This report provides an overview of the industry in which Roast Ltd operates and analyzes the business performance of the company. It also discusses investment appraisal, sources of finance, and the comparison between different sources of finance. Find study material and solved assignments on financial decision making on Desklib.
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FINANCIAL DECISION MAKING
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EXECUTIVE SUMMARY This report has considered the case study of Roast Ltd in this report. This report has presented the overview of industry in which the organization used to deal. Overview of the company includes the position of the business in the industry and amount of competition present in the industry in which organization is dealing. After that the report has highlighted the business performance analysis of the business. This has been presented with the help of statement of profit and loss which has helped in analysing the profitability position of the business. After that the report has highlighted the statement of financial position as well as of cash flow this statement used to help in understanding the cash and cash equivalent present with the company in the current scenario. After that in the third part of the report the report has highlighted the investmentappraisalofthecompanywhichgenerallyincludesthemanagementforecast, different investment Appraisal technique i.e. Payback period, accounting rate of the return and net present value of the company in the market. After that these report goes on to explain the comparison between two source of the finance in the organization on the basis of advantage and disadvantage of different source of the finance which can be used by the organization at the time of making the investment of 400,000 pounds in coming future.
TABLE OF CONTENTS TABLE OF CONTENTS................................................................................................................3 INTRODUCTION...........................................................................................................................1 Industry Overview.......................................................................................................................1 Part 2 Business Performance Analysis............................................................................................1 2.1 Statement of Profit or Loss....................................................................................................1 2.2 Statement of Financial Position.............................................................................................4 2.3 Statement of Cash Flows.......................................................................................................6 PART 3 INVESTMENT APPRAISAL...........................................................................................8 3.1 a. Management forecast.........................................................................................................8 3.1 b. Investment appraisal technique..........................................................................................8 3.2 Sources of finance................................................................................................................10 REFERENCES..............................................................................................................................11
INTRODUCTION Industry Overview Roast Ltd used to operate in the food and beverage industry of the UK. Roast Ltd. Is an independent coffee house chain established in the UK in the year 2008. Specifically Roast. Ltd used to operate in the coffee industry of UK. Coffee market is the fifth largest coffee consumer market in Market. As a result it is one of the strongest industries of the UK and used to provide good contribution in the economy of the UK as a whole. Coffee market is very competitive industry as there are many different organizations that used to operate in the industry. As a result Roast Ltd used to face variety of the competition from the market, Star buck is one of the biggest competitors of the company in the market. Starbuck generally used to attract huge number of the customer in the market with the quality of product offered by them. Coffee industry is one of the successful industry of UK reason behind the same is identified that there are good number of the consumer in the UK who used to drink coffee. Looking at the scope of this industry it can be said that coffee industry is well developed in the UK as there are few oligopoly company who used to run almost whole the market of the UK. At the same time preference of different consumer are changing on regular basis as a result many different organization used to enter in the market by bringing variety of different product in the market to attract the eye of the consumer. Part 2 Business Performance Analysis 2.1 Statement of Profit or Loss Financial statement of profit or loss statement refers to the financial performance of the company. This represents the financial performance of the company during the year and this helps the company to take effective measures for improving the financial position of the company. Financial performance of the Roast ltd will be analysed using ratio analysis. it will be used for knowing the internal functioning of the company. it used for assessing whether it was profitable or not for the company. financial statement of the company are required to be prepared as per the financial statements of company. 1
