Break-Even Analysis & Working Capital Cycle Assignment

This assignment focuses on applying concepts of break-even analysis and the working capital cycle to a manufacturing company. Students are required to calculate break-even points in units and revenue, margin of safety, contribution margin ratio, and variable cost per unit for two different years (2014 and 2015) with varying selling prices and fixed costs.

Financial Management

TABLE OF CONTENTS
1. Preparing a report for BOD of Honeywell Plc in relation to evaluating financial
performance.................................................................................................................................1
To,....................................................................................................................................................1
2. Calculating working capital cycle for Honeywell Plc.............................................................6
PART B...........................................................................................................................................8
1. Calculating BEP and margin of safety for Thompson Ltd......................................................8
2. Critically evaluating the key assumptions that are associated with BEP model.....................8
PART C.........................................................................................................................................10
1. Assessing the internal and external sources of finance that can be undertaken by business.10
2. Critically evaluating the investment appraisal techniques that are available for business....12
REFERENCES..............................................................................................................................15
APPENDIX....................................................................................................................................16

1. Preparing a report for BOD of Honeywell Plc in relation to evaluating financial performance

To,
Board of Directors,
Honeywell Plc
Date: 28Th July 2017
Subject: Financial performance analysis
Respected sir,
In order to get information about the financial health and performance over the year’s ratio
analysis is done. Ratio analysis is the tool which is turn helps in evaluating and getting
information about profitability, liquidity and solvency aspect. Thus, to present fair view of
performance financial statements of Honeywell plc are evaluated through the means of ratio
analysis.
Profitability ratio analysis
Ratios/ year Formulas 2016 2015
Profitability ratios
Gross profit (GP) 6,350 6,180
Operating profit (OP) 4,290 4,845
Net profit (NP) 2,570 3,130
sales revenue 11,150 9,700
GP ratio
GP / net
sales *
100 57% 64%
Operating profit ratio Operatin
g profit /
net sales *
38% 50%

100
Net profit ratio
NP / net
sales *
100 23% 32%
GP ratio Operating profit ratio Net profit ratio
0%
10%
20%
30%
40%
50%
60%
70%
2016
2015
From profitability ratio analysis, it is reported to the higher management team that gross,
operating and net profit of the company declined in 2016 as compared to 2015. Graphical
presentation shows that GP margin of Honeywell Plc declined from 64% to 57% respectively.
On the other side, in 2016, operating and net profit margin of the business unit accounts for 38%
& 23% significantly. It shows that profitability aspect of the company decreased in 2016 in
against to the prior times. Thus, company is required to make focus on promotional aspects
which in turn help in enticing the decision making aspect of customers and thereby maximize
sales revenue. Besides this, manufacturing firm should also undertake budgeting tools which in
turn helps in making control on expenses (Smith and et.al., 2017). By taking such significant
action or measure business unit can increase the level of both sales and profit.
Liquidity ratio analysis
Ratios/ year Formulas 2016 2015
Liquidity ratios

Current assets (CA) 4300 3460
Inventory 2200 1220
Quick assets (QA) 2100 2240
Current liabilities (CL) 3270 2125
Current ratio CA / CL 1.31 1.63
Quick ratio QA / CL 0.64 1.05
2016 2015
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
Current ratio
Quick ratio
By doing ratio analysis it has been assessed that current ratio of Honeywell Plc decreased from
1.63:1 to 1.31:1. In accordance with the ideal ratio, business unit must 2 assets in against to one
financial obligation. On the basis of this aspect, it can be said that liquidity position and
performance of Honeywell is not in line with the ideal ratio. Further, quick ratio of the
corporation declined from 1.05:1 to .64:1 significantly. It shows that Honeywell Plc is able to
meet obligation more effectually through the means current assets except inventory and prepaid
expenses (Tsai and et.al., 2016). Thus, for improving the liquidity position it is highly required for
Honeywell Plc to make focus on maintaining current assets.
Gearing ratio analysis
Ratios/ year Formula 2016 2015

