Investment Appraisal Techniques

This assignment delves into the influence of different investment appraisal techniques on the profitability of small manufacturing firms. It examines various methodologies used to evaluate potential investments, such as payback period, net present value (NPV), and internal rate of return (IRR). The focus is on understanding how these techniques can help businesses make informed decisions regarding resource allocation and ultimately enhance their profitability. The assignment likely incorporates real-world examples and case studies to illustrate the practical application of investment appraisal concepts.

MANAGING FINANCIAL
PRINCIPLES AND
TECHNIQUES

TABLE OF CONTENTS
INTRODUCTION......................................................................................................................1
ACTIVITY 1..............................................................................................................................1
1.1 Importance of costing in to pricing strategy of Innovetec ltd.....................................1
1.2 & 4.1 Designing a cost system for Innovetec ltd and cost reduction ideas regarding
same..................................................................................................................................3
4.2 Potential use of activity based costing for Innovetec ltd............................................4
2.2 Sources of finance for Innovetec................................................................................5
ACTIVITY 2..............................................................................................................................6
2.1 & 3.1 Forecasting technique to estimate cost and expected return and setting a
budgetary target for an organization.................................................................................6
3.2 Budgeted cash flow for first six months.....................................................................7
3.3 Reasons due to variance comes when budget is compared with actual results..........8
3.2 Budgetary monitoring process....................................................................................8
Tasks 5.1 Calculation of Pay-back period and net present value...................................10
AC 5.2 Recommendations..............................................................................................12
AC 5.3 Commercial factors relevant to the investment decisions..................................12
ACTIVITY 4............................................................................................................................13
Comparative analysis of the company's financial statements........................................18
Recommendations...........................................................................................................19
AC 6.3 Limitations of decisions that are based on financial information only..............20
CONCLUSION........................................................................................................................20
REFERENCES.........................................................................................................................22
INDEX OF TABLES
Table 1: Mater budget................................................................................................................6
Table 2: Calculation of profits and cash flows...........................................................................8
Table 3: Calculation of profits and cash flows...........................................................................9
Table 4: Calcualtion of NPV....................................................................................................10
Table 5: Ratio analysis of Sainsbury........................................................................................13
Table 6: Ratio analysis of Tesco Plc .......................................................................................14

INTRODUCTION
Finance plays a very important role in the organization success. Every organization is
required to have adequate availability of funds to run the business operations in a possible
manner. The present report will helps us in identifying the finance sources available to the
Innovetec Company. Further, cost and pricing decisions and its role in the business success
are also analysed in this report. Moreover, the budgeting process, preparation of budget and
variance analysis also has taken place. Variance is computed through identifying the
difference between actual and budgeted results. It helps to take effective business decisions.
In addition to it, different investment appraisal techniques such as payback period method
and net present value method also discuss in this report. At the end of the report financial
statements are analysed of two retail sector companies Tesco Plc and Sainsbury so as to take
decisions for making investment.
ACTIVITY 1
1.1 Importance of costing in to pricing strategy of Innovetec ltd.
Costing plays a very important role in the pricing strategy of the firm. This is because
it is the cost by using which any firm determines its own pricing strategy. With change in cost
firm pricing strategy also change. If any firm adopt a cost control measures then its cost of
production of reduced. Consequently it’s also change its pricing strategy. Thus, it can be said
that cost has a very high importance to the pricing strategy of the firm. In highly competitive
business environment it becomes necessary for the firms to give stiff competition to the
competitors. Innovetec is operating in market in which there are many competitors which are
offering innovative products at a low price in comparison to features (Abernethy, Lillis,
Brownell and Carter, 2001). Hence, Innovetec is going to launch a new mobile which is
totally different in features and it also needs to launch its product at low price in order to
make its product acceptable in the market. Hence, this target indicates that cost has a due
importance in the pricing strategy of Innovetec ltd pricing strategy. In order to reduce cost
firm needs to generate economies of scale. It can be generated by using supply chain
management techniques and cost concepts. Economies of scale refer to saving in cost that
comes in existence due to purchase of raw material in bulk or implementing any cost
reduction technique in an organization (Attwell and Laughlin, 2001). According to
economics as a discipline total cost is a combination of variable and fixed cost. Fixed cost
refers to the cost that does not get changed with change in production. On other hand,
variable cost is a cost that changes with change in a production. This means that if production

will increase then variable cost will also increase vice-verse. So, most of the firm increase
their production level up to certain limit in order to reduce variable cost to maximum level
(Definition of economies of scale. 2015). Hence, as production increase variable cost of the
firm decline but fixed cost remain same. Due to this reason cost of production also reduced.
