EFL Business Finance Report: Financial Analysis and Capital Investment

This report provides a comprehensive analysis of EFL's financial performance, addressing the critical difference between cash flow and profitability. It examines the impact of working capital, particularly the issues stemming from outstanding customer dues and excess inventory at the London site. The report explores capital budgeting methods, focusing on the evaluation of potential investment opportunities in Leeds and Bristol. The findings highlight the need for EFL to recover outstanding debts, manage inventory effectively, and implement sound capital budgeting practices. The report recommends strategies for improving cash flow, managing working capital, and making informed investment decisions, including the use of Net Present Value (NPV) for project selection. The report also emphasizes the importance of formal documentation in the capital budgeting process to compare actual project performance with initial estimates. The report also includes an executive summary that details the steps of capital budgeting and its importance.

Business Finance
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Part 1
Executive Summary
EEL is not having enough cash and there is a big difference between cash and profit because of dues
from customers and lined up inventory at the London site of business. EEL should try to recover the
dues and stop adding inventory at London site, as there is not work going in there, and consume the
inventory there by using it or selling it.
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Table of contents
Introduction ……………………………………………………………………………………………………............ Page 4
Findings ...…………………………………………………………………………………………………............ Page 5
Conclusion ……………………………………………………………………………………………………............ Page 7
Recommendation ……………………………………………………………………………………………………............ Page 8
References ................................................................................................................ Page 9
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Introduction
This report is prepared to provide the information about the difference between the cash flow and the
profitability of EFL and how these are shown in the accounts of it. It also puts impact of working capital
on the company and how it is used in the company and how it can be improved or financed so that it
can be used effectively as per the needs of EFL.
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Findings
a. Three factories are operated by EFL and generating turnover of £35 million.
b. Ownership is Dieter – 25% and 75% between Hild, Angela and Ragnar.
c. Operating profit for last year £5 million before interest and taxes
d. Debt increased to £18 million which was earlier £15 million.
e. £1.5 million owed by company by the customers Canterbury Cookers and £2 million of payment
is outstanding amount from customer Radio Formidable
f. Due to the disputes, large stock of inventory is lined up at the company’s London site which Mr.
Dieter thinks is the required level of stock needed after the dispute is solved and is unwilling to
put pressure on the customers to make due payments.
1. What is profitability and what is Cash Flow
There is a big difference between profit and cash. Profit can be defined as the amount of
money which a business makes after deducting all the expenses incurred by it from the
revenues earned, whereas cash is the amount of money which a business has in hand to pay
the expenses. There can be instances where the business may make good profit but is
unable to perform good as it does not have enough cash. There may be much reason for not
having enough cash, out of which the common one is the amount owed by the customers
and making payment for expense which is not being used currently.
The other reasons being as per the American Express Article published in year 2013 which
can affect the cash or profit or both:
- New products: When these are launched, it carries warranty repairs or product recall,
whereby customer service department has to work more, leading to customer
dissatisfaction as there may be no expansion in the staff as per the growth of the
product. This increases expense for repairs, refunds, etc.
- Over spending: During the success period of the business, spending decisions in the light
of overly optimistic becomes over. For example: purchasing costly machineries, etc.
- Problems related to operations- Where volume increases, there may not be immediate
action plan to overcome it, which can lead to increase in unexpected expenses.
- HR problems: Dissatisfaction among the staff due to change of supervisors, or payroll
problems may make the business deliver the products after the given period of time,
which can lead to extra penalty or expense.
2. Need for working capital and how it is used
Working capital as the name suggests means, capital needed for working. It is an important
term for business, as it is useful to know what is needed for day to day operations. There are
two concepts for it. One is quantitative and the other on is qualitative. Quantitative is
defined as the capital which is gross working capital. Qualititative concept focuses on the
source to finance capital. It calculates working capital as current assets excess over current
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liabilities. In the event of inadequate working capital, the company can face many difficulties
such as:
- Production department gets affected, as there are not enough funds to cater it needs.
