost their sales
by excessive sales promotion tools and by minimizing the cost.
QUESTION 4.
(a)Payback period
Payback period refers to the period in which an investment is able to realize the value of
its investment. The project with the least timing is considered to be the most suitable project.
Year Appraisal A Appraisal B Appraisal C
cash inflow
cumulative
CF cash inflow cumulative CF
cash
inflow
cumulative
CF
1 75000 75000 95000 95000 50000 50000

2 65000 140000 65000 160000 60000 110000
3 60000 200000 45000 205000 65000 175000
4 55000 255000 45000 250000 66000 241000
5 50000 305000 45000 295000 57000 298000
 Payback period for project A
The value of the investment is getting realized in the 3rd year itself thus :
payback period = 2+ (175000-140000) / 60000
=2+(35000/ 60000)
=2.58 years
 Payback period for project B
The value of the investment is getting realized in the 3rd year thus :
payback period = 2 + (195000 – 160000) / 45000
=2+(35000 / 450000
2.77 years
 Payback period for project C
The value of the investment is getting realized in the 4th year thus :
payback period = 3 + ( 190000-1750000 / 66000
=3+(15000 / 66000)
=3.22 years
Accounting rate of return
ARR = average annual pofit / average initial investment (Sang, 2021)
 ARR for project A
Year cash inflow Deprecation Profit
1 75000 35000 40000
2 65000 35000 30000
3 60000 35000 25000
4 55000 35000 20000
5 50000 35000 15000
Average annual profit = (40000+30000+25000+20000+15000) / 5
= 130000/ 5

=26000
Average investment = ( initial investment+ scrap value) / 2
= (175000+5000) / 2
= 90000
ARR = (26000 *100) / 90000
=28.89%
 ARR for project B
Year cash inflow Deprecation Profit
1 95000 39000 56000
2 65000 39000 26000
3 45000 39000 6000
4 45000 39000 6000
5 45000 39000 6000
Average annual profit = (56000+26000+6000+6000+6000) / 5
= 100000 / 5
= 20000
Average investment = ( initial investment+ scrap value) / 2
= (195000+8000) / 2
= 101500
ARR = (20000*100) / 101500
=19.70%
 ARR for project C
Year cash inflow Deprecation Profit
1 50000 38000 12000
2 60000 38000 22000
3 65000 38000 27000
4 66000 38000 28000
5 57000 38000 19000

Average annual profit = (12000+22000+27000+28000+19000) / 5
= 108000 / 5
= 21600
Average investment = (initial investment+ scrap value) / 2
= (190000+4000) / 2
= 97000
ARR = (21600*100) / 97000
=22.27%
Net present value
This method calculates the present value of the future cash outflows and analyses the
investments as to which investment proves out to be most beneficial. (Taghizadeh-Hesary, and
Yoshino, 2019) It is calculated as :
= (PV of cash inflows + PV of the scrap value) – present value of cash outflow
Appraisal A Appraisal B Appraisal C
Year
COC
@18% CI PV of CI CI PV of CI CI PV of CI
1 0.847 75000 63525 95000 80465 50000 42350
2 0.718 65000 46670 65000 46670 60000 43080
3 0.609 60000 36540 45000 27405 65000 39585
4 0.516 55000 28380 45000 23220 66000 34056
5 0.437 50000 21850 45000 19665 57000 24909
5 0.437 5000 2185 8000 3496 4000 1748
Total PV of
cash inflow 199150 200921 185728
 Net present value for project A
= 199150 – 175000
= 24150
 Net present value for project B
= 200921 - 195000
= 5921