s
long-term loan capital 8000 3895
total capital employed
(7330 + 8070 +
8000) = 23400
(7330
+7000
+
3895)
=
18225
Debt-equity ratio
Long-
term loan
capital /
Total
capital
employe
d * 100 34.19%
21.37
%
2016 2015
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
Debt-equity ratio
Debt-equity ratio
Outcome of ratio analysis presents that debt-equity ratio of Honeywell Plc inclined from 21.37%
to 34.19% respectively. It shows that debt level of firm increased in the year of 2016 in
comparison to 2015. Besides this, debt-equity position of Honeywell plc is also in line with the

ideal ratio such as .5:1. Hence, it can be presented that solvency position and performance of
company is sound.
Efficiency ratio analysis
Ratios/ year
Formula
s 2016 2015
COGS 1220 1050
Average inventory or
stock 2200 1710
Inventory turnover
ratio (in times)
COGS /
Average
inventor
y 0.55 0.61
Fixed assets 22,370 16,890
Net sales 11,150 9,700
Fixed assets turnover
ratio (in times)
Fixed
assets /
net sales 2.01 1.74

2016 2015
0
0.5
1
1.5
2
2.5
Inventory turnover ratio
Fixed assets turnover ratio
From ratio analysis, it has been found that inventory turnover ratio of Honeywell Plc declined
from .61 to .55 times in 2016. It indicates that company is taking more time in relation to selling
and replacing the inventory. Thus, business unity should employ inventory control tools and
techniques for improving the performance level. In addition to this, fixed assets turnover ratio of
the company increased from 1.74 to 2.01 times respectively. It presents that business unit is
making effectual use of assets while performing business activities and functions.
Thus, from overall evaluation or analysis it can be stated that profitability, liquidity and
efficiency performance of Honeywell decreased in FY 2016. Hence, business unit is required to
undertake strategic action for enhancing financial performance and position.
Sincerely
Financial analyst
2. Calculating working capital cycle for Honeywell Plc
Financial management is highly concerned with making efficient utilization of funds
which in turn contributes in the attainment of organizational goals. This function of the business
organization is highly associated with top management that takes decision about the monetary
aspects (Zsidisin, 2016). In the business unit, manager has accountability to develop sound
framework by making continuous evaluation of financial health and performance. Thus, aspect
of financial management lays high level of emphasis in framing strategies that assists in gaining
competitive edge over others.

Working capital cycle presents the time which business unit will undertake for converting
the net current assets and liabilities into cash. In this, longer cycle presents that business
organization will have to wait more for generating cash through current assets (Working Capital
Cycle, 2017).
Working Capital (Operating) Cycles: Average Inventory Holding Period +Average
settlement period for receivables -Average payment period for payables = Operating Cycle
Particulars Formulas 2015 (Figure 2016 (Figure
Average Inventory
holding Period
((opening inventory +
closing inventory) /2) /
cost of sales X 365
days
(1,050,000 =
1,220,000) / 2) /
3,520,000 X 365 days
= 117.69 days
(1,220,000 =
2,200,000) /2) /
4,800,000 X 365
days = 130.03 days
Receivable turnover
(in days)
Trade Receivable /
Credit Sales Revenue
X 365 days
(1,480,000 /
9,700,000) X 365
days = 55.69 days
(2,100,000 /
11,150,000) X 365
days = 68.74 days
Average payment
period
Accounts
payable/credit
purchases x 365 days
(1,275 / 3,520) X 365
days = 132.21 days
(1,400 /4,800) X
365 days = 106.46
days
Operating Cycle (in
days)
Average Inventory
Holding Period
+Average settlement
period for receivables -
Average payment
period for payables
117.69 + 55369 –
132.21 = 41.17 days
130.03 + 68.74 –
106.46 = 92.31 days
Working capital (in
days)
41 days 92 days