- Less liquidity results into damaging credit worthiness.
- The day to day expenses can hamper because of lack of cash for paying repair and
maintenance.
- The shareholders will get fewer dividends as the funds are less or no.
- It may result into insolvency of the company because of non-payment of debts and
expenses.
3. How the working capital can be managed by the company effectively.
There are multiple ways to manage the working capital:
- Alternative funding: It means that there must be some other source of fund which must
be there to help operating expenses go easy Other than raising funds through debts, the
business can have finance through crowd funding, invoice discounting, etc.
- Making expenses visible: there are many such expenses which a company can avoid
such as late fees, penalty, travel expenses, etc.
- Management of stock: Stock is one of the most important parts of production, without
which production cannot be carried easily. Over stock or under stock, both are harmful
to the business. Overcrowding stock will make increase chances of wastage, theft,
storage expenses, etc. and the amount of purchase money is also blocked. It will not be
realized, unless they said inventory comes into production and it gets sold.
- Managing payments or receipt effectively: Payment to suppliers and receipt from
customers should be timely met. With suppliers discount can be negotiated so that the
total cost of purchase decreases. In case of receipt from customers, proper invoices
should be maintained. Fees or penalty may be charged to them for late payments, to
increase the receipt of dues from them.
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Conclusion
1. Difference between profit and cash.
There is variance between cash and profit, as the former is the money which is present in
hand, and the latter is accrued amount of net profit. As profit and cash are two separate
terms and cannot be merged with each other, a business earning good profit does not mean
that it has enough cash.
In case of EEL, the two main customers of it are Canterbury Cookers Ltd and Radios
Formidable SA. Alone Canterbury is owing £1.5 million of amount for the large
orders which it placed and for the other customer Radio formidable, there
is a dispute going on due to which £2 million amount is withheld by it. It
clearly shows that though the profit made by EEL is £5 million, but £3.5
million is the amount which is still not received. This shows that the
company is short of £3.5 million of cash.
2. Application of working capital for EFL and causes for it.
In respect of the business, the current assets include debtors. The customers are having
outstanding balance of £3.5million which is a lot of amount and can affect
working capital completely to finance the operating needs.
There is not enough cash in the hands of business to cater the expenses.
3. Steps to improve EFL’s working capital requirement.
In EEL, there are two major problems of getting money blocked because of which the
working capital is not managed properly.
One is dues from customers and other is inventory. Amount due from customer is £3.5
million which is a large sum. The area of work suspended in company’s
London site, suspended the inventory, due to which it is getting lined up.
The company should insist the customers to pay the balance amount with
them soon.
As for the inventory, no more should be purchased for the London site,
and any other inventory available there must be consumed.
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Recommendations
Cash and profit both are different. Cash is net of receipts over payment, whereas profit is net of
income over expenses. Being profitable does not mean that the cash system of the company is
sound. To make it sound, the difference of amount between the profit and cash should be
minimized. The major points which create difference between ash and profit are dues from
customers and unused inventory at London site. The company should insist the customers to
pay the balance amount on time and take necessary actions to recover the amount left with
them.
Both of these are current assets and also form working capital. There may be no difference in
working capital amount when calculate with debtors or cash, as both are part of current assets,
and the amount shifting from debtors to cash will make no change in the net amount. However,
unused inventory will make false decision on working capital.
The company should pay attention in recovering its receipts from both the customers and
should eliminate the inventory stocked up at London site by either using it or selling it.
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References
Reference. 2017. What is the difference between cash and profit? | Reference.com. [ONLINE] Available
at: https://www.reference.com/business-finance/difference-between-cash-profit-d7cfabcb8adb893e#.
[Accessed 10 April 2017].
Susan J. Penner RN MN MPA DrPH CNL, 2013. Economics and Financial Management for Nurses and
Nurse Leaders: Second Edition. 2 Edition. Springer Publishing Company.
bdc.ca. 1801. 11 ways to manage your working capital. [ONLINE] Available at:
https://www.bdc.ca/en/articles-tools/start-buy-business/start-business/pages/managing-working-
capital-10-tips.aspx. [Accessed 10 April 2017].