Apart from this, firm can make change in its supply management strategies. This will help
firm in reducing its transportation or logistics cost (Blocher, Chen and Lin, 2008). Due to
adoption of these measures cost of production per unit will be reduced for then firm. Hence, it
can be said that Innovetec ltd can adopt these techniques in order to reduce its production
cost.
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1.2 & 4.1 Designing a cost system for Innovetec ltd and cost reduction ideas regarding same
Cost system refers to the process which a firm is using to compute cost of production
for its products. A costing system is mainly used by the management to monitor their cost of
production. It is also used to ensure that cost is incurred in line to the standards determined by
the management. In management accounting there are several costing systems and some of
them are as follows
1. Job order costing- This cost system is used when a firm is producing a multiple
products. In this costing system separate cost is prepared for each and every product
line. Firms mostly use this costing system when its multiple products produced are
different from each other on usage and features (Cagwin and Bouwman, 2002). This
costing system is also used when firm is receiving orders for production of goods. In
other words, it can be said that mentioned costing system is used by the firm when
they receive order for production of specific quantity of goods from various clients.
Due to this unique feature mentioned costing system is widely used by the business
firms.
2. Process costing- This costing system is entirely different from batch costing because
in this mode of costing on process basis cost of production is determined. Means that
for producing a specific product many steps are performed (Dey, 2006). So in this
costing system cost of each and every step of production is considered for computing
final cost of production. In this costing system cost of production is determined in a
legitimate manner and due to this reason this method of costing is popular among
manufacturing firms.
3. Traditional costing system- This is old method of costing under which a rate is used
to determine cost of production. Means that different departments are involved in the
production process. So rate is determined for each of these departments and by suing
same cost of each department is determined by the cost manager. This feature is major
limitation of the costing system. With change in business environment cost of raw
material also changed (Drexler, Black and Sparks, 2013). These changes taken place
overnight. But overnight it is difficult to determine new rates of costing for each
department. Due to determination of wrong percentage wrong cost will be calculated
and due to this reason firm may face heavy loss in the business. Hence, due to this
limitation this technique is not used by the companies at the workplace.
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4. Activity based costing- This is unique costing system in which cost of each and every
activity performed for producing specific product is determined by the cost
accountant. After identification of activity cost for each and every activity that is
performed in production process is determined by the managers. Cost for these
activities is determined on the basis of use of resource done by these departments.
On the basis of evaluation of these costing system it can be said that activity based costing is
better for the firm (Garrison, Noreen and Brewer, 2003). This is because in mobile
manufacturing several tasks are performed in sequence. Hence, by determining cost of all
these activities cost of production can be determined. Hence, it can be said that this costing
system will be suitable for Innovetec ltd.
There are many ways that can be adopted in order to reduce cost. Some of them are as
follows.
 Analysis of activities- In activity based costing several activities are performed. In
this method of cost reduction each and every activity will be analyzed. Main focus
will be on identifying sub unproductive task in each activity. Elimination of these
activities from production process will reduce both time and cost for the firm. In this
way cost of production will be reduced for the firm (Healy, 2002).
 Management audit- It is a technique in which top managers analyse costs where firm
makes extravagance. After identification of such kind of costs managers identify the
reason due to which these over expenses co0mes in to existence. After identification
of reasons management identify the ways that can be adopted in order to prevent
repetition of such kind of mistakes (Horngren and et.al, 2002). Hence, this technique
is also very effective in cost control.
