Financial Management and Control

This report evaluates the financial performance of Bitmap plc based on its past two year's financial statements. It analyzes profitability, liquidity, gearing, and asset utilization by calculating important financial ratios. The report also includes a brief evaluation of Bitmap's working capital cycle.

Running Head: Financial Management and Control
FINANCIAL MANAGEMENT AND
CONTROL
STUDENT NAME
UNIVERSITY NAME

Financial Management and Control
Contents
Part A..........................................................................................................................................................2
Introduction.............................................................................................................................................2
Evaluation of the financial performance of Bitmap plc on the basis of past two year’s financial
statements...............................................................................................................................................3
Asset utilisation:......................................................................................................................................9
Investor’s potential:...............................................................................................................................11
A brief evaluation of Bitmap plc’s working capital cycle........................................................................12
Conclusion:............................................................................................................................................14
Part B.........................................................................................................................................................15
Capital Budgeting Analysis:....................................................................................................................15
Cash-flow details:..............................................................................................................................15
1) The Payback Period...................................................................................................................17
2) The Discounted Payback Period................................................................................................18
3) The Accounting Rate of Return.................................................................................................19
4) The Net Present Value...............................................................................................................21
5) The Internal Rate of Return.......................................................................................................22
Evaluation of different investment appraisal techniques:.....................................................................23
Evaluation of two suitable sources of finance to fund this investment:................................................25
Part C.........................................................................................................................................................27
Budgeting..............................................................................................................................................27
Evaluation of the budgeting process and the interlinking of various budgets used within a business.. 28
References:................................................................................................................................................31
1

Financial Management and Control
Part A
Introduction
Bitmap plc is a recognised furniture manufacturer based in London. This report evaluates its
financial performance on the basis of the financial results which the company has posted over the
past two years. Various changes in the key elements of the two most important financial
statements: income statement and balance sheet, will be analysed to evaluate Bitmap’s
performance in relation to profitability, liquidity, gearing, asset utilisation and investors
potential. This evaluation will be done by calculating important financial ratios for the company
and then interpreting the results (Bragg, 2012). This report also includes the calculation and brief
evaluation of the working capital cycle for Bitmap plc.
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Financial Management and Control
Evaluation of the financial performance of Bitmap plc on the basis
of past two year’s financial statements
Bitmap plc’s financial statements
Statement of comprehensive income for the year ended 2016 and 2017
(£000) 2017 (£000) 2016
Revenue 23,000 18,000
Less: Cost of sales
Opening Inventory 1,800 1,700
Manufacturing cost 12,000 9,000
Total cost of goods
available to sell
13,800 10,700
Less: Closing inventory 3,000 1,800
Total cost of sales 10,800 8,900
Gross profit 12,200 9,100
Less: Expenses
Selling & distribution
expenses
4,000 3,000
Administrative expenses 1,400 1,000
5,400 4,000
Operating profit 6,800 5,100
Less: Interest payable 1,000 500
Profit before tax 5,800 4,600
Less: Income tax (30%) 1,740 1,380
Profit after tax 4,060 3,220
Less: Dividends paid 300 200
Retained profit for the 3,760 3,020
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Financial Management and Control
year
Statement of financial position as at 31st of December 2016 and 2017
(£000) 2017 (£000) 2016
Non-current assets (net)
Land and building 12,000 9,000
Equipment 1,400 1,250
Motor vehicles 1,800 1,100
15,200 11,350
Current assets
Inventory 2,360 1,800
Trade receivables 2,300 1,600
Cash 500 750
5,160 4,150
Current liabilities
Trade payables 1,100 1,500
Net current assets 4,060 2,650
19,260 14,000
Non-current liabilities
Loan stock 3,500 2,000
3,500 2,000
Net assets 15,760 12,000
Equity
Ordinary shares of £1
each
10,000 10,000
Retained earning 5,760 2,000
15,760 12,000
4

Financial Management and Control
Evaluation of Bitmap plc’s financial performance:
Profitability:
2017 2016
Gross profitability or Gross margin=
Gross Profit/ Revenue 12200/23000 = 53.04% 9100/18000 = 50.56%
Operating Profit Margin= Operating
Profit / Revenue 6800/23000 = 29.57% 5100/18000 = 28.33%
Net profitability or Net margin= Net
Profit / Revenue 4060/23000 = 17.65% 3220/18000 = 17.89%
Return on assets= Net Profit / Total
Assets
4060/(15200+5160) =
19.94%
3220/(11350+4150) =
20.77%
Gross profitability ratio measures the profit generating ability of the company. It tells what
proportion of net sales is left after taking out the total cost of goods sold or total cost of sales
(Peavler, 2018).
Bitmap’s gross profitability has increased from 50.56% in 2016 to 53.04% in 2017. This can be
due to the combined effect of the increased revenue and cost efficiency from the economies of
scale.
Operating profit margin measures the profit a company is generating from its business
operations. Bitmap’s operating profit margin has increased from 28.33% in 2016 to 29.57% in
2017. It tells that the company’s operations are becoming more efficient as it is selling its
5

