Financial Management: Tax Liabilities, Risk & Return, Financial Statements

This document provides an introduction to financial management and covers topics such as tax liabilities, risk & return, and preparation of financial statements. It also discusses the role of capital-budgeting technique for choosing projects.

FINANCIAL
MANAGEMENT

Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................3
Question 1....................................................................................................................................3
Question 2 ...................................................................................................................................4
Question 3 ...................................................................................................................................6
Question 4 ...................................................................................................................................8
Question 5 .................................................................................................................................13
Question 6 .................................................................................................................................14
Question 7 .................................................................................................................................17
CONCLUSION..............................................................................................................................18
REFERENCES..............................................................................................................................19

INTRODUCTION
The term financial management can be defined as a systematic process of planning,
organising and controlling the monetary activities in an effective manner (Finkler, Smith and
Calabrese, 2018). This management of financial aspects is essential for companies in order to
make better utilisation of resources. The aim of project report is to demonstrate understanding
about different terms of finance. The project report covers about tax liabilities, risk & return,
preparation of financial statements. The further part of project report concludes about different
kinds of ratios and financial planning. In the end part of report, role of capital-budgeting
technique for choosing projects is covered.
MAIN BODY
Question 1.
(A) Taxable liability:
Earnings ×
Marginal Tax
Rate = Taxes
50000 × 15.00% = 7500
25000 × 25.00% = 6250
626500 × 34.00% = 213010
226760
Add: Additional Surtax
[5% on income between $100,000
and $335,000]
235000 x 5.00% = 11750
Total Tax Liability = 238510
(B) ‘Taxes are a fact of life, and businesses, like individuals, must pay taxes on Income’ –
Elucidate.

The taxes play a crucial role in aspect of development of a nation. It is so because if a
country's total taxable income is lower then this can be difficult to develop various aspects of
environment due to lack of funds (Horton and Farnham, 2015). On the other hand, if in a nation
taxable income is higher then there will be more chances of development. Thus, it is important
for businesses and individuals to pay tax on time on generated amount of expenditures.
Question 2 .
(A)
Expected return= P*R
Herein,
P= Probability
R= Return on probability
Return on common stock A:
Expected return= (0.30*0.12)+ (0.40*0.16)+ (0.30+0.18)
= 0.036+0.064+0.054
0.154 or 15.4%
Return on common stock B:
Expected return= (0.20*0.15)+ (0.30*0.06)+ (0.30*0.13)+ (0.20*0.21)
= 0.03+0.018+0.039+0.042
=0.129 or 12.9%
Standard deviation ^ 2 = summation of P(r-R)^2
For common stock A
Probability r r-R (r-R)^2 P(r-R)^2
0.3 0.12 -0.03 0.0009 0.00027
0.4 0.16 0.01 0.0001 0.00004
0.3 0.18 0.03 0.0009 0.00027
0.00058
Thus,
Expected return= 15.4%

Standard deviation= 0.058%
For common stock B
Probability r r-R (r-R)^2 P(r-R)^2
0.2 0.15 0.021 0.000441 0.0000882
0.3 0.06 -0.069 0.004761 0.0014283
0.3 0.13 0.001 0.000001 0.0000003
0.2 0.21 0.081 0.006561 0.0013122
0.002829
Thus,
Expected return= 12.9%
Standard deviation= 0.2829%
So, stock A should be preferred because of higher expected return.
(B) ‘Understanding the relationship between risk and return and how it’s affected by time is
probably one of the most important aspects of investment’ – Discuss.
(I) Different types of risks: The term risk can be defined as a possibility of loss on
investment made by companies into different types of projects. There are different types of risks
and some of them are mentioned below that are as follows:
 Business risk- It can be defined as a kinds of risk that is related with business entities.
This occurs due to different factors such as competition, customers preference and many
more.
 Volatility risk- It can be defined as a kinds of risk in which a portfolio can face changes
in value because of variation in prices (Renz and Herman, 2016).
 Inflation risk- This is also known as purchasing power risk. It can be defined as a kinds of
risk in which cash from investment will not be useful because of inflation in purchasing
power.
 Market risk- It can be defined as a kinds of risk which is faced by companies due to
different types of factors such as change in interest rate, currency risk and many more.
(ii) Diversification reduces risk