4.2 Potential use of activity based costing for Innovetec ltd
There are many uses of activity based costing and due to this reason this method is
widely used by the business firms. This technique compute cost of production in proper
manner in comparison to other costing techniques. This is because for producing goods
resources are required and these resources may be people working in an organization and
resources that are used for producing goods at the workplace (Huber, 2011). Basically
resources are used for producing goods and computation of their cost directly helps firms in
calculating cost of production. So, due to this reason this method of costing is assumed better
than other costing techniques. On other hand, by analyzing previous months activity based
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costing data managers can identify resources whose consumption is increasing, decreasing or
remain stable in the production. Hence, on the basis of analysis of these trends managers gets
lots of information (Kaplan and Atkinson, 2015). They also get a direction on which they
need to work in order to control cost of production. So, it can be said that this costing
technique has a varied use for the business firms.
2.2 Sources of finance for Innovetec
There are many sources of finance and these sources may be divided in to two
categories one is internal and second is external sources of finance. These categories of
sources of finance are described below.
Internal sources of finance Retained earnings- It is a part of profit that remains after paying all expenses from
the revenue. There is cost of this source of finance and due to this reason this source
of finance is widely used by the firms. Sale of asset- Sale of asset is another common internal source of finance that is
widely used by the firms when an asset is not generating sufficient returns for the firm
or it remain idle for the firm for long time period (Kaplan and Schoar, 2005). There is
not cost of this source of finance which is major reason due to popularity as a source
of finance among large corporations.
External source of finance Equity- Under this source of finance firm raised a capital from the market by bringing
IPO or FPO. For doing this it needs to pass some criteria that are determined by the
recognized stock exchange. In this source of finance cost can be adjusted and due to
this reason this source of finance is widely used by the firms. Debentures – It is a written acknowledgment of debt taken by the firm from the
public. In return firm need to pay interest to the debenture holders. In this source of
finance, finance cost cannot be adjusted (Kennedy and Affleck-Graves, 2001). Due to
this reason equity is mainly prefer above debentures.
 Hire purchase agreement- Under this agreement firm takes an asset on lease. It pay
lease amount on regular interval. If lease amount cumulatively become equivalent to
the price of the leased asset then it is amused to be purchased by the lessee (Koltai
and et.al, 2000). So, it can be said that in this source of finance by making payment in
instalments an asset can be purchased by the firm.
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ACTIVITY 2
2.1 & 3.1 Forecasting technique to estimate cost and expected return and setting a budgetary
target for an organization
Forecasting technique that Innovetec can use in the business is as follows. Cash flow forecast – In order to estimate cost and revenue for upcoming time period
technique of preparing a cash flow statement can be used by the Innovetec. Under this
technique a projection for cost and revenue is prepared. For this a technique of
financial modelling is used by the firm in which by using old data forecast for
upcoming month or year is prepared by the finance manager. In order to predict
output economic environment is analyzed by using economic data like GDP, IIP and
PMI. On the basis of output estimation revenue amount is envisaged by the firm (Lee,
Ellenbecker and Moure-Ersaso, 2004). After that first old data is taken and some
calculations regarding same is done. Cost covers a fixed percentage of sales. Even
sales increase or decrease this proportion remains same. Hence, in this technique
Innovetec will use revenue that it computes in early stage. After doing this it will use
cost percentage that was determined by doing calculation on old data to compute or
predict cost for upcoming time period. In this way cost and revenue will be
determined by the firm under this forecasting technique.
 Forecasting prices movement of metals using indices- Innovetec is using metals for
producing mobiles. Thus, change in price of these metals brings changes in the cost of
production of the firm. Due to this reason it becomes necessary for the firm to predict
price changes because it directly affects firm cost and revenue. In order to forecast
changes in price of base metals managers can review change in LME indices of base
metals (Marginson and Ogden, 2005). Changes in the price of these indices will
indicate the direction in which price of these metal may go. In order to confirm this
trend manager can use concept of open interest. It is a terminology that is used in
commodity market. This terminology indicates the number of fresh contracts that are
newly opened in the market. Increase in open interest indicates that fresh money is
introduced in the market. Similarly, decrease in open interest indicates that fresh
money is coming in market at slow pace. Means that in upcoming months price may
fall or grow at a slow rate (Maskell and et.al, 2007). By using such kind of data cost
of raw material can be estimated and by using this cost of raw material will be
determined. On other hand, increase in cost cannot be passed to consumers. Hence,
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trends in price change can be used to predict firm revenue. In this way, index helps
firm in determining cost and profit of then firm.