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The financial statement of Roast ltd represents the increase in revenues from last year. Revenues have been increased by company by the adoption of new promotional strategies that are relevant for the business. It has eared operating income this year of £60,000 that helped the company to raise its profit levels. Company has also achieved significant rise in operating profit of company from the last year. Increase in the operating from last year shows that the expansion strategies of the company. Growth of the company is essential to attract new investments in the company whether it is equity capital or venture capital. Reduction of global prices of oil has reduced the cost of power and heat of company(Moradi, Abtahi and Zilouchian, 2017). The operating expenses of the company are reduced as the company has outsourced many of its operations such as human resources, payroll, customer support and finance. Through this company reduced its operating expenses to considerable extent. Rise in the operating expenses is not made with the same proportion as that of the revenues. From the current years chief executive officer will be solely handling the roles and responsibilities of directors who left without any additional pay. Company is not having any legal cost this year as all the costs are paid by the company in previous related to the expansion plan has been already paid in last year. The financial analysis shows that the company has grown with significantly by adoption of new costs effective strategies in the business. Further analysis of the financial performance is analysed using ratio analysis. Ratio Analysis 2
Ratioanalysisisatoolusedbyexpertsandanalystsforassessingthefinancial performance and position of the company. Performance of the company y could not be analysed just by the figures given in financial statements. Ratio analysis helps the analysts to assess the efficiencyof themanagementin carrying out itsoperationand the effectivenessof the management strategies. It is done by using various ratios such as profitability, efficiency and such other ratios. Profitability Ratios Return on capitalEmployedrefers to the ratio measuring the efficiency of company to use its assets for generating returns. Capital employed refers to the funds and assets involved by the owners for starting and operating the business successfully. Return on capital employed is 8.80 9 of the company and it has shown a upward movement by 75.50%. the returns are not much high of company over the assets employed. This requires the company to provide renew its strategies for the operations of business which will help the company to improve its returns. Company can also increase the return by writing off t assets that are not required and are unproductive. Return on Equityis used to measure the return over the equity investment of company. Equity refers to the amount of ownership in the company. Return on equity of company is 9.42% 3
where it was 4.62% in last year. The returns show whether the equity investors will be earning enough returns over their investments or not (Hausmann, Kokkinaki and Leng, 2019).. Return of the company has increased from last but it is required to take steps for maintaining the stability in returns. Lower returns will affect the company and its value in the market. Company is required to increase its profits for raising the returns over equity. Lower return may cause the investors to withdraw fund from the company. Gross Marginof the company shows how effectively company has managed its cost of sales for the production of goods and services. Gross profit ratio is 21.475 for the current with a decline from 25.42% in last year. Decrease in the gross profit is seen even when the revenues of company has raised. The company has been making imports of raw material and there has been increase in the raw material prices and labour rates. The rise in cost of sales has the gross profit to go down itis essential for the company to manage its operation else it may suffer decline in the returns and profit levels. Net Profit marginof company is the ration of the profit earned as against its revenues. Higher profits are desire of every company but it is dependent on the size and nature of the enterprise. The profit ratio of company is 5.02% which was 2.52% the return of the company has doubled this year. The increase is not solely due to the raise of revenues but also due the other operating income which will be not earned every year. Though company has tried to achieve the profit levels by reducing the cost such as director remuneration and outsourcing of many of the activities it is required to raise the profit levels. It is required to further take steps that will help the company to raise the profit levels. 2.2 Statement of Financial Position Balance sheet is also known as statement of financial position that represents the health and wealth of the company. it represents the holdings and obligations of the enterprise during the given financial year. Balance sheet of the company is prepared to represent the financial standing of the company in comparison with the market. Companies are required to disclose the additional information related to the assets and liabilities in detail in notes to account. This is used for assessing the risks associated with the business. Liquidity Ratio of the company is used for assessing the liquidity position of company. This is essential for assessing the management of liquid assets and liabilities of company and ensuring that the company is able to meet its short tern obligation with the available assets. 4