In the aspect of minimising risk, term diversification plays a significant role. This is so
because under it, different types of investments are allocated into various financial instruments
(Mitchell, 2017). Basically, the main objective of this approach is to maximise returns by making
investments into various kinds of areas.
(iii) Common measures of risk
There are basically, five risk measures which provides a better way to assess risk in
investments. Description of these risks is mentioned below in such manner:
 Alpha- It measures risk regards to market or a particular benchmark index. In the case
when funds exceed the benchmark then it is considered as a positive alpha (Bryce,
2017). On the other hand, if funds fall below the benchmark then it is assigned that alpha
is negative.
 Beta- It measures the systematic risk of funds as compare to benchmark index. Under
this, if betas are below one then volatile considers as below then benchmark. On the other
hand, betas over one are considered more volatile compare to benchmark.
 R- Squared- It measures the percentage of a particular investment movement which is
attributable to variation in its benchmark index. Basically, it shows the correlation
between evaluated investment and its benchmark.
 Standard deviation- It can be defined as a way of measuring data dispersion in related to
value of data (McKinney, 2015).
 Sharpe ratio- It measures performance as per the associated risks. This is being done by
abstracting the rate of return on a risk free investment.
Question 3
(A)Income Statement for the year ended December 31, 2018
Particulars Amount
sales 123000
Less: Cost of Sales
62000
Add: Closing Stock 82000

Gross profit 143000
Operating expenses
Prepaid expenses 12000
Salaries 22000
Depreciation 24000
Utility expenses 8000
Interest expenses 4500
Income tax expenses 4500 -75000
Net profit 68000
Balance sheet for the year ended December 31, 2018
Liability
Retained Earning (Net Profit) 68000
Non current liabilities
Loan form bank 320000
Long term liability 35000
Current liabilities
Accounts payable 57000
short term notes payables 44000
Total liabilities 524000
Assets
Non current assets
Building 255000
less depreciation -24000 231000

Trademark 6000
Equipment 76000
Total non current assets 313000
Current assets
Accounts receivables 34000
Cash 15000
Prepaid expenses 12000
Inventories 82000
Other current assets 68000
Total current assets 211000
Total assets 524000
(B) ‘The finance department of an enterprise performs several functions in order to achieve the
objectives. The scope of finance is very wide.’ explain.
This is true that finance department in various companies play a significant role in order
to achieve overall objective (Waxman, 2017). Herein, below some key role of finance
department are mentioned below that are as follows:
 Better management of company's cash flows- The finance department of business entities
play a key role in aspect of effective management of cash flows (Sofat and Hiro, 2015).
It is being done by preparing cash flow statement at the end of accounting period.
 Helps in budgeting and forecasting- In addition, another role of finance department in
companies is to help in effective projection of income and expenditures. It is so because,
this department provides key informations to managers regards to monetary transactions
of a particular time period. As per it, managers become able to take corrective action in
order to make better financial planning.
 Management of company's investments- As well as, this department is beneficial for
companies in order to make proper management of long & short-term investments
(Banerjee, 2015). It is so because finance managers assess possible value of risk and

return on the investments. On the basis of it they guide to company about whether they
should make investment or not.
 Management of taxes- It becomes essential for companies to make proper management of
taxes so that retained earning can be increased. The finance department provides
institutions to managers in order to save total amount of tax payable liabilities.
Question 4
1. How liquid is the firm:
Answer- In order to address this question, it is essential compute liquidity ration of McDonald's
company that is as follows:
Approach 1.
Current ratio= Current assets/ current liabilities
= $1143/ $2985
= 0.38 times
Quick ratio= Quick assets/ current liabilities
= 1072/2985
= 0.36 times
Compare to industry ratios:
McDonald corporation Industry average
Current ratio= 0.38 times 0.70 times
Quick ratio= 0.36 times 0.40 times
Analysis- On the basis of above calculated ratio of McDonald company, this can be find out that
their liquidity position is weaker as compare to industrial ratios. This is so because their current
ratio is of 0.38 times but industrial ratio is of 0.70 times. As well as their quick ratio is also lesser
that is of 0.36 while industrial ratio is of 0.40 times. Hence, it is important for above company
that they should focus on increasing their current assets so that they can make payment of their
short-term debts and their efficiency can be increase.
Approach 2