Setting a budgetary target requires determination of cost and revenue of the firm.
Revenue of the firm is directly affected by the economic environment. Hence, change in
economic environment affects revenue of the firm. Due to this reason before preparing a
budget economic environment must be analyzed. On the basis of analysis revenue amount
must be determined in the budget (Mayer, Schoors and Yafeh, 2005). Firm must consider old
budget performance and economic data of GDP, PMI and IIP for estimating accurate amount
of revenue for the budget. By using economic data and previous month cost sheet firm can
estimate cost for the budget. Hence, in this way budgetary target can be set for an
organization.
3.2 Budgeted cash flow for first six months
Table 1: Mater budget
Particulars Price(£) Jan(£) Feb(£) Mar(£) Apr(£) May(£) Jun(£)
Number of units 24000 2000 2100 2200 2500 2600 2900
Cash from sales 400 800000 840000 880000 1000000 1040000 1160000
9600000
Variable Costs
Direct material 50 100000 105000 110000 125000 130000 145000
Direct Labour 20 40000 42000 44000 50000 52000 58000
Selling Costs 10 20000 21000 22000 25000 26000 29000
Total Variable
costs 160000 168000 176000 200000 208000 232000
Fixed Costs
Production OH 450000 37500 37500 37500 37500 37500 37500
Administration OH 288000 24000 24000 24000 24000 24000 24000
Selling OH 180000 15000 15000 15000 15000 15000 15000
Total Fixed Costs 76500 76500 76500 76500 76500 76500
Total Costs 2838000 236500 201500 201500 201500 201500 201500
Net cash flow 6762000 563500 638500 678500 798500 838500 958500
Opening balance 0 563500 1202000 1880500 2679000 3517500
Closing Balance 563500 120200 1880500 2679000 3517500 4476000
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0
Interpretation
On analysis of budget it can be seen that management think that with passage of time
sales of the firm will increase. Due to this reason it increases its production of goods. With
increase in production cost keeps on changing which is variable in nature. But fixed cost is
same with change in level of output. Due to continue increase in sale and stability in growth
rate of cost of the firm closing balance is increasing. Hence, it can be said that firm is
performing well.
3.3 Reasons due to variance comes when budget is compared with actual results
Mostly it has been seen that when budget is compared with actual results variance
comes in existence. This variance may be positive or negative in nature. It is very difficult to
predict change in economic environment in accurate manner. With change in economic
environment cost of raw material and sales of the firm also get changed. Hence, actual results
do not come in line to budget prepared (Mestry and Naidoo, 2009). If variance is positive
then there is no problem but if variance is negative then management needs to take action
immediately in order to ensure that mistakes will not committed again which was responsible
for variance in the budget.
3.2 Budgetary monitoring process
Following is a process that is followed for monitoring a budget. Determination of standard- In this stage a standard is prepared for the budget. These
standards are determined by the managers by considering various economic data and
company past performance in several business situations (Olawale, Olumuyiwa and
George, 2010). These are use by the firm in later stage in order to identify company
performance. Measurement of performance- After a specific time period performance of the
company is identified on the basis of values or unit. This period may be three months
or a year. Comparison with standard- In this stage actual figures that were identified in earlier
stage is compared with budgeted figures in order to identify that company perform
better or worse.
 Taking corrective action- In this stage if variance is negative then corrective actions
are taken in order to make sure that mistakes committed in this stage will not be
committed again in future (Panayotidis, Montesanto. and Orfanidis, 2004).
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ACTIVITY 3
As per the given scenario, Innovetec has an investment propsoal that requires initial
investment amounted to 600000£ for production of expa4. The revenue and operating cost for
five years are given. Therefore, the profits can be calculated by subtracting the business cost
to its total revenue. Further, for calculating the cash flows, amount of depreciation will be
added to the profits.
