Analysis of Financial Performance of XYZ Ltd

In 1995, XYZ Ltd had a net profit of 25%, which declined to 17.5% in 1996, indicating a decline in the company's efficiency and requiring corrective actions for growth. Ratio analysis reveals that the company is underperforming and not utilizing its financial resources effectively, with gross and net profit ratios declining. The study highlights the importance of selecting appropriate sources of finance, such as bank loans or retained earnings, and applying investment appraisal techniques to make informed decisions.

MANAGING FINANCIAL
RESOURCES
1

TABLE OF CONTENTS
INTRODUCTION ...............................................................................................................................3
TASK 1 UNDERSTANDING SOURCES OF FINANCE AVAILABLE TO BUSINESS .................3
Scenario 1.............................................................................................................................................3
Information pack for new and existing businesses which Identifies the sources of finance
available to business....................................................................................................................3
Implications of source of finance along with its advantage and disadvantage...........................5
Evaluating appropriate source of finance for business project...................................................7
M2: Appropriate source of finance for small business................................................................8
TASK 2 UNDERSTADING IMPLICATIONS OF FINANCE AS A RESOURCE.............................8
Scenario 1 ............................................................................................................................................8
2.1 Cost of different sources of finance......................................................................................8
2.2 Importance of financial planning..........................................................................................9
2.3 Types of information required for decision making..............................................................9
2.4 Sample profit and loss account and balance sheet with explanatory notes...........................9
TASK 3 MAKING FINANCIAL DECISIONS ................................................................................10
Scenario 1...........................................................................................................................................10
3.1 Findings and recommendations in formal written report ...................................................13
Scenario 2 .................................................................................................................................14
3.3 Written report to Directors..................................................................................................16
Scenario 3 ..........................................................................................................................................16
Scenario 4 ..........................................................................................................................................21
LO4 EVALUATING FINANCIAL PERFORMANCE OF BUSINESS ...........................................22
Scenario 1...........................................................................................................................................22
Scenario 2 ..........................................................................................................................................23
4.1 Books of prime entry...........................................................................................................23
Scenario 3...........................................................................................................................................24
CONCLUSION..................................................................................................................................24
REFERENCES...................................................................................................................................26
2

INTRODUCTION
Management of financial resources is necessary in every organization and it is required for
smooth functioning of the enterprise. Further, every organization prepares different plans through
which finance can be managed in an appropriate manner. This allows business to focus on its key
activities and in turn boosts overall efficiency of the firm (Reid, 2003). Different sources of finance
are present which businesses can consider for satisfying its financial needs but it depends on every
organization which source to adopt so as to gain long term benefits with the help of this. To
consider implications of sources of finance is also necessary as through this appropriate decision
can be taken easily. The present study is being carried out by focusing on the range of finance
available to business along with its implications such as advantage, disadvantage etc. Apart from
this, three case study examples have been discussed in the report which involves small business
start up, large expansion etc.
TASK 1: UNDERSTANDING SOURCES OF FINANCE AVAILABLE TO
BUSINESS
SCENARIO 1
Information pack for new and existing businesses which Identifies the sources of finance available
to business
Different sources of finance are present in business with the help of which enterprise can
easily satisfy its financial needs. Selecting most appropriate financial source depends on the nature
of business, its size and type of operations being carried out in the company (Vereker, 2002).
Further, to avoid unfavourable situations appropriate sources are adopted by the management which
enhances organizational performance in the market. Long and short/ medium term sources are
present in business but decision has to be taken which source has to adopt which is cheap and can
enhance profitability level. Different sources of finance present are as follows: Share capital: It is regarded as one of the most effective source of finance which usually
every organization considers. In order to satisfy financial needs business can issue equity
shares in the market through which large number of investors can be attracted. This source
of finance is generally suitable for businesses which are old and large. Companies which are
operating on wider platform can issue shares in the market and can easily raise additional
funds with the help of this (Weaver, 2012). By adopting this source it is possible for the
business to avoid unfavourable situations such as inadequacy of finance which can further
enhance overall reputation in the market which is one of the main objectives of firm behind
3

