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Financial Management and Control

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Added on  2023/01/19

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This document discusses various financial ratios such as profitability ratios, liquidity ratios, gearing ratios, asset utilization ratios, and investor potential ratio. It also explains the working capital cycle and different investment evaluation techniques.

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FINANCIAL MANAGEMENT AND CONTROL

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PART A
Answer 1.
PROFITABILITY RATIOS
Particulars 2017 2016
Gross profit 12200 9100
Revenue 23000 18000
Gross profit margin 53% 51%
Particulars 2017 2016
Net profit 4060 3220
Revenue 23000 18000
Net profit margin 18% 18%
Profitability ratio is a measure of financial metrics which is used to ascertain the ability of a
business to generate earnings which is relative to its operating cost, revenue, balance sheet
assets, which is used from its data from a specific point in time. So, the indication when the
company is doing well is depicted by the profitability ratio which has a higher value relative to
its competitor’s ratio or relative to the same ratio from a previous period. The marginal profit of
the company is measured by the it’s profit. It is usually measured in percentage. As we can see
that the gross profit of the company has increased when it is compared from the year 2017 to
2016. Although, the gross profit is increased, the net profit is decreased due to increase in
interest payable from 500 in 2016 to 1000 in 2017as the income tax is 30% constant. The
shareholders of the company always expect the company to earn higher profits such that the
wealth of the company is maximized. The net profit is affected by the higher interest rate.
LIQUIDITY RATIOS
Particulars 2017 2016
Current assets 5160 4150
Current liabilities 1100 1500
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Current ratio
4.
69
2.
77
Particulars 2017 2016
Current asset 5160 4150
Inventories 2360 1800
Current Liabilities 1100 1500
Quick Ratio
2.
55
1.
57
Liquidity ratio is a very important class of financial metrics which is used to determine the
debtor’s ability to pay off the current debt obligations without raising external capital. The
margin of safety is also calculated through metrics which includes current ratio, operating cash
flowing ratio and quick ratio. It is the ability to convert the assets into cash quickly and cheaply.
The current ratio is calculated by dividing the ratio of current assets by the current liabilities
which as we see has increased from 2.77 in 2016 to 4.69 in 2017. The quick ratio is calculated by
dividing quick assets and current liabilities which has increased from 1.57 in 2016 to 2.55 in
2017. The current ratio measures the financial strength of the company to meet its short term
obligations (Adelaja, 2015). The quick ratio also measures the liquidity of the company but in a
stringent manner. Ideal ratio is 1:1. Therefore, the company is maintaining more than adequate
liquidity position. In other words, these ratios compare the combinations of relatively liquid
assets to the amount of current liabilities which is stated on an company’s most recently prepared
balance sheet. The examples of liquidity ratio are current ratio which compares the current assets
to current liabilities, quick ratio is the same as the current ratio but it excludes the inventories,
cash ratio simply compares just cash and readily convertible investments into current liabilities
(Alvarez, 2013).
GEARING RATIOS
Particulars 2017 2016
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Total Debt 3500 2000
Total Equity 15760 12000
Total Debt to Equity
ratio
0.
22
0.
17
Particulars 2017 2016
Total Debt 3500 2000
Total Asset 19260 14000
Debt ratio
0.
18
0.
14
Gearing ratio represents a group of financial ratios which compares a form of owner’s equity to
the funds borrowed by the company. It is a measurement of the entities financial leverage which
demonstrates the degree of the firms activity which is funded by the share holders funds versus
the creditor’s fund that is the equity capital versus the debt financing (Atkinson, 2012). The debt
to equity ratio has increased from 0.17 to 0.22 which shows that the amount of debt in the capital
structure of the company has increased. The company is using debt for its operations more in
2017 when compared to 2016. An optimal gearing ratio is determined by the individual company
relative to the other companies within the same industry. The calculation of the gearing ratio is
done by the total debt by the total shareholders’ equity. This ratio is also expressed in percentage
which reflects the amount of existing equity which is a requirement to pay off all the outstanding
debt. A high gearing ratio is anything above 50% while a low gearing ratio is anything which is
below 25%. If the gearing ratio is anything in between 25% to 50% then it is considered to be the
optimal gearing ratio (Berry, 2009).
ASSET UTILISATION RATIOS
Particulars 2017 2016
Revenue 23000 18000
Net assets 15760 12000
Asset turnover ratio 1. 1.