Calculation of annual depreciation as per the straight line method
Depreciation = Total initial investment – Scrap value/ Estimated life
Total Initial investment = 600000£
Scrap value = 50000£
Estimated life of the project = 5 year
Annual depreciation = (600000£ - 50000£) / 5 year
= 550000£/5
= 110000£
Calculation of profits and cash flows:
Table 2: Calculation of profits and cash flows
Year Revenue
Operating
cost Profit Depreciation Cash flow
1 250000 110000 140000 110000 250000
2 350000 115000 235000 110000 345000
3 450000 115000 335000 110000 445000
4 250000 150000 100000 110000 210000
5 250000 150000 100000 110000 210000
Total 910000
Tasks 5.1 Calculation of Pay-back period and net present value
Different types of investment appraisal techniques are available to organization for
taking effective decisions (Carmichael, 2011). It includes pay-back period method and net
present value method that are described as below:
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Pay-back period = It is the time period that the project will take to get an initial investment
of 600000£. Lower the pay-back period of investment, to a high extent, the proposal will be
good for company (Irani, 2010). The pay-back period for the given scenario is calculated here
as under:
Table 3: Calculation of profits and cash flows
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Year Cash flow Cumulative cash flow
0 -600000 -600000
1 250000 -350000
2 345000 -5000
3 445000 440000
4 210000 650000
5 210000 860000
Total 860000
Pay-back period = 2 year + 5000£/445000£
= 2 year + 0.11 year
= 2.11 year
Net present value method: In this method, all the cash flows are discounted by using a
discounted rate. Moreover, the difference between discounted cash inflows and cash outflow
is known as net present value of the project (Carr, Kolehmainen and Mitchell, 2010). In
context to given scenario, the net present value of project is computed by using 15% cost of
capital.
Table 4: Calculation of NPV
Year Cash flow
Discounted value of
1 at 15% Discounted cash flow
0 -600000 1 -600000
1 250000 0.8695652174 217391.304347826
2 345000 0.7561436673 260869.565217391
3 445000 0.6575162324 292594.723432235
4 210000 0.5717532456 120068.181574537
5 210000 0.4971767353 104407.114412641
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Total 860000 395330.88898463
The net present value of the project is positive amounted to 395330.8889£.
AC 5.2 Recommendations
On the basis of pay-back period and net present value, it should be recommended that
business has to make investment in such proposal. It is because; according to pay-back period
method, if an investment proposal will get its investment in shorter period then the project
should be accepted. In the given scenario, the project will take 2.11 years. Further, the project
also has post pay back profitability amounted to 860000£. Therefore, it can be said that
through accepting this investment proposal, company will get initial cash outlay earlier and
also, it can get an additional profitability of 860000£ after receiving this initial investment of
600000£. Pay-back period is an easier method in investment appraisal techniques as it is easy
to calculate. However, the disadvantage of this method is that it does not consider the time
value of money. Therefore, the net present value is considered as an appropriate method as
compared to pay-back period method for taking investment decisions. Net present value
method is based on the assumption that money has time value over the period (Ling and
Archer, 2012). Therefore, effective and strategic investment decisions can be taken by
considering this factor. According to the net present value method, all the cash inflows of five
years are discounted at 15% cost of capital. However, net present value is determined through
subtracting the total discounted cash inflows to the total cash outflow. It is also called as
discounted cash flow method. The technique says that if any investment project gives positive
net present value then the investment can be made. In the given business scenario, the net
present value of investment proposal is 395330.8889£. It indicates that if the business makes
investment in this proposal then company can earn profits. Therefore, on the basis of above
results, it can be recommended that the business can introduce new expa4. It is because of
lower pay-back period of proposal and availability of positive net present value (Olawale,
Olumuyiwa and George, 2010). Thus, Innovetec should start the production of expa4. It gives
benefit to the firm through increasing business revenue and profitability. This in turn results
in making the business grow and business development for the future period.
AC 5.3 Commercial factors relevant to the investment decisions
Capital investment decisions aim at allotting the business capital in business assets in
the most effective manner. Business has to make investment in such investment proposal that
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yields maximum returns to the firm. There are different factors that affect the business
investment decisions. Company has to ensure that the investment decisions will contribute to
improve the business value. Investment decisions involve a number of factors that affect such
decisions. Investment decisions may be taken for business expansion, renewal and
replacement. Initially, the management has to determine the capital requirement that
organization requires to invest. They have to identify the way in which business collects the
required amount of capital from different available sources (Schniederjans, Hamaker and
Schniederjans, 2010). Further, they have to assess the risk return analysis associated with the
proposal. Business has to accept such proposal that yields maximum benefits at an acceptable
risk. In case of investment for implementing technological changes in business, management
has to identify its opportunities. Moreover, the managers of business have to analyse the
competitor’s strategies. Further, company has to forecast or estimate the cash inflows for the
future period. They have to identify the relative profitability of different proposals and need
to select the appropriate ones. Management of business should analyse the market behaviour
for assessing the business risk. Discounted cash flow techniques are used by the organizations
for this purpose. They have to analyse the profit potential and the gestation period for project.