In order to assess the liquidity position, this is important to identify firm's ability to convert
accounts receivable and stock into cash on a particular time. In the aspect of above McDonald's
company it is mentioned below in such manner:
McDonald corporation Industry average
Average collection period= Accounts
receivable/ daily credit sales
-
$484M/ $11508M= 0.420 times or 15.3 days 6.5 days
On the basis of above calculation, this can be find out that above company does not collect their
debts in an effective manner as compare to average industries. This is so because they take 15
days in order to gather debts while average time of industry is 6.5 days. Thus, it is important to
focus on collecting debt in an effective manner so that days can be minimised.
Accounts receivable turn over
McDonald corporation Industry average
Accounts receivable turnover= Credit sales/ accounts receivable -
$11508M/ $484M= 23.8 times/ year 56.2 times/ year
As per the above calculated ratio, this can be find out that company is not able to meet turn its
receivable in long time period. Such as their receivable turn over is of 23.8 time in a year but
average industrial ratio is 56.2 time/ year.
Inventory turn over ratio
McDonald corporation Industry average
Inventory turn over= Cost of good sold/ inventory -
$6537M/ $71M= 92 times/ year 35 times year

The above results shows that McDonald's company is effective in order to manage its
inventories. This is so because above company is turning its inventories over 92 times while
average industrial ratio is 35 times. Thus, in this case above company's performance is better.
2. Is management generating adequate operating profits on the firm's assets?
Answer:
Operating income return on investment= Operating income/ total assets
McDonald corporation Industry average
Operating income return on investment= Operating income/
total assets
-
$2794/$18242= 0.153 or 15.3% 11.60%
On the basis of above calculation, this can be find out that McDonald's company is able to
generate more return on a particular investment as compare to industries' average ratio. Their
return on investment is of 15.3% but industrial average return is of 11.60%.
Operating profit margin
McDonald corporation Industry average
Operating profit margin= Operating income/ sales -
$2794/11508= 0.243 or 24.3% 6.10%
Total assets turn over ratio
McDonald corporation Industry average
Total assets turn over ratio= sales/ total assets -
$11508M/ $18242M= 0.63 1.90%
OIROI

McDonald corporation Industry average
OIROI = Operating profit margin* total assets turnover -
24.3*0.63= 15.3% 6.1%*1.90= 11.6%
Fixed assets turn over ratio
McDonald corporation Industry average
Fixed assets turn over= Sales/ fixed assets -
$11508/$14961M= 0.77 3.2
On the basis of above ratios, this can be find out that McDonald's company seems more
competitive in terms of cost, profits and sales. This is so because above company is able to
generate $0.63 in sales per dollar of assets while the industrial average is of $1.90 in sales from
each dollar in assets. As well as their operating profit margin is also higher as compare to
competitors of industry. In addition, their turn over of fixed assets is of 0.77 times and industrial
ratio is of 3.2 times. This is indicating that above company is better in all the computed ratios
regards to efficiency.
3. How is the firm financing its assets?
Debt ratio:
McDonald corporation Industry average
Debt ratio= Total debt/ total assets
$9310/$18242M= 0.51 or 51% 69.00%
On the basis of above calculated ratio, this can be find out that above company is using their
debts in an effective manner as compare to industrial ratios. This is so because their debt ratio is
of 51% while their competitors ratio is of 69%.
Times interest earned:
McDonald corporation Industry average

Times interest earned: Operating income/ interest -
$2794M/$387M= 7.22 3.30%
As per the above ratio, this can be find out that above company is being able to service their
interest expenses without any issues. The company's operating income can fall down as its
current level and they even have income to make payment of required interest.
4. Are the owners (stockholders) receiving an adequate return on their investment?
Return on common equity
McDonald corporation Industry average
Return on common equity= Net income/ common equity -
$1617M/$8852M= 0.183 Or 18.3% 12.78%
On the basis of above calculated ratio, this can be find out that above company's return on equity
is of 18.3% which is higher then industrial average ratio. This is indicating that above company
is more efficient in order to gain return on the each equity shares.
(B) “Financial ratios calculated and analysed in a particular situation depend on the user of the
financial statements.”- Expound the advantages and limitations of ratio analysis.
Ratio analysis- It can be defined as a kinds of technique in that a wide number of ratios are
calculated and interpreted in order to assess companies financial performance (Matthew, 2017).
There are wide range of ratios which are covered under the ratio analysis and each of them has a
integration over companies various kinds of departments. Herein, below some key advantages
and disadvantages are mentioned that are as followings:
Advantages-
 The ratio analysis is useful for companies in order to measurement of profitability in an
effective manner.
 As well as it is beneficial for business entities for assessing operational efficiency.