Interpretation: By doing analysis, it has been assessed that, working capital days in the
year of 2015 and 2016 accounts for 41 & 92 respectively. Hence, in 2016, working capital days
of Honeywell Plc increased to the significant level. Thus, it can be presented that, in 2016,
company was not in position to convert its working capital into cash within the less time.
However, in 2016, company received money from debtors after more time as compared to 2015.
Further, in the accounting period 2016, business unit was obliged to make payment to creditors
earlier over 2015. Thus, to strengthen the liquidity position or performance Honeywell Plc is
required to revise credit policy pertaining to debtors. Along with this, firm is also needed to
approach the supplier who grants credit for long time or duration. From overall evaluation, it can
be said that liquidity position and performance of Honeywell Plc was not good in 2016. Thus,
business unit should make focus on developing highly strategic and policy framework that
strengthen the liquidity aspect.
PART B
1. Calculating BEP and margin of safety for Thompson Ltd
BEP: From evaluation, it has been identified that in 2014, BEP in sales and units account
for 1050 washing machines & £4020000 significantly. On the other side, in the financial year
2015, BEP level was 11902 units and £5474545.45 respectively. Thus, it can be stated that as per
the selling price and level of fixed cost BEP level is affected to a great extent. Higher BEP in
units are not good because it shows that company will take more time to attain profit.
Margin for safety: Table depicted in appendix clearly shows that margin of safety in the
year of 2014 accounts for 9950 unit & £3980000. In contrast to this, margin of safety was
£3725454.55. Hence, it can be entailed that as per the changes take place in the selling point and
cost level margin of safety is also getting highly influenced.
2. Critically evaluating the key assumptions that are associated with BEP model
Break even point analysis is highly significant which in turn provides high level of
assistance to the firm in determining relationship between cost, volume and profit. Moreover,
such analytical tool entails the point at which business unit will get the situation of no profit and
loss. In other words, it can be stated that BEP analysis helps Thomson Ltd in assessing the units

of washing machine which they need to offer for recovering all the expenses. BEP analysis is
based on several assumptions such as total costs can be distinguished into two types such as
fixed and variable (Break-Even Analysis: Introduction, Assumptions and Limitations, 2017).
Hence, it completely ignores semi-variable cost which is also one of the main parts of business.
For instance: Electricity expenses are come in the category of semi-variable expenses whose
some part is fixed and other is variable. Further, such method or model assumes that price of the
product is constant. However, on the critical note, it can be said that it is not possible to offer
products to the customers on fix price. Moreover, there are several factors that have direct impact
on the pricing of products or services such as competitor’s strategy, low demand etc (Van der
Stede, 2016). Hence, due to all such aspects it is not possible for Thomson Ltd to follow constant
pricing policy.
Further, BEP model is based on the assumption that volume of sales and production are
equal. It is one of the highly non-realistic approaches because company makes estimation of
production as well as sales on different basis. Besides this, sales level varies as per the changes
take place in the needs, wants and expectation level of customers. Along with this, BEP assumes
that technology is constant and no changes will take place in the efficiency of labour. However,
it is to be critically evaluated that efficiency of labour can be increased through the means of
training & development session (Jung, 2017). Besides this, now technological advancements also
take place with the very high pace. Thus, it can be presented that BEP assumptions are not highly
realistic as per the current business scenario.
Advantages and disadvantages of BEP model are as follows:
Advantages Disadvantages
 BEP model assists in measuring profit
or loss on the varied level of production
as well as sales
 This model helps in making evaluation
of the effects when changes take place
in selling price.
 Business unit can determine suitable
relationship between fixed and variable
 Time consuming process
 It assumes that variables like
technology, cost, production and sales
are constant which is unrealistic.
 It is applicable or suitable only for
single products rather than multiple. ‘
 Due to having unrealistic assumptions
it can be served as a planning aid rather

cost through conducting BEP analysis.
 Financial analyst can also make
assessment of profitability as per the
changing aspect of cost and efficiency
level.
 Increase in profit level or performance.
than decision making tool.
 Arbitrary valuation (Disadvantages
and Advantages of Break-Even
Analysis, 2017)
From overall assessment, it has been identified that BEP valuation is suitable to some
extent. Moreover, it clearly depicts the point of no profit and no loss. However, in the globally
diversified business environment it is not possible for Thomson Ltd to make planning in the right
direction such as unrealistic assumptions like: b
 Sales = production
 Avoidance of semi-variable cost
 Technology is constant
 No improvement in labor efficiency
 Price is constant
PART C
1. Assessing the internal and external sources of finance that can be undertaken by business
In the business organization, entity requires fund to implement the plan as well as for
exploring business operations and functions. In this, it is highly required for the manager to
select suitable source of finance that aid in the optimal capital structure of the firm. The rationale
behind this, every financial source imposes cost in front of the business organization. Thus,
business entity is required to select suitable source of finance after making proper assessment of
financial and non-financial cost. Hence, there are several internal and external sources of finance
are available to the firm that it can undertake for meeting monetary needs and requirements
(Abor, 2017). Internal sources are the one that available within the business organization namely
sales of assets, retained profit, working capital etc. On the contrary to this, external sources of
finance include bank loan, share capital, leasing, debentures etc. Hence, external financial