Financial Management and Control
product in more profitable manner after accounting for all operating expenses.
Net profit margin measures overall profitability, profit the company is making as a proportion of
its sales after considering all types of incomes and expenses. Net profit margin of Bitmap has
decreased slightly from 17.89% in 2016 to 17.65% in 2017. This change can be due to the
increased interest cost from the additional debt which the company has taken for its capital
investments.
Return on assets measures the profit generated by the company’s assets. Bitmap’s return on
assets has decreased from 20.77% in 2016 to 19.94% in 2017.
Year on year increase in company’s net profit in 2017 = (4060-3220)/3220 or 26.08%.
Year on year increase in company’s total assets in 2017 = ((15200+5160) - (11350+4150)) /
(11350+4150) = 31.35%.
Even though the company’s net profit has increased by 26% in 2017 as compared to previous
year but its return on assets has decreased because of the higher year on year increase in its total
assets as the company has been making high capital investments.
Bitmap’s core business has generated higher profits in 2017 but its overall profitability as
measured by net profit margin has decreased due to the company’s decision to increase its capital
investments. It shows that Bitmap has good potential to generate future profits as company is
expanding and its business is doing well.
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Financial Management and Control
Liquidity:
2017 2016
Current Ratio= Current
Assets/Current Liabilities 5160/1100 = 4.69 4150/1500 = 2.77
Quick Ratio= (Current Assets –
Inventory)/Current Liabilities (5160-2360)/1100 = 2.55 (4150-1800)/1500 = 1.57
Cash Ratio= (Current Assets –
Inventory- Trade
Receivables)/Current Liabilities
(5160-2360-2300)/1100 =
0.45
(4150-1800-1600)/1500 =
0.50
Year on year growth in company’s current assets in 2017 = (5160-4150)/4150 = 24.34%.
Year on year growth in company’s current liabilities in 2017 = (1100-1500)/1500 = -26.67%.
Working capital in 2017 (£000) = 5160-1100 = 4060.
Working capital in 2016 (£000) = 4150-1500 = 2650.
Year on year growth in company’s working capital in 2017 = (4060-2650)/2650 = 53.21%.
Bitmap’s current assets have increased by 24.34% and its current liabilities have decreased by
26.67% in 2017 as compared to previous year. As a result its current ratio has increased from
2.77 in 2016 to 4.69 in 2017 and its working capital has increased by 53.21% in 2017. This tells
that the company’s ability to meet its day to day obligations with its sort term assets has
increased (Company Partners, n.d.). This can also be seen in the increase in its quick ratio. There
is a slight decrease in its cash ratio that is the ability of the company to meet its sort term
obligations with assets that can be readily converted into cash because the company has been
utilising its cash reserve for the capital investments.
7

Financial Management and Control
Gearing:
2017 2016
Debt-to-equity ratio = Total debt / Total
equity (3500)/15760= 22.21% (2000)/12000 =16.67%
Interest coverage or times interest earned
= Earnings before interest and taxes
(EBIT) / Total interest 6800/1000 = 6.80 5100/500 = 10.20
Debt ratio = Total debt / Total assets (3500)/(5160+15200) =
17.19%
(2000)/(4150+11350) =
12.90%
Year on year growth in company’s total debt in 2017 = (3500-2000)/2000 = 75%.
Year on year growth in company’s interest burden in 2017 = (6800-5100)/5100 = 33.33%.
Gearing tells about the financial leverage of a company that is the degree to which it is funded by
the creditors in comparison to the shareholders (IG Group Limited, n.d.). Bitmap’s debt has
increased by 75% in 2017 as compared to previous year. Its debt to equity has increased from
16.67% in 2016 to 22.21% in 2017 and debt to asset has increased from 12.90% in 2016 to
17.19% in 2017. This increased debt can be the result of the company’s decision to increase its
capital spending by borrowing funds. As a result of the higher debt, the interest costs increased
by 33.33% in 2017 as compared to 2016 and interest coverage decreased from 10.20 in 2016 to
6.80 in 2017. This shows that the financial leverage of Bitmap has increased a lot so there is a
higher financial risk as the company needs to make higher fixed interest charges irrespective of
its business performance.
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Financial Management and Control
Asset utilisation:
2017 2016
Inventory
Turnover
Ratio =
COGS/
Average
Inventory (13800)/((1800+3000)/2) = 5.75 (10700)/((1700+1800)/2) = 6.11
Receivables
Turnover =
Net
Revenues/
Trade
receivables 23000/2300 = 10.00 18000/1600 = 11.25
Payable
Turnover =
COGS/
Trades
payables 13800/1100 = 12.55 10700/1500 = 7.13
Total Asset
Turnover =
Net
Revenues/
Total assets 23000/(15200+5160) = 1.13 18000/(4150+11350) = 1.16
9