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Current Ratioof company measures the liquidity position of the company and the ability of company in meeting its short term obligations. Current Ratio of the company for the year is 1.45 which was 2.51 in previous year. This shows that the liquidity of the company is declined from last year. Though company will be able to meet its obligations but it is required to increase theliquidityposition.Thisalsoshowstheworkingcapitalchangesarenotmanaged appropriately by the company. Stakeholders of the company are concerned with the liquidity position of the company and it also represents the effectiveness of company to manage its short term obligations(Grennan and Michaely, 2019). Company in current year has suffered negative cash balances that is required to be considered for adopting the changes accordingly. Quick Ratioof company measures liquidity position excluding inventory from the current assets. Number of experts and analysts consider that the inventory is not current asset as it could not realise immediate cash on sale. It is having liquidity ratio of 0.48. Bank overdraft and reducing the inventory has led the liquidity position to go even down. This requires the company to restructure its strategies to strengthen the liquidity position of the enterprise. Solvency Ratios Debt equity ratiois used for assessing the solvency ratio of the company. Debt equity ratio of company shows the financial risks associated with the business. Debt of company includes the non current liabilities such as debentures and borrowings. Debt to equity ratio is also used for assessing the financial structure of company.Debt equity ratio is 31.98% in the current year 5
where last year it was 12.84%. Debt of the company is increased due to the expansion pan of entity to the Romania. However even after raising the new borrowings the financial risks has not risen to a level of attention or high risks. This is due to the high equity capital of company and it will not affect the financial position of company. The capital structure of company should be adequate where the cost of capital of the company is least. Cost of equity is high but raising excessive debts will raise the financial risks of the business, therefore further funds should be raise by doing effective analysis. 2.3 Statement of Cash Flows Statement of cash flow is one of the three financial statement prepared by the company to represent the cash position of entity. This reflects the cash flows of the enterprise throughout the business year. Cash flow statement of company represents the fiscal position of organisation during the given period of time. Cash flows during the year from operating activities are negative of the enterprise amounting -24000. From the negative operating cash flows it could be interpreted that the company is not in state for paying its trade bills unless the additional capital is raised by the company. A company having negative cash flows is considered to be inefficient in managing its operations and current assets. Investing activities represents the cash flows from the sale or purchase of investments or assets. It had negative cash flow from investing activities of -358000. It has made investment in the purchase of equipments of the expansion plan of the business. The investments made by the company are part of the long term business plan for expanding the business to new borders(de Assis and et.al., 2017). Financing activities provided cash flows of 175000 during the year. Positive cash flows from this activity show that company has raised new capital. The funds have flown to the firm increasing the liquidity position of company. However it is seen that company suffered a net decrease of -207000 in 2018. This could be interpreted that the outflows of the company are higher than the cash inflows incurred during the year. 6
Operating cash cycle refers to the time required for making initial outlay of the funds for selling or production of goods. Inventory days have reduced to 29 days from 55 days in last year. This shows the frequency of inventory movements is raised reflecting efficiency in inventory management.Inventoryturnovercouldbefurtherimprovedbyadoptingotherinventory management systems where the cost of managing inventory is lowest. Asset turnover of company is 2.23 that was 2.30 in 2017. It has shown a downward movement however it could be seen that asset turnover is still significant of the company that shows it is effectively utilising its assets for generating sales. Higher asset ratio is beneficial for company as this shows the efficiency of management to earn revenues using the existing resources of company. Receivablesdays have been increased to 21 days in 2018 from 17 days in previous year. This shows cash collection from the debtors are not made as earlier. It has increased the sales by giving more credit to its debtors as part of the business strategy. on the other payables have also increased to 43 days from 33 days in 2017 which shows more longer time is taken for making payments. It paid a dividend of 30 million in 2017 whereas no dividend is paid by the company in 2018. Choice of company of not paying dividends is right as it is the part of earnings made during the year that is required to be passed on to the shareholders of organisation. As the company is planning to grow its business, it should have enough funds for meeting the requirements of expansion plan(Schroeder, Clark and Cathey, 2019). Though the company is having profits during the year but its cash position is negative. Paying dividend in negative cash position would have increased the cash position of company even more negative. 7