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46 50
Asset utilisation ratio helps to determine whether the company is using its assets in the best
possible manner. This ratio is calculated by dividing revenue by net assets. A higher asset
utilisation ratio indicates that the company is able to generate higher revenues given the assets of
the company. As we can see that the asset turnover has fallen in 2017 when compared to 2016.
This shows that the efficiency of the company to manage and use its assets has fallen. In 2016,
the revenue generated by the company was 1.5 times its assets whereas in the year 2017 the
revenue generated was 1.46 times the assets it owns (Bierman & Smidt, 2010).
INVESTOR POTENTIAL RATIO
Particulars 2017 2016
Dividend 300 200
Net income 4060 3220
Dividend payout ratio
0.
07
0.
06
Investor’s Potential Ratio is an array of ratio’s which is used by the investors to have an estimate
of the attractiveness of the potential or the existing investment and to get an idea of its valuation.
Therefore, when the financial statement is looked upon the company many users can suffer from
information overload as there are many financial values (Boyd, 2013). This may include revenue,
gross margin, operating cash flow etc. The investment valuation ratio attempts to simplify the
evaluation process by comparing relevant data which help users gain an estimate of valuation.
Therefore, the investor’s potential ratio is calculated by by net income which has been increased
in 2017 than 2016. The ratio was 0.07 in 2017 and was 0.06 is 2016 (Bragg, 2015). It basically
accesses the company’s performance of a company’s share which for example can be price
earnings ratio, the earning per share and the earnings yield. In addition, of great interest to the
ordinary shareholders, investors ratio are also of some interests of analysts and competitors.
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Answer 2.
Calculation of Working
capital
Current assets 2017 2016
Inventory 2,3
60
1,8
00
Trade receivables 2,3
00
1,6
00
Cash 5
00
7
50
5,1
60
4,1
50
Current liabilities
Trade payables 1,1
00
1,5
00
Working capital
employed
4,0
60
2,6
50
2017 2016
Working capital
employed
2,0
30
1,3
25
Number of days in a year
3
65
3
65
Total WC employed
7,40,95
0
4,83,62
5
Revenue
23,0
00
18,0
00
Working capital cycle
32.
22
26.
87
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Working capital cycle can be defined as the time period that a company takes to convert its
working capital into cash. The working capital cycle for 2016 was 26.87 days whereas for 2017
is 32.22 days. This shows that the company has become inefficient than before and so it is not
able to convert its working capital into cash as fast as before. The company can reduce its
working capital by collecting the dues from receivables faster and sometimes also stretching the
accounts payable. The working capital cycle is calculated by adding inventory turns and account
receivable in day and then subtracting accounts payable in days. The working capital cycle of the
company can be positive or negative. If it is negative then the company is faster in collecting
payments and slow in paying off bills. However, in the given case the working capital cycle is
positive which means that the company is faster in making payment than in collecting it (Datar,
Cost accounting, 2015). A working capital cycle of 26.87 days indicate that the company makes
payment 5 days before it receives from the customers. The working capital cycle has increased
from 2016 to 2017 which shows that the company is inefficient in collecting its money from
customers (Datar, Horngren's Cost Accounting: A Managerial Emphasis, 2016).