Gestation period is the time lag between initial investment and anticipated returns (Arrow and
Lind, 2014). Lower the gestation period will be prefer by every organization. In addition to
it, there are some other factors that affect the investment decisions. For instance, money has
time value over the period. Therefore, they should consider the cost of capital. Higher the
cost of capital contributes to higher the business risk and vice versa. Further, the rate of
inflation also impacts the decisions to a great extent. Therefore, business requires analysing
all the factors. It helps to assess the financial viability of project so as to take strategic and
appropriate investment decisions.
ACTIVITY 4
AC 6.1, 6.2
Innovetec is considering investing in any other food retailing business through buying
shares worth 1.4 million. Therefore company has to analyse the profitability and risk to the
company associated with such investments. It can be done through analysing the financial
statements of the company. Two food retailing businesses that are Tesco and Sainsbury are
selected for the investment purpose. Tesco is a multinational retail business that operates in
distinct part over the world. Headquarter of the company was established in Cheshnut,
Hertfordshire, England, UK. The company is achieving its mission through providing
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qualified services to the customers. Sainsbury is the second largest supermarket chain
headquartered in Holborn, London, United Kingdom. The operational as well as financial
performance of both the company is analysed here through analysing its financial statements
(DeFusco and et. al., 2011). It can be done through ratio analysis method. Ratio analysis is
the best financial tool for this purpose. Ratio represents the relationship between two
variables. It calculates different kinds of ratios such as profitability ratio, solvency ratio,
liquidity ratio and turnover ratios.
Table 5: Ratio analysis of Sainsbury
Ratios Formula 2014 2013 2012
Profitability ratios
Gross profit 1377 1277 1211
Operating profit 1009 887 874
Net profit 716 614 598
Net Sales 23949 23303 22294
Gross Profit Ratio (Gross Profit/ Net Sales) *100 5.75 % 5.48 % 5.43 %
Operating Profit Ratio
(Operating Profit/ Net Sales)
*100 4.21 % 3.81% 3.92 %
Net Profit Ratio (Net Profit/ Net Sales) *100 2.99 % 2.63 % 2.68 %
Return on equity 12.2 10.82 10.81
Liquidity ratios
Current Assets 4362 1901 2032
Current Liabilities 12171 3115 3136
Closing Stock 1005 987 938
Current Ratio
Current Assets / current
Liabilities 0.36 0.61 0.65
Quick Ratio
(Cu. Assets - Cl. Stock)/Cu.
Liabilities 0.28 0.29 0.35
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Effciency Ratios
Net Sales 23949 23303 22294
Total Assets 16540 12695 12340
Total Assets Turnover
Ratio Net Sales/ Total Assets
1.45
times
1.84
times
1.81
times
Cost of goods sold 22562 22026 21083
Inventory 1005 987 938
Inventory Turnover ratio COGS/Inventory
22.45
times
22.32
times
22.48
times
Gearing ratios
Debt 2250 2617 2617
Equity 6005 5733 5629
Debt Equity Ratio Debt/ Equity 0.37 0.46 0.46
Net income 716 614 598
Annual Interest Expense 159 142 138
Times Interest Ratio Net Income/ Interest expense
4.5
times
4.32
times
4.33
times
Net credit sales 23949 23303 22294
Net receivables 433 306 286
Accounts receivable
turnover Net credit sales/Net receivable
55.31
times
76.15
times
77.95
times
Net purchase 22562 22026 21083
Creditors 2692 2726 2740
Net purchase/ creditor 8.38 8.08 7.69
Payment turnover ratio 365/payment turnover ratio
43.55
days
45.17
days
47.44
days
Earning per share 0.37 0.32 0.32
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Table 6: Ratio analysis of Tesco Plc
Ratios
Formula 2014 2013 2012
Profitability ratios
Gross profit 4010 4089 5397
Operating profit 2631 2188 4182
Net profit 970 120 2814
Net Sales 63557 64826 63916
Gross Profit Ratio (Gross Profit/ Net Sales) *100 6.31 % 6.31 % 8.44 %
Operating Profit Ratio
(Operating Profit/ Net Sales)
*100 4.14 % 3.38 % 6.54 %
Net Profit Ratio (Net Profit/ Net Sales) *100 1.53 % 0.19 % 4.40 %
Return on equity 6.21 0.72 16.36
Liquidity ratios
Current Assets 13085 12465 12353
Current Liabilities 20206 18703 19180
Closing Stock 3576 7744 3598
Current Ratio
Current Assets / current
Liabilities 0.65 0.67 0.64
Quick Ratio
(Cu. Assets - Cl. Stock)/Cu.