sources are those that come from outside of an organization. Main internal and external sources
of finance that companies can undertake to meet the financial requirements are enumerated
below:
Internal source of finance: Companies can use retained profit source for meeting their
funding requirements. Moreover, every business unit lays high level of emphasis on retaining
some amount from profit with itself. The main motive behind such retention is to cope up with
the contingent situation more effectually. Such internal source of finance has following
advantages and drawbacks:
Advantages
 Saving cost: Retained profit source enables firm to save cost to a great extent. Moreover,
it does not include acquisition cost and business unit has no requirement to pay in against
to making use of retained profit. Hence, it is one of the cheaper sources of finance that
offer financial benefits to the organization.
 Free from fixed obligation: When company makes use of retained profit source then it is
free from the fixed obligations like interest or dividend etc.
 Incline in share value: Cost of capital is cheaper when business organization uses
retained profit source to fulfil the monetary needs (Ferrando, Popov and Udell, 2017). In
this case, value of share will increase to the significant level and thereby helps in
attracting the large number of investors.
 Retained profit source also enables firm to get relaxation in terms of taxation when
number of shareholders are not high.
Disadvantages
 Over capitalization: Sometimes, retained profit source leads the issue of over-
capitalization. Moreover, when company makes use of retained profit with the level of
frequency then it may result into insufficient finance.
 High dissatisfaction among the shareholders: In the case of using retained profit as a
financial source, company is not in position to offer high dividend to the shareholders
(Detzer and et.al., 2017). This in turn closely influences the satisfaction level of
shareholders and affect brand image.

External source of finance: In the category of external funding, by using bank loan source
company can generate fund. Moreover, interest is one the main income source for banking
institutions so they focus on giving loan to the organizations whether they are small or big. Thus,
by approaching to the banking institution companies can generate enough funds and thereby
become able to attain success (Cowling, Matthews and Liu, 2017). Besides this, bank loan source
also enables firm to take loan as per their convenience whether for long or short term.
Advantages
 Easy procurement: companies can easily get loan from financial institutions on the
behalf of collateral security. Moreover, security offers protection to the banks in against
to defaults and thereby encourages to grant loan to the concerned entity.
 Tax deduction: Bank loan source also offers opportunity to the firm to get concession in
tax brackets (Chang, Fernández and Gulan, 2017). Thus, such source of finance helps in
reducing the level of tax obligations significantly.
Disadvantages
 In case of high borrowing, company faces issue pertaining to decreased cash flow.
 Along with this, sometimes banking institutions sanction the some part such as 60 to 80%
rather than the whole amount demanded.
 Further, such financial source imposes fixed obligation in front of the company in the
form of interest (Ferrando, Popov and Udell, 2017). This in turn places direct impact on
the working capital position and overall business planning.
By taking into account all the above depicted aspects, it can be said that companies should
keep in mind all the pros and cons when making selection of financial source.
2. Critically evaluating the investment appraisal techniques that are available for business
Investment appraisal techniques are highly significant which in turn offers opportunity to
the analyst to make evaluation of the viability of potential projects. Moreover, earning higher
returns on investment is one of the main motives of firm. In this, tools and techniques of
investment appraisal provide direction to the analyst or manager of the firm about the project
which will prove to be more profitable (Gotze, Northcott and Schuster, 2016). Hence, main
investment appraisal techniques that can be undertaken by the firms are as follows:

Payback period: This method of investment appraisal furnishes information about the
time period within which firm will recoup its initial investment. In the real life, it is highly
required for the manager to get information about the time period after which it would become
able to generate profit. Hence, company can make effectual profit planning by using such
method.
Advantages Disadvantages
 Such method of investment appraisal
gives high level of importance to
liquidity aspect when taking decision
about the selection of proposal.
 Pay-back method deals with the risk
level and helps in highlighting the
proposal whose recovery period is less.
 Ignorance of time value of money
concept is one of the main drawbacks
of such tool.
 Further, emphasis is only laid on
liquidity rather than profitability
(Advantages and Disadvantages of Pay
Back Period (PBP), 2017).
Net present value: This method of capital budgeting comes under the category of
discounted methods. Now, business analysts make focus on using such method because it helps
in assessing the returns which will be generated by the firm after a certain time period. In
accordance with such method companies should give priority to the project having higher NPV.
Advantages Disadvantages
 NPV method presents result or return
by taking into account the time value of
money concept.
 It helps in ranking the projects and
thereby assists in comparing the same.
 Net present value tool clearly depicts
figure in monetary terms which in turn
facilitates easy comparison between the
projects (Laird and Venables, 2017).
 This technique of investment appraisal
does not help in making comparison
between the two mutually exclusive
projects.
 Under such method, analyst assumes
discounting factor by keeping in mind
market trend or other aspects. Hence, if
assumption will be inappropriate then
manager would not be in position to
select suitable project for investment

purpose.
Average rate of return: In ARR, business analyst makes comparison of the potential
profitability aspect of two or more investment opportunities. Under ARR, manager of the firm
makes assessment of average profitability aspect and thereby assess the project that that is
suitable for investment (Li and Trutnevyte, 2017). As per the selection criteria, manager should
employ money in the project that has higher ARR.
Advantages Disadvantages
 ARR helps in measuring and
evaluating the profitability aspect more
effectually (Advantages and
Disadvantages of Accounting Rate of
Return (ARR), 2017).
 Assessment of ARR is highly based on
accounting information. Thus, financial
analyst does not require other report for
calculating ARR.
 It ignores time value of money concept
and avoids cash flow from investment
when calculating ARR.
 At the time of determining ARR,
business or financial analysts do not
consider terminal value of project. It is
one of the main aspects that limit the
significance of such valuation
technique.
Internal rate of return: In the recent times, companies tend to make more focus on
undertaking IRR technique. Moreover, such technique clearly depicts the return in the form of
percentage that is associated with the specific proposal by considering the time value of money
concept. As per such method, companies should go with the project that has higher IRR.
Advantages Disadvantages
 IRR tool lays emphasis on the
selection of project that maximizes
shareholders wealth.
 This method of investment appraisal
offers solution by taking into account
both cash inflow and outflow
 IRR involves tedious calculation
because in this analysts do evaluation
by considering two discounting factors.
 This method does not give suitable
framework for decision making when
size, life and time of projects differ.

(Advantages and Disadvantages of
Internal Rate of Return Method, 2017).
 In IRR, it is highly easy for financial
analyst to give ranks to the project
because it indicates return in percentage
form.
All the above presented aspects show that NPV and IRR have high level of importance in
the real life scenario. Moreover, both such methods presents outcome by taking into
consideration the time value of money concept. Thus, companies should use such method when
making selection of best project out of several. Further, payback and ARR are also one of the
most effectual techniques that can be undertaken by the firms for profit planning. Thus, it can be
stated that significance level of all the above depicted techniques are very high in the dynamic
business environment.
REFERENCES
Books and Journals
Abor, J.Y., 2017. New Venture Development and Sources of Financing. In Entrepreneurial
Finance for MSMEs (pp. 21-50). Springer International Publishing.
Chang, R., Fernández, A. and Gulan, A., 2017. Bond finance, bank credit, and aggregate
fluctuations in an open economy. Journal of Monetary Economics. 85. pp.90-109.
Cowling, M., Matthews, C. and Liu, W., 2017. The role of loan commitment terms in credit
allocation on the UK small firms loan guarantee scheme. International Review of
Entrepreneurship. 15(1). pp.15-28.
Detzer, D. and et.al., 2017. Sources of Funds for Business Investments: Non-financial Corporate
Sector and Small and Medium-sized Enterprises (SMEs). In The German Financial System
and the Financial and Economic Crisis (pp. 155-173). Springer International Publishing.