 By help of different kinds of ratios, it becomes possible for companies to measure
companies possible strength and weaknesses. On the basis of it, business entities make
their further plan to overcome weaknesses.
 In addition, the ratio analysis, makes able to companies in order to do comparison their
recent performance from past years' performance.
 Another advantage of the ratio analysis is to help companies in the context of identifying
problem areas and to bring focus of management department on theses areas.
Disadvantages:
 The ratio analysis ignores price level changes because of inflation. It is so because most
of the ratios are calculated on the basis of historical costs.
 As well as it neglects the qualitative aspect of firms (Pandey, 2015).
 There is no any specific definition of ratios and because of it companies apply different
formulas to compute ratios.
 The ratios do not help companies in solving monetary issues. These are a mean to end not
the actual solution.
Question 5 .
(A) Estimated requirement of funds:
Balance Sheet
2002 % 15 Million of
Sales
Current assets $3.75 Million 25%
Net fixed assets $ 7.5 Million 50%
Total $ 11.25 Million
Liabilities and Owners' Equity
Accounts payable $3.75 Million 25%
Long-term debt $1 Million N A

Total liabilities $4.75 Million
Common stock $2 Million NA
Paid-in capital $1.9 Million NA
Retained earnings [1.1 + 2 (Net Income)] $3.1 Million
Common equity $ 7 Million
Total $11.75 Million
Predicted financial need= Projected total assets- Projected total liabilities-Projected owner's
equity
= 11.25 – 4.75 - 7
= $ 0.5 Million
(B) Brief overview of financial planning and its types.
The above company is expecting that their sales will increase by one million and will
became of $15 million. In the context of this, company will require funds of $1.5 million in order
to fulfil the need of estimated sales and net income. As well as their financial planning is of long
term. This is so because long term financial planning can be defined as a kinds of plan in which
firms makes estimation of funds for one year or more then one year (Moutinho and Vargas-
Sanchez, 2018). In the above case of company, they are making plan of long term funds as well
as for time period of one year. Along with their estimated value of total assets is of $11.25 and
estimated liabilities are of $4.75. In addition, the value of projected owner's equity is of $1.5
million.
Question 6
(a) Calculation as per the payback period, ARR, NPV and profitability index.
Payback period:
Project M
Year Cash flow Cumulative cash flow
1 10000 10000

2 15000 25000
3 20000 45000
4 25000 70000
5 30000 100000
Payback period= 4+ 30000/7000
= 4+4.43
= 4.4 years
Project N
Payback period= Initial investment/ cash flows
= 100000/25000
= 4 years
ARR:
Project M
Year Cash flow
1 10000
2 15000
3 20000
4 25000
5 30000
Total 100000
Average cash flows: 100000/5
= 20000
Accounting rate of return= Average cash flows/ Initial investment*100
= 20000/100000*100

= 20%
Project N
= Total average profit : 125000/5
= 25000
= 25000/100000*100
= 25%
NPV:
Project M
Year Cash flows PV factor Discounted cash flow
1 10000 0.91 9100
2 15000 0.83 12450
3 20000 0.75 15000
4 25000 0.68 17000
5 30000 0.62 18600
72150
NPV= Discounted cash flow-Initial investment
= 72150-100000
= -27850
Project N:
Year Cash flows PV factor Discounted cash flow
1 25000 0.91 22750
2 25000 0.83 20750
3 25000 0.75 18750
4 25000 0.68 17000
5 25000 0.62 15500
94750

NPV= 94750-100000
= -5250
Profitability index= PV of cash flows/ initial investment
Project M:
= 72150/100000
= 0.72
Project N:
= 94750/100000
= 0.94
(b) Selection of suitable project.
Payback period- As per this method, it can be find out that project M' s cost can be covered in
4.4 years while project N' s cost can be covered in 4 years. So project N should be chosen.
ARR- The accounting rate of return on project M is of 20 % while on project N, it is of 25%.
Thus, project N should be chosen.
NPV- The net present value of project M is of -27850 and project N has value of -5250. So both
project should not be accepted. Though, project N seems better in comparison.
Profitability index- The profitability index of project M and N is of 0.72 & 0.94. Hence, project
N is better as compare to project M.
So overall project N is better in all the methods.
Question 7
Short note on the following Financial Management Axioms:
(I) Risk-Return trade off- The term risk return trade off defines that the value of return increases
in relation to increase in risk.