Liabilities 0.47 0.25 0.46
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Efficiency Ratios
Net Sales 63557 64826 63916
Total Assets 15572 13096 12863
Total Assets Turnover
Ratio Net Sales/ Total Assets
4.08
times
4.95
times
4.97
times
Cost of goods sold 59547 60737 58519
Inventory 3576 7744 3598
Inventory Turnover ratio COGS/Inventory
16.65
times
7.84
times
16.26
times
Gearing ratios
Debt 9303 10068 9911
Equity 14772 16661 17801
Debt Equity Ratio Debt/ Equity 0.63 0.60 0.56
Net income 970 120 2814
Annual Interest Expense 564 459 411
Times Interest Ratio Net Income/ Interest expense
1.72
times
0.26
times
6.85
times
Net credit sales 63557 64826 63916
Net receivables 2190 2525 2657
Accounts receivable Net credit sales/Net receivable 29.021 25.67 24.06
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turnover times times times
Net purchase 59547 60735 58519
Creditors 10595 11094 11234
Net purchase/ creditor 5.62 5.47 5.21
Payment turnover ratio 365/payment turnover ratio
64.94
days
66.67
days
70.07
days
Earnings per share 0.12 0.02 0.35
Comparative analysis of the company’s financial statements
Gross profit ratio: The gross profit represents the gross margin on total business
sales. It helps to examine the business profitability of both the organizations. Sainsbury gross
profit ratio tends to increase from 5.43% to 5.75% in the year 2014. However, Tesco gross
profit ratio tends to decline from 8.44% to 6.31% in the year 2013. Further, it is still remains
constant to this percentage. Therefore, it can be said that Tesco is getting higher gross margin
than Sainsbury.
Net profit ratio: Net profit is calculated by dividing the net profit to the total
business sales. Sainsbury's net profit ratio in the year 2014 was 2.99% However, Tesco net
profit ratio was 1.53% lower than Sainsbury. Therefore, it can be said that Sainsbury's
operational performance is better as compared to Tesco plc.
Return on equity: Return on equity of Tesco is 6.21 in the year 2014. However,
Sainsbury's is earning 12.20% of return on total equity. Thus, it is higher in the case of
Sainsbury. This implies that company is earning higher level of profitability on its total
equity comparatively than that of Tesco Plc.
Gearing ratio: It is measured through debt and equity ratio. Tesco plc debt equity
ratio gets inclined from 0.56 to 0.63 in the year 2014. However, Sainsbury's gearing ratio gets
declined from 0.46 to 0.37 in the year 2014. Lower the gearing ratio indicates lower the risk
to the company and vice versa. Therefore, it can be said that through investing in Sainsbury
lead to lower the risk to Innovetec Company.
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Liquidity ratio: Business liquidity can be measured through computing current ratio
and quick ratio. The current ratio of Sainsbury gets declined from 0.65 to 0.36. However, the
current ratio of Tesco plc gets inclined from 0.64 to 0.65. Another the quick ratio of
Sainsbury and Tesco plc are 0.28 and 0.47 respectively. Both the ratios indicate that Tesco
Plc is having greater amount of liquidity in the business. Thus, the company is more able to
paying its short term obligations (Vogel, 2014).