Financial Management and Control
Year on year growth in company’s trade payables in 2017 = (1100-1500)/1500 = -26.67%.
Year on year growth in company’s trade receivables in 2017 = (2300-1600)/1600 = 43.75%.
Year on year increase in company’s total assets in 2017 = ((15200+5160) - (11350+4150)) /
(11350+4150) = 31.35%.
Year on year growth in company’s revenues in 2017 = (23000-18000)/18000 = 27.78%
Efficiency or asset utilisation ratios tell how efficiently company is using its assets to generate
revenues (Bragg, 2012). Bitmap’s trade receivable turnover ratio decreased from 11.25 in 2016
to 10 in 2017 as its trade receivables have increased a lot in comparison to the increase in the
company’s revenue. This shows that the company is opting for loose credit policies or it is
inefficiently collecting the money from the customers. It can have negative consequences as the
company’s increased revenues might not get converted into cash. Bitmap’s inventory
management can be bit of a problem as its inventory has been increasing at higher pace as
compared to sales, so there is risk of inventory write-down in future. The company’s payables
turnover has increased from 7.13 to 12.55, which can be because of a stricter credit arrangement
from its suppliers and it can cause liquidity issues in future. Bitmap’s total asset turnover has
decreased from 1.16 to 1.13 as the company is expanding and its asset base is rapidly increasing
because of the higher capital investments. Decreasing asset turnover means that the company is
not effectively generating revenues with its assets but this can be because of Bitmap’s decision to
increase its business investment.
10

Financial Management and Control
Investor’s potential:
2017 2016
Return on equity=
Net Profit /
Stockholder equity 4060/15760 = 26% 3220/12000 = 27%
Return on Capital
Employed
(ROCE) =
Operating
Profit/Total
Capital Employed (6800)/(15200+5160-1100) = 35%
(5100)/(11350+4150-1500) =
36%
(Total Capital employed = Total Assets – Current Liabilities)
Return on
invested capital
(ROIC)= NOPAT
or EBIT(1-tax)/
Invested capital
((1-0.3)*(6800))/(5160+15200-1100-500) =
25%
((1-0.3)*(5100))/
(4150+11350-1500-750) =
27%
(Invested capital = Total Assets – Current Liabilities – Cash)
Return ratios can be used to analyse a company’s potential from the investment perspective (Lan,
2012). Bitmap’s key return ratios have slightly decreased: ROE decreased from 27% in 2016 to
26% in 2017, ROCE and ROIC decreased by 1% and 2% respectively. There is an increase in
company’s net profit and operating profit so the company’s business is definitely moving
forward but the increased capital investment is impacting its return ratios. Company’s investors
may not like this scenario but the expansion decision of the company can have future benefits.
11

Financial Management and Control
A brief evaluation of Bitmap plc’s working capital cycle.
A
12
Inventory Turnover
Ratio = COGS/
Average Inventory
(13800)/((1800+3000)/2) =
5.75
(10700)/((1700+1800)/2) =
6.11
Days of Inventory on
hand = Days in period
(365)/ Inventory
turnover ratio 365/5.75 = 63.48 365/6.11 = 59.74
Receivables Turnover =
Net Revenues/ Trade
receivables 23000/2300 = 10.00 18000/1600 = 11.25
Days of sales
outstanding = Days in
period (365)/
Receivables turnover
ratio 365/10 = 36.5 365/11.25 = 32.44
Payable Turnover =
COGS/ Trades payables 13800/1100 = 12.55 10700/1500 = 7.13
Days of payables
outstanding = Days in
period (365)/ Payables
turnover ratio 365/12.55 = 29.08 365/7.13 = 51.19
Cash conversion cycle =
Days of inventory on
hand + Days of sales
outstanding – Days of
payables outstanding:
(365/5.75)+(365/10)-
(365/12.55) = 70.88
(365/6.11)+(365/11.25)-
(365/7.13) = 40.97

