Investment Appraisal Methods for Firms

The assignment focuses on investment appraisal methods used by firms to evaluate and choose the most suitable projects. It emphasizes the importance of these methods in facilitating informed decision-making. The content delves into both financial and behavioral aspects influencing investment decisions, drawing upon relevant academic research and literature.

FINANCE FOR STRATEGIC
MANAGERS

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................3
Activity- 1........................................................................................................................................3
1.1 IMPORTANCE OF FINANCIAL INFORMATION...........................................................3
1.2 Identification of business financial risks...............................................................................4
1.3 Financial information ............................................................................................................5
Activity-2.........................................................................................................................................6
2.1 Purpose, contents and structure of accounts-.........................................................................6
2.2 Interpretation- .......................................................................................................................6
2.3 Financial Ratios-....................................................................................................................6
Activity 3.........................................................................................................................................7
3.1Diffference between long and short term financial requirements of business .......................7
3.2 Comparison of long and short term source of finance...........................................................7
3.3 Cash flow management methods and importance of cash management .............................9
Activity 4.......................................................................................................................................12
4.1 Structures and roles as well as responsibilities....................................................................12
4.2 Project evaluation methods..................................................................................................13
CONCLUSION .............................................................................................................................15
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INTRODUCTION
Finance is a fuel in the business. Finance is an elixir and proves to be of great help for the
purpose of value creation in businesses. All the activities that are conducted in any organisation
are connected either directly or indirectly through finance(Kolk and Pinkse,2010 ). Financial
decisions are most crucial decisions for the business. In the present report the discussion will be
regarding the financial information that is going to be required while making the financial
decisions for an organisation. Also, efforts have been made to highlight the major risks
associated with the businesses. The detailed analysis are performed for Clariton Hotel operating
in UK which is a growing company. The organisation is engaged in providing hospitality
services.
ACTIVITY- 1
1.1 IMPORTANCE OF FINANCIAL INFORMATION
The main objective regarding preparation of financial information is to assess the
financial position of the business. Apart from this the financial information also enables the users
to make comparison for different periods. Therefore an effective assessment can be made
regarding the financial performance of the company and the economic decisions can be made
taken on that basis. Financial information has distinctive significance for the different users
which is discussed in detail as follows-
Business Managers- Financial information is required by them to manage the liquidity and
finances of the company effectively. This will ensure an adequate assessment of the business
which can be useful for financial decision making.
Shareholders & Prospective Investors- They use financial information to make an assessment
of the risks & returns of the company and take investment decisions. Prospective investors
require financial information for the purpose of taking decisions regarding the viability of the
investments(Irwin and Scott,2010 ). Financial information is useful for making predictions about
the future earnings, dividend policies of the company. Also an effective assessment regarding the
risks and returns from the particular assessment can be made by a prospective investor.
Financial Institutions- These institutions require the financial information for the purpose of
decision making regarding whether a particular business has repaying capability or sufficient
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earnings for the timely repayment of the loans. The financial health of the company is being
assessed by the financial institutions. This is being done with the help of the financial
information provided by the business.
Suppliers- The financial statements and other financial information of the company is being
assessed by the suppliers to assess the credit worthiness of the company for the purpose of
providing credit on the goods or raw material supplied. The other terms of credit is based on the
basis of the financial health of an the Clariton hotel.
Customers- They require the financial information for the purpose of ensuring a steady supply
of the goods in future.
Employees- The financial information of Clariton Plc is of vital use for employees as well as it
helps them to assess the future remunerations and about job security.
Government- Governmental authorities require financial statements for the purpose of making
assessments of tax liabilities and other duties that are required to be paid by an organisation.
Also comparison can be made regarding the data provided in the return by Clariton with that of
the actual financial information.
1.2 Identification of business financial risks
Financial risks of the business can broadly be broadly divided to the three segments
namely- Capital structure risks, liquidity risks, and long term stability risks. A brief description
of the of these risks along with some important risk management techniques are discussed as
follows-
Capital structure risks- These risks are high when the capital structure of an organsation is
unbalanced. That could be due to en excess of debt or equity( Simons,2013.). This will affect the
returns of the company and thus there are going to financial disturbances. Hence it is extremely
important to manage the capital structure that is to employ adequate equity and debt portions in
order to maintain an appropriate returns for the investors.
Liquidity risks- These risks occur when there is inadequate cash or other liquid assets with the
business to repay its current liabilities. Liquidity position of the hotel is a vital factor as it poses
threats of bankruptcy. These can be managed by making an detailed assessment about the
company's short term liabilities along with the contingent liabilities and maintaining adequate
working capital for its repayment.
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Long term stability risks- Long term stability of Clariton hotel is connected with the various
sources of finance that are being used to buy long term or fixed assets. The inefficient
management of these assets will enhance the risks of insolvency for the hotel. Hence it is very
important to manege these risks in order to develop the business of Clariton.
The other risks to which Clariton is exposed are strategic risks that are due to the
irrelevant or inefficient strategic policies of the company. Another risks could be operational
risks that could be due to the hurdles faced by the hotel in carrying out its routine operations. All
these business risks can be managed by following an effective risk management. The different
steps involved in the process of risks management and which will help Clariton to manage its
risks are-
1. Identification of risks
2. Analysis Of risks
3. Evaluation of risks
4. Treating the risks
5. Monitoring & reviewing risks
These steps are required to be followed for each of the financial and other risks identified for the
purpose of managing risks effectively for Clariton.
1.3 Financial information
The financial data that is required for strategic decision-making for Clariton are its cash
flows statements which which reflects the movement of cash flows and thereby helps ion making
analysis regarding the various activities and about the major cash inflows and outflows. Balance
Sheet of the company is required for decision making regarding the employment of the adequate
assets and managing liabilities of the business(Shiller,2013 ). Profit and Loss statement discloses
the revenues and the expenses and thereby help in controlling excess expenditures and framing
policies for increasing the revenues. Then another important financial information is the ratio
analysis which help in making comparisons regarding the profitability and other aspects of the
business.
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ACTIVITY-2
2.1 Purpose, contents and structure of accounts-
Purpose-The general purpose for the preparation of the financial statements is to provide
a structured information about the operations performed by Clariton. Financial statements as the
whole are prepared by companies to analyse data which is being presented and take various
strategic decisions. These decisions could be either related to the credit positions, or investments
decisions, or may be related to the taxation and strategic planning.
Contents:
Balance Sheet- This statement includes an elaborate information about the assets and the
liabilities which are both short term and long term. The description regarding these is provided in
the notes to accounts which are to be prepared after the financial statements.
Profit and Loss Statement- This statements is prepared to present in detail the revenues arising
from distinct sources and the expenses incurred for earning those incomes.
Cash flows statement- This statement reflects the movements of cash flows for a particular
period.
Structure- Financial Statements for Clariton are required to be prepared in the format stated in
IAS-1.
2.2 Interpretation-
The interpretation is being given in the notes to accounts(Ahmed and Duellman,2011. ). It
includes the details of the figures in the financial statements. The financial statements can be
interpreted by the help of the notes to accounts.
2.3 Financial Ratios-
The various financial ratios that can be used for the purpose of assessing the liquidity of the
company are current liability ratio, quick assets ratios. Also ratio analysis can be used for making
comparison from the financial statements of the previous years and that of its competitors.
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ACTIVITY 3
3.1Diffference between long and short term financial requirements of business
Business finance needs can be classified in to two categories namely long and short term
finance needs. Long term finance needs refers to the amount of finance that company require for
more than a year. On other hand, short term finance needs indicate the fund that firm needed to
meet its financial requirements within a year. Working capital is used to meet day to day finance
needs of the business. Managers on single time period have to take decision in respect to short
term and long term finance needs of the firm. This is because for carrying out large size projects
it is important to arrange long term finance so as to ensure that sufficient amount of money will
be available to meet finance needs of the project (Bamber, Jiang and Wang, 2010). On other
hand, short term finance is required perform day to day business activities of the firm. Hence, it
can be said that there is a difference between long and short term finance requirements because
long and short term funds are used for different purpose by the managers. Thus, Clariton hotel
must clearly determine its short term and long term finance needs so that it can be ensured that
when funds will be required they will be available in sufficient amount on time to the business
firm. Short term finance requirements are determined by considering number of factors like the
present number of the current ratio and expenditure that is made by the firm on quarterly basis in
its business. Whereas, in order to determine long term finance requirement existing capital
structure and cost of finance is mainly taken in to account (Brealey and et.al., 2012). Apart from
this, plan that firm prepare in respect to investment that it will made on its project in upcoming
year in also considered while determining long term finance needs of the business. Thus, it can
be said that short and long term finance requirements of the business are determined on the basis
of varied factors.
3.2 Comparison of long and short term source of finance
Basis Long term source of finance Short term source of finance
Definition Long term sources of finance
are those that are used to raise
fund that will be invested in
the business for multiple years
Short term source of finance
are those which are used to
meet day to day fund needs of
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after one year will be paid to
relevant entity with cost of
capital (Droms and Wright,
2015).
the business firm.
Matching to project Long term source of finance
like equity, debentures and
bank loan are used to make
heavy investment in the
project for long term.
Short term source of finance
are used by the Clariton hotel
to support project related
activities that are usually
performed on daily basis.
Range of sources There are wide variety of
funds that are available in long
term category like shares,
venture capital, bonds,
debentures, private equity.
In case of short term funds
there are varied sources from
money is raised like factoring,
bank overdraft, lease and sale
of asset.
Uses of sources of finance As mentioned above long term
source of finance are used to
finance large size projects of
the business firm (Bamber and
Parry, 2014).
Short term source of finance
are used to support business
activities and to increase
liquidity in the business which
is used to perform operational
activity of the business firm.
Implications of sources of
finance for financial
statements
If long term sources of finance
are used to finance business
activities then in that case
values of shareholder equity
and long term liability as well
as current assets get changed.
Contrary to this, if fund is
raised through short term
source of finance then in that
case numbers of current
liability and current assets get
changed. Thus, it can be said
that long term source of
finance highly affects financial
statements then short term
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source of finance.
Impact on business If fund is heavily raised from
long term source of finance
then in that case capital
structure of the firm become
imbalanced. Due to this reason
firm cost of capital increased
at fast pace (Kolk and Pinkse,
2010).
In case fund is raised from
short term source of finance
then firm liquidity position get
affects. Many times due to
sharp elevation in the current
liability firm failed to make
payment to suppliers on time.
This create negative image of
the firm among customers. It
can be said that short term
source of finance put heavy
impact on the business firm.
3.3 Cash flow management methods and importance of cash management
Month 1 2 3 4 5 6
Month name January February March April May June
Money in (£)
Sales revenue 50000 55000 60000 65000 61000 62000
Funding from
2000 5000 3000 4000 5000 6000
trade receivables
Own funds 20000 0 0 0 0 0
Other 1000 1200 1300 1300 1200 1100
Total Money in (£) 73000 61200 64300 70300 67200 69100
Money out (£)
Loan repayments 10000 12000 15000 19000 22000 25000
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Trade payables 3000 4000 4500 4500 5000 5200
Inventory purchase 6000 7000 8000 9000 10000 11000
Total money out (£) 19000 23000 27500 32500 37000 41200
Balance (£) 54000 38200 36800 37800 30200 27900
Opening balance 10000 10000 10000 10000 10000 10000
Closing balance 48200 46800 47800 40200 37900
Interpretation
On analysis of cash flows it can be said that values of closing balance increased from the
month of January to March. Thereafter, cash flow declined for the months of April and May.
This reduction is observed because sales of the firm declined from £ 65000 to £61000. Even
though firms does not curtail its expenses. Raw material purchase increase consistently and firm
buy more goods on credit basis even sales declined on hope that market conditions will get
improved. Hence, cash balance declined in cash flow statement. Cash flow can be improved by
following strong cash management and expense control strategy. Firm must purchase less goods
on credit and must track expenses on daily basis. By doing so curb can be maintained on
elevation of expenses.
Purpose of budget
The main purpose of preparing a budget is to ensure that resources will be utilized
effectively in the business and stiff control will be maintained on the cost (Coleman,
Maheswaran and Pinder, 2010). Other main purpose of the budget is to measure the firm
performance for specific time period.
Importance of budget and way in which budgetary control work
There is huge importance of budget because by using same effective utilization of
resources can be done by the managers. Moreover, elevation in expenses can be controlled which
lead to elevation in the firm profitability(Ahmed and Duellman,2011). Under budgetary control
actual performance is compared with standard valued and corrective actions are taken if negative
variance is identified in case of specific variable.
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Interpretation
In case of material variance is positive because firm use resources according to its
production requirements. Firm give more wages to its employees and due to this reason labor
cost increased even production declined. Fixed overhead remain same even production get
changed. Electricity variance is positive because due to decline in production, less variable units
of electricity is consumed. Sales variance is positive because sales price of the firm product is
increased. Hence, it can be said that firm needs to reduce its labor force and must do their best
utilization. By doing so negative variance can be converted to positive.
ACTIVITY 4
4.1 Structures and roles as well as responsibilities
Company
In case of company corporate governance is very strong. In the company all employees
even CEO is responsible for his action to the shareholders. Hence, there is strong mechanism of
control in terms of policies and procedures in company (Irwin and Scott, 2010). There are strong
rules and regulations in the company and due to this reason legal system of same is very strong.
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Role and responsibility of owner
Owner: Owner play an important role in controlling business operations and giving strategic
direction to business. Owner is accountable to shareholders for the business performance.
Role and responsibility of manager
Manager play an important role in looking after day to day business operations. Manager
is responsible to the top managers for strong or poor performance of the business firm.
Sole trader
Corporate governance system of the sole trader business is not so strong like company.
As sole trader at its own discretion form rules and regulations (Simons, 2013). Hence, many
loopholes remain in CG structure of the business firm.
Role and responsibility of owner
Owner: Owner maintain entire control firm business activities (Baker and Wurgler, 2011).
Owner is responsible to treat all stakeholders in proper manner.
Role and responsibility of manager
Manager play role in smooth functioning of the business. Manager is responsible to sole
trader for communicating information about day to day performance of business activity.
4.2 Project evaluation methods
Figure 1Calculation of payback period
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Figure 2Calculation of ARR
Figure 3Calcualtion of NPV
Figure 4 Calculation of IRR
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Interpretation
 Payback period: This method reflect the time interval in which project cost can be
recovered by the managers. No project is assumed viable because both of them are
covering investment amount in same duration.
 ARR: This technique indicate mean return that can be gained on the project (Shiller,
2013). ARR of project A is 53% and same of project B is 44%. Hence, former one is
assumed viable for company (Ahmed and Duellman, 2011).
 NPV: This method help one in computing worth of project in numbers after considering
investment amount. NPV of project A is greater than other one and it is selected for firm.
 IRR: This method is used to estimate the real percentage profit that can be delivered by
the project to firm. IRR of project A is 36.32% and same of other one is 17.32%. Hence,
former is again selected for the firm.
CONCLUSION
It is concluded that financial information must be used by managers for making business
decisions. It is also concluded that ratio analysis must be done time to time in order to evaluate
business performance. Long and short term source of finance must be used by the firm with due
care. This is because if same will not be done then business problem will come in existence.
Investment appraisal method must be used to select most viable project for the business firm.
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REFERENCES
Books & Journals
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