Ferrando, A., Popov, A. and Udell, G. F., 2017. Sovereign stress and SMEs’ access to finance:
Evidence from the ECB's SAFE survey. Journal of Banking & Finance. 81. pp.65-80.
Ferrando, A., Popov, A. and Udell, G. F., 2017. Sovereign stress and SMEs’ access to finance:
Evidence from the ECB's SAFE survey. Journal of Banking & Finance. 81. pp.65-80.
Gotze, U., Northcott, D. and Schuster, P., 2016. INVESTMENT APPRAISAL. SPRINGER-
VERLAG BERLIN AN.
Jung, C., 2017. Public 6 finance and financial management. Public Administration and Policy in
Korea: Its Evolution and Challenges. p.118.
Laird, J. J. and Venables, A. J., 2017. Transport investment and economic performance: A
framework for project appraisal. Transport Policy. 56. pp.1-11.
Li, F.G. and Trutnevyte, E., 2017. Investment appraisal of cost-optimal and near-optimal
pathways for the UK electricity sector transition to 2050. Applied Energy. 189. pp.89-109.
Smith, K. E. and et.al., 2017. High-Precision (MC-ICPMS) Isotope Ratio Analysis Reveals
Contrasting Sources of Elevated Blood Lead Levels of an Adult with Retained Bullet
Fragments, and of His Child, in Milwaukee, Wisconsin. Biological trace element
research. 177(1). pp.33-42.
Tsai, J. and et.al., 2016. Lymph node ratio analysis after neoadjuvant chemotherapy is prognostic
in hormone receptor-positive and triple-negative breast cancer. Annals of surgical
oncology. 23(10). pp.3310-3316.
Van der Stede, W., 2016. Big data, bigger picture, financial management. Financial
Management. pp.40-43.
Zsidisin, G. A., 2016. Robert J. TrentSupply Chain Financial Management: Best Practices,
Tools, and Applications for Improved Performance2016J. Ross PublishingPlantation, FL.
Online

Advantages and Disadvantages of Accounting Rate Of Return (ARR). 2017. [Online]. Available
through: <http://accountlearning.blogspot.in/2011/07/advantages-and-disadvantages-
of.html>. [Accessed on 16th August 2017].
Advantages and Disadvantages of Internal Rate of Return Method. 2017. [Online]. Available
through: <http://accountlearning.com/advantages-disadvantages-internal-rate-return-
method/>. [Accessed on 16th August 2017].
Advantages and Disadvantages of Pay Back Period (PBP). 2017. [Online]. Available through:
<http://accountlearning.blogspot.in/2011/07/advanyages-and-disadvantages-of-pay.html>.
[Accessed on 16th August 2017].
Break-Even Analysis: Introduction, Assumptions and Limitations. 2017. [Online]. Available
through: <http://www.economicsdiscussion.net/break-even-analysis/break-even-analysis-
introduction-assumptions-and-limitations/21770>. [Accessed on 16th August 2017].
Disadvantages and Advantages of Break-Even Analysis. 2017. [Online]. Available through:
<https://toughnickel.com/business/Breakeven-analysis>. [Accessed on 16th August 2017].
Working Capital Cycle. 2017. [Online]. Available through:
<https://efinancemanagement.com/working-capital-financing/working-capital-cycle>.
[Accessed on 28th July 2017].

APPENDIX
In 2014:
Product sold: 20,000 units
Selling price: £400 per unit
Particulars Formula Figures
Contribution Margin
ratio
Contribution (PU) /
Selling price (PU)
400 – (100 + 20 +
25+ 20+ 15) / 400 =
0.55
BEP (in units) Total fixed cost /
Contribution (PU)
2211000 / (400 –
180) = 1050
Break-even point (in
Revenue)
TFC / Contribution
margin ratio
2211000 / 0.55 =
£4,020,000
Margin of Safety (in
Unit)
Expect Sales in Unit –
Break-even point in unit
20,000 – 10,050 =
9950 units
Margin of Safety (in
Revenue)
Expect Sales in
Revenue – Break-even
point in Revenue
= (20,000 X 400) –
4,020,000
=3,980,000
In 2015,
 New selling point = $ 400 X 1.15 = $460
 New fixed cost = $2,211,000 + $800,000 = $3,011,000
 Contribution margin ratio = 0.55 (same as 2014)
 Break-even point in Revenue = 3,011 000 / 0.55 = 5,474,545.45 unit
 Break-even point in unit = 5,474,545.45 /460 = 11,901.19 = 11,902 unit