Financial Management and Control
company’s working capital cycle (wcc) tells how much time it takes for the business between
making the cash payments to the suppliers and collection of cash from the sale of products (Atrill
and McLaney, 2019). Bitmap’s WCC increased from 41 days in 2016 to 71 days in 2017. This
can be slightly impacted by the small increase in days of inventory on hand and days of sales
outstanding due to some inefficiency in inventory management and in cash collection from
customers. The major factor affecting WCC is huge decrease in Bitmap’s days of payables
outstanding which can be due to the tough credit terms from its suppliers.
The increase in Bitmap’s WCC impacts the short term liquidity of the company. The working
capital cycle has increased a lot which can result in the capital getting struck in its business
operations for longer duration without generating any returns (efinancemanagement, 2019). So,
Bitmap might need to improve the efficiency of its operation to shorten its working capital cycle.
Conclusion:
13

Financial Management and Control
The financial analysis of Bitmap’s past two year statements show that the company’s
performance as depicted by its key financial ratios is declining. The company’s core business is
still improving as shown by the increase in its revenues and increase in its operating margins.
The company has used cash reserves and debt financing to expand its business via increased
capital investment. This led to increased debt numbers, increased interest costs and increased
fixed assets, which has negatively affected its gearing and return ratios.
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Financial Management and Control
Part B
Capital Budgeting Analysis:
Toyland ltd is a recognised toy manufacturer based in London. The demand of toys is expected
to increase significantly in coming time. So, the company is thinking to purchase a new machine.
This report uses different capital budgeting methods like payback period, discounted payback
period, accounting rate of return, net present value and internal rate of return to help the
company choose one machine out of two available options (Atrill and McLaney, 2019).
Cash-flow details:
Given Annual Cash-
flows from machines
without considering
initial
investment/depreciation
expense/terminal values
C1a or
C1b
C2a or
C2b
C3a or
C3b
C4a or
C4b
C5a or
C5b C6a or C6b
Time period year 1 year 2 year 3 year 4 year 5 year 6
Machine A 300000.00 250000.00 200000.00 150000.00 50000.00 20000.00
Machine B 20000.00 50000.00 150000.00 200000.00 250000.00 300000.00
Initial
Investment
C0a or C0b
Machine A -500000.00
Machine B -500000.00
Terminal value Ta or Tb
Machine A 50000.00
15

Financial Management and Control
Machine B 50000.00
Straight line depreciation = (Total cost – Salvage value)/ Useful life = (500000-50000)/6 = 75000
Annual
Depreciatio
n
year 1 (D1a
or D1b)
year 2 (D2a
or D2b)
year 3 (D3a
or D3b)
year 4 (D4a
or D4b)
year 5
(D5a or
D5b)
year 6 (D6a or
D6b)
Machine A -75000 -75000 -75000 -75000 -75000 -75000
Machine B -75000 -75000 -75000 -75000 -75000 -75000
Net Cash-
flows
year 0
(N0a= C0a
or
N0b=C0b)
year 1
(N1a =
C1a + D1a
or N1b =
C1b +
D1b)
year 2
(N2a =
C2a + D2a
or N2b =
C2b +
D2b)
year 3
(N3a =
C3a + D3a
or N3b =
C3b +
D3b)
year 4
(N4a =
C4a + D4a
or N4b =
C4b +
D4b)
year 5
(N5a =
C5a +
D5a or
N5b =
C5b +
D5b)
year 6
(N6a =
C6a +
D6a + Ta
or N6b =
C6b +
D6b +
Tb)
Machine A -500000.00 225000.00 175000.00 125000.00 75000.00 -25000.00 -5000.00
Machine B -500000.00 -55000.00 -25000.00 75000.00 125000.00 175000.00 275000.00
16