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Part B
Answer 1.
a) The payback period
Machine A
Year 0 1 2 3 4 5 6
Cash flow
-
5,00,000
3,00,0
00
2,50,0
00
2,00,0
00
1,50,0
00
50,0
00
20,0
00
Cumulative cash
flow
-
5,00,000
-
2,00,00
0
50,0
00
2,50,0
00
4,00,0
00
4,50,0
00
4,70,0
00
Machine B
Year 0 1 2 3 4 5 6
Cash flow
-
5,00,000
20,0
00
50,0
00
1,50,0
00
2,00,0
00
2,50,0
00
3,00,0
00
Cumulative cash
flow
-
5,00,000
-
4,80,00
0
-
4,30,000
-
2,80,000
-
80,000
1,70,0
00
4,70,0
00
Pay-back period
Machine A
1
.80
Machine B
4
.32
Recommendation: Using the payback period technique, the company must invest in machine A
because of its shorter payback period.
b) The discounted payback period
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Machine A
Year 0 1 2 3 4 5 6
Cash flow
-
5,00,000
3,00,0
00
2,50,0
00
2,00,0
00
1,50,0
00
50,0
00
20,0
00
Discounting
factor
1
.00
0.
91
0.
83
0.
75
0.
68
0.
62
0.
56
Discounted cash
flow
-
5,00,000
2,72,7
27
2,06,6
12
1,50,2
63
1,02,4
52
31,0
46
11,2
89
Cumulative cash
flow
-
5,00,000
-
2,27,27
3
-
20,661
1,29,6
02
2,32,0
54
2,63,1
00
2,74,3
89
Machine B
Year 0 1 2 3 4 5 6
Cash flow
-
5,00,000
20,0
00
50,0
00
1,50,0
00
2,00,0
00
2,50,0
00
3,00,0
00
Discounting
factor
1
.00
0.
91
0.
83
0.
75
0.
68
0.
62
0.
56
Discounted cash
flow
-
5,00,000
18,1
82
41,3
22
1,12,6
97
1,36,6
03
1,55,2
30
1,69,3
42
Cumulative cash
flow
-
5,00,000
-
4,81,81
8
-
4,40,496
-
3,27,799
-
1,91,196
-
35,966
1,33,3
77
Discounted Pay-back period
Machine A 2.14
Machine B 5.21
Recommendation: The sCompany must invest in Machine A as the discounted payback period is
less when compared to machine B
c) The accounting rate of return
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Machine A
Year 0 1 2 3 4 5 6
Cash flow
-
5,00,000
3,00,0
00
2,50,0
00
2,00,0
00
1,50,0
00
50,0
00
20,0
00
Machine B
Year 0 1 2 3 4 5 6
Cash flow
-
5,00,000
20,0
00
50,0
00
1,50,0
00
2,00,0
00
2,50,0
00
3,00,0
00
Accounting rate of return
Machine A 38.80
Machine B 38.80
Recommendation: On the basis of accounting rate of return, the company should be indifferent
between investing in machine A and machine B.
d) Net Present Value
Machine A
Year 0 1 2 3 4 5 6
Cash flow
-
5,00,000
3,00,0
00
2,50,0
00
2,00,0
00
1,50,0
00
50,0
00
20,0
00
Machine B
Year 0 1 2 3 4 5 6
Cash flow
-
5,00,000
20,0
00
50,0
00
1,50,0
00
2,00,0
00
2,50,0
00
3,00,0
00

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Net Present
Value
Machine A
2,74,389.3
7
Machine B
1,33,376.5
5
Recommendation: As per the net present value analysis, the company must invest in Machine A
because the NPV is higher and positive for machine A.
e) Internal Rate of Return
Machine A
Year 0 1 2 3 4 5 6
Cash flow
-
5,00,000
3,00,0
00
2,50,0
00
2,00,0
00
1,50,0
00
50,0
00
20,0
00
Machine B
Year 0 1 2 3 4 5 6
Cash flow
-
5,00,000
20,0
00
50,0
00
1,50,0
00
2,00,0
00
2,50,0
00
3,00,0
00
Internal Rate of Return
Machine A 35.04%
Machine B 16.17%
Recommendation: The company must invest in Machine A because the internal return for it is
35.04% which is higher when compared to that of machine B (16.17%).
Answer 2.
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The payback period - This benefit of using this method is that it is very simple, understandable
and easy to calculate. However, the limitations of this method are that it takes into consideration
the initial investment and ignores the subsequent investments completely (Donohue, 2015). Also,
it does not account for time value of money.
The discounted payback period- It helps the business to decide whether to accept or reject a
particular project after taking into consideration the profitability along with the time value of
money concept. This technique is usually used when the company has to take decision for
mutually exclusive project. The limitation of using this technique is that it does not take into
account the cash flows generated after the breakeven point. Also, this just a breakeven technique
which helps the company to know the duration of recovering the initial investments made by it
(Easton, 2010).
The accounting rate of return- Accounting rate of return is the least preferred method to
analyse the acceptability of the project. The reason behind this is it completely ignores time
value of money and also it only considers profits that are earned by the company and ignores
cash flows (Elaine, 2015). It is very important to analyse the cash flows before accepting or
rejecting a project and so this technique is not preferred.
The Net present value- This is the most commonly and the best technique of investment
appraisal. There are various benefits of using this technique such as its assumption of
reinvestment of cash flows, it considers all the cash flows and also accepts the conventional cash
flow pattern. It is a good measure of profitability as it takes into consideration the factor risks.
However, there are certain limitations also. The limitations include ignoring sunk cost,
estimation of opportunity cost, difficulty in the estimation f required rate of return, does not
account for differences in size of various projects. A company must accept a particular project if
the net present value of a project is positive and higher when compared to the NPV’s of other
projects (Fisher, 2012).
Internal rate of return- This method helps to forecast the profits that are expected to be
generated in future. This method also considers the concept of time value of money. This method
is said to be the most accurate and credible method of evaluating the various projects that the
company has been proposed for (Fridson & Alvarez, 2012). However, the disadvantage of this
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method is that it ignores duration, the future costs as well as the sixe of the project. This, it not a
correct decision to accept or reject the projects based on IRR only.
Answer 3:
There are various sources of finance through which funds can be raised. The financial manager
of the company usually takes this decision. This decision has a great influence of the profitability
of the company as it directly affects the cost of capital (Girard, 2014). The two major source of
finance for investing in machine A is debt and equity. If the company raises debt in order to
finance this machine then the financial leverage of the company will rise. An increase in
financial leverage indicates an increase in financial risk of the company because the company
has an obligation to pay dividend periodically and also maintain debt at a specific level. The
benefit of raising funds through debt is that there is no lack of control and also the company is
benefitted by tax deductions. Debt does not dilute ownership interest in the company. However,
the second option of raising funds through is by issuing equity. The company can sell shares to
the stakeholders of the company and raise finance. There is no impact on the profitability of the
company but it effects the ownership position. The stake of existing shareholders gets diluted
when the company issues more shares in order to finance a particular project because the number
f shares outstanding increases. Thereby, decreasing the earnings per share of the company. In
case of equity financing, the company has no obligation to make any periodical payments. The
debt is considered to be cheap source of finance when compared to equity because in case of
equity only interest payments has to be done but in case of equity the required return of the
investors are very high (Holtzman, 2013).

