Managerial Finance: Financial Analysis and Capital Investment Appraisal

This report provides financial analysis of Shell and BP Ltd. using various ratios and suggests recommendations for the poor performing company. It also includes capital investment appraisal techniques to advise senior management on project selection.

Managerial Finance

Table of Contents
INTRODUCTION...........................................................................................................................3
Portfolio 1 – Financial analysis........................................................................................................3
A. Evaluation of report for the potential investors which analyses is for finance and suggest
which organization is better:..................................................................................................3
B. Analysing the performance of both the company with the help of Ratio:.........................8
C. Recommendation for the poor performing company:......................................................11
D. Limitations of financial ratios to measuring a company’s performance:........................12
Portfolio 2 – Capital Investment Appraisal...................................................................................12
A. Using appropriate investment appraisal techniques, advise senior management on whether
they should opt for project A or project B............................................................................12
B. Discuss the limitations of using investment appraisal techniques in long term decision
making..................................................................................................................................15
CONCLUSION..............................................................................................................................16
REFERENCES..............................................................................................................................18

INTRODUCTION
In the below report, first task determine the two companies financial statements which
analysed by calculating two year financial ratio of each company (Aggarwal and Raja, 2018).
Ratio describe the financial position, growth or expansion of the company Shell and BP plc by
obtaining the difference of two years. In this report, ten types of ratios are calculated, such as
current ratio, Quick ratio, operating profit ratio, gross profit margin, return on capital employed,
Average inventories turnover ratio period, debtor's days, creditor's days, gearing ratio and
earning per ratio. In second task, two projects are provided Project A and Project B in which 6
years cash flow and initial cash investment for both plants will be £ 100000 given. This report
calculate the NPV of both the project for advising the senior management on whether they
should opt for project A or project B. It also discuss the limitation of using investment appraisal
technique in long term decision making.
Portfolio 1 – Financial analysis
A. Evaluation of report for the potential investors which analyses is for finance and suggest
which organization is better:
Computation of financial ratio of company Shell :
Current Ratio : Current assets / Current Liabilities
For year 2020,
= 90695 / 73951
= 1.22 times
For year 2019,
= 92689 / 79624
= 1.16 times
Quick Ratio: Quick assets / current Liabilities
For year 2020,
= 71238 / 73951
= 0.96 times
For year 2019,
= 68618 / 79624
= 0.86 times

Operating Profit Ratio: (Operating Profit / net sales) * 100.
Working Note
Operating Profit of 2020= Revenue – COGS – operating expenses
= 180543 - ( 19457+117,093-24071) – 33882
= 180543 – 112479 – 33882
= 34182
Operating Profit of 2019 = Revenue – COGS - operating expenses
= 344877 – (24071+ 252983 – 21117) – 36931
= 344877 – 255937 – 36931
= 52009
For year 2020,
= (34182 / 180543) * 100
= 18.93%
For year 2019,
= (52009 / 344877) * 100
= 15.08%
Gross Profit Ratio: (Gross profit / net sales) * 100
For year 2020,
= (68064 / 180543) * 100
= 37.79%
For year 2019,
= (88940 / 344877) * 100
= 25.78%
Return on Capital Employed: EBIT / Capital Employed
For year 2020,
= (26967) / 305317
= (0.088)
For year 2019,
= 25485 / 324712
= 0.078

Average Inventory Turnover Ratio: COGS / Average inventory
For year 2020,
= 112479 / 21764
= 5.16
For year 2019,
= 255937 / 22594
= 11.32
Debtors' Day: (Trade receivable / credit sales) * 365
For year 2020,
= ( 21781/180543 ) * 365
= 44.03 days
For year 2019,
= (30216/180543) * 365
= 61.08 Days
Creditors' Day: (Trade Payables / Credit purchase) * 365
For year 2020,
= (22664 / 117093) * 365
= 70.64 Days
For year 2019,
= (29497 / 252983) * 365
= 42.55 Days
Gearing Ratio: Debt / equity
For year 2020,
= 91115/ 155310
= 0.58
For year 2019,
= 81360 / 186476
= 0.43
Earning Per Share Ratio: Net income / Average outstanding shares