carrying out operations in the market. Retained earnings: It is the next effective source of finance which business can easily
consider. Retained earnings are the amount saved by company in order to meet any
unforeseen contingency. This type of source can be easily considered by large sized
organizations that are having strong financial base and in turn this can easily satisfy
financial needs of the entity in the most efficient manner. This source is not applicable in
case of businesses that have been newly established in the market as their financial position
is regarded to be weak. Apart from this, one of the key attribute of using this source is that it
is cheap and amount can be easily obtained as per requirement of the firm (Norton and
Kelly, 2014).
 Bank loan: Taking loan from financial institutions also supports organization in satisfying
its financial needs and in turn acts as a development tool. Further, various banks are present
in the market who can provide loan to company at a cheaper rate of interest. In order to
satisfy financial needs, company can compare interest rate of different banks and can obtain
funds from specific financial institution present in the market. It is considered as an effective
external source of finance and through these financial needs of entity can be satisfied easily.
This source is especially beneficial when organization takes expansion decision and it assist
in carrying out operations in an effective manner (Burgess, 2007).
So these are some of the long term sources of finance which business can easily consider as
per requirement of the management. Further, short term sources of finance are also present which
are as follows: Cash management: It is considered as an effective short term source of finance where
organization can manage its cash through proper planning (Mohsin, 2013). Through this
source organization can easily deal with the situation of inadequacy of finance and this can
be favourable for business in every possible manner. This source is beneficial for new
business start ups as through effective management of cash they can easily manage funds
which are necessary for the organization.
 Hire purchase and leasing: Hire purchase is regarded as the agreement in which owner of
assets lets them on hire for regular instalments paid by the hirer. This short term source of
finance can be easily considered by small and large businesses. When leasing as a source of
finance is adopted then assets can be financed without actually having to buy them outright.
On the other hand, with the help of hire purchase firm can use an asset for fixed period in
return for regular payment (Shahrokhi, 2008). Therefore, this source of finance is also
considered to be effective for small and start up businesses in the market.
4

Implications of source of finance along with its advantage and disadvantage
Before considering any source of finance, it is necessarily required for business to know its
implications as it is also associated with growth and development of business enterprise.
Implications of different sources of finance are as follows:
Sources Legal Dilution of
Ownership control
Bankruptcy
Share capital Restriction on
authorized capital
Yes No
Retained earning No No No
Bank loan Bankruptcy No Yes
Cash management No No Yes
Due to poor cash
management business will
not be able to pay out
their obligations in timely
manner due to this aspect
solvency and liquidity of
business will be adversely
affected consequently and
this will lead to the
situation of insolvency
(Butters, 2004).
Hire purchase and
leasing
yes No Asset transfer Yes
Share capital: Main advantage of using this source in business is that it is permanent source
of capital which allows business enterprise to satisfy its financial requirement. Further, in case of
ordinary shares business enterprise has to pay dividend if there is a profit. On the other hand, main
disadvantage of using this source is that dividends have to be paid to be shareholders in relation
with the shares purchased by them (Shaoul, Stafford and Stapleton, 2010). One of the major legal
implications of this source of finance is that there is restriction on authorized capital where it is not
possible for the company to issue more shares than authorized capital. This source has dilution of
5

ownership where some rights are transferred to the investors of company along with right to take
decisions.
Retained earnings: Main advantage of using this source is that it is not required for business
to increase liability and there is no need to pay interest. But on the other hand, main disadvantage of
using this source is that it is not applicable in case of small businesses. Retained earnings as a
source of finance has no legal implication as it is type of internal source. Apart from this, condition
of bankruptcy is not applicable in case of retained earnings as source of finance (Danso and
Adomako, 2014).
Bank loan: Main advantage of using bank loan as a source of finance is that loan taken can
be easily procured; interest paid on bank loan is tax deductible expenditure. On the other hand, main
disadvantage of using this source is that excess borrowing can lead to decreased cash flow and some
financial institutions carry prepayment penalty. Legal implication of taking bank loan is that it leads
to bankruptcy as sometime it is possible that organization may not be able to repay the amount of
loan taken which has adverse impact on the enterprise. Further, dilution of ownership does not take
place in case of bank loan (Bokpin, 2010).
Cash management: It is one of the most effective internal sources of finance whose main
advantage is that it saves major expenses of the business and cash can be managed with the support
of management. On the other hand, main disadvantage of this source is that it becomes difficult to
determine the most effective way to manage cash within the organization. There are no legal
implications and dilution of ownership control issues associated with this source. Apart from this, in
case of bankruptcy due to poor cash management business will not be able to pay its obligations and
due to this aspect liquidity position of enterprise can be badly affected (Dittenhofer, 2001).
Hire purchase and leasing: Main advantage of adopting hire purchase and leasing as source
of finance is that business can take benefit by utilizing assets without purchasing it. Further, all the
responsibility linked with maintenance of assets is done by the leasing company. On the other hand,
main disadvantage of using this source is that total cost of leasing may exceed and it can be higher
than the purchase of asset. In case if organization is not able to make payment for the assets
acquired then it leads to bankruptcy. Further, the legal implication of this source is that ownership is
not transferred and organization is having right to use the assets (Ezeoha, 2011).
So, these are some of the advantage along with disadvantage of source of finance which
every organization has to consider so that its operations can be carried out in an effective manner.
Further, every source has some implications in the form of legal, bankruptcy and dilution of
ownership control. By considering all these implications, it is possible for business to satisfy its
6