8 ways to… improve working capital | CIMA Financial Management Magazine. 2017. 8 ways to… improve
working capital | CIMA Financial Management Magazine. [ONLINE] Available at: http://www.fm-
magazine.com/feature/list/8-ways-%E2%80%A6-improve-working-capital. [Accessed 10 April 2017].
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Part Two
Executive summary
This report details out the steps of capital budgeting process and why it is important to keep formal
documentation of it. It states the different methods of capital budgeting and why the chosen method
Net Present value is considered for selecting or not selecting a project.
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Table of contents
Introduction ……………………………………………………………………………………………………............ Page 12
Findings ...…………………………………………………………………………………………………............ Page 13
Conclusion ……………………………………………………………………………………………………............ Page 16
Recommendation ……………………………………………………………………………………………………............ Page 17
References ................................................................................................................ Page 18
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Introduction
This report is prepared to see which method of capital budgeting is useful in selecting a project and
what are the steps for capital budgeting appraisal.
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Findings:
a. Dieter is thinking to invest in either of the two: Leeds or Bristol.
b. Leeds venture involves construction from scratch costing £10m and operating for 9 – 10
years.
c. Bristol venture involves taking over an existing out dated plant costing £6
million with useful life 5 – 6 years.
1. Stage of Capital budgeting to evaluate which project is worthful
i. Identifying and evaluating the potential opportunities: This is the first step of capital
budgeting. A company have different options available to them with different durations
and cost involves and different clauses attached to it. In this step, the company seeks
the potential options which are available to them.
ii. Second step is to estimate the costs attached to the options identified in step first. It
involves summing up the costs which will be incurred to implement the project. This is
done by researching both internal environment and external environment.
iii. Estimation of the benefits to be derived from the options selected: There must be some
cash flow or benefit being derived from the options available. List them all by identifying
the cash flow for an option by either watching the similar projects in the industry which
were proved successful or where the cash flows are certain, then such amount to be
taken into consideration, and in cases where the cash flow is not fixed or can’t be
determined with similar projects, then company must make best possible way to
ascertain the benefit amount of that option.
iv. Assessment of Risk: Almost every project involves risk. It can be because the project is a
fresh option which no one has availed, or will stand to lose, if the project does not
worked out, or the estimated benefit is less than the estimated. After ascertaining the
risks involved, the best option can be identified.
v. Implementation – After ascertaining which option is to be followed or start with, an
implementation plan is needed. This plan includes the payment method for the selected
project, method of tracking the costs of the project, and how the cash flows will be
recorded. It also mentions the starting date of project and estimated ending date of
project.
Benefit of keeping the capital investment appraisal formal, helps in comparing the
performance of the project actually some with the estimated results. It also mentions
the details of the person responsible for the implementation, the targets to be achieved,
and the steps to achieve it. The start date and end date of project. It helps in knowing
each and very detail of the project selected, so that it is easy to compare and know how
the project is implemented and to justify any errors.
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The main appraisal method to identify which project is to opted are:
NPV: in this method the cash flows, the discounting factor, the period of lease or
project, cost of the project is to be known to calculate the total net present value of the
project. This method is used widely as it is easy to compute, and is used largely by all. It
calculates the present value of the future cash flows and is based on the assumption
that the present value of any fore value is less that it. It is not trusted in case of the
projects which are completely.
IRR method: It involves identification of cash flows, period of project, self assumed
discounting factor, project; s cost and estimated rate of return at which NPV is zero. In
this method rate of return is calculated at which the Net present value is zero. This will
give a rate of return at which there will be no profit or no loss made by the project and
therefore it can be compared with the discounting factor applicable on the projects, can
state how much scope is there to choose the method and to avail risk.
Payback period: This method is used to ascertain the payback period of the project. It
involves the cash flows, total life of the project, and cost of the project. In this method
no time value of money is calculated. Instead it is seen that in how much time a project
will payback its cost and other expenses. The shorter the period, the better the project
is. This method is good for those companies, which are small in size and is more liquid.
Where the cash flows are uneven, this method is not suitable in such place.
2. The potential application to the project considered by EEL.
Net present value method
Let’s assume that the cash flows are even in both the projects. It means that for each year it will
be £1 million. Cost of equity is 10%.
Under Net present value method:
Project Leed :
Time period – 10 years
Formula = Present value of project – Cost of the project.
Net present value = £1/(1+0.1)1 + £1/(1+0.1)2 + £1/(1+0.1)3 + £1/(1+0.1)4 +
£1/(1+0.1)5 + £1/(1+0.1)6 + £1/(1+0.1)7 + £1/(1+0.1)8 + £1/(1+0.1)9 +
£1/(1+0.1)10 - £10 million
= 0.9090 + 0.8264 + 0.751 + 0.6830 + 0.6209 + 0.5644 + 0.5131 + 0.4665
+ 0.4240 + 0.3855 - £10 million
= 6.1438 million – 10 million
= - 3.8562
Bristol project
Time = 6 years, cost of equity assumed to be 10%, cost of project is £6
million
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Net present value = £1/ (1+0.1)1 + £1/ (1+0.1)2 + £1/ (1+0.1)3 + £1/ (1+0.1)4 +
£1/ (1+0.1)5 + £1/ (1+0.1)6 - £6 million
= 0.9090 + 0.8264 + 0.751 + 0.6830 + 0.6209 + 0.5644 - £6 million
= 1.6453
IRR method
As the cash flows are considered to be equal, the internal rate of return is
zero for both the projects.
Payback period
Project Leed: The cost of investment is £10 million, time period 10 years. It
will take 10 years time to payback on the assumption that cash flows are
equal.
Project Bristol: The cost of investment is £6 million, time period 6 years. It will
take 10 years time to payback on the assumption that cash flows are equal.
3. Analysis of method suitable to make decisions
In the light of the three methods Net present value, IRR and payback period,
two methods are not creating any difference for both the projects. These two
methods are IRR and Payback period. On considering the Net present value
method, it is seen that on the assumption that cash flows are equal, Net
present value is negative in both the projects.
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Conclusion
1. Capital budgeting process involves five steps consisting of identification of
various alternatives available to the business, cost attaché to such
investment options, cash flows to be derived from such options, any risk
attached to such options, and last one is Implementation. It is important
to maintain document of the same for future and comparison purpose
reasons. The method used to evaluate budgeting decisions is Net present
value, internal rate of return and last one is Payback period.
2. On applying all the three methods, only Net present value method can be
used as internal rate of return and payback period is zero and full time
period respectively.
3. Net present value method is most appropriate to make ision in relation to
which option to be considered. However, in this case both the options are
showing negative cash flows, it means that no option is feasible to go
ahead with and will not contribute in the EEL’s business.
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Recommendation
No project can be considered to be pursued as both are having negative net present
value method, which means both will not be able to make profit and the present
value of the amount invested in them which is after deducting the cost of
investment is a negative present value. Therefore, EEL should not go ahead with
any one of the projects.
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References
Motley Fool Staff. 2017. The 5 Steps to Capital Budgeting -- The Motley Fool. [ONLINE] Available at:
https://www.fool.com/knowledge-center/the-5-steps-to-capital-budgeting.aspx. [Accessed 10 April
2017]. Add to My References
CIMA. N.d. Investment Appraisal in the NHS. [ONLINE] Available at:
http://www.cimaglobal.com/documents/importeddocuments/cid_techguide_investment_app_nhs_200
0.pdf. [Accessed 3 April 2017].
Pamela P. Peterson, 2008. Capital Budgeting: Theory and Practice (Frank J. Fabozzi Series). 1 Edition.
Wiley.
Peter; Parrino, Robert; Kidwell, David Moles, 2011. Corporate Finance. European ed Edition. John Wiley
& Sons Ltd
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