Financial Management and Control
1) The Payback Period
Cumulative
Cash-flows Year 0
Year 0 +
Year 1
Year 0 +
Year 1 +
Year 2
Year 0 +
Year 1 +
Year 2 +
Year 3
Year 0 +
Year 1 +
Year 2 +
Year 3 +
Year 4
Year 0 +
Year 1 +
Year 2 +
Year 3 +
Year 4 +
Year 5
Year 0 +
Year 1 +
Year 2 +
Year 3 +
Year 4 +
Year 5 +
Year 6
Machine A -500000.00 -275000.00 -100000.00 25000.00 100000.00 75000.00 70000.00
Machine B -500000.00 -555000.00 -580000.00 -505000.00 -380000.00 -205000.00 70000.00
Payback
period
machine A
Last year of the negative cumulative cash-flows ( year 2) + Portion of the year in which breakeven
is achieved ( Cumulative cash flow in the year 2 / net annual cash flow in year 3) = 2 +
(100000/125000) = 2.80 years
Payback
period
machine B
Last year of the negative cumulative cash-flows ( year 5) + Portion of the year in which breakeven
is achieved ( Cumulative cash flow in the year 5 / net annual cash flow in year 6) = 5 +
(205000/275000) = 5.75 years
The payback period for machine A is lower than the payback period for machine B. So,
according to the payback rule the company should choose machine A.
17

Financial Management and Control
Discount
rate 10%
Cumulativ
e
discounted
Cash-flows
Year 0 Year 0 +
(Year
1)/(1.1)
Year 0 +
(Year
1)/(1.1) +
(Year
2)/(1.1)^2
Year 0 +
(Year
1)/(1.1) +
(Year
2)/(1.1)^2
+ (Year
3)/(1.1)^3
Year 0 +
(Year
1)/(1.1) +
(Year
2)/(1.1)^2 +
(Year
3)/(1.1)^3 +
(Year
4)/(1.1)^4
Year 0 +
(Year
1)/(1.1) +
(Year
2)/(1.1)^2 +
(Year
3)/(1.1)^3 +
(Year
4)/(1.1)^4 +
(Year
5)/(1.1)^5
Year 0 +
(Year
1)/(1.1) +
(Year
2)/(1.1)^2 +
(Year
3)/(1.1)^3 +
(Year
4)/(1.1)^4 +
(Year
5)/(1.1)^5 +
(Year
6)/(1.1)^6
Machine A -500000.00 -295454.55 -150826.45 -56912.10 -5686.09 -21209.12 -24031.49
Machine B -500000.00 -550000.00 -570661.16 -514312.55 -428935.87 -320274.63 -165044.30
2) The Discounted Payback Period
The discounted payback period for both the machines is more than their useful life of 6
years. So, investment in neither machine A nor machine B makes any sense according to
the discounted payback period rule.
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Financial Management and Control
3) The Accounting Rate of Return
year 1 year 2 year 3 year 4 year 5 year 6
Total profit
for machine
A 225000.00 175000.00 125000.00 75000.00 -25000.00 -5000.00
Total profit
for machine
B -55000.00 -25000.00 75000.00 125000.00 175000.00 275000.00
Average
profit for
machine A 225000.00 + 175000.00 + 125000.00 + 75000.00 - 25000.00 - 5000.00 = 95000
Average
profit for
machine B -55000.00 - 25000.00 + 75000.00 + 125000.00 + 175000.00 + 275000.00 = 95000
Average
investment
for machine
A 500000 + 50000 = 275000
Average
investment
for machine
B 500000 + 50000 = 275000
Accountin
g rate of
return for
machine A 95000 / 275000 = 35%
Accountin
g rate of
return for
machine B 95000 / 275000 = 35%
Both machine A and machine B have same ARR. So, according to accounting rate of return
method the investment returns of both the machines is at par.
19

Financial Management and Control
4) The Net Present Value.
Net Cash- year 0 year 1 year 2 year 3 year 4 year 5 year 6
20

Financial Management and Control
flows
(N0a or
N0b)
(N1a =
C1a + D1a
or N1b =
C1b +
D1b)
(N2a =
C2a + D2a
or N2b =
C2b +
D2b)
(N3a =
C3a + D3a
or N3b =
C3b +
D3b)
(N4a =
C4a + D4a
or N4b =
C4b +
D4b)
(N5a =
C5a +
D5a or
N5b =
C5b +
D5b)
(N6a =
C6a +
D6a + Ta
or N6b =
C6b +
D6b +
Tb)
Machine A -500000.00 225000.00 175000.00 125000.00 75000.00 -25000.00 -5000.00
Machine B -500000.00 -55000.00 -25000.00 75000.00 125000.00 175000.00 275000.00
NPV Machine A = Year 0 + (Year 1)/(1.1) + (Year 2)/(1.1)^2 + (Year 3)/(1.1)^3 + (Year 4)/(1.1)^4 +(Year
5)/(1.1)^5 + (Year 6)/(1.1)^6 = -24031.49
NPV Machine B = Year 0 + (Year 1)/(1.1) + (Year 2)/(1.1)^2 + (Year 3)/(1.1)^3 + (Year 4)/(1.1)^4 +(Year
5)/(1.1)^5 + (Year 6)/(1.1)^6 = -165044.30
The NPV for both the machines is negative. So, according to the NPV rule both the projects
should be rejected. But, if there is any compulsion then machine A will be preferable over
machine B because its NPV is less negative.
5) The Internal Rate of Return.
Net Cash- year 0 year 1 year 2 year 3 year 4 year 5 year 6
21