financial needs in an efficient manner and it can act as development tool for the entity. Moreover,
selection of source of finance directly depends on the size, operations and overall nature of the
company which is also significant.
Evaluating appropriate source of finance for business project
Different sources of finance are present but it is required for management to determine the
best one through which financial needs of company can be satisfied easily. In the present scenario
three case study examples for businesses has been considered which involves small business start
up, large business expansion and small group of people who are looking to buy existing medium
sized company.
Small business start up: In case of small business start up it is feasible for business to use
bank loan as source of finance in order to purchase medium sized company. Further, this can easily
enhance liquidity position of the organization and in turn is fruitful for business (Fay, 2015).
Generally small businesses does not have sound liquidity position due to which taking loan from
banks at an cheaper rate of interest is beneficial for company and this can surely satisfy financial
requirement of the company. Main benefit of adopting this source is that it enhances liquidity
position of enterprise which is the main requirement of every company. Apart from this business has
to pay high amount in the form of interest to bank for the amount obtained which is one of the
major drawbacks of this source. Moreover, other sources of finance such as retained earnings and
issuing shares in the market are not at all appropriate for small business as their financial base is
considered to be weak and this does not allows management in accepting this source.
Large business expansion: For large business expansion appropriate source of finance is
retained earnings as through this finance can be easily obtained with the help of internal source.
Further, finance obtained by management can support in purchasing existing medium sized
company. This can surely support business in taking expansion decision where financial needs of
enterprise can be satisfied easily (Norton and Kelly, 2014). Need of large business expansion is to
purchase existing medium sized organization for which internal source is most appropriate as it can
easily assist in acquiring large finance keeping in view overall aim of the company. Generally it is
well known fact that in case of large businesses their financial base is quite strong due to which they
can easily utilize overall funds saved so as to meet any unfavourable situations.
Small group of people: The most appropriate source of finance for small group of people is
cash management as individuals can plan different things and can take corrective actions so as to
manage cash in appropriate manner. Further, main benefit of adopting this source to the business is
that financial requirements can be satisfied internally and it can save major expenses. Basic need of
business operated by small group of people is to purchase medium sized company already operating
7

in the market (Mohsin, 2013). So, this need can be only satisfied only when cash management
techniques are adopted so as to manage funds of the business in effective manner. Main advantage
of using cash management techniques to business is that it supports in dealing with the situation of
inadequacy of funds and enhances overall performance of firm in the market. Through proper cash
management liquidity position of company can be improved to an extent and it can provide base to
business enterprise in every possible manner.
M2: Appropriate source of finance for small business
For small business enterprise taking bank loan is one of the most appropriate source of
finance as through this organization can enhance its liquidity position. Generally businesses
operating on smaller platform have weak financial position and in such condition it is preferable to
take loan from financial institutions at a cheaper rate of interest. This source is considered as best
for company as through this management can easily satisfy its financial requirement and in turn
situation such as inadequacy of funds can be easily avoided. But on the other hand, it can increase
expenditure level of business as company has to pay interest to bank for the amount obtained. Apart
from this savings of small businesses are not adequate due to which it is not possible to implement
financial decisions by using retained earnings as source of finance (Dittenhofer, 2001). Therefore, in
this way taking loan from financial institution is appropriate for small business and can assist in
implementing the financial plan. On the other hand, before considering any source of finance it is
necessary for management to consider its pros and cons so that source considered may not
adversely affect business enterprise. Sometime it can be possible that organization is not able to pay
the interest amount to bank for the loan taken and due to this reason it is necessary to ensure well in
advance regarding the source which can be considered for satisfying financial needs of business.
TASK 2: UNDERSTADING IMPLICATIONS OF FINANCE AS A RESOURCE
SCENARIO 1
2.1 Cost of different sources of finance
In order to select the most appropriate source of finance it is necessary for management to
identify its cost as through this organization can easily utilize its financial resources in effective
manner. Further, cost of considering bank loan as a source of finance is payment of interest which
business enterprise has to pay in large amount in the form of interest for the amount obtained. So,
this increases expenditure level of the firm as management has to bear this cost. At the time when
any business obtains loan from bank then management has to bear interest cost on the same and it
has to be paid on monthly basis (Montier, 2010). Due to presence of this type of cost, expenditure
8

