Business Finance Report: Working Capital and Capital Budgeting

This report provides a comprehensive analysis of business finance, focusing on two key areas: working capital management and capital budgeting. Part 1 delves into the critical differences between profitability and cash flow, using the example of Wild Frontiers Builders Ltd to illustrate these concepts. It explores the application of working capital management, analyzing the financial health of the business through income and cash flow statements, and the impact of factors like bank overdrafts and inventory on financial performance. Part 2 shifts the focus to capital appraisal techniques, specifically discussing the capital budgeting process and its various methods. It examines how these methods are applied to different projects, using a case study of a video game design company, and analyzes the best methods for making informed investment decisions. The report concludes with a synthesis of the key findings and recommendations for improving financial strategies.

BUSINESS FINANCE

Table of Contents
INTRODUCTION...........................................................................................................................3
PART 1............................................................................................................................................3
1. Explaining the difference between profitability and cash flow...............................................3
2. Explaining the application of working capital management concept......................................6
3. Analysis of working capital management in the business.......................................................7
PART 2............................................................................................................................................8
1. Explain Capital budgeting process and its methods................................................................8
2. Application of methods applied to the projects.....................................................................13
3. Analysing the best suitable methods for making decisions 13
CONCLUSION..............................................................................................................................14
REFERENCES..............................................................................................................................15
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Index of Tables
Table 1: Extract of income statement of WFB................................................................................5
Table 2: Extract of cash flow statement of WFB.............................................................................5
Table 3: Extract of trading and profit and loss account...................................................................6
Table 4: Extract of cash flow statement...........................................................................................6
Table 5: Calculation of payback of Call of assassins....................................................................10
Table 6: Calculation of payback period of Coal mining& oil extract............................................11
Table 7: Calculation of NPV of call of assassins...........................................................................11
Table 8: Calculation of NPV of Coal mining and oil Extract........................................................12
Table 9: Calculation of IRR...........................................................................................................12
Table 10: Calculation of ARR.......................................................................................................13
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INTRODUCTION
Finance is the lifeline of every business which acts like a boat to rescue the business users
from the situations of bankruptcy. The business worships finance as the God to take care their
business operations by supplying adequate financing requirements. This report has fragmented
into two parts which show the significance of finance in different contexts. In the first part, Wild
Frontiers Builders Ltd has been selected which deals in the construction industry and on the
other hand, part 2 has selected Eye water which provides designing services in the video games.
The first part of the report focuses on financial reports and working capital management. The last
part of the report has stressed on the capital appraisal techniques.
PART 1
1. Explaining the difference between profitability and cash flow
Generation of profit and cash flow availability in existing business will be beneficial for the
business to maintain its financial position (Lien, 2016). Profit is the outcome generated by an
entity by conducting their business operations. Cash flow is the residual amount held by business
by paying all expenses and losses from their available cash. A difference of profit and cash flow
is created due to changes that take place in its treatment which is given as below:
Cash flow forecasting statements will record all the cash transactions which take place in
the business in real time. The increasing cash can generate with higher sales which further
enhances the profit earned by an enterprise (Wapshott, 2016). The capital is invested by owners
and cash gathered by selling of idle assets held with an entity.
The treatment of profit and loss statements is totally different in which all cash inflows
and cash outflows are considered to reflect the true business position of the business entity.
Factors which are considered in the estimation of true profit includes depreciation, bad debts
written off, assets sold at a profit or loss and availability of higher stock of inventory keeping
idle in the existing business.
In the given case scenario, Wild Frontier Ltd. (WFB) deals in providing services of property
maintenance by offering buy-to-let. The maintenance of property will include various services
such as plumbing, electrical, roofing and general repairs. The repair will target the major areas
that present existing house or property in a new structure to please all its clients.
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There is various basis which helps in justifying the existing financial position in relation to the
changes that take place in profitability and cash flow which are given as below:
Bank overdraft- This source of financing is usually taken by an entity owner to meet its