Financial Management and Control
flows
(N0a or
N0b)
(N1a =
C1a + D1a
or N1b =
C1b +
D1b)
(N2a =
C2a + D2a
or N2b =
C2b +
D2b)
(N3a =
C3a + D3a
or N3b =
C3b +
D3b)
(N4a =
C4a + D4a
or N4b =
C4b +
D4b)
(N5a =
C5a +
D5a or
N5b =
C5b +
D5b)
(N6a =
C6a +
D6a + Ta
or N6b =
C6b +
D6b +
Tb)
Machine A -500000.00 225000.00 175000.00 125000.00 75000.00 -25000.00 -5000.00
Machine B -500000.00 -55000.00 -25000.00 75000.00 125000.00 175000.00 275000.00
IRR Machine A: Year 0 + (Year 1)/(1+ IRR) + (Year 2)/ (1+ IRR)^2 + (Year 3)/ (1+ IRR)^3 + (Year 4)/ (1+
IRR)^4 +(Year 5)/ (1+ IRR)^5 + (Year 6)/ (1+ IRR)^6 = 0
IRR = 7%
IRR Machine B: Year 0 + (Year 1)/(1+ IRR) + (Year 2)/ (1+ IRR)^2 + (Year 3)/ (1+ IRR)^3 + (Year 4)/ (1+
IRR)^4 +(Year 5)/ (1+ IRR)^5 + (Year 6)/ (1+ IRR)^6 = 0
IRR = 2%
As the sign of the cash flows is changing more than once so IRR is not a reliable measure in this
case. IRR for both the machines is less than the cost of capital. So, according to the IRR rule it
does not make sense to invest in any of the machine. But if there is a compulsion to choose from
one of these options, then machine A with higher IRR will be preferable over machine B.
The preferable capital budgeting methods are telling that investment in both the machine does
not seem advantageous because NPV’s are negative, IRR’s are less than cost of capital and
discounted payback periods are higher than the useful life of the machines. But according to
payback period method the company should choose machine A over machine B.
Evaluation of different investment appraisal techniques:
22

