Business Finance: Working Capital and Budgeting Analysis Report

This report analyzes key aspects of business finance, focusing on working capital management, cash flow analysis, and budgeting techniques. Part 1 delves into the differences between profit and cash flow, emphasizing the importance of managing working capital components such as receivables, inventory, and payables. It examines the impact of working capital changes on cash flows and applies these concepts to a case study involving Mediterranean Delights Ltd (MDL), identifying inefficiencies in their financial management and recommending improvements in cash flow through better working capital management. Part 2 shifts the focus to budgeting, exploring the purpose of budgeting and comparing traditional budgeting with alternative approaches like rolling, zero-based, and activity-based budgeting. The report highlights the deficiencies of traditional methods and advocates for the adoption of more flexible and adaptive alternative budgeting approaches to optimize resource utilization.

Running head: BUSINESS FINANCE
Business Finance
Name of the Student
Name of the University
Author’s Note

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Table of Contents
Part 1..........................................................................................................................................2
Executive Summary...............................................................................................................2
Answer to [i]..........................................................................................................................3
Requirement [a]..................................................................................................................3
Requirement [b].................................................................................................................3
Requirement [c]..................................................................................................................4
Answer to [ii].........................................................................................................................5
Answer to [iii]........................................................................................................................5
Part 2..........................................................................................................................................8
Executive Summary...............................................................................................................8
Answer to [i]..........................................................................................................................9
Purpose of Budgeting.........................................................................................................9
Traditional Budgeting........................................................................................................9
Rolling Budget.................................................................................................................10
Zero-Based Budget (ZBB)...............................................................................................10
Activity-Based Budget (ABB).........................................................................................11
Answer to [ii].......................................................................................................................11
Answer to [iii]......................................................................................................................12
References................................................................................................................................14

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Part 1
Executive Summary
The main aim of this part of the report is the analysis of different aspects associated with
managing working capital and cash flows. Analysis displays that there is a difference
between profit and cash flows as business is adequately profitable does not always means that
it has adequate cash inflows. Managing working capital includes proper management of its
main components such as inventories, receivables and payables. Since cash conversion cycle
that is a part of cash flow in connected with managing working capital, changes in working
capital affects cash flows. Companies are needed to effectively manage the components of
working capital for better management of cash flows.

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Answer to [i]
Requirement [a]
Profit which is also called as net income refers to the part that remains from sales after
the payment of all expenses. It is not possible for a business to survive unless it is profitable.
On the other hand, cash flows can be regarded as the money that flows out and in the
company from three core activities which are operating, financing and investing. This is the
money required by the businesses for meeting current business obligations.
As per the above discussion, profit and cash flows are two separate financial
parameters having significance in running a business. The definition of profit can be provided
as sales revenue less expenditures; and outflows and inflows of cash of a business is
considered as cash flow. Therefore, these two parameters are different from each of them.
There is not any immediate increase in cash due to earning revenue; and there is not always a
decrease in cash due to incur an expense. It indicates towards the notion that being profitable
does not mean that a firm automatically have sufficient cash flows (Aktas, Croci and
Petmezas 2015).
Requirement [b]
Working Capital – The definition of working capital can be given as current assets as
current liabilities. A net investment in the short-term assets is represented by working capital.
Continuous inflows and outflows of these assets can be seen in the businesses for continuing
the day-to-day business operations. Variation in the components of working capitals can be
seen in different industries; and there is interrelation in various elements of working capitals.
Receivables – Selling goods or services to the customers on credit leads to the generation of
receivables as the dues from these customers will be received by the company. Key

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receivables that affect the level of receivable include sales term in the area of business of the
company and the capability of the firm to match and serve the terms of sales.
Inventory – Inventories refer to a business’s raw materials, work-in-progress and finished
goods; and businesses invest significant amount of working capital in inventory. There are
various reasons for which a business may hold inventories, but the most crucial reason is
satisfying immediate requirements of production and customers on day-to-day basis. The aim
of the companies is the minimization of inventories held.
Payables – Most of the business organizations use credit for buying goods and services and
trade payable is the amount that a business needs to pay for purchasing goods and services in
credit. Trade payable is a crucial source of finance for many firms and increase in trade
payables can be seen with the increase in the level of archived activities by the companies
(Atrill 2005).
Requirement [c]
The role of working capital can be seen in maintaining a equilibrium between current
liabilities and current assets; likewise, working can also be viewed as stability between
resource-purchasing and resource-generating activities in which it has close connection with
cash conversion cycle. Cash conversion cycle assists in representing the communication
between the working capital components and cash flows in a firm; and firms use this cash
conversion cycle for determining the required amount of cash for any level of sales. Longer
cash conversion cycle leads to the greater requirement of working capital. Increase in
working capital points towards the aspect that there has been an increased investment in
short-term resources which requires the utilization of cash flows available from operating,
financing and investing activities. At the same time, a decrease in the working capital of a
firm implies that the company is using short-term debts in order to finance its business