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PART 3 INVESTMENT APPRAISAL 3.1 a. Management forecast The management forecast is referred to as the predicting or forecasting of the company in order to manage or operate the business in proper manner (Harris, 2017). The management need to forecast the expansion of the project of Romania project using the different capital budgeting techniques. The capital budgeting technique s the technique which is helpful for Roast Ltd in analysing the fact that whether the investment in Romania project will be successful or not. The initial investment proposed by the company is around £500 million. Also, the company and the management need to analyse the different source of fund for the investment in the other project. This involves the use of different budgeting techniques and are used before the investment is done and this include techniques like NPV, payback period method, IRR and many other investment appraisal techniques. In accordance to the forecast of the management of Roast Ltd it was found that the project is viable and it must be adopted in order to get profitability. This project will involve the buying of different types of machines of coffee and manufacturing as per the demand of the company and the consumers. Also, this machine will involves the Italian process of making the coffee and this will bring in more taste and texture to the coffee for the consumers. If Roast ltd will adopt this project of investment then this will bring in company in developing and increasing the profitability of the company. Also, the properties and equipment if the expansion needs to be purchased and this will increase the cost of the company. But this will also result in the increase in the growth of company by at least 20 % is this Romania project will be adopted. 3.1 b. Investment appraisal technique These are the techniques which will help the company in order to analyse the different options which will help the company in analysing the different types of investment will be present for the company. There are different techniques of investment appraisal technique which are as follows- Payback period- this is amethod of capital budgeting which is used by Roast Ltd in order to indentify the viability of the project that is whether the project is viable or not (Hausmann, Kokkinaki and Leng, 2019). This is calculated due to the reason that this helps the company in knowing the time which will take the company in recovering the initial cost of the investment which company is doing in the other business. The present project will recover the cost of investment in not more than 4 years. 8
Advantage The major advantage of this is that this is easy and simple method and it is more beneficial in case of uncertainty activity. Disadvantage The major disadvantage of this method is that this ignores the time value of the money and this also does not cover the cash flow and it will do not take into account the profitability. Accounting rate of return- this is another financial ration which is used in order to calculate the capital budgeting. This method is used for calculation of the return which is generated from the capital investment which is done by the company. The current ARR for the present project is approximately 18 % and this is enough and adequate for the current project which is accepted by the company (Kogadeeva and Zamboni, 2016). Advantage The major advantage of this method is that this is easy to calculate and this is better for understanding the total profit for the whole period of economic life cycle. Disadvantage The major drawback of this method is that time factor is not considered and this does not involve external factors which affect the profitability of the company to a great extent. Net present value- this is another method of capital budgeting which is being used by the companies in investment appraisal. This method uses the discounting factor which help the company in knowing the fact that whether the future cash flow from the project form covering the cost of the project. The negative cash flow depicts that project is not profitable for the company and if it is positive then this is profitable for the company (Knežević and Mitrović, 2018). Advantage The major advantage of this method represents the initial investment of cash and it takes into consideration the time value of money and other risk. Disadvantage This is the major drawback of this method as there is no set guideline for the determination of the required rate of return and this is not used to compare the project which has different sizes. 9
3.2 Sources of finance The finance is the most important thing without which the business cannot run and operate in the profitable manner (Kengatharan and Nurullah, 2018). There are different sources from which Roast Ltd can generate or borrow finance for the operations of the business which are as follows- Equity capital- this is the most important source because in this the company publicly provide the shares of the company to the general public. When the people invest money in the company equity share capital then they become the shareholder of the company. The major benefit of the equity share capital is that the company does not has to pay the taxes on the interest which is being provided on the equity share capital. The major drawback of this is that the equity shareholder has the control in the management and the profit of the company as well. Debt- this is another source of finance through which Roast Ltd can borrow the money in order to operate the business. Thus, it is a good source of finance under which the company borrows the money from other people like bank or financial institution or sell debenture within the market. The major benefit of this method is that here the ownership is not given to the debenture of debt holder. But the major drawback of this method is that the tax is levied on the interest which is being paid to the debenture holder (Jibril and Jagun, 2018). RECOMMEDNAITON The major recommendation for Roast Ltd is to use a combination of both that is equity and debt. This is majorly pertaining to the fact that this will help the company in gaining more advantage to the company. 10
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