Financial Management and Control
Payback period and discounted payback period method concentrate upon the cash flows from the
projects. It measures the time duration for the recovery of the investment amount and tells about
the project’s liquidity. Discounted payback considers the time value of money but the payback
period does not consider timing and magnitude of different cash flows. Both these methods do
not consider cash flows after the breakeven or the payback period and they do not tell about the
profitability of the project. There is not a fixed decision rule for these methods as it depends
upon the cut-off set by the company’s management (Atrill and McLaney, 2019).
Accounting rate of return (ARR) method is easy to compute and it gives the return generated
from the profits or net inflows of the project. The main advantage of this method is its easy
computation and the disadvantage is that it does not consider the time value of money. Another
issue with this method is that it is inappropriate to evaluate projects of different size. This
method does not have a particular decision rule but when comparing two projects it recommends
one with the higher return rate.
Net present value method considers all the cash flows related to the project. This method is
theoretical strong as it uses time value of money and it is based on the objective of maximising
shareholder’s wealth. The disadvantage of this method is that it can sometimes be difficult to
calculate due to the complexities of the business. NPV method assumes that the discount rate
related to the project is always known but it is not always easily available. This method is useful
in making investment decisions as it has an easy to understand decision rule based on the
positive higher NPV.
Internal Rate of Return is somewhat similar to the NPV method as it also uses time value of
money and it considers all the cash flow related to the investment project over its entire life.
Another positive related to this method is that it does not need the cost of capital for its
calculation. This method also provides the profitability information of the project. The
disadvantage for this project is its complex calculation based on hit and trial method. IRR
method assumes that the intermediate cash flows are reinvested at the internal rate of return not
the weighted cost of capital. Another issue is that this method can give multiple IRR’s or
negative IRR’s depending upon the nature of the project’s cash flows.
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Financial Management and Control
It has a practical decision rule as it recommends the projects with the higher IRR or IRR greater
than the firm’s capital cost.
According to Graham and Harvey (2005), Small firms use less sophisticated methods for the
capital budgeting decisions so they prefer payback period method to the NPV method. Among
these firms, the one with non MBA CEO are more likely to use payback criterion due to their
non-familiarity with complex and computational methods. Payback or discounted payback
method is also preferred by the capital-constrained firms as these firms are more concerned with
the cash-flows from projects to meet their annual financing costs.
Large firms with CEO having management degrees prefer sophisticated methods like NPV and
IRR. It is also noted that highly leveraged firms prefer NPV and IRR methods as compared to
firm with low debt to equity ratios. The same was also noted for the public firms that pay
dividends (Graham and Harvey, 2005).
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Financial Management and Control
Evaluation of two suitable sources of finance to fund this
investment:
There is a requirement of £500,000 for this investment and the main sources of finance available
to Toyland are equity and debt financing.
Debt financing allows a business to borrow funds from some outside source and the firm needs
to repay the borrowed amount along with the interest payments. These debts can be secured or
unsecured depending upon the characteristics of the projects or the borrower’s credit history. The
secured loans provide cheap source of funding but the firm will lose the collateral in event of
default. There can also be various restrictions on the borrower’s activities with the debt financing
because of debt covenants. These covenants may force the company to forgo some future
profitable opportunities. Debt financing is available in various forms including bank loans or
corporate bonds. The advantage of the debt financing is that the firm owners retain the control of
the business and they can take independent decisions according to the business needs. Also, there
are fixed terms involved that allows the firm to forecast financing expenses in a precise manner
and to plan accordingly. The interest costs are tax deductible so it will help reduce the tax
burden, a major cash outflows for most of the firms. The disadvantage of debt financing is fixed
interest payments that the firms need to make periodically. This can increase the financial
leverage of the firm and if there are some uncertainties and market slowdown, the firm might
find it difficult to make these payments. This can hamper the growth of the company and can
even lead to the bankruptcy (Atrill and McLaney, 2019).
Equity financing can sometimes take a longer time to raise funds as it involves lot of disclosures
and regulatory requirements. Equity financing allows the company to share the risk and returns
generated from the investment with the investors as there are no fixed costs involved and the
investors are directly affected with the success and failure of the business. The company does not
need to pay to investors till the time the project is profitable so the financial risk involved with
this source of funding is less as compared to debt financing. There is another concern involved
with the equity financing that it can dilute the ownership of the firm and so the firm owners
might not be able to take independent business decisions.
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Financial Management and Control
Financing decision between debt and equity depends upon the characteristics of the investment
because if the risks are high due to the future uncertainties, then it makes more sense to go with
equity financing as it does not have fixed future obligations. On the other hand debt financing
does not endanger the ownership of the business and it too has the tax benefits (Uzialko, 2018).
Part C
Budgeting
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Financial Management and Control
Budgeting process helps an organisation to achieve its financial goals. It involves forecasting of
various incomes and expenses of a business. Budgeting helps firm make future plans to acquire
and to distribute its resources to achieve its annual objectives. This process makes the business
operations more efficient and budgeting is done for a particular duration depending upon the
firm’s business (Dyson, 2017).
Strategic planning is a comprehensive process which combines various business functions and