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operations. Based on the above discussion, it can be said that inception of new cash flows can
be seen because of the change in working capital (Watson and Head 2010).
Answer to [ii]
The inefficiency in Miditerranean Delights Ltd (MDL) in managing different financial
aspects is creating negative impact on its financial performance. Referring the above
discussion that profit and cash flows are different from each other, in presence of insufficient
cash inflows is observable in the business even in the presence of the fact that the company
has been reasonably profitable. Moreover, MDL has increased the utilization of long-term
debts for acquiring the required capital to fund the business and increase in the debts of MDL
from £16 million to £18 million. All these facts support the notion that the working capital of
MDL has negatively changed and this can be considered as the outcome of poor working
capital management. As per the provided case, MDL is owed £1.5 million pounds from the
order placed by Delios last year; and it is dealing with a dispute of £2 million delivery to San
Pedro completed in 2017. All these indicate towards the poor receivable management and
credit policy within MDL and this is creating negative impact on its working capital as net
cash inflows of the business has been decreased. Moreover, there has been building up of a
huge materials stock and supplies at the London warehouse of the company and MDL has not
been able in maintaining the quality of materials. These are the proofs that MDL has poor
inventory management in place which would create a negative impact on the company’s sales
revenue. As the management of MDL does not want to push its customers for payment, this is
an indicator that MDL does not have an effective credit policy that ensures the timely
collection of dues from trade debtors (Watson and Head 2010).
Answer to [iii]
Followings are the recommended steps that should now be taken for improving
MDL’s cash flow through better working capital management:

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1. The recommendation to the management of MDL is to undertake the forecast of
working capital requirement on the basis of forecast of sales. Moreover, the
management needs to take care of periods of reduced economic activity in order to
ensure the non-occurrence of overinvestments in inventories of raw materials, work-
in-progress and finished goods.
2. The management of MDL needs to focus on the cash conversion cycle in order to
decrease the amount of cash tied up in the current assets. It is recommended to shorten
the cash conversion cycle with the aim to reduce cash invested in current assets. This
can achieved through the decrease in inventory conversion period, by reducing trade
receivable collection period or through increasing trade payable deferral period.
3. It is recommended to the management of MDL to reduce the inventory conversion
period through limiting the length of the production cycle; for instance, this can be
done through planning the production more effectively or through outsourcing the
portions of the production process. MDL has the option of utilizing the JIT (Just-in-
Time) method of production for the reduction of the level of inventory in London and
other warehouses.
4. It is recommended to the management of MDL to shorten the trade receivable
conversion cycle through offering incentives for paying early, through the reduction
of credit period to the customers, through detecting the late or slow payers and
through assessing the creditworthiness of the customers in more stringent manner.
This will help in the timely collection of the dues from the trade debtors.
5. There is less flexibility in the trade payable deferral periods as the suppliers of MDL
are responsible for the determination of this period. In case the date of payment to the
payables is delayed by a company past the due dates, it is exposed to the risk of

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paying interests on the accounts overdue and this increases the risk of losing suppliers
or to be refused from credit in future.

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Part 2
Executive Summary
This report aims at the analysis and evaluation of different aspects of traditional budgeting
and alternative budgeting approach. Analysis shows that alternative budgeting methods like
direct labour budget, direct material budget and others have many deficiencies as they are not
flexible, they do not encourage question approach and others. However, alternative budgeting
methods are adaptive and flexible in nature and provide much scope of properly utilizing the
organizational resources based on the needs. Therefore, it is advised to the companies to
adopt the alternative budgeting approaches instead of traditional budgeting approach.

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Answer to [i]
Purpose of Budgeting
Followings are the purposes of preparing a budget:
1. Annual budget is prepared for the refinement of long-term plans for the development
of detailed plan detailed plan in order to implement long-range plans.
2. Another major purpose to prepare a budget is to coordinate the activities of different
parts of the organization in order to ensure that the parts are in agreement with each
other.
3. Appropriate communication of plan to different respksbility centres of the managers
is another major purpose of preparing a budget. This helps in creating a define line of
communication for the effective functioning of the companies.
4. A budget is prepared within the organizations in order to motivate the organizational
managers for striving to achieve the organizational goals and objectives. A budget can
be considered as a useful tool for positively influencing the behaviour of the managers
towards organizational goals and objectives.
5. A budget is prepared for the purpose of controlling the activities for which the
managers are responsible. This can be done by comparing the actual result with the
budgeted results.
6. Evaluation of the performance of the managers is another key purpose of preparing a
budget. Performance of a manager can be measured by measuring his or her success
in meeting the budget (Atrill and McLaney 2009).
Traditional Budgeting
Traditional budget is considered as budget where the consumption of resources varies
proportionately with the final output’s volume of the products or services. However, for those
support activities and indirect costs where the input-output relationship is not clearly