(ii) Time value of money- This can be defined as a concept which states that money available in
current time period has more worth as compare to future time period. In other words, this defines
that it is beneficial to get money in current time rather than to future (Martin, 2016).
(iii) Cash is king- This is a kinds of phrase which defines that it is beneficial to keep investment
in the form of cash. This principle is being used in the case when price of investment is higher.
(iv) Incremental cash count- It can be defined as a cash flow from different cash inflows and
outflows during a particular time period.
(v) It’s hard to find really profitable projects- This is correct that it’s hard to find really profitable
projects. The reason behind this is that different projects have risks along with return and it
becomes typical for investors to find out proportion between risk and return.
(vi) Efficient capital markets- The efficient capital markets can be defined as those markets in
that security prices reflects all information which is available regards to fundamental value of
securities.
(vii) The agency problem- This can be defined as kinds of conflict of interest in any relationship
in which one party is expected to work according to another ones interest (Cornwall, Vang and
Hartman, 2019). In the aspect of finance, the term agency problem can be defined as those
conflicts which arises due to differences of interest in company's management and stakeholders.
(viii) Taxes bias business decisions- It is true that taxes bias business decisions, it is so because
business entities are liable to pay tax on their earned value of profits. So overall taxes are
considered as liability for businesses and each liability effect decision-making process.
(ix) All risk is not equal- This is right that all risk is not equal. It is so because some risks can be
diversified and some risks can not be. The process of diversification can minimise impact of rist
on return.
(x) Ethical dilemmas are everywhere in finance- There are different types of ethical dilemmas in
the aspect of finance (Penner, 2016). In the aspect of finance, key dilemmas are manipulation of
financial data and making frauds etc.
CONCLUSION
On the basis of above project report, financial management is too crucial for business
entities and for which there are wide number of techniques. The project report concludes about
different types of financial aspects such as relationship between risk and return, calculation of

taxable liabilities. As well as under the project report, financial statements are prepared as per
given data along with financial projection is done. In the further part of report role of ratio
analysis is concluded and concept of capital-budgeting is covered by some practical questions. In
the end some Financial Management Axioms are concluded such as time value of money, cash is
king.

REFERENCES
Books and journals:
Finkler, S. A., Smith, D .L. and Calabrese, T.D., 2018. Financial management for public, health,
and not-for-profit organizations. CQ Press.
Renz, D. O. and Herman, R .D. eds., 2016. The Jossey-Bass handbook of nonprofit leadership
and management. John Wiley & Sons.
McKinney, J. B., 2015. Effective financial management in public and nonprofit agencies. ABC-
CLIO.
Banerjee, B., 2015. Fundamentals of financial management. PHI Learning Pvt. Ltd..
Matthew, B .T., 2017. Financial management in the sport industry. Routledge.
Pandey, I. M., 2015. Essentials of Financial Management, 4th Edtion. Vikas publishing house.
Moutinho, L. and Vargas-Sanchez, A. eds., 2018. Strategic Management in Tourism, CABI
Tourism Texts. Cabi.
Martin, L. L., 2016. Financial management for human service administrators. Waveland Press.
Cornwall, J. R., Vang, D .O. and Hartman, J. M., 2019. Entrepreneurial financial management:
An applied approach. Routledge.
Penner, S .J., 2016. Economics and financial management for nurses and nurse leaders. Springer
Publishing Company.
Bryce, H. J., 2017. Financial and strategic management for nonprofit organizations. Walter de
Gruyter GmbH & Co KG.
Horton, S. and Farnham, D. eds., 2015. Public management in Britain. Macmillan International
Higher Education.
Mitchell, G .E., 2017. Fiscal leanness and fiscal responsiveness: Exploring the normative limits
of strategic nonprofit financial management. Administration & Society. 49(9). pp.1272-
1296.
Waxman, K .T. ed., 2017. Financial and business management for the doctor of nursing
practice. Springer Publishing Company.
Sofat, R. and Hiro, P., 2015. Strategic financial management. PHI Learning Pvt. Ltd..