Financial and Economic Principles and Analysis for Managers

This report delves into essential financial and economic principles for managers, covering a range of topics from production classifications (job, batch, mass) and opportunity costs to market structures (perfect competition, monopoly) and government intervention. It explores macroeconomic objectives, the circular flow of income, and the four major areas of finance. The report also analyzes interest rate determinants, the purpose and format of key financial statements (balance sheet, income statement, cash flow statement, and statement of shareholders' equity), and capital budgeting techniques like net present value (NPV), alongside an examination of yield curves. Furthermore, it provides a ratio analysis of Marks and Spencer for the year 2014, offering a practical application of the financial concepts discussed.

Financial and Economic
Literacy for Managers

Table of Contents
Question 1......................................................................................................................................4
a) Three classifications of production with examples................................................................4
b) Opportunity costs with examples...........................................................................................4
c) The purpose and evolution of the UK standard industrial classification (SIC) since 1948...5
d) The shift in the demand curve and the movement along the demand curve along with
diagram.......................................................................................................................................6
e) The income and substitution effect of an increase in price....................................................7
Question 2......................................................................................................................................8
a) Two types of markets with examples.....................................................................................8
(b) Public good with example....................................................................................................9
c) Three ways in which government intervenes in the market including examples..................9
d) Four key macroeconomic policy objectives that governments typically pursue.................10
e) The circular flow of income including the inner flow, withdrawals and injections............10
Question 3....................................................................................................................................11
a) Examples of each of the four major areas of finance...........................................................11
b) Determinants of market interest rates including the various types of risk premiums..........11
c) Four basic financial statements, including formats and purpose.........................................12
d) Ratio analysis of Marks and Spencer for 2014....................................................................12
Question 4....................................................................................................................................13
a) Importance of capital budgeting decisions and purpose of use............................................13
b) Use of net present value (NPV) technique to make investment decisions..........................13
c) Yield curve including the reasons why yield curves differ..................................................14
d) Selection of project on the basis of Net present value tactic...............................................14
REFERENCES.............................................................................................................................17

Question 1
a) Three classifications of production with examples
Three main types of production are Job Production, Batch production and Mass or flow
production
Job Production: The cited production method is one where manufacturing companies
produces special or non-standardized products as per the orders placed by customers. For
example: The method is used in ship, dam or bridge building, book printing, wood working
shops, metal fabrication shops etc (Chen, 2010).
Batch production: This method is used to manufacture identical products on the basis of
current and expected demand for products in advance (Chen, 2010). The example are small
hand tools such as drill, screw driver, bakeries, tinned food etc.
Mass or flow production: Here mentioned method of production includes continuous
production of standardized products in a large volume. This method is mostly used to reduce
direct manufacturing cost. For example food, chemicals, and household appliances and
automobiles (Armendáriz and Morduch, 2010).
b) Opportunity costs with examples
Opportunity cost is considered as a fundamental cost in economics, which denotes to the
value forgone, for the purpose of making one specific investment instead of another. The cost is
significantly used to compute cost benefit analysis of a project. Generally, such cost is excluded
from accounting books, however, is recognized in decision making process through calculating
cash outlays and profit or loss gained by a business as an impact of opportunity cost. In terms of
economics, opportunity cost is associated with optimal use of scare resources to resolve issue of

scarcity. Illustration: An individual has £10,000, which can be either invested in XYZ’s
company’s stock or can put towards a post graduate degree. However, the person has chosen to
invest in stocks, then, opportunity cost is the increased lifetime earnings which might have
resulted from completing post-graduation degree. Hence, individual forgo the increase in
earnings as he purchased stock.
c) The purpose and evolution of the UK standard industrial classification (SIC) since 1948
A Standard Industrial Classification (SIC) was familiarized into the UK in 1948 which
has a purpose of classifying business institutions according to the type of economic activity in
which they are engaged. This framework is used by regulatory bodies to classify industrial
activities into a common structure. Since 1948, there have been number of revision in SIC UK
because new products and industries came into force. UK SIC Codes are helpful in identifying
the line of business in which company operates and it is also necessary to fill company’s annual
return.
Figure 1 Timeline for Standard Industrial Classification (SIC) in the UK since 1948

Figure 2 Changes from UK SIC 2003 to UK SIC 2007
d) The shift in the demand curve and the movement along the demand curve along with diagram
The shift in demand curve occurs when the perception of customers changes about the
worth of a product. In case customers want to pay higher prices for a product or they want to
purchase then, demand curve shifts to the right. But in case, they want to purchase less they
curve shifts to the left.

Figure 3 Shift in Demand Curve
(Source: Pettinger, 2008)
To the other hand, movement in the demand curve occurs at the time when the price of a
product changes. For an illustration, when manufacturer raises or lowers the price of particular
good and services, the demand curve moves
Figure 4 Movement along Demand Curve
(Source: Pettinger, 2008)
e) The income and substitution effect of an increase in price
The income of customers and substitute effect are seen when the income of consumer
changes and there are substitute available in the marketplace. The increase in price of a
particular product decreases the disposable income however, the lower income can significantly

reduce demand that is known as an income effect. On the other hand, substitution effect is on
where an increase in the price encourages customers to purchase alternative goods. As per a
substitution affect, the high price of a product as compared to substitute product encourages
individual to use other goods.
Figure 5 Income and substitute impact of wages
(Source: Pettinger, 2013)
Question 2
a) Two types of markets with examples
Within the scenario of market economics, different market systems exists and depends
on industry and companies within the industry. There are different market systems includes
perfect competition, monopoly, oligopoly, monopolistic competition and monopsony. Here are
two main markets:

Perfect Competition
Perfect competition is a market where many buyers and sellers exists in the market,
however, as per classical definition infinite number of buyers and sellers exist in the
marketplace. Due to existence of many competitors, it is impossible for a company to alter the
prevailing price. In such market, strong competition is found therefore, buyers have various
option to purchase products.
Monopoly
The monopoly market is totally opposite from perfect market system as there are
number of buyers exist but the seller is only one who produces particular goods, hence, no
reasonable substitute for product is found in the market. In this regard, monopoly firms are free
to charge prices as they want. For example
(b) Public good with example
The definition of public good explained it as an economic good which possesses two
main properties such as non-rivalrous and non-excludable. In general terms, public goods are
those used by a society at large. The theory of public goods represents public goods as a goods
which are collectively consumed by public at a large extent. These goods include clean air,
defense services, and judiciary, street lights, as so on. Including this, goods are those which are
financed by business owners and government, in return public is charged via taxes. No
competition is found in providing public goods as these are supplied to everyone.
c) Three ways in which government intervenes in the market including examples
There are various reasons for which government intervenes in the market, among them,
one is when government wants to overcome market failure and to do so it spend on education

and training so as to reduce occupational immobilities. In addition to this, government reduces
regulations on trade so that entities can work in the market more freely. For an illustration,
power of trades unions are reduced so that labour market inflexibility can be overcame. The
major areas of government intervenes are the changes held in fiscal and monetary policy
(Arestis, 2011). As an impact of fiscal policy government reduces the level of spending and
taxation, whereas monetary policy influences supply and demand for money for which
regulatory bodies make changes in interest rates.
d) Four key macroeconomic policy objectives that governments typically pursue
The government changes microeconomic policy for various purposes. The main aim of
modern macro-economic policy makers is to attain stable and sustainable economic growth and
development. Including this, macroeconomic policy objectives of government includes stable
prices, Full employment, balance of payments and an equal distribution of income. These are
four main macroeconomic policy objectives that are pursued by government. However, these
are used to stabilize the economy and boosting GDP (Blanchard Dell’Ariccia and Mauro, 2010).
e) The circular flow of income including the inner flow, withdrawals and injections
The circular flow of income represents a connection between various activities of
economy on which basis national income or Gross Domestic Product are computed. It has been
witnessed that all the incomes flows from households to businesses directly, however, some part
of income put aside as savings (S), some of sent to government as taxation (T) and some seen in
terms of imports. As a link, withdrawals increases savings, taxes or imports hence, reduces
circular flow of income. Other side, injections into circular flow are witnessed to be additions to
investment, government spending or exports which lead to boost in circular flow of income and

output increases. Nonetheless, where rate of injections equals to the rate of withdrawals then
equilibrium in economy is found.
Question 3
a) Examples of each of the four major areas of finance
Finance is the most important part of business which helps in gaining success. There are
major four areas of business finances including Corporate Finance, Investments, financial
Markets and financial Institutions. The corporate finance area includes actions of company
taken to make viable decisions about financing. For example, this area includes budgeting,
working capital management, financial analysis etc. Investment is an area of business
management where firm invest range of short and long-term securities to get good returns. The
stock and bond market (money and capital markets) as well as the primary and second markets
are included in financial markets. At the end financial institutions are the areas of finances
which play a crucial role as intermediaries between businesses and savers (Baker Singleton and
Veit, 2011).
b) Determinants of market interest rates including the various types of risk premiums
The total interest rate is a sum of major five smaller part, which is determined by own
set of factors. These five determinants of interest rates are real risk-free rate, Expected Inflation,
Default-Risk Premium, Liquidity Premium and Maturity Premium. The risk free rate of return
shows the riskiness of securities (Verdelhan, 2010). These above are main four types of risk
premium in which inflation premium is one under which investor add real risk free rate of return
as inflation has a major impact on interest rates. Default risk premium is a difference between
interest rates on US bond treasury and corporate bond of a similar maturity and marketability.

The liquidity premium is which is added to a rate of