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identifies, traditional budget merely serve as an levels of authorization for the budget level of
spending for each of the expenses associated item. The major examples of traditional budgets
are direct labour budget and direct materials budget. Direct labour budget is considered as the
responsibility of the respective managers of the departments; but the direct materials purchase
budget is considered as the responsibility of the purchasing manager.
Rolling Budget
Rolling budget is also recognised as continual budget and this budget is continuously
updated. A new month is added in the rolling budget for replacing the month that has just
passed in order to ensure the presence of an available budget for full planning period.
Flexibility is the main strength of this budget and therefore, it is possible for the managers to
bring any necessary changes in the budget of prior year. Since it is needed to develop the
budget more many times, it is really tough for the mangers to administer this budget. In the
absence of any continuous change, it is not possible to prepare rolling budget Drury, C.,
2005.
Zero-Based Budget (ZBB)
ZBB is grounded on the viewpoint that it is needed to justify all the spending. ZBB
works from the premise that it is needed to start the projected expenditures for existing
programmes from base zero with the compilation of each year’s budget as if the company is
launching the program for the first time. The key advantage of ZBB is that it provides
encouragement to the managers in adopting a more questioning method to the areas of
responsibilities. This helps in justifying the consumption of resources. As disadvantage, it can
be said that it is time consuming to prepare ZBB and development of this budget requires the
support of many people within the organization.

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Activity-Based Budget (ABB)
The main aim of ABB is the more effective management of costs through the
authorization of the supply of only those resources that are required for performing activities
needed for meeting the budgeted production and volume of sales. The budgeted output
ascertains the required activities that are then utilized for estimating the required resources
for budget. Elimination of the needless activities for cost savings can be considered as the
main advantage of ABB. Blockages in budgeting can be easily eliminated as ABB considers
budget as a single unit. As a disadvantage, it can be said that that deep understanding is
required for developing and implementing this budget as this is a complex process (Atrill and
McLaney 2009).
Answer to [ii]
Traditional Budgeting – Second Sight Plc can apply Direct Labour Budget as traditional
budget for preparing their labour budget. For example, this budget can be used by the
managers of sales and finance departments in Netherlands facility. These managers will need
to prepare the estimates of the labour hours of their departments for meeting the planned
production of prescription glasses. These need to be stated distinctly in budget in the presence
of different grades of labour.
Rolling Budget – Direct labour budget as a traditional budget is prepared once in a year and
breaking this budget into months is an alternative approach; and this is called Continuous or
Rolling Budget. For example, the monthly direct labour budget of second quarter will be
prepared during the first quarter. This budget can be reviewed as the year unfolds.
ABB – Second Sight Plc has the option to adopt ABB as an alternative of traditional
budgeting for production and sales budget of facilities in Netherlands and Indian venture.
ZBB requires the estimation of production and sales volume by individual types of

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prescription glasses and its customers; and them demand needs to be estimated. After that,
required resources need to be determined for performing organizational activities. Then,
quantity of each resource needs to be estimated and the actions need to be taken for amending
the size of resources for matching the predictable supply of glasses.
ZBB – ZBB is another alternative of traditional budgeting that Second Sight Plc can use for
its new facilities in Netherlands and India along with the existing facilities. For example, in
case Second Sight Plc wants to apply it in Manchester facility, then the managers are required
to project the expenditures of the departments like Sales, HR, Finance and others from zero
instead of last year’s budget. This would lead in justifying all budgeted expenditures of the
company (Weetman 2010).
Answer to [iii]
Traditional budget is the budget where the variation of the consumption of resources
with the final output’s volume of the products or services can be seen in proportionate basis.
A traditional budget is prepared on yearly basis and therefore, adoption of this budget will not
provide any chance to bring any changes in the budgets in their planned future facilities.
Therefore, it is rigid in planning process while taking much time to prepare. Lack of
flexibility will not encourage continuous improvements in the new future facilities and this
will lead to achieve the target even if the outcome is undesirable. On the other hand,
alternative budgets such as ABB, ZBB and rolling budgets ignore the deficiencies of
traditional budgeting and contribute toward the allocation of resources as per the requirement
or benefit (Atrill and McLaney 2009). Therefore, adoption of the traditional budgeting
methods by Second Sight Plc in the future facilities would lead to the appropriate allocation
and utilization of resources in accordance with the organizational needs. In addition, this will
help in developing a questioning mind of the organizational managers of Second Sight Plc
that would facilitate in justifying every expenses made by the company. This will put major

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emphasis on value of money. Unlike traditional budgeting approaches, traditional budgets
such as ZBB and rolling budgets are adaptive in nature and provide scope to make changes in
the budgeting system in case of requirement. Based on the above analysis, it can be said that
the alternative budgetary system is suitable to all parts of the new business facilities of
Second Sight Plc.

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References
Aktas, N., Croci, E. and Petmezas, D., 2015. Is working capital management value-
enhancing? Evidence from firm performance and investments. Journal of Corporate
Finance, 30, pp.98-113.
Atrill, P. and McLaney, E., 2009. Management accounting for decision makers. Pearson
Education.
Atrill, P., 2005. Financial management for decision makers. Pearson Education.
Drury, C., 2005. Management accounting for business. Cengage Learning EMEA.
Watson, D. and Head, A., 2010. Corporate finance: principles and practice. Pearson
Education.
Weetman, P., 2010. Management accounting. Harlow: FT.