financial business requirements (Petrovic, Manson and Coakley, 2016). The existing state of
WFB is in danger in relation to the existence of bank overdraft which lies in business for around
nine months. The idleness of this risky debt obligation in the business decreases cash flow along
with interest charged on the amount taken. The reducing cash position will, in turn, reduces the
profit of the existing firm.
Treatment of bank overdraft in Income statements
Table 1: Extract of income statement of WFB
Particulars Amount Particulars Amount
Interest charges (XXX) Profit XXXX
Bank overdraft (XXX)
Balance Carryforward XXX
XXXX XXXX
Treatment of bank overdraft in cash flow statements
Table 2: Extract of cash flow statement of WFB
Particulars Amount
Cash flow from operating activities XXX
Cash flow from investing activities XXX
Cash flow from financing XXX
Bank overdraft (XXX)
Net increase or decrease XXX
Bank overdraft (XXX)
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Cash balance XXX
Closing inventory- The existing business of Wild Frontiers building has higher closing
stock that is held at the end of the period. This idle stock will raise the scope of this entity as it
affects the business positively. Effect of larger stock is that it reduces the cost of goods sold
which in turn increases the sales and revenue (Huang and Petkevich, 2016). The increment of
sales will directly affect in terms that it will enhance the existing profit of WFB. On the other
hand, idleness of unsold stock held within the business will not create any cash flow for WFB as
increasing inventory will reduce the overall cash flow from available cash held in business
enterprise.
Treatment of closing stock in income statements
Table 3: Extract of trading and profit and loss account
Particulars Amount Particulars Amount
Purchases (XXX) Sales XXX
Wages (XXX) Closing stock XXX
GP XXX XXX
XXX XXX
Treatment of closing stock in cash flow statements
Table 4: Extract of cash flow statement
Particulars Amount
Operating activities
Net profit XXX
Increase in inventory (XXX)
cash flow from operating activities XXX
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Cash flow from investing activities XXX
Cash flow from financing XXX
Net increase or decrease XXX
Cash balance XXX
It has been observed from the above statements such as income and cash flow statements
the performance of an entity is stable.This is one of the important statements in determining
profitability and available cash held within a business entity (Wapshott, 2016). The larger stock
has two perspectives as it is beneficial for generating higher profits but the same will reduce cash
flow of this entity. The bank overdraft will negatively affect the business enterprise by showing
negative positions in income as well as in the cash flow statements of an enterprise.
2. Explaining the application of working capital management concept
The working capital management has two important concepts which help an entity to uplift
existing business conditions which are given as below:
Qualitative- The current focus of this particular technique is on identifying all sources
from which WFB can arrange finance to meet its existing requirements (Cumming, Hou and Lee,
2016). Existing elements such as current assets over current liabilities are evaluated to determine
the working capital need of business.
Quantitative- The existing business efficiency will be improved with the utilization of
the current assets to fight against the competitors. These rivals impose challenges to suppress the
financial performance of an entity.
There are various kinds of working capital management systems that are required to be
adopted by WFB. These are mentioned as below:
Concept classification- An entity has classified overall working capital into various
segments according to the standard concepts.
 Gross working capital
 Net working capital
 Working capital deficit
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Financial classification- The rationale behind the classification of concepts on a
financial basis is that information can be gathered from different financial statements such as
income, balance sheet and the cash flow statements.
 Cash working capital
 Balance working capital
Variability classification- Business requirement and convenience of an entity owner will
decide its working capital to be held in the existing enterprise.
1. Permanent working capital
2. Temporary working capital
The current financial condition of WFB is not stable which needs to be improved by using a
financial concept of working capital management (Loughran and McDonald, 2016). This is
essential to align the financial resources applied in existing business. The current business is
required to reduce all their expenses such as bank overdraft and all kinds of expenses incurred in
a particular business. Expenses are needed to be controlled as this restricts the future potential of
an entity in generating higher sales and revenue along with the cash flow.
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The overall system of working capital needs to be executed properly in a business of
Wild Frontiers Building who are struggling with the cash problems (Wapshott, 2016). Expenses
are an integral part of an enterprise which needs to be ruled and dominated by them. Above
mentioned figure is explaining the current business situation of WFB that emphasises more on
the expenses rather than generating cash flows in the corporation.
3. Analysis of working capital management in the business
The terminology working capital is widely used in a business which is a difference between
current assets and the current liabilities incurred in the business. The management of the working
capital is essential as today's business is based on giving credit. The credit needs to be given to
all the customers to maintain the existence of an enterprise for a long time. The existing working
capital of Wild Frontier Building is not sufficient to manage its existing expenses and losses
(Liang and Chin, 2016). There are various steps required to be taken by the owner in amending
their existing business structure which is given as below:
Information systems- The execution of the proper information system is essential to
communicate important announcements within the business (Huang and Petkevich, 2016). The
Proper passing of information related to the financial and non-financial areas will assist the top
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Illustration 1: Working capital management
(Source: Importance of working capital management, 2009)