For year 2020,
= The company has earned loss in this year
For year 2019,
= 16432 / 3940.6
= 4.16
Computation of ratios of BP Limited:
Current Ratio: Current assets / Current Liability
For year 2019,
82059 / 73595
= 1.12 times
For year 2020,
= 72982 / 59799
= 1.22 times
Quick Ratio: Quick assets / current liability
For year 2019,
= 60322 / 73595
= 0.82 times
For year 2020,
= 54840 / 59799
= 0.92 times
Operating Profit Ratio: (Operating Profit / net sales) * 100
For year 2019,
= (11706 / 278397) * 100
= 4.20%
For year 2020,
= (-21740 / 180366) *100
= -12.05% (operating loss)
Gross Profit Ratio: (Gross profit / net sales) * 100
For year 2019,

= (4190 / 278397)*100
= 1.51%
For year 2020,
= (-20729 / 180366) * 100
= -11.49% (gross loss)
Return on Capital Employed: EBIT / Capital Employed
For year 2019,
= 11706 / 221599
= 0.05
For year 2020,
= -21740 / 207855
= - 0.10
Average Inventory Turnover Ratio: COGS / Average inventory
For year 2019,
=206780 / 19434
=10.64
For year 2021,
= 136111 / 18876.5
= 7.21
Debtors' Day: (Trade receivable / credit sales) * 365
For year 2019,
= (24442 / 278397) * 365
= 30.05 Days
For year 2020,
= (17948 / 180366) * 365
= 36.32 days
creditors' Day: (Trade Payables / Credit purchase) * 365

For year 2019,
= ( 46829 / 209672) * 365
= 81.52 days
For year 2020,
= (36014 / 132104) * 365
= 99.51 days
Gearing Ratio: Debt / equity
For year 2019,
= 120891 / 100708
= 1.20
For year 2020,
= 122287 / 85568
= 1.45
Earnings Per Share Ratio: Net income / Average outstanding shares
For year 2019,
= 4190 / 91,105
= 45990
For year 2020,
= -20729 / 87517
= The company has earned loss in this year
B. Analysing the performance of both the company with the help of Ratio:
Two year financial of company Shell
Ratio Shell
2019 2020
Current ratios 1.16 times 1.22 times
Quick ratios 0.86 0.96 times
Operating profit margin 15.08% 18.93%
Gross Profit margin 25.78% 37.79%

Return on capital employed 0.08 -0.09
Average inventories turnover
period
11.32 5.16
Debtors’ days 61.08 Days 44.03 Days
Creditor’s days 42.55 Days 70.64 Days
Gearing ratio 0.43 0.58
Earnings per share 4.16 The company has earned loss
in this year
According to the above computed ratios the liquidity position of shell limited is not good
because quick ratio of the company is under the ideal position so company is not able to pay-off
their short term debts with current assets. Company successfully improve itself in maximisation
of gross as well as operating profit. Company also improve Debtors collection period and
creditor's payment period. Company also decrease their debt so that gearing ratio is improved.
There is bad news for investors that the company is suffering loss per share as compared to last
year. Company has to improve their earnings on the behalf of the investors.
Two year financial of company BP Ltd.
Ratio BP Ltd.
2019 2020
Current ratios 1.12 times 1.22 times
Quick ratios 0.82 times 0.92 times
Operating profit margin 4.20% -12.05%
(operating loss)
Gross Profit margin 1.51% -11.49% (gross
loss)

Return on capital employed 0.05 -0.1
Average inventories turnover
period
10.64 7.21
Debtors’ days 30.05 Days 36.32 Days
Creditor’s days 81.52 Days 99.51 Days
Gearing ratio 1.2 1.45
Earnings per share 45990 -236556.84
According to the above computed ratios Current ratio of the company is showing good
performance but quick ratio of the BP limited is less than the ideal ratio which shows company
not able to meet current liabilities by realisation of current assets. Operating profit margin ratio
showing loss in the year 2020 which shows company is not able to maintain their expenses.
Company completely using operating profit in their operating expenses. Company's collection
period from debtors is increased as compare to last year. This shows company not able to take
payment on time from Debtors. Company well improved their gearing ratio which means
company decrease the long term debt and increase capital. Overall company is suffering from
losses in the year 2020.
Difference between Shell and BP Ltd. Financial Ratio:
Ratio Shell BP Ltd.
2019 2020 2019 2020
Current ratios 1.16 times 1.22 times 1.12 times 1.22 times
Quick ratios 0.86 0.96 times 0.82 times 0.92 times
Operating profit
margin
15.08% 18.93% 4.20% -12.05%
(operating loss)
Gross Profit
margin
25.78% 37.79% 1.51% -11.49 % (gross
loss)
Return on capital 0.08 -0.09 0.05 -0.1