 Net present value for project C
= 185728 - 190000
=4272
(b) Project A should be undertaken
By the company in order to yield highest profits in the least time possible. This is so because the
payback period for the same is 2.58 years which is the least of all. Also it has the highest ARR at
28.89% and highest NPV which is 24150.(Tan, 2021)
(c) Capital appraisal technique: -
This technique let the companies, investors and financial experts know whether a project or
investment made by the company would result into profit making or not. It assess the
profitability and affordability of investments in long term projects, machinery, equipment’s, etc.
The process is really crucial whenever the investments include large sum of money, limited
resources, etc. In such cases, the organisations cannot depend on subjective data, they need to
compare both quantitative and qualitative aspects to analyse the return on investment and risk
involved(Zhou, and Li, 2019).
The major techniques used for the purpose of capital appraisal includes: -
1. Payback period: - This refers to the time or period required by a project to recover the
investment or capital. Payback period should be as short as it can be. A shorter payback period
indicates a faster cash inflow, and effectiveness of the management to operate the activities.
When the amount recovered from the project equals to the investment costs, it creates a situation
of breakeven point.
Advantages: -
 Helpful in Small investments: - Payback period is more beneficial to the small businesses
and enterprises, as they tend to make small investments. Therefore, they do not have to
perform complex calculations.
The formula of payback period is (Initial Investment / Net Annual Cash Inflow).
 Risk focus: - A project with a short payback period bears less risk, which is significant for
small enterprises with restricted resources. Payback period focuses how quickly money can
be recovered from an investment, which is therefore a measure of risk.

 Liquidity Focus: - This analysis focuses on the projects that return money quickly, they tend
to result in investments with a higher degree of short-term liquidity. This is very beneficial at
times when long-term returns on investment are uncertain.(Tseng, Lim, and Wu, 2019)
Disadvantages: -
 Ignores Time Value of Money: - Payback period purely focuses on short-term cash flow
and getting the fastest possible returns, so it misses a lot of other factors. The value of money
can vary over time, especially when the company is expecting stable and long term
investments.
2. Accounting rate of return: - The accounting rate of return, also known as the return on
investment, gives the annual profits arising from an investment as a percentage of the investment
made.
Advantages: -
 Easy to determine returns: - The accounting rate of return is a simple calculation in
determining a project's annual percentage rate of return. This allows management to easily
compare ARR to the desired rate of returns(Xu, Mi, Mierzwiak, and Meng, 2020).
 Evaluates performance of project: - This method evaluates projects annual returns via
comparing it with expected returns. This allows management to evaluate the performance as
how efficient is the management in managing activities.
Disadvantages: -
 Based on profits: - This method is based on profits rather than cash flow. Therefore, it can
be affected by non-cash items such as the depreciation and bad debts when calculating
profits. The changes in the method of calculating depreciation can lead to different outcomes.
3. Net Present Value: - This method is used to estimate the profitability of the project via
comparing the differences of the present value of cash inflows with cash outflows over the
project's time period. If the difference is positive, it's a profitable project and if negative then it's
making loss.
Advantages: -
 Time Value of Money: - The main benefit of using NPV is that it considers the concept of
time value of money i.e., a dollar today is worth more than a dollar tomorrow owing to its
earning capacity. The calculation of NPV considers the discounted net cash flows of an
investment to determine its viability(Westland, 2018).

 Considers the cost of capital and risk factors: - NPV considers risk and capital costs when
making future projections. Cash flows that are up to ten years into the future are much less
certain than one that will happen in the next 12 months. NPV holds unique accuracy and this
is the reason behind using it as an evaluation tool by investors and agencies.
Disadvantages: -
 Focuses on short term projects: - Net Present Value presents the ratio that mainly focuses
on short-term projects instead of looking for long-term results. If a company have to evaluate
long term returns, then it may not be a wise decision to look upon the NPV only.
CONCLUSION
In the above report various ratios such as the current ratio, acid test ratio, inventory holding ratio,
etc have been calculated for analysing the financial position of the company. After that the cash
flow statements have been prepared followed by the calculation of BEP and MOS. Last but not
the least the project gave a brief insight nto the project appraisal techniques such as ARR, NPV
and payback period.

REFERENCES
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