level of business enhances and in turn, overall cost increases. Moreover, in case when shares are
issued by company in the market then major cost is linked with payment of dividend to its investors
(James, Leavel and Mainam, 2002). Dividend cost also enhances expenditure level of the
organization where it is necessary to provide dividend to the investors. Further, it is a well known
fact that every shareholder expects some sort of return and for every business, it is necessary to
satisfy such need. For satisfying financial needs of business, each and every source is beneficial but
it is necessary to determine well in advance the actual cost of sources of finance. On the other hand,
when retained earnings are considered as a source of finance then company has to bear opportunity
cost as firm uses opportunity of investing in one profitable project. Opportunity cost is regarded as
the loss of other alternatives when one alternative is being chosen by business. Therefore, this cost
has to be beard by business in case when one project is selected and other one is rejected.
2.2 Importance of financial planning
Financial planning plays most important role in organization as through this it becomes easy
for business enterprise to utilize financial resources in efficient manner. Further, for local businesses
financial planning is must as through this it is possible for business to remove instability along with
uncertainty associated with the organization (Montier, 2010). Moreover, planning is directly linked
with estimation of funds required for conducting business operations and building various policies
which are associated with the financial operations of the entity. It also assist in policy formation,
setting of objectives, budget and other type of procedure through which financial operations of the
organization can be carried out in effective manner. Apart from this, for local businesses it is must
for management to determine the basic difference in outflow and inflow of cash in order to know
financial stability of enterprise. Further, business can obtain idea regarding its overall performance
in the market through proper financial planning. Thus, proper financial planning is must for
business and it supports in accomplishment of long term goals along with objectives (Siano,
Kitchen and Confetto, 2010).
Through presence of appropriate financial planning, it is possible for the organization to
invest funds in right project as comparison can be done in between different projects and this
directly increases the business efficiency (Mohsin, 2013). Further, it supports in operational
activities where success along with the failure of production and distribution relies on financial
decisions taken. In short, through proper planning, it is possible to indulge into the key activities
which supports in optimum utilization of finance and assist in coordination. Further, it is possible
for business to link present with the future and provide base to company in accomplishment of long
term goals and objectives.
9

2.3 Types of information required for decision making
Different type of information is required by financial department of organization and these
assist managers in taking appropriate decisions. Further, different type of financial statements is
prepared such as profit and loss account, income statement, balance sheet etc. Through all these
statements crucial information can be obtained easily linked with assets and liabilities of the
business enterprise (Mumford, Schultz and Osburn, 2001). Further, information linked with sale and
purchase supports in preparing different type of trading accounts with potential customers and
supplies. Information linked with payment of wages and purchasing assets is also provided. Further,
presence of appropriate financial information supports organization in taking different type of
decisions which are associated with enhancing profitability level, investing in new project, reducing
overall cost, selecting source of finance etc. On the other hand past record present linked with
financial performance assist in enhancing current performance. Moreover, budgets are analysed so
as to know the major difference in actual and expected results.
Management of the organization requires information regarding financial position of
enterprise on the basis of which it can be known whether business is performing up to the mark or
not. On the basis of profitability information, expansion decision is taken and it assists organization
in carrying out overall operations in an effective manner (Mumford, Schultz and Osburn, 2001).
Further, shareholders of business require information regarding liquidity and profitability position
of business through which it is possible to know the capability of organization in providing
dividend to them on time and as per their requirement. Moreover, suppliers of business require
information regarding profitability on the basis of which they can take decision whether to supply
them goods as per their requirement or not.
10

2.4 Sample profit and loss account and balance sheet with explanatory notes
Income statement
Balance sheet
11

Finance has direct impact on financial statements as in case if business considers owner’s
funds as source of finance then it is highlighted in the liability’s side of balance sheet. Further, this
amount directly represents that business owner has invested some amount in carrying out business
operations (Montier, 2010). Moreover, when retained earnings as a source of finance is considered
then it is also highlighted in the balance sheet of business and supports in knowing that overall
savings of business are reducing at a faster pace which is having adverse impact on company. When
debt as a source of finance is considered then such amount is shown in the liability side of balance
sheet and highlighted business has taken loan from bank and is a kind of burden for the
management.
TASK 3: MAKING FINANCIAL DECISIONS
SCENARIO 1
Sales budget
Month Monthly
budget
Cumulative
Budget
Actual
Monthly
Actual
Cumulative
Variance
July 230,000 230,000 215,000 215,000 -15,000
12

August 230,000 460,000 220,000 435,000 -25,000
September 270,000 730,000 245,000 680,000 -50,000
October 265,000 995,000 235,000 915,000 -80,000
November 265,000 1,260,000 237,000 1,152,000 -108,000
December 300,000 1,560,000 270,000 1,422,000 -138,000
January 250,000 1,810,000
February 265,000 2,075,000
March 300,000 2,375,000
April 325,000 2,700,000
May 325,000 3,025,000
June 350,000 3,375,000
13

