FIN 7040 - Financial Decision Making: ABC Consulting LLP Case Study

This report evaluates the financial condition and investment appraisal policy of ABC Consulting LLP, a UK-based consultancy. Financial ratios indicate a decline in performance in 2018 due to falling market revenue, though the US subsidiary showed improvement, prompting an expansion plan. The management's forecasts, while subject to limitations, support the expansion. Investment appraisal techniques suggest accepting the project to maximize return on investment and profitability, with funding primarily from equity and less from debt. Non-financial factors should also be considered before finalizing the investment proposal. Desklib provides access to similar case studies and solved assignments for students.

Running head: FINANCIAL DECISION MAKING
Programme MSc Management
Module name Financial Decision Making
QAA Level 7
Schedule Term Summer Term 2018
Student Reference Number (SRN)
Report/Assignment Title CASE STUDY – ABC CONSULTING LLP
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1FINANCIAL DECISION MAKING
Financial Decision Making
[FIN 7040]
Author’s Note:

2FINANCIAL DECISION MAKING
Table of Contents
Executive Summary:..................................................................................................................3
Part 1: Business Performance Analysis......................................................................................4
1.1 Statement of Profit or Loss:.............................................................................................4
1.2 Statement of Financial Position:......................................................................................6
1.3 Statement of Cash Flows:...............................................................................................11
1.4 Segmental Analysis:.......................................................................................................13
Part 2: Investment Appraisal and Sources of Finance.............................................................14
2.1 Investment Appraisal:....................................................................................................14
2.1.1 Management Forecast:............................................................................................14
2.1.2 Investment Appraisal Techniques:..........................................................................14
2.1.3 Payback Period:.......................................................................................................15
2.1.4 Accounting Rate of Return:....................................................................................15
2.1.5 Net Present Value:...................................................................................................15
2.2 Sources of Finance:........................................................................................................16
2.3 Non-Financial Factors:...................................................................................................16
References:...............................................................................................................................17

3FINANCIAL DECISION MAKING
Executive Summary:
The current report deals with evaluating the financial condition and investment
appraisal policy of ABC Consulting LLP, which is an UK based organisation providing
consultancy services in UK, US and Australia. From the various financial ratios computed, it
has been found that the organisation has experienced a decline in its performance and
position in 2018 compared to the previous year due to the significant fall in market revenue
owing to declining market demand. However, performance improvements could be observed
in its US subsidiary, due to which it has planned to make an expansion plan in the project.
In order to conduct the expansion plan, the management of ABC Consulting LLP has
made certain forecasts, which are subject to certain limitations. The most significant
limitation is that since forecasts are based on assumptions, any decision taken might not be
irreversible in future. By using the various investment appraisal techniques, it has been
advised to the management of the organisation to accept the project, as the assumptions made
would help in maximising their overall return on investment and profitability. Moreover, in
order to raise funds for the expansion program, it is advised to raise maximum funds from
equity and lower funds from debt. Finally, ABC Consulting LLP needs to take into account
certain non-financial factors for arriving at the final decision before undertaking the
investment proposal.

4FINANCIAL DECISION MAKING
Part 1: Business Performance Analysis
The report would deal with analysing the business performance of ABC Consulting
LLP, which is a reputed organisation providing professional services in London, UK. It
operates as a limited liability partnership since 2001 and it has gained popularity for being a
popular provider of consultancy support for aiding in transforming businesses operating in
different industrial sectors. In order to conduct its business performance analysis, ratio
analysis is deemed fit for the purpose to analyse its various financial statements like income
statement, balance sheet statement and cash flow statement.
1.1 Statement of Profit or Loss:
By using Exhibit 1 provided in the case study, the statement of profit or loss of ABC
Consulting LLP has been evaluated with the help of the following ratios, which are
demonstrated briefly as follows:
Table 1: Profitability ratios of ABC Consulting LLP for the years 2017 and 2018
(Source: As created by author)

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Net margin Return on
capital
employed
(ROCE)
Return on
equity (ROE) Operating
margin
-40.00%
-20.00%
0.00%
20.00%
40.00%
60.00%
80.00%
100.00%
120.00%
140.00%
160.00%
Profitability Ratios
2017
2018
Percent change
Figure 1: Profitability ratios of ABC Consulting LLP for the years 2017 and 2018
(Source: As created by author)
The three ratios that have been considered to be significant for the organisation
include net margin, return on capital employed (ROCE) and return on equity. Net margin is a
ratio that generally assists the investors and the analysts in measuring the ways through which
an organisation is managed efficiently and estimating future profitability depending on the
sales projections of the management. For ABC Consulting LLP, net margin is observed to
decline from 25.81% in 2017 to 22.79% in 2018, which has declined by 11.69%. This is not a
good sign, as the organisation has not managed to increase its profit level over the year
despite increase in revenue. From the income statement, it is evident that there is increase in
revenue margin over the year; however, this is outweighed by the considerable increase in
operating expenses. The operating costs that significantly increased over the year include
staff costs and marketing, as the organisation might have recruited additional staffs and focus
has been kept on attracting more clients for ensuring further rise in revenue. As a result, this
has resulted in fall in net margin of the organisation.
A higher return on capital employed (ROCE) is always desirable, as it implies that
additional profits are earned from each unit of money employed (Benedict and Elliott 2011).
In case of ABC Consulting LLP, the return has fallen drastically from 89.13% in 2017 to
62.74% in 2018 and the decline is by -29.61%. The primary reason identified behind the fall
in ROCE is that the organisation does not have adequate cash balance to invest in assets, as

6FINANCIAL DECISION MAKING
they are utilised for settling off the existing dues and obligations. If this ratio is declining, it is
an early signal for the investors to sell the shares that they hold in order to avoid losses.
Return on equity (ROE) gauges the efficacy of an organisation in using the money
from the shareholders for generating profits along with ensuring business growth (McClaney
and Atrill 2014). In case of ABC Consulting LLP, the ROE of the organisation has fallen
from 132.19% in 2017 to 87.23% in 2018 and the decline is by 34.01%. This implies for
every pound of shareholders’ equity, earnings have been £1.32 in 2017 and £0.87 in 2018.
This ratio is considered to be significantly high for the organisation, even though decline
could be observed in the current year. Thus, ABC Consulting LLP has managed a stable
growth over the years. Finally, operating margin has fallen by 10.45% in 2018 due to the rise
in operating costs and hence, adequate profit level is not maintained despite the rise in
revenue in 2018.
Based on the above evaluation, it could be stated that the organisation is experiencing
decline in its profitability aspect.
1.2 Statement of Financial Position:
By using Exhibit 1 provided in the case study, the statement of financial position of
ABC Consulting LLP has been evaluated with the help of the following ratios, which are
demonstrated briefly as follows:
Liquidity analysis:
Table 2: Liquidity ratios of ABC Consulting LLP for the years 2017 and 2018
(Source: As created by author)

7FINANCIAL DECISION MAKING
2017 2018
1.50
1.55
1.60
1.65
1.70
1.75 1.74
1.61
1.74
1.61
Liquidity Ratios
Current ratio
Quick ratio
Figure 2: Liquidity ratios of ABC Consulting LLP for the years 2017 and 2018
(Source: As created by author)
From the above figure, both current ratio and quick ratio have identical figures, as
both the ratios have declined from 1.74 in 2017 to 1.61 in 2018. The ideal current ratio is
considered as 2, while the ideal quick ratio is considered as 1. The two ratios have remained
identical due to the fact that the organisation does not maintain any inventory or incur prepaid
expenses in conducting its business operations (Collier 2015). These two ratios help in
measuring the liquidity position of an organisation by assessing its efficiency in clearing off
its short-term dues with the existing short-term asset base available. Since the quick ratio is
above 1, it denotes that ABC Consulting LLP has huge amount of idle working capital, which
has remained unutilised, since trade receivables are observed to increase from £1,179 in 2017
to £1,194 in 2018. However, there is significant decline in cash balance over the year from
£214 in 2017 to £75 in 2018, due to which a slight decline could be observed in 2018.
Hence, in terms of liquidity, ABC Consulting LLP is not placed in a favourable
position due to the declining trend of current ratio and quick ratio owing to huge amount of
idle cash stuck in the hands of the clients.
Efficiency analysis:
In terms of efficiency ratios, the two ratios that have been taken into consideration
include receivables turnover period and payables turnover period. It is noteworthy to mention
that in order to compute the payables turnover period, cost of revenue is needed to arrive at

8FINANCIAL DECISION MAKING
the desired figure. However, in case of ABC Consulting LLP, the staffs costs are taken into
consideration as cost of sales for calculating payables turnover period. In addition, inventory
turnover period could not be calculated, as the organisation does not maintain any inventory
level, since it is mainly involved in providing consultancy services (Thomas and Ward 2015).
Therefore, the results of the two ratios computed are illustrated briefly as follows:
Table 3: Efficiency ratios of ABC Consulting LLP for the years 2017 and 2018
(Source: As created by author)
Receivables turnover period (in
days) Payables turnover period (in
days)
-
20
40
60
80
100
120
140 125
82
121
77
Efficiency Ratios
2017
2018
Figure 3: Efficiency ratios of ABC Consulting LLP for the years 2017 and 2018
(Source: As created by author)
From the above figure, it could be clearly seen that there is a slight decline in
receivables turnover period of ABC Consulting LLP from 125 days in 2017 to 121 days in
2018. Receivables collection period gauges the ability of a business organisation to collect
receivables in an efficient manner. A lower period in terms of days is always favourable,

9FINANCIAL DECISION MAKING
since it implies that the organisation is collecting amounts from the debtors more frequently
in a year. For ABC Consulting LLP, it has managed to minimise such period to a certain
extent in 2018, as it huge amount of idle cash stuck with the clients. Moreover, since the sales
are made on credit, ABC Consulting LLP needs to wait 121 days in 2018 to collect the
amount from the debtors from those sales in contrast to 125 days in 2017.
The payables turnover period signifies the capability of an organisation in paying off
its vendors, which is used by the creditors as well as the suppliers to determine whether to
grant credit terms to any business organisation. If the period is higher in terms of days, it
implies that the organisation makes frequent and timely payments to the creditors and the
suppliers. However, clearing the amount before the stipulated time might lead to cash
shortage for the concerned organisation. For ABC Consulting LLP, payables turnover period
is observed to fall from 184 days in 2017 to 171 days, as the creditors are unwilling to extend
their terms due to slight fall in market demand causing the creditors to implement stringent
terms and policies on the organisation.
Thus, in terms of efficiency, ABC Consulting LLP needs to undertake efforts for
minimising the settlement period of debtors to further, since the creditors have reduced their
collection period for receiving payments.
Solvency analysis:
The four ratios that have been chosen to conduct the solvency analysis of ABC
Consulting LLP include debt-to-equity ratio, debt ratio, equity ratio and interest cover ratio
and their detailed calculations are presented as follows:
Table 4: Solvency ratios of ABC Consulting LLP for the years 2017 and 2018

10FINANCIAL DECISION MAKING
(Source: As created by author)
Debt-to-equity ratio Debt ratio Equity ratio
-
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
2.00
1.75
0.64
0.36
1.31
0.57 0.43
Solvency Ratios
2017
2018
Figure 4: Solvency ratios of ABC Consulting LLP for the years 2017 and 2018
(Source: As created by author)
From the above figure, it is evident that there is decline in debt-to-equity ratio from
1.75 in 2017 to 1.31 in 2018; however, the ideal standard is considered to be 1. This is
because this standard implies that an organisation has maintained an appropriate mix of debt
and equity in its capital structure for funding its capital projects. In case of ABC Consulting
LLP, the ratio is well above 1, even though it has declined in 2018 due to significant rise in
long-term loan of the organisation. As a result, the capital structure of the organisation is
highly leveraged.
This is supported further by debt ratio and equity ratio, as these two ratios indicate the
percentage of funds that are obtained through debt and through equity respectively. The debt
ratio is observed to decline by 7% in 2018 coincided with rise in equity by 7% in the same
year. This implies that the organisation has started to raise more funds via equity, which
could be observed from significant increase in members’ reserves from £671 in 2017 to £940
in 2018. However, it is still not sufficient, as ABC Consulting LLP has to find some ways to
minimise its overall debt further in order to avoid drainage of working capital in future.
However, interest cover ratio is significantly high despite the drastic decline in 2018. The
organisation has adequate capability of clearing its interest expenses with the operating
income earned, as it has not undertaken adequate bank loans.

11FINANCIAL DECISION MAKING
Henceforth, in terms of solvency, the organisation is not placed in a favourable
position in the industry due to more reliance on obtaining funds through debt financing.
1.3 Statement of Cash Flows:
Reasons behind drop in cash:
Based on the provided cash flow statement of ABC Consulting LLP, it could be found
that the organisation has purchased property, plant or equipment for which it has to incur
£525 in 2018. Moreover, the working capital of the organisation has declined from £222 in
2017 to £34 in 2018. Hence, a considerable amount of cash has been invested to buy this
asset, which has resulted in negative investing cash flows. Another reason that could be
identified behind the significant decline in cash balance is the payment made to the members
of the organisation. These payments are made due to the collection from them for raising
equity capital and hence, the organisation has to pay a portion of its profits earned in the year
2018. Due to these reasons, there has been significant decrease in cash and cash equivalents
resulting in adverse figure, which has been offset partially by the positive cash balance in the
previous year. As a result, the closing cash balance of ABC Consulting LLP has been £75 in
2018, which was lower in contrast to the cash balance of £214 in the past year.
Operating cash cycle:
Table 5: Operating cash cycle of ABC Consulting LLP for the years 2017 and 2018
(Source: As created by author)

12FINANCIAL DECISION MAKING
2017 2018
-60
-58
-56
-54
-52
-50
-48
-46
-44
-59
-50
Operating cash cycle (in days)
Figure 5: Operating cash cycle of ABC Consulting LLP for the years 2017 and 2018
(Source: As created by author)
Operating cash cycle is the time needed to convert purchases into cash receipts from
the customers. This helps in disclosing the use of working capital in an organisation. For
ABC Consulting LLP, the operating cash cycle has been negative in both the years, even
though a slight improvement could be observed by reduction of 9 days in 2018. This is not a
sound trend, as negative operating cash cycle implies that a business organisation clears its
supplier payments after cash receipts from the customers and hence, this minimises the
chance for debt repayment or additional purchases. Therefore, it needs to take care of its
debtor settlement period further for minimising its operating cash cycle to increase the
working capital base.
Evaluation of the payment to partners:
Based on the provided case study, it could be observed that ABC Consulting LLP
provides a portion of the profits to its partners based on the amount earned. The Executive
Board of the organisation decides the amount of profit to be earned based on their
performance. However, in 2018, it has been found that the payments of the members have
dropped by 17.50% due to fall in profit margin over the year. This decision is rightly
justified, as it would help the organisation in increasing its retained earnings. Moreover, it has
been found that ABC Consulting LLP is observed to increase its equity funding for
maintaining balance in its capital structure. Once adequate return on investment is generated,

13FINANCIAL DECISION MAKING
it would help in generating additional profit and this, in turn, would increase the payments of
the members. Therefore, it could be stated that ABC Consulting LLP has made the right
decision of minimising the final payments to the partners.
1.4 Segmental Analysis:
After evaluating the segment wise performance of ABC Consulting LLP for the two
years, it has been found that the revenue base of the organisation has declined in Australian
market by £132 million; however, considerable increase could be observed in the US market
and the UK market by £229 million and £64 million respectively.. However, the expenses
and disbursements of the organisation has increased in UK and Australia, while such
expenses have declined in US market despite the rise in revenue. As a result, considerable
increase in gross margin could be seen in US market, while the margin in both Australian and
UK markets has declined. In addition, despite the operating loss suffered by the US segment,
it has managed to turn around its position significantly in 2018 and the operating margin is
highest for this segment in 2018 to 35.52%, which was -7.84% in 2017. However, the other
two segments have experienced downfalls in their operating margins in 2018.
For the UK market, ABC Consulting LLP could follow market penetration strategy
that would intention to draw the customers by offering lower prices for its services. After
considerable penetration, it could increase its prices again for better reflection of the state of
its market position. For the Australian market, ABC Consulting LLP could follow economy
pricing strategy for reducing the marketing costs in order to minimise the service prices. As a
result, the customers could buy the services without any frills. Finally, for the US market, the
organisation could adopt price skimming strategy by setting rates, since their services are in
the introductory phase. However, with the passage of time, it could minimise prices
gradually, since the products of the competitors appear to gain popularity in the market.

14FINANCIAL DECISION MAKING
Part 2: Investment Appraisal and Sources of Finance
2.1 Investment Appraisal:
2.1.1 Management Forecast:
ABC Consulting LLP is planning to expand its business in the US market, for which it
has decided to adopt the investment appraisal methods by making certain forecasts. However,
it is to be borne in mind that forecasts are made on certain assumptions, which could change
eventually and investment appraisal techniques are not an exception to this fact as well. The
management forecast of ABC Consulting LLP could be challenged by considering the
following points:
 Investment appraisal decisions are based on long-term and therefore, they could not
be reversed in future. It is evident from the provided information that the US segment
has doubled its net revenue in 2018 from 2017 and it is expected that the same would
continue for the next year as well and then it is expected by grow 25% in the next two
years. This indicates that the management has forecasted strong revenue growth in
future for the US segment. Hence, The US project is designed for five years and
hence, any decision that would be taken by ABC Consulting LLP in the initial stage
would be irreversible in nature in future.
 As these techniques are dependent on assumptions and projections, uncertainty tends
to prevail in future. Thus, if the forecasts for the three years suddenly change due to
factors like inflation and interest rate, revenue base is likely to decline in future.
 Investment appraisal is still introspective, since the discounting factor and risk factor
remains subjective to the perceptions of the managers of ABC Consulting LLP.
 If inaccurate investment appraisal decision is undertaken, the long-term durability of
the organisation could be influenced and therefore, the professionals of ABC
Consulting LLP need to conduct it judiciously by having effective understanding of
the expansion requirements of the organisation.
2.1.2 Investment Appraisal Techniques:
The following investment appraisal techniques are considered for the expansion
project of ABC Consulting LLP in the US market:

15FINANCIAL DECISION MAKING
2.1.3 Payback Period:
Payback period is the time needed where the initial cash outflow of investment is
expected to be generated from the cash inflows over the economic life of the project. A lower
period is always favourable from an organisational perspective, as the initial outlay would be
recovered in shorter timeframe. In case of US expansion project, the payback period is
computed as 2 years and 7 months, which is much lower in contrast to the economic life of
the project. The most significant advantage of this method is its universal use along with easy
understanding and interpretation. Moreover, this method provides significance on liquidity in
order to undertake decision regarding the investment proposal. By considering all these
factors for the US expansion project, it is recommended to ABC Consulting LLP to undertake
the project for maximising its return on investment. However, some significant drawbacks of
this method include non-recognition of the time value of money, more importance on
liquidity by ignoring profitability completely and before payback period cash flows are only
taken into consideration.
2.1.4 Accounting Rate of Return:
This method gauges the amount of return or profit expected on a particular
investment. A higher ARR is desirable for maximising the overall rate of return. Some
significant benefits of this method include the recognition of net earnings concept along with
providing clear overview of the project profitability. In case of ABC Consulting LLP, the rate
is obtained as 100%, which is way too higher than the cost of capital. Therefore, the
organisation could accept this investment proposal; however, this technique suffers from
certain drawbacks. Some significant limitations include ignorance of time value of money
and determination of fair rate of return.
2.1.5 Net Present Value:
This method could be explained as the variation between the cash inflows generated
and initial outlay of the project. The significant benefits of this method include consideration
of time value of money, priority to project risks and profitability and consideration of both
before tax and after tax cash flows. A higher NPV is always desirable and in case of ABC
Consulting LLP, NPV is computed as £886 million, which suggests the acceptance of the
project. However, this method could not provide accurate decision, if two mutually exclusive
projects have varied economic lives and it is complex to compute the appropriate discount
rate.

16FINANCIAL DECISION MAKING
2.2 Sources of Finance:
For this particular investment, the two source from which ABC Consulting LLP could
raise funds include debt financing and equity financing. It has already been observed that the
organisation has relied on raising more funds by obtaining loans from the market. Hence, for
this particular expansion programme, the organisation could raise £600 million by raising
equity shares in the market and the remaining £200 million by obtaining loans from any
reputed US bank. This would help in reducing the leverage of the organisation by
maintaining an appropriate mix of debt and equity. Hence, if ABC Consulting LLP decides to
progress with the expansion programme, it needs to raise additional funds through equity so
that the overall leverage of the organisation does not increase in future.
2.3 Non-Financial Factors:
Along with considering financial factors, ABC Consulting LLP needs to take into
consideration certain non-financial factors, which are represented briefly as follows:
 Matching the industrial yardsticks and effective practice, as the organisation has to
comply with the standard wage rate in US (about $857 per week for 40 hours a week)
and safe environment or its staffs, which might lead to additional expenses
 Boosting the morale of the staffs in order to make the retention of the staffs much
easier by providing incentives and promotions for superior performance so that any
staff associated with the US project did not leave before project completion (Weetman
2006)
 Enhancement of relationships with the suppliers as well as the customers by providing
timely payments to the suppliers and ABC Consulting LLP could offer discounts to its
customers for bulk purchases to guarantee additional revenue generation in the future
years (Weetman 2006)


17FINANCIAL DECISION MAKING
References:
Benedict, A. and Elliott, B., 2011. Financial Accounting: An Introduction. Financial
Times/Prentice Hall.
Collier, P.M., 2015. Accounting for managers: Interpreting accounting information for
decision making. John Wiley & Sons.
McClaney, E. and Atrill, P., 2014. Accounting and Finance for non-Specialists. 9th ed.
Harlow: Pearson.
Thomas, A. and Ward, A.M., 2015. Introduction to Financial Accounting. McGraw-Hill
Education.
Weetman, P., 2006. Financial Accounting: An Introduction. Financial Times Prentice Hall.
Weetman, P., 2006. Financial and Management Accounting: An Introduction. Financial
Times Prentice Hall.