Capital Budgeting Analysis and Techniques

This assignment delves into the crucial area of capital budgeting, examining its significance in influencing firm performance. It requires a thorough analysis of diverse capital budgeting techniques employed for investment appraisal, including payback period, net present value (NPV), internal rate of return (IRR), and profitability index (PI). Students are expected to critically evaluate these methods, highlighting their strengths, weaknesses, and suitability for different investment scenarios.

MANAGING FINANCIAL
RESOURCES AND
DECISIONS

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
TASK 1............................................................................................................................................1
1.1 Financial sources which are available for different firms................................................1
1.2 Implications of financial sources on business..................................................................2
1.3 Most suitable financial sources for Clariton Antiques Limited........................................4
TASK 2............................................................................................................................................4
2.1 Cost of Venture capital and bank loan.............................................................................4
2.2 Significance of financial planning on the firm Clariton Antiques Ltd.............................5
2.3 Informations which will be needed in order to take financing decisions.........................6
2.4 Influences of financial statements of Clariton while using financial sources..................6
TASK 3............................................................................................................................................7
3.1 Preparation of cash budget for Clariton and its analysis..................................................7
3.2 Method to derive cost and price per unit with an example...............................................9
3.3 Assess the viability of investment with help of financial tools......................................10
TASK 4..........................................................................................................................................12
4.1 Key elements of various financial statements................................................................12
4.2 Comparison between financial formates of Clariton and sole trader.............................13
4.3 Interpretation of financial performance of Clariton with helps to financial ratios.........14
CONCLUSION..............................................................................................................................17
REFERENCES..............................................................................................................................19

INTRODUCTION
In the corporate world, finance plays an important role and helps to entrepreneur in order
to establish business in the industry. If fund is not available then he cannot exist in the market s
well as operate in proper way. Further, it is too much necessary to take effective business
decisions for sustain smooth functioning of the organisation. In the present case a Clariton
Antiques limited is expanding its business in another country such as Birmingham. For this it
needs finance which is provided by several sources of finance. The report throws light on
financial sources as well as its impact on the firm. Apart from this, it shows cash budget and
financial tools which help to take better business decisions and formulate strategies. Beside it,
the report emphasis on financial performance of the Clariton with help of different financial
ratios.
TASK 1
1.1 Financial sources which are available for different firms
a.) Unincorporated business: A firm which not possess legal identity in the corporate world and
not require to follow rules and regulations of the authority, identified as an unincorporated
company (Greene, Brush and Brown, 2015). Further, it includes sole trader firm where all the
liabilities of business is with owner or proprietor. For this available financial sources are such as
follows: Owner's fund: As per respective source the entrepreneur use its own fund which is saved
in his personal life. It can be know as a personal savings which are drawn in the business
for expanding in another market. For this he has not pay any cost after raising fund. Selling the assets: Another source is sale of assets where the business sale those assets
which are unused as well as not help to firm for generating sales and revenue. The
amount which comes after sale those assets is drawn in the firm for raising fund.
 Retained profit: According to this profit which is remaining after paying dividend amount
to shareholders is used in the business (Post and Byron, 2015).
b.) Incorporated business: Those firms which cannot establish and run business in the industry
without following legal rule and regulations, that are known as an incorporated company. In this
1