management in preparing good financial statements. The risk will be minimised by using credit
monitoring system in which existing risk or credit are recorded to minimise it's completely over
the years. The system followed to safeguard the interest of an entity is to use Enterprise resource
planning system in which financial resources are properly planned in the existing business
concern. The tally will be used as one of the segments of the ERP system.
Payment behaviour- The amount collected from all the customers will increase the cash balance
and the sales and the revenue level of the business entity. The basic problem faced by WFB is
rigid behaviour followed by the employees of WFB while dealing with their customers. The
automatic system will be applied in this business which will record all kinds of payments made
from and outside the business (Petrovic, Manson and Coakley, 2016). The payment will be
monitored by serial numbered online vouchers which can be cross checked at any point in time.
This will also form as legal evidence in the case of default committed by any individuals in the
business.
Invoice disputes- The conflict created by an individual in relation with the receivables collected
from all kinds of clients. The disturbances created in the existing structure will destroy the needs
and the expectations of the business. This conflict will increase the leakage in the current level of
revenue. The trade factoring system will be followed in which the receivables from all the
customers will ensure by the specialised persons.
PART 2
1. Explain Capital budgeting process and its methods
The capital budgeting is one of the important approach used by the business entity to assess the
efficiency of different business projects taken in order to grab higher market opportunities (Lien,
2016). There are various stages of the capital budgeting process which are given as below:
Idea generation- The generation of the idea is essential for the business enterprise through the
medium of top management and senior employees. The business proposals are identified from
different sources which are assessed properly in order to get higher benefit in the near future.
Analysis of proposals- The cash flows are forecast for all the project taken up by an entity
owner for a specific period. The forecasting of the cash flow is an integral aspect in assessing the
overall performance of a project.
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Corporate capital budget- The business owner will select the best suitable projects on the basis
of the initial investment applied on all of them (Hanssens, Deloof and Vanacker, 2016). The
current projects are further analysed on the basis of initial investment and the cash flows
generated by the project at a particular time.
Post audit- This stage will involve reviewing of the existing business proposals on the basis of
the standard criteria framed by an entity. These measures will be used to compare the
performance of the given projects with the budgeted frameworks.
There are various capital budgeting techniques used by the business entity in order to assess the
efficiency of the two projects such as call of assassins and coal mining&Oil extract which are
given as below:
Payback period
Table 5: Calculation of payback of Call of assassins
Year Call of assassins Cumulative
0 10
1 0 0
2 0 0
3 0 0
4 8 8
5 13 21
Calculation of payback period
=4 + 13/10
=4+1.3
=5.3 years
Table 6: Calculation of payback period of Coal mining& oil extract
Year Coal mining and Extract oil Cumulative
0 6
11

1 0 0
2 0 0
3 0 0
4 5 5
5 8 13
Calculation of Payback period
=4 +8/6
=4+ 1.33
=5.33 years
Advantages
 It is simplified structure which can be easily interpreted by non-financial users
 It helps in taking decisions quickly in order to assess its effectiveness
Disadvantages
 It ignores all the cash flows generated by the initial investment covered in a specific
period.
 It will not present true picture due to the ignorance of time value of money concept.
NPV
Table 7: Calculation of NPV of call of assassins
Year Call of assassins PV@12% Present value method
0 10
1 0 0.8928571429 0
2 0 0.7971938776 0
3 0 0.8928571429 0
4 8 0.6355180784 5.0841446272
5 13 0.5674268557 7.3765491243
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