Cash Forecast
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Brought
Forward
40,00
0
Sales 200,0
00
300,0
00
300,0
00
300,0
00
250,0
00
260,0
00
300,0
00
260,0
00
300,0
00
325,0
00
265,0
00
265,0
00
Total
Income
240,0
00
300,0
00
300,0
00
300,0
00
250,0
00
260,0
00
300,0
00
260,0
00
300,0
00
325,0
00
265,0
00
265,0
00
Purchases 150,0
00
140,0
00
135,0
00
135,0
00
140,0
00
130,0
00
135,0
00
145,0
00
140,0
00
140,0
00
145,0
00
145,0
00
Wages 55,00
0
55,00
0
55,00
0
55,00
0
55,00
0
55,00
0
55,00
0
55,00
0
55,00
0
55,00
0
55,00
0
55,00
0
Rent &
Rates
56,00
0
56,00
0
56,00
0
56,00
0
Light &
Heat
55,00
0
55,00
0
55,00
0
55,00
0
Advertisin
g
2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000 2,000
Insurance
s
55,00
0
52,00
0
Equipmen
t
50,00
0
10,00
0
10,00
0
10,00
0
Vehicles 20,00
0
Directors'
Salaries
22,00
0
22,00
0
22,00
0
22,00
0
22,00
0
22,00
0
22,00
0
22,00
0
22,00
0
22,00
0
22,00
0
22,00
0
Motor
Expenses
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
Sundry
Expenses
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
11,00
0
Total
Expenditur
e
432,0
00
251,0
00
291,0
00
302,0
00
293,0
00
296,0
00
292,0
00
246,0
00
296,0
00
297,0
00
246,0
00
301,0
00
Monthly
Deficit /
Surplus
-
192,0
00
49,00
0
9,000 -
2,000
-
43,00
0
-
36,00
0
8,000 14,00
0
4,000 28,00
0
19,00
0
-
36,00
0
Accumula
tive
Deficit /
Surplus
-
1920
00
-
143,0
00
-
134,0
00
-
136,0
00
-
179,0
00
-
215,0
00
-
207,0
00
-
193,0
00
-
189,0
00
-
161,0
00
-
142,0
00
-
178,0
00
14

Scrutinising cash flow forecast and sales budget
On analysing cash flow forecast and sales budget of ABC manufacturing company, it has
been found that organization is not operating efficiently in the market. Further, sales budget of
enterprise is representing negative variance in every month such as July, August and September, etc.
This is all not favourable for the business (Murphy, 2001). Cash flow forecast is showing that
expenditure level of business enterprise is more as compared with income which is also not
favourable for the organization. Due to rise in expenditure level company is not able to operate
efficiently and it is directly leading to decline in overall performance of the firm in the market.
Further, there is a need to take corrective actions for management so that major expenses can be
controlled and through this profitability level can be enhanced easily which is also beneficial for the
business.
Likely causes of the problem
Sales budget of ABC manufacturing ltd from the month of July to December is showing
negative variance of 8 to 10% every month. Further, two type of variance are present namely
positive and negative. Positive variance is considered to be most favourable situation for the
business and negative variance has adverse impact on enterprise (Nofsinger and Varma, 2005). On
the other hand, ABC ltd has not considered figures of budgeted sales especially at the time of
preparing cash flow forecast. It is representing accumulate deficit and it is showing that business
enterprise has incurred extra expenses which needs to be reduced to extent.
Causes of those problems
The main reason for variance is unpredictable shifts in the marketing condition of enterprise.
The main reason can be that overall planning of the business does not matches with marketing
conditions. Further, poor predictions can also be regarded as major reason of variance. Business has
not estimated price properly and due to this reason sales were at different price from what was
planned (Ulbrich, 2006). Moreover, another reason can be alteration in business strategies of
enterprise. Apart from this overall unfavourable conditions in the cash flow forecast will influence
liquidity position of enterprise. It will prevent organization from accomplishing its overall aims
along with objectives which is not at all favourable for business.
3.1 Findings and recommendations in formal written report
To, The Director
ABC Manufacturing company
Subject: Recommendation to improve sales positioning and cash forecasting
15

Recommendations
In order to enhance overall performance of enterprise in the market there is a need to
remove variance in the sales budget. Firstly management must focus on designing effective
business strategies through which it is possible to enhance sales volume. Further, appropriate
pricing strategies needs to be adopted where company must consider market conditions. Moreover,
effective budgeting technique must be considered as per the functions and operations of the
organization. Apart from this company has hire efficient workforce who can achieve sales target of
business. On the other hand to improve deficit level in cash flow company must control its major
expenditure. Through cost reduction technique it is possible to enhance profitability along with
revenue level which is beneficial for company. Further, it is also recommended to issue shares in
the market and utilizing amount of retained earnings for improving liquidity position.
Scenario 2
Payback period
For uneven cash flows,
A = last year value with a negative cumulative cash flow
B = absolute value of cumulative cash flow at the end of the period A
C = total cash flow while the period after A
For option A = 2+
= 2.05 years
For option B = 3+
= 3.02 years
According to the Payback Period method ABC Engineering Ltd should invest in the project A as the
return is expected to come early i.e. in 2.05 years
Accounting rate of return
16