the entrepreneur needs to follow all the laws and legislations which are set out by regulatory
bodies. In order to raise fund for such firms, financial sources are mentioned below: Bank loan: As per the external sources of finance the business can take loan from
commercial banks in order to raise fund. Further, it takes interest amount as a cost of
finance from the business entity. Leasing: Another source of finance for incorporated businesses is leasing where company
can lease small part of the firm or particular item to external party (Bogsnes, 2016). In
this case firm has not pay any cost of finance as well as it is the cheapest way to raise
finance.
 Government or EU grant: Further, European Union grant is provide funds to the UK
companies for business expansion. It is one type of loan from government or EU which
charges lower interest compare to commercial banks.
1.2 Implications of financial sources on business
Sources of finance Financial implication Legal implication Dilution of control
Internal sources of
finance for
unincorporated
firms:
Owner's fund As per the sources
there are any cost is
not to be given.
In this case there is
not any legal rules are
applied.
-
Selling assets The firm should not
pay cost of fund but it
leads to reduce assets
in balance sheet of
firm (Shibata and
Nishihara, 2015).
Here government or
regulatory body not
interfere for raining
fund.
-
Retained profit Using company's
profit there is not any
Due to internal
sources there are any
No dilution of control
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financial impacts on
the business.
rules are not imposes. is here.
External sources of
finance for
incorporated firms:
Bank loan As per this the firm
has to pay interest
amount which impact
on net profit in
negative way.
In order to raising
fund from banks firm
must complete all the
formalities and
documentation
process. Further, it
has to provide value
of the firm to bank
(Johnson and Pfeiffer,
2016).
Very low dilution of
control.
Leasing Here the firm not pay
cost or charges but
due to giving
particular asset to
external party it leads
to decrease total assets
of company.
The company has to
complete
documentation
process and fulfil all
the rules and then can
raise fund.
Dilution of control is
not there in leasing
source.
Government or EU
grant
Further, the EU grant
or government
imposes interest on the
firm in order to raising
fund by which
financial performance
is reduced
(Mukherjee, Al
The business which
takes loan from EU
grant then it needs to
show its financial
position to the
government.
Dilution of control is
in hand of EU grant.
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Rahahleh and Lane,
2016).
1.3 Most suitable financial sources for Clariton Antiques Limited
As per the present scenario Clariton is going to expand the business for which suitable
sources of finance are venture capital and bank loan which are elaborated below:
Bank Loan: Very main advantage of the financial source is that it is based on the value
of business as well as helps to identify ability of firm to generate profit. Further it is most
beneficial order to expand the company in another new market. However, it imposes higher
charges in terms of interest on the loan which lead to decrease profitability to the Clariton. Apart
from this sometimes bank demand for repayment which affects to the firm adversely in order to
generating sales (Geng, Bose and Chen, 2015).
Venture capital: Another appropriate financial sources for firm Clariton is venture
capital which is very helpful for it in order to expanding business. Further, it is beneficial for
firm due to increase shareholders in the market which lead to increase fund smoothly. On the
other side after using the source there are some limitations such as the firm become more
depended on the venture capital because of providing better ideas due to having expertise in
business. Further it takes dividend in terms of cost of finance which is adverse for Clariton.
TASK 2
2.1 Cost of Venture capital and bank loan
Each sources of finance charging cost after providing financial services to the firm in
different forms which is described below:
A) Dividends: When the firm taking finance from external sources then it imposes
various types of costs. Here Clariton is raising fund using venture capital firm such as We
Finance Limited which is taking charges in terms of stake (Greenbaum, Thakor and Boot, 2015).
Further, it turns into shareholder where Clariton has to give dividend amount. Hence, dividend is
a cost which is imposes by venture capital on the firm that is 20% stake of overall amount such
as 0.5m GBP.
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B) Interest: Further, another cost of finance is in terms of interest amount which is taken
by the commercial banks for providing financial services to Clariton. As per the present scenario
the bank is charging 2% annual interest rest of the loan amount 0.5m GBP over the period of 10
year. Higher the rate of interest is lead to reduce net profit of Clariton which highly affects
overall financial performance in the industry. Further, the firm has to give brokerage amount to
the finance broker that is 1% of the loan amount.
C) Tax: As per the element tax, when Clariton raise fund from bank that it gives
relaxation in terms of taxation amount. Hence, the business not requires to pay any type of
taxation amount due to using bank loan as a financial source (Yellen, 2016). It is the most
beneficial for Clariton and helps for raising net profit. Further, the business become more
financially sound in the respective industry.
2.2 Significance of financial planning on the firm Clariton Antiques Ltd.
A) Budgeting: Budget is an important process which is applied in firm for predicting
financial performance of the business. It can be prepared after analysing past performance of the
company in its industry. It helps to the management of Clariton for allocating resources in every
function in an appropriate manner. Apart from this using budgeting process a firm able to
analyse its performance using variance analysis. Further, it can be said that by proper financial
planning management can reduce cost of production as well as enhance level of profitability.
B) Implications of failure to finance adequately: Adequate finance is helps to firm in
smooth functioning and operate without occurring any types of obstacles. When the business
able to allocate financial resources properly as well as adequately then able to meet with its goals
and objectives (Akhtar and Kröner-Herwig, 2015). Financial planning is a process by which
Clariton can appropriately allocate resources which not affects smooth functioning of the firm
and helps to become more profitable.
C) Over trading: The situation where company unable to control over the production
and produce more number of products and services in comparison to availability of resources. It
leads to hinder overall business of Clariton as well as reduce profit because management not
utilizing its resources in an appropriate way. Hence, it can be assessed that financial planning is
the most important element for generating sales and run the business in smooth way.
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2.3 Informations which will be needed in order to take financing decisions
A) Partners: When the business is taking fund for expansion from partners then it needs
to know that in profit or loss will be divided on which basis. In this all the partners contributing
in order to enhance level of capital and on the basis of proportion of capital losses and profits are
divided (Upton and et.al., 2015). Hence, the company needed such informations, if it is unable
then overall business is affects. Further, each and every partner needs to know that business is in
which condition as well as earning profit or not.
B) Venture capitalist (We Finance Limited): Another source which provides financial
resources is venture capital where it uses some terms and conditions. In the present case Clariton
is taking fund from We Finance Limited so it needs to know that which are the legal formalities
are to be fulfilled while taking fund from such source. Further, We Finance also require taking
informations related to return on investment because venture capital provide finance when firm
has at least 50% ROI in the business.
C) Finance Broker: In this there a person who plays role as an intermediary between the
Clariton as well as bank. It charges brokerage amount from the company behind providing
financial services and complete the formalities of bank in behalf of Clariton (Locatelli, Invernizzi
and Mancini, 2016). Hence, the company needed informations that he will be charges how much
percentage of the overall loan amount. In the present scenario it imposes 1% brokerage of 0.5m
GBP.
2.4 Influences of financial statements of Clariton while using financial sources
Financial statements of company are affected from each and every accounting treatment in
terms of increasing or decreasing manner. As per the present scenario the Clariton is raising fund
from two financial sources such as venture capital as well as bank loan. Both the sources are
affects to the financial statements which are mentioned below:
A) Venture capitalist (We Finance Limited): The Clariton gives stake from its business
to the venture capital company such as We Finance Limited. Afterwards the VC firm turn into
shareholder of respective business where it has to give dividend to them (Misund, 2016). The
amount which is given to shareholders is one type of expense for the firm which affects to net
profit in the negative manner. Further, fund which is taken from We finance limited is treated in
capital account in the balance sheet of Clariton which lead to increase total liabilities. Hence, it
6