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Part C
Answer 1.
A budget is an estimate of expenses and revenue over a specific period of time which is
formulated, compiled and re-evaluated on a periodic basis. It is considered to a formal statement
of estimated income and expenses which is based on the plan and objective. Budget preparation
can be done for a person, a family, a group of people, a organization, a business, a country or a
government. Budget is about anything that deals with money. Usually, for a company or an
organization, a budget is prepared by internal management team by using various tools and is
mostly not required for reporting by the external party. Also, a budget depends on the nature and
the size of the business (Horngren, 2012).
The budget varies and are of different types depending on the short-term and long-term and is
department specific as well. In simple terms, it is a written financial plan in which a company’s
financial goal is mentioned for a future period. It is a standard tool for measuring performance
and is also a device for coping foreseeable adverse situations. Creating this spending plan allows
to determine in advance whether or not there is enough money to carry out the plan to achieve
the goals and objectives. Budgeting is an integrated process which allows in planning,
implementing and operating budgets. It is used to fix targets and also control the deviation if any.
The performance of an organization can be measured and ascertained by evaluating its budget.
(Horngren, 2012).
How budget, strategic plan and strategic objective are related.
The budget that spans or lasts for a period of time which is mostly more than one year is strategic
budgeting which is processed for creating a long-range budget. This is a type of budgeting that is
to prepare a plan and develop it which enables to support an entity with a long-range vision for
the future position. It may involve the evolution and enlargement of new geographic market area,
the research and development required to evolve a new product line. In these examples, it is not
possible to curate a budget only for a year. Therefore, by engaging strategic planning in the
budget will help an organization achieve their long-term vision in its strategic positioning.
A strategic budget is not much concerned with the detailing of the revenue and expense line
items which can be seen in an annual budget. Emphasis is a little less on the accuracy of some
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specific items and it has a major focus on the overall goals and objective that needs to be
achieved.(Lyon, 2010).
A strategic budget is a little less concerned with detailed revenue and expense line items found in
an annual budget. There is less emphasis on the accuracy of specific items and has a greater
focus on the overall goals to be achieved. The focus of strategic budgeting therefore shifts away
into such matters as: Strategic direction, Risk management, Competitive threats, and Growth
options.
Therefore, a budget plan acts as a good direction indicator which shows the organization how it
must move from its present level of performance to the expected level of performance and is also
based on the assumed economic environment conditions. The budgeting plan accounts for the
activities, dependency, assumptions, timelines, and the resources which supports an overall
strategic objective planned to be achieved.
Answer 2.
Budget evaluation is referred as the final stage of the budget cycle when there is an assessment
of whether resources have been used in an appropriate and effective manner. Ascertain current
financial goal of the organization. The goal does change over a period of time. For example, a
person maybe focusing on clearing the debt, and the time that goal has been achieved, the person
may have a lot of extra money to be redistributed. Therefore, at least three accomplishments of
goals to work towards, must be worked upon. Most experts agree that about fifteen percent
savings of income must be accomplished towards the walk of retirement. Evaluation of current
budget must be done to see if it’s helping the organization to reach the ascertained financial
goals. This may seem be fairly straightforward, but if something has recently changed, then the
changes in the budget must be made. Also, if the organization is debt free, it is extremely
important to make savings a major priority, although it may increase the expenditure in various
different spheres. Budget improvement methods must be looked upon. It may be found that
savings needs to be maintained in a different bank so that it becomes more difficult to access the
money. This might add extra incentives to keep a track on the spending throughout the month. It
means that identifying the weaknesses of the budget and making changes in the strategies so that
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they don’t occur as problems any further. For example, if eating outside is difficult then one must
find their ways to make eating at home easier.
Steps in Budgeting Process
Step 1: Update budget assumptions
Step 2: Note Available funding
Step 3: Step costing points
Step 4: Create budget package
Step 5: Obtain revenue forecast
Step 6: Obtain department budgets
Step 7: Validate compensation
Step 8: Validate bonus plans
Step 9:Obtain capital budget requests
Step 10:Review the budget
Step 11:Obtain approval
Step 12:Issue the budget
Master Budget
As the name suggests, a master budget is an aggregate of all the business smaller individual
budgets. This is the true and the complete representation of the business financial activity and
health. Factors like sales, assets, expenses and revenue streams which allow companies to
establish their goals and their performance are all included in the master budget. The cost centre
of different teams within the large organisation which helps keep the individual managers
aligned with the financial capability are all included in the master budget.
Operating Budget
Operating Budget includes the analysis and the forecast of the projected revenue, expenses over
the course of given time duration. Operating budget includes all the factors that helps the
organisation to operate its business which includes sales, material manufacturing, labour,
production, and the administrative cost. The time duration for these budgets can be in the order