resources to implement strategies to attain firm’s objectives in the long run. Strategic objectives
are the necessary long term goals.
Both the strategic planning and budgeting are important for the success of the business and these
are related to each other as planning process develop a firm’s long-term goals and budgeting
decides how a firm can use its resources to implement its objectives.
Strategic plan and budgeting is linked via a business plan. Business plan includes the strategic
plan and it further explains how this plan can be implemented to achieve its long term goals
using specified action steps. It includes firm’s budget explaining how the firm will convert this
strategic plan into a reality. So, the company’s business plan ensures that a firm will be
strategically and financially successful by synchronising the budgeting process with its strategic
plan.
Example- Firms first decide the objectives that are the long term goals like, increasing revenues
per customer by aiming for higher individual spending at the firm’s stores. Then, the firms
develop strategies to attain these goals like, expanding the firm’s product offering to increase
revenues per customer. Then, the budgeting process allows the firm to decide and to control the
use of the firm’s limited resources to implement above strategies like, allocation of resources
among various units (R&D, manufacturing and marketing) to diversify firm’s product portfolio
to achieve above objectives.
Evaluation of the budgeting process and the interlinking of
various budgets used within a business.
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Financial Management and Control
Most of the companies generally start their budgeting process three to six months before the
initiation of a new business year. Firms first set the budget and then they perform variance
analysis each month to compare actual business results with the budget and to analyse reasons
for the variance. There are various steps involved in the budgeting process from planning and
assumptions stage to issuance of the company’s final budget (Weetman, 2015).
Assumptions involved
Budgeting process is based on various assumptions such as, the sales trends and other business
conditions. In order to have an effective budget, these assumptions should be carefully reviewed.
Determine the available fund
Inadequate funding can have impact on the success of the business projects. Therefore,
budgeting process should give a lot of attention to the available funds because it is this
availability of adequate funds that helps in effective initiation of feasible projects.
Determine costing
Business environment is dynamic and the firms need to model their operations according to these
challenges, which lead to changes in the cost structure of the company. Therefore, in the process
of budgeting certain factors that could affect the estimate for the business should be carefully
considered.
Revenue Forecasting
An effective budget is the one that provides a good estimated return after the in-depth analysis of
all the factors that affect the revenue.
Obtain department budgets
To capture a budgeted expenditure for estimated period in an effective manner, each business
department prepare its budget separately, which are combined to prepare the firm’s master
budget.
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Financial Management and Control
Frame a budget
A new budget is framed by keeping in mind the elements of previous year’s budgets. The
standards of past budgets are changed or updated as per the on-going business conditions.
Review the budget
Once the budget is prepared it must be reviewed carefully to avoid any flaws, as even the
misplacement of a single decimal may lead to imbalance in the budget.
Obtain approval
Once the budget is reviewed and final blue print is framed it is send to the officials for approval.
Issue the budget
As soon as the approval is given by the top officials the budget is issued and the concern amount
is allocated to the departments.
Interlinking of various budgets
There are three major budgets that every company needs: Cash budget, operating budget and
capital budget.
Operating budget is associated with the daily business operations that are the revenues and the
expenses (sales, cogs, etc.) related to the core business of the firm.
Capital budget is associated with the capital investments like purchase of fixed assets
(equipment, technology systems, etc.) to allocate funds for maintaining or expanding firm’s
business.
Cash budget is associated with the timing and amount of cash payments and receipts of the
company. Cash budget helps to effectively manage cash flows by assessing if there is a need for
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additional capital or the company has an excess capital. Cash budget inter-connect both the other
budgets (Drury, 2018).
Cash budget defines the cash flows of the company, which helps in effective preparation of the
operating budget and the capital budget. As cash budget allows the company to meet its daily
operations (operating activities including production and sale of firm’s goods) and capital
investments (decisions related to capital investments such as purchase of large assets). The
operating budget is related to the capital budget, as operating activities occurs only in the
presence of the capital assets.
References:
Atrill, P. & McLaney, E. (2019). Accounting and Finance for Non-Specialists. 11th ed. Harlow:
Pearson
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Bragg, S. M. (2012). Business Ratios and Formulas: A Comprehensive Guide. John Wiley &
Sons: New Jersey
Company Partners. (n.d.). Understanding Financial Ratios. Accessed 24 April 2019:
https://www.companypartners.com/content/resource/understanding-financial-ratios#q3
Drury, C. (2019). Management and cost accounting. 10th ed. Australia: Cengage
Dyson, J. R. (2017). Accounting for non-accounting students. 9th ed. Harlow: Pearson
Efinancemanagement. (2019). Working Capital Cycle. Accessed 24 April 2019:
https://efinancemanagement.com/working-capital-financing/working-capital-cycle
Graham, J. & Harvey, C. (2002). HOW DO CFOS MAKE CAPITAL BUDGETING AND
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IG Group Limited. (n.d.). Gearing ratio definition. Accessed 24 April 2019:
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Lan, J. (2012). 16 Financial Ratios for Analyzing a Company’s Strengths and Weaknesses.
Accessed 24 April 2019: https://www.aaii.com/journal/article/16-financial-ratios-for-analyzing-
a-companys-strengths-and-weaknesses
Peavler, R. (2018). Profitability Ratio Analysis. Thebalancesmb. Accessed 24 April 2019:
https://www.thebalancesmb.com/profitability-ratio-analysis-393185
Uzialko, A. C. (2018). Debt vs. Equity Financing: What's the Best Choice for Your Business?
Business News Daily. Accessed 24 April 2019: https://www.businessnewsdaily.com/6363-debt-
vs-equity-financing.html
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Weetman, P. (2015). Financial and management accounting: an introduction. 7th ed. Harlow:
Pearson
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