For project A:
For project B:
According to the ARR method company should invest in project A because it is rendering higher
rate of returns for the ABC Engineering Ltd.
Net present value
Table 1 : NPV for project A
Year Cash flow (£) P.V. factor@6% Present Value (£)
1 180000 0.94 £169200
2 230000 0.89 £ 204700
3 280000 0.84 £ 235200
4 120000 0.79 £ 94800
Total Present value £ 703900
Initial investment £ (450000)
Net Present value £ 253900
Table 1 : NPV for project B
Year Cash flow (£) P.V. factor@ 6% Present Value (£)
1 60000 0.94 £ 56400
2 120000 0.89 £ 106800
3 250000 0.84 £ 210000
4 250000 0.79 £ 197500
Total Present value £ 570700
17

Initial investment £ (450000)
Net Present value £ 120700
According to the Net Present Value method again project A should be selected because its net
present value is higher as compared to project B.
Internal Rate of Return
Table 1 : IRR for project A & B
Year Cash Flow -
project A
PV factor
@29%
PV @ 29%
- Project A
Cash Flow -
project B
PV factor
@ 15%
PV @ 15% -
Project B
1 180 0.78 139.53 60 0.87 52.17
2 230 0.60 138.21 120 0.76 90.74
3 280 0.47 130.43 250 0.66 164.38
4 120 0.36 43.33 250 0.57 142.94
Total PV 451.51 450.23
By calculating internal rate of return for both the projects it has been identified project A is
more feasible for company as its internal rate of return is higher as compared with project B. By
applying all the investment appraisal techniques it has been found that project A must be accepted
by ABC ltd company and project B can be rejected as it will not provide higher return to the target
market (Barnes, 2006).
3.3 Written report to Directors
To, The Directors
ABC Engineering Ltd
Subject: Regarding selection of investment project
In order to know the feasibility of the investment project different techniques have been applied
such as net present value, internal rate of return, accounting rate of return and payback period.
Each and every technique applied has shown that project A is more feasible for business enterprise
and by investing funds in this project it is possible for business enterprise to earn higher profits and
overall amount of investment can be recovered in short period of time. Therefore, it is
recommended to directors of ABC engineering company to allocate funds in project A rather than
project B.
18

SCENARIO 3
Evaluating the performance of machine A
Contribution Margin Ratio
Contribution margin ratio Formula
Contribution per unit Unit contribution margin / unit price
Unit CM Unit price – variable cost per unit
For machine A
Variable cost per unit 52.50 + 35.75 + 10.20 = £98.45
Unit CM 120-98.45 = £21.55
Contribution per unit 21.55 / 120
0.18 = 18%
Breakeven point
For machine A:
Break-even sales unit 120,000/120-98.45 = 5568 units
Break-even point in £ =£ 120*5568 = 668160
Margin of Safety
Margin of safety in sales value 7500-5568 = 1932 units
Margin of safety per unit = Budgeted sales –
Break-even sales / Budgeted sales
1932/7500 = 26%
Impact on Break-even point
Changes in the Break-even point will be recorded as;
At £ 5 increase in selling price
Break-even point at At £ 5 increase in selling 120000 / 125 – 98.45
19

price 120000/26.55 = 4519 units
At £ 5 decrease in selling price
Break-even point at At £ 5 increase in selling
price
120000 / 115 – 98.45
120000/16.55 = 7250 units
A ₤5,000 increase in fixed costs
Break-even point 125000 / 120 – 98.45
125000 / 21.55
= 5800 units
A ₤5,000 decrease in fixed costs
Break-even point 115000 / 120-98.45
115000 / 21.55
= 5336 units
₤5 increase in material or labour costs per unit
Break-even point 125000 / 120- 103.45
115000 / 16.55
= 7553 units
₤5 decrease in material or labour costs per unit
Break-even point 125000 / 120- 93.45
125000 / 26.55
= 4708 units
Machine A
Contribution Per Unit 18%
Break-even Sales unit 5568 units
Break-even in £ £668,160
Margin of Safety (sales value) 1932 units
Margin of Safety per unit 26.00%
Sales Units Price / Unit
7500 120
5000 120
20