affects income statements in negative way as well as statement of financial position in positive
way.
B) Finance broker: Another source of finance which influence to the financial statement
is bank loan as well as finance broker. Bank takes charges in form of interest while finance
broker charges brokerage of the overall loan amount that is 0.5m GBP. Interest and brokerage
are expenses for the firm which lead to increase indirect expenditures and reduce profitability.
On the other side assets as well as liabilities both are increases due to enhancing capital in the
firm. So, it can be said that profit and loss account and balance sheet influence in negative and
positive way respectively.
TASK 3
3.1 Preparation of cash budget for Clariton and its analysis
In the corporate world, management needs to formulate plan in order to operate in the
industry smoothly. For making future plans and determine financial performance for upcoming
years cash budget is a popular, easy and widely used tool. With this the Clariton is able to know
future incomes as well as expenditures. Further it helps to prepare effective business strategies
for become more financially sound in the segment (Throsby, 2016). It can be prepared using past
financial performance of Clariton Antiques limited company. It has mainly two headings that is
cash inflows and its disposal or expenditures. It is too much beneficial for the business in order
to allocate resources in an appropriate way which leads to increase profit of the company.
7

Analysis
From the above presented cash budget it can be visualised that the Clariton is generating
higher cash flow is in the month of March that is worth £315250. On the other side lowest cash
flow is worth £-649750 which is negative and indicate that firm is unable to manage expenses in
proper way. It can be analysed that overall closing cash balance is lower due to Clariton has high
amount of bank overdraft. Further, cash inflows are lower in comparison to cash outflows cause
of receiving only 5% cash in the current period. In the February closing balance is low and net
cash balance is increase from the month of January that is £147750. Afterwards, it increases in
the month of March and reaches upto £315250 due to increasing incomes. Further, net cash
balance is consistently reduces from the month of March to the June. In the month of June net
cash balance is worth 69000 because of reducing incomes and increasing outcomes from
previous month.
Suggestions for reducing shortfalls:
 It can be suggested to the management of Clariton that it should make effective
marketing strategies which helps to attract more number of customers and enhance sales
as well as cash inflows. It will lead to increase turnover and revenue by which net cash
8