Interest coverage ratio: It measures the ability of the company to pay the debt
interest on time (Petzke, Fuller and Metges, 2010). The time interest ratio of Tesco plc
showed and highly decreases to 6.85 to 1.82 times. However, Sainsbury’s time to interest
ratio get increased from 4.33 to 4.5 times. It implies that Sainsbury is much able to pay the
interest out of its profits on time.
Efficiency ratio: It measures the business ability to use the business assets. It can be
measured through computing assets and inventory turnover ratio. The assets and inventory
turnover ratio of Sainsbury is 1.45 and 22.45 times. On contrary, Tesco Plc assets and
inventory turnover ratios are 4.08 and 16.65. Assets ratio indicates that Tesco Plc is using its
assets at higher level of efficiency. However, inventory turnover ratio implies that Sainsbury
is using its inventory at higher level of efficiency.
Recommendations
On the basis of above analysis it should be recommended that Innovetec should buy
shares of Sainsbury Company. The reason for such decisions is that Sainsbury is getting
higher net profitability as compare to Tesco plc. On contrary, gross margin of Tesco Plc is
higher while company did not distribute dividend out of its gross profits. Shareholders of the
company get return out of their net profits. Therefore, it is advantageous for Innovetec to
make investment in Sainsbury. Moreover, return on equity is also higher in the case of
Sainsbury. Thus, it can be said that Sainsbury is earning higher amount of return on the total
equity (Schroeder, Clark and Cathey, 2011). However, liquidity ratios indicate that Tesco plc
has good liquid availability. But Innovetec being an investor has a long term perspective in
Sainsbury so they can invest in this company. On contrary, the gearing ratio of Sainsbury is
lower therefore through investing in this business Innovetec will have lower risk. Moreover,
the time interest ratio of Tesco plc showed and highly decreases. Therefore there will be a
great level of risk for Innovetec to invest in this company. On contrary, time interest ratio of
Sainsbury shows an increasing trend. Therefore, the company is facing lower level of
financial risk. Sainsbury can bear higher financial burden than compared to Tesco Plc. In
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addition to it, the earning per share of Sainsbury is higher to 0.37 as compared to Tesco plc.
Thus, it can be concluded that operational performance of Sainsbury is higher in terms of net
results. Further, higher the time interest ratio and lower the risk factor also contributes to
invest in Sainsbury business. Thus, it became clear that Innovetec should purchase share
worth 1.4 million of Sainsbury business. Through investing in Sainsbury company can
increase its profitability and get higher amount of return on their invested funds.
AC 6.3 Limitations of decisions that are based on financial information only
Financial statements are the source of financial information of the business. They did
not consider the non monetary transaction of the business. Therefore, investment decisions
that are based on the company's financial statements only have many limitations. It provides
only the quantitative information about company's affairs. It does not include qualitative
information (Gibson, 2010). For instance, customer satisfaction level, manager's skills are
equally important for decisions making purpose. It gives historical information for company's
affairs. However, investors are more concern about the future business performance
(Maynard, 2013). Further, the incorrect financial statements also can mislead the users.
Investors can take wrong decisions on the basis of those statements. Moreover, it does not
consider the market changes and environmental impacts while it may be of great importance
in decision making process. For instance, inflation affects are not considered in the financial
statements (Iornem, 2011). Further, different accounting practices are followed by every
organization. Therefore, the types of accounting planning for preparing the financial
statements can distort the comparison between companies. Thus, it can be concluded that
while taking any investment decisions investor should consider both the quantitative and
qualitative information. It helps to make a proper analysis of the company so as to take better
and qualified decisions.
CONCLUSION
On the basis of above report it can be concluded that organization can fulfil its finance
sources from equity and debt capital to a great extent. Moreover, the report explained that
cost and pricing decisions are also plays a vital role in the company's success through
increasing the business revenue and increase its profitability. Further, payback period and net
present value helps to select an appropriate investment proposal that yields maximum results
to the company. On contrary, ratio analysis is the best tool for identifying the business
operational and financial performance. Moreover, comparative analysis of the financial
statement helps to take strategic investment decisions. This in turn, helps to increase the
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business profitability and the business growth over the period. Thus, the organization can
achieve the business targets and ensure long term business sustainability.
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