employed
Average
inventories
turnover
period
11.32 5.16 10.64 7.21
Debtors’ days 61.08 Days 44.03 Days 30.05 Days 36.32 Days
Creditor’s days 42.55 Days 70.64 Days 81.52 Days 99.51 Days
Gearing ratio 0.43 0.58 1.2 1.45
Earnings per
share
4.16 The company has
earned loss in this
year
4.59 The company has
earned loss in this
year
According to the above computed ratios company Shell limited is more efficient and
effective from company BP Limited. The current ratio and quick ratio of both the company is
almost similar but Shell limited is generating good profit as compare to BP limited. Bp limed
suffer from Operating as well as gross loss in the year 2020. Both companies financial position is
not good but Shell limited position is better than the PB limited. Overall performance of the
company BP limited is not good because of losses but Shell limited is performing well and also
earning profits.
C. Recommendation for the poor performing company:
BP limited is poor performing company because it is suffering from losses and low liquidity
position. It has suggested to increase the sales because the sale of company decrease massively
from 2019. Company has to generate more profits and Decrease the operating expenses.
Company has to perform better managerial activities. It has to perform planning and controlling
activities to maintain expenses of the company. It has to increase the production in the reference
of increasing sells. Finance cost of the company is increase in year 2020 and it is recommended
that it has to take strict action to reduce them. Due to suffering from losses goodwill of the

company is also damaged. Company's net assets also decreased. It has to also manage the cash
and cash equivalents because there is decrease in them from 2019.
D. Limitations of financial ratios to measuring a company’s performance:
Ratio help in measuring results and analysing performance of a company. This is an important
tool for outsider or investors to measuring company's performance. Ratios are computed on the
basis of past results. There are many limitations of the ratios which creates problems in analysing
them (Al-Okaily and Naueihed, 2019).
 Past actual company's financial statement help in calculating ratios so that it is not
possible that the result are same in future. They only shows current position of the
company.
 Ratios are calculated on the basis of current cost but in future cost may be increased so
the results of ratio is unusual (Andayani and et.al., 2021).
 If inflation rate is changed in the period of computation of ratios, this means that the
values are not included for such period. The value of different period is not comparable
without adjusting inflation.
 Every company have its own policies of recording transactions so that comparing of
different ratios of different companies is inaccurate just like comparison of mangos and
grapes. For example, if two companies using different methods of depreciation then the
results of ratios are not usable (Ashrafi, 2019).
 Ratios are calculated on the basis of normal business environment but business
environment may change during the year. For example company trade payable are less in
the period of massive sale but in down market environment payable are more.
Portfolio 2 – Capital Investment Appraisal
A. Using appropriate investment appraisal techniques, advise senior management on whether
they should opt for project A or project B
Project A:
 Compute the value of Net present Value:
Year Cash Flows PV Factor @ 15% Present Value
2021 19000 0.87 16530

2022 22000 0.76 16720
2023 32000 0.66 21120
2024 35000 0.57 19950
2025 45000 0.5 22500
2026 45000 0.43 19350
2026 12000 (S.V) 0.43 5160
Present value of Cash Inflow 121330
Net Present Value = Present value of cash inflow – Initial Cash investment
Net Present Value= 121330 – 100000
Net Present Value = 21330
 Compute the value of Pay Back Period:
Year Cash Flow Cumulative Cash Flow
0 -100000 -100000
2021 19000 -81000
2022 22000 -59000
2023 32000 -27000
2024 35000 8000
2025 45000 53000
2026 45000 98000
2026 12000 (S.V) 110000
Pay Back Period = Years Before Break-Even + ( Uncovered Amount / Cash Flow in Recovery
Year )
Pay Back Period = 3 + (8000 / 35000)
Pay Back Period = 3 + 0.22
Pay Back Period = 3.22 Years