balance will be increase in the upcoming financial year (Locatelli, Invernizzi and
Mancini, 2016).
 Further, the company needs to offer cash discounts, skims etc. to users as well as policy
maker should prepare attractive policies for enhance level of consumers.
 Beside these, management should use cash control policies in order to reduce cost as well
as wastage products and increase revenue of Clariton.
3.2 Method to derive cost and price per unit with an example
For deriving cost there are mainly two concept used that is fixed cost and variable
expenses. Expenditures which are not varied and changes according to the level of finished
goods are known as fixed. On the other side disposals which are related to each production unit
and changes as per the output level, identified as a variable costs (Crosby and Henneberry,
2016). In the present case Clariton is a services based industry where numerous costs are
incurred which are helps to compute cost of each unit, which is stated below:
Cost of Designing: £30000
Labour charges: £9000
Selling expenses: £7000
Utility charges: £3500
Rent on property: £2000
Other expenditures: £4500
Total expenses or costs: £56000
Number of units delivered: 280 items
Cost of each antique unit: £56000/280 = £200
Selling price per unit = cost of one item + profit margin
= £200 + (£200 * 30%)
= £260 per item
From the above example it can be stated that Clariton can sell its each antique item worth
£260. In order to compute price of each unit is computed with help of cost plus pricing method in
which profit margin is suppose to add in cost of per unit. Here margin of profit is 30% which
added in cost of each item i.e. £200.
9

3.3 Assess the viability of investment with help of financial tools
Every business needs to take decision in order to take better and profitable investment
decision which helps to become more financially sound. There are numerous techniques and
tools by which Clariton is able to make highly profitable investment decisions (Benefits of
capital budgeting, 2017). The tools are such as NPV, IRR, ARR, payback period etc., which are
mentioned below:
Net Present Value
10

Average rate of return
Payback Period
11

From the above stated table it can be visualised that project one has higher NPV while
project two has lower that is £3.37 and £2.53 respectively. Further, according to the average rate
of return as well as payback period project two is more profitable for the Clariton (Eckerd,
2015). Beside it, both the mentioned projects meet criteria of Peter’s in each case such as NPV,
PP and IRR. According to the benchmark of NPV i.e. 2m GBP investment one is much better.
Apart from this as per the ARR and payback period i.e. 35% and 3.5 years respectively project
two is more beneficial for Clariton. NPV is a technique which considers time value of money as
well as discounting factor. Due to which respective method is more reliable and give appropriate
investment decisions to the analyser. Hence, it can be recommended to the management of
Clariton that it should make investment in project 1 which helps to generate higher yield in the
future in comparison to project 2.
TASK 4
4.1 Key elements of various financial statements Income statement: Very first financial statement is profit and loss account by which the
businessman able to derive its position in terms of profit generating. It is most widely
used statement in order to calculate profitability ratios such as gross, operating and net
margin ratio. Key elements of respective statement are such as incomes, expenditures and
sales or revenue by which company able to formulate effective business strategies. Statement of financial position: Further, according to the statement Clariton can know its
ability in terms of meet with short term obligations. The balance helps to derive different
liquidity as well as solvency rations using its components (Khalili and Jangi, 2016).
Assets as well as liabilities are key components of the statement of financial position.
Apart from this it has another heading that is total shareholder’s equity. Statement of cash flows: The Clariton company requires to make the respective financial
statement to derive its incomes and its disposals in various avenues. Apart from this it
helps to the business in order to know shortfalls in the company by which management
able to make policies to reduce such conditions. It has mainly two elements that are cash
inflows or incomes and cash outflows or expenditures. Statement of changes in equity and gains: Another financial statement is changes in
equity and gains by which the management is able to derive capital of total shareholder’s
equity (Emerson, 2015). Further, another component of the statement is retained earnings
12

which helps to know remaining profit after paying all the debts, interest amount as well
as dividend to potential shareholders. Hence, it can be said that it has two elements like as
total shareholder’s equity as well as retained earnings or profit. Notes to the financial statement: Each and every business needs to shows its every
accounting treatment which is used while preparing financial statements. In this there are
rules, regulations, theories and standards are shown. As per the statement of disclosures
company suppose to show used UK accounting standards, GAAP, IFRS etc. which helps
to analyser to know that particular treatment is on which basis completed (Post and
Byron, 2015).
4.2 Comparison between financial formates of Clariton and sole trader
Basis of difference Sole trader business Clariton Antiques
Meaning of firm Those companies which have not
follow legal rules and regulations
and all the liability is with owner
only, which is known as sole
trader business.
The respective company is a
partnership firm on which regulatory
body imposes all the laws and
legislations of the company. In this
case there are two or more partners
who establish and run the business
(Shibata and Nishihara, 2015).
Financial statements
which are required
to prepare
 Every partner’s current as
well as capital account
 Account of Profit & Loss
 Balance sheet
 Statement of profit and
expenditures
 Statement of financial
position
 Cash flow statement
 Statement of changes in
equity and gains
 Disclosure of accounting
treatment
Legal compulsion Not any requirement to prepare all
the financial statements using
various accounting standards.
These types of firms must require to
prepare all the above mentioned
financial statements using proper
rule and regulation. Further, needs to
13

use UK GAAP and accounting
standards.
Capital accounts As per the sole trader there is only
one account is to be prepare due
to one owner.
Further, as per the partnership
business number of capital accounts
are depend on the number of
partners (Johnson and Pfeiffer,
2016). These accounts are shows in
the balance sheet of respective firm.
Audit process Not required any type of auditing
process.
Required to use auditing process in
legal manner.
Publication Not required to publish accounts. The firm must publish its financial
statements.
4.3 Interpretation of financial performance of Clariton with helps to financial ratios
Every business wants to know its financial performance in the industry that up to which
extent it is able to generate sales and revenue in respective segment. There are various measures
which shows that company is how much financially sound in the market. Higher the performance
is better for the firm due to attracting more number of consumers as well as create brand image
in the industry. One of the best and widely used measures is financial ratios in order to get
financial performance in the industry (Mukherjee, Al Rahahleh and Lane, 2016). Various
financial ratios such as profitability, liquidity, solvency, efficiency etc. for Clariton are given as
below:
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Profitability ratios: From the above stated table it can be stated that gross profit ratio is
declining from 14.34% to 14.18% due to increasing cost of goods sold. Further, as per the OPR
the Clariton is able to manage its operating as well as direct expenses in the business. Beside it,
Clariton’s net profit ratio is also increases from the year 2015 to accounting period 2016 that is
from 1.89% to 2.63%. hence, it shows that the management is more efficient in order to control
its expenses and generate sales and profit.
15

Liquidity ratios: In an accounting period 2014 current as well as acid test ratios are 0.23
and 0.08 respectively. Both the ratios are increases in the financial year 2015 that is 0.33 and
0.19 for current and quick ratio respectively. The increasing ratios indicate that the Clariton is
more able to meet with its short term obligations or debt amount in an effective manner. Further,
it can be assessed that Clariton is performing well in the industry of antique items.
Debt to equity ratio: It can be ascertained from above mentioned table that the company
having high debt as well as higher equity in the year 2015 in comparison to accounting year 2014
which lead to decrease respective ratio. Debt equity ratio is decreases from 0.51 to 0.47 which
indicate that the company is able to generate high equity capital and reduce burden of loan
amount.
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Efficiency ratio: It can be visualised from the above calculation of efficiency ratios that the
Clariton is more able as well as highly efficient in order to generate sales and revenue in the next
accounting period. Inventory turnover ratio is increases from 22.72 to 23.41 which shows that it
is utilizes its stock in effective way. Further, as per the total and fixed assets ratio it can be
analysed that the management of Clariton is utilize available assets to generate sales in highly
effective manner.
CONCLUSION
From the above mentioned report it can be summarized that the Clariton Antiques Limited
company is using venture capital and bank loan in order to raise fund for expanding business in
Birmingham. It can be said that both the sources are charging different cost of finance from
Clariton after taking financial services which affects financial statements in positive as well as
negative way. Further, it can be analysed that the management should put money for investment
17

in the project 1 which will give high yield in the future years. As per the last task of financial
performance it can be concluded that Clariton is performing well in the industry because it is
able to generate more profit in next accounting year. Further it is more efficient in order to
generate sales and revenue in the financial year 2015.
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