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of weeks, months or on the yearly basis. Recurring reports of this budget helps the organisation
analyse the gradual growth/revenue and the cost of the operations.
Cash Flow Budget
Cash flow budgets is a analysis of the cash flow within the organisation within a specified time
period. The cash flow could be inward or outward. It help the company decide if the cash is
being managed wisely. The analysis of the accounts payable and the accounts receivable helps
the company to assess despite it has sufficient cash to continue operations, the extent of the
expenditure and the likelihood of generating cash for the future growth.
Static Budget
A static budget is a budget that is fixed in nature which remains unchanged regardless of the
changes in some factors such as the volume of sales or revenue. For example, a steel supply
company may be having has a static budget every year for warehousing and storage which is
irrespective of how much inventory it shifts in and out due to an increase or decrease in sales.
Financial Budget
Financial budget gives an overview of the organisation’s financial health and presents a detailed
overview of it’s expenses and it’s revenue from its core operations. It presents the strategy of a
company for managing its revenue, expenses, assets and the cash flow within the organisation. A
start up for example might use its financial budget to predict their valuations. A public company
might use it to determine the value of its public stock offering.
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Bibliography
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Chicago: CreateSpace Independent Publishing Platform .
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Berry, L. E. (2009). Management accounting demystified. New York: McGraw-Hill.
Bierman, H., & Smidt, S. (2010). The Capital Budgeting Decision. Boston: Routledge.
Boyd, W. K. (2013). Cost Accounting For Dummies. Hoboken: Wiley.
Bragg, S. (2015). IFRS guidebook. Hoboken: Wiley.
Datar, S. (2015). Cost accounting. Boston: Pearson.
Datar, S. (2016). Horngren's Cost Accounting: A Managerial Emphasis. Hoboken: Wiley.
Donohue, R. (2015). An introduction to-- cashflow analysis. Mission Viejo, CA: Regent School
Press.
Easton, P. (2010). Financial statement analysis & valuation. Cambridge, UK: Cambridge
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Elaine, H. (2015). International financial statement analysis. Hoboken: John Wiley & Sons.
Fisher, J. (2012). Investment analysis for appraisers. Chicago, Ill.: Real Estate Education Co.
Fridson, M., & Alvarez, F. (2012). Financial Statement Analysis: A Practitioner's Guide. New
York: John Wiley & Sons.
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