8000 120
10000 120
21

Actual break even obtained breakeven Effect
£5 increase in selling price 5568 4519 Decreases
£5 decrease in selling price 5568 7250 Increases
₤5,000 increase in Fixed Cost 5568 5800 Increases
₤5,000 decrease in Fixed Cost 5568 5336 Decreases
₤5 increase in variable cost 5568 7553 Increases
₤5 decrease in variable cost 5568 4708 Decreases
SCENARIO 4
Southwood electricals
Calculation of profit and loss
Below calculations shown are on the basis of assumptions
Particulars Amount (in £)
Actual Sales 7500
Price per unit 200
Revenue 1500000
Additional demand 500
Price per unit (discounted 15% ) 170
Additional revenue 85000
Total Revenue 1585000
Fixed Cost 250000
Variable cost 700000
Total Cost 950000
Profit/loss 635000
The order given by Southwood electrical has supported ABC manufacturing Ltd to earn
profit of £635000. Further, through this order it is possible for business enterprise to enhance the
rate of customers and can increase the profitability level. Therefore, in this way it is beneficial for
the organization (Estrada, 2005).
Below calculations shown are on the basis of assumptions
Westbrook Engineering
Particulars Amount (in £)
Actual Sales 7500
Price per unit 200
Revenue 1500000
Additional demand 500
Price per unit (discounted 25% ) 150
Additional revenue 75000
Total Revenue 1575000
22

Fixed Cost 250000
Variable cost 700000
Total Cost 950000
Profit/loss 625000
Order of Westbrook Engineering will support in earning profit of £625000 which is
considered to be less as compared with Southwood electrical. Therefore, it is recommended to
business enterprise to accept the order of Southwood electrical.
LO4 EVALUATING FINANCIAL PERFORMANCE OF BUSINESS
SCENARIO 1
Accounting terminology and financial statements
Balance sheet
Balance sheet is prepared by business at the end of financial year through which
management obtains idea regarding financial position of company. It has two sides namely asset
and liability. Statement shown represents the asset owned by the business equals the liability of the
business enterprise. The key terminology of balance sheet involves it represents financial position
of the entity with the help of assets and liabilities (Shahrokhi, 2008). Assets are owned by
organization and it involves cash, building, equipments, furniture etc. On the other hand liability
involves loans, bonds etc.
Income Statement
23

Above shown in the income statement of the firm which involves major items such as
revenue, cost of goods sold, expenses, other income etc (Ittelson, 2009). Through all these items it
is possible for company to ensure whether operations carried out are profitable or not. Further, it is
prepared quarterly, monthly or yearly. Income statement represents overall expenses, income and
profits earned by organization. Moreover, it also considers the cost of production along with other
type of indirect expenses.
SCENARIO 2
4.1 Books of prime entry
The range of events which are recorded in the journal relies on three basic principles which
are:
 Real account: Debit what comes in and Credit what goes out
 Nominal account: Debit all losses and expenses and credit all income and gains Personal account: Debit the receiver and credit and giver
ledger: It is considered as the book of final entry in which all the financial transactions are recorded
in individual accounts (Broadbent, 2013).
Trial balance: This statement is prepared in order to measure the correctness of the ledger account
prepared. Further, it is necessary that debit side must match with credit one.
Sole traders: Majority of the sole traders does not prepare financial statements and those who
prepare they keep it very simple.
24

Limited companies: Statements prepared by organizations are very complex in nature. Further, they
are prepared as per rules and regulations of IFRS (Leigh, 2008).
Partnership: It is the agreement between two or more individuals to carry out operations. Further,
partner's capital account is prepared along with P&L appropriation account.
SCENARIO 3
Ratios Formula 1995 1996
Liquidity Ratios
Current Ratio Current assets / current liabilities 20000/600 = 3.33 54000/25000=2.16
Quick Ratio Current assets - closing stock /
current liabilities
20000-7000/6000=2.1 54000-
18000/25000=1.44
Activity Ratios
Fixed assets turnover
Ratio
Net sales / Fixed assets 120000/15000=8 200000/12000=16.6
Total assets turnover
Ratio
Net sales / Total sales 120000/35000=3.43 200000/66000=3.03
Profitability Ratios
Gross Profit Ratio Gross profit /Net sales *100 40000/120000*100=33.3
% 35000/200000*100=
25%
Net Profit Ratio Net profit /Net sales *100 30000/120000*100=
25%
35000/200000*100=
17.5%
After calculating ratios it has been identified that firm is not having sound liquidity position and
management must focus on enhancing its liquidity position to perform efficiently. Further, this can
easily support in meeting with short and long term obligations of the enterprise (Financial ratio and
Analysis, 2013). Further, activity ratios of the company have shown direct improvement from the
year 1995 to 1996. Moreover, profitability position of enterprise has also declined where in the year
1995 net profit of company was 25% but in the year 1996 it declined and was 17.5%. So, this
represents decline in efficiency of XYZ ltd where corrective actions are required to be taken for
growth of business.
The main difference between current and acid test ratio is that former one considers
inventory but later one does not. Current ratio considers total amount of all the current assets and
acid test ratio only uses current assets which are quick such as short term marketable securities,
accounts receivable, etc. (Leigh, 2008). On the other hand, main difference in gross and net profit is
that in computation of gross profit, all the direct costs are deducted with the motive to determine
revenue level of business. Further, for calculation of net profit, all the overheads are deducted which
25

is the main difference in between two. Apart from this, knowing the difference between ratios is
very important as through this it is possible to determine whether company is operating efficiently
in the market or not. One of the main differences between current and quick ratio lies in the
inventory where in quick ratio it is not considered and due to this reason considering this ratio is
quite important for firm and knowing financial position becomes easier for the business. On the
other hand, gross and net profit of business supports in knowing the overall profits earned by
carrying out operations wherein for calculation of gross profit all the costs are deducted and it is the
basic difference in between gross and net profit.
CONCLUSION
From the above study carried out, it has become easy to understand the importance of
selecting appropriate source of finance. Different sources has been identified and has been
evaluated on the basis of implication dilution, bankruptcy etc. In case of small businesses it is
beneficial to adopt bank loan as a source of finance as it enhances liquidity position of organization.
Further, for large sized organizations they can easily consider retained earnings as a source as
management has strong financial base which allows them to use amount of savings which is fruitful
for business. On the other hand ratio analysis has shown that XYZ ltd is underperforming and is not
efficient enough in carrying out overall operations in the market. Gross and net profit ratio of
enterprise is declining which is representing that its financial resources are not utilized in
appropriate manner. Further, different financial statements are prepared by organizations such as
balance sheet, profit and loss account with the help of which it is possible to know overall
efficiency of company in conducting its day to day operations. Apart from this, the investment
appraisal techniques applied in choosing investment proposal were effective and through this it has
been recommended to enterprise to allocate funds in project A which is having higher return and by
investing fund amount can be easily recovered by firm in short period of time.
26

27

REFERENCES
Books and Journals
Barnes, P., 2006. The use and analysis of financial ratios: a review article. Wiley-Blackwell. 14(4).
pp.449-461.
Bokpin, A. G., 2010. Financial market development and corporate financing: evidence from
emerging market economies. Journal of Economic Studies. 37(1) .pp.96 – 116.
Broadbent, M., 2013. Managing financial resources. 3rd ed. Elsevier.
Burgess, C., 2007. Do hotel managers have sufficient financial skills to help them manage their
areas? International Journal of Contemporary Hospitality Management. 19(3) .pp.188 –
200.
Butters, J., 2004. Managing finances for a fulfilled Canadian retirement. Leadership in Health
Services. 17(1) .pp.12 – 18.
Danso, A. and Adomako, S., 2014. The financing behaviour of firms and financial crisis.
Managerial Finance. 40(12) .pp.1159 – 1174.
Dittenhofer, A. M., 2001. Behavioral aspects of government financial management. Managerial
Auditing Journal. 16(8) .pp.451 – 457.
Estrada, J., 2005. Adjusting P/E ratios by growth and risk: the PERG ratio. International Journal of
Managerial Finance. 1(3). pp.187 – 203.
Ezeoha, E. A., 2011. Firm versus industry financing structures in Nigeria. African Journal of
Economic and Management Studies. 2(1) .pp.42 – 55.
Ittelson, R. T., 2009. Financial Statements: A Step-by-Step Guide to Understanding and Creating
Financial Reports. Career Press.
James, J., Leavel, H. W. and Mainam, B., 2002. Financial planning, managers, and college students.
Managerial Finance. 28(7). pp. 35-42.
Leigh, E., 2008. Managing Financial Resources to Deliver Better Public Services. The Stationery
Office.
Mohsin, A. M., 2013. Financing through cash-waqf: a revitalization to finance different needs.
International Journal of Islamic and Middle Eastern Finance and Management.
6(4) .pp.304 – 321.
Montier, J., 2010. Value Investing: Tools and Techniques for Intelligent Investment. John Wiley &
Sons.
Mumford, D. M. Schultz, A. R. and Osburn, K. H., 2001. Planning in organizations: Performance as
a multi-level phenomenon. Emerald group publishing. 12(2). pp.5–64.
Murphy, K. J., 2001. Performance Standards in Incentive Contracts. Journal of Accounting and
Economics, (30), pp. 244-275.
28