Project B:
Compute the value of Net Present value:
Year Cash Flows PV Factor @ 15% Present Value
2021 29000 0.87 25230
2022 38000 0.76 28728
2023 45000 0.66 29610
2024 35000 0.57 20020
2025 27000 0.5 13419
2026 25000 0.43 10800
2026 Nil Nil Nil
Present value of Cash Inflow 127807
Net Present Value = Present value of cash inflow – Initial Cash investment
Net Present Value = 127807 – 100000
Net Present Value = 27807
 Compute the value of Pay Back Period:
Year Cash Flow Cumulative Cash Flow
0 -100000 -100000
2021 29000 -71000
2022 38000 -33000
2023 45000 12000
2024 35000 47000
2025 27000 74000
2026 25000 99000
2026 Nil Nil

Pay Back Period = Years Before Break-Even + ( Uncovered Amount / Cash Flow in Recovery
Year )
Pay Back Period = 2 + ( 12000 / 45000)
Pay Back Period = 2 + 0.27
Pay Back Period = 2.27 Years
Compare both Project Net present value and Pay back period:
Projects Net Present Value Pay Back Period
A 21330 3.22 Years
B 27807 2.27 Years
Recommendation: From the above calculated investment appraisal techniques it can be
recommended to the senior management that project B is more viable for the business of Sam
Limited. In theory, a higher net present value is considered better and lesser pay – back period is
good. After comparison it can be seen that project A has an net present value of 21330 while
project B has 27807. The higher Net present value is considered much better than the lesser one.
On comparing the payback period of both the project it can be seen that project B is returning the
initially invested capital in just 2 years 2 months while Project A has longer duration of returning
the invested amount. Hence, it is recommended to the business to invest in project B. If the
business invests in project B higher returns are guaranteed with much lesser time compare to
project A.
B. Discuss the limitations of using investment appraisal techniques in long term decision making
Investment Appraisal techniques : It is the techniques which is useful in taking decision
in relation to long term investment. The business considered investment appraisal technique for
selecting the right project by analysing the cash inflows in given period of time. Net present
value, pay back period, accounting rate of return and internal rate of return are methods of
investment appraisal techniques (Chakraborty, Gao and Sheikh, 2019).
Following are Limitation of Investment Appraisal techniques:
Pay Back Period:

 It is the method which is not controlled by the management of the company because the
pay back it not calculated or analysed during the given period of time. It determine at the
end of the set time period.
 In this technique the wrong or unproductive decision also been taken place. If the senior
management of the company is unskilled or inexperienced it is chance of bearing risk.
 Training of manager or other senior management are more costly in pay back period.
 After the calculation payback period the company avoid all cash flow.
 The value of time is neglected because it is more time consuming.
 The payback period ignore the profit of the company. It only focus on the initial
investment and does not measure the gain.
Net present Value:
 It is not easy to understand by the people because it required more knowledge and skills.
 In net present value there is a chance of fluctuation in the rate of interest during the
given period of time.
 It depends on accurate cost of capital any wrong calculated to wrong net present value.
 The company face problem in making decision if the comparison net present value of
two projects are equal and contradictory.
 There is not fixed rules to calculation the net present value of the company (Eniola,
2018).
Accounting Rate of return:
 The accounting rate of return is not valued the importance of time.
 It is calculated using average, therefore there is no time boundation in this method.
 The method of calculating accounting rate of return is not fixed. It is depend on the data
or situation.
 To determine the profit is takes several types of accounting policies such as depreciation.
The different stages of project are not taken into consideration while calculating accounting rate
of return (Fabisik and et.al., 2021).
CONCLUSION
From the above mentioned report it can be concluded that the performance of both the
companies are not good but Shell limited is more suitable for investment because BP plc is
suffering from losses as compare to last year and it is also giving loss per share. According to

gross profit and operating profit ratio Shell limited is performing well and financial position is
also strong as compare to BP plc. Both the companies need massive improvement in the
managerial and controlling activities. As per the calculation of net present value and payback
period of both the project it is concluded that project B is more efficient and effective. Project B
satisfy both the methods a higher net present value and lesser pay back period. Hence it is
recommended to the management they can invest in project B which is more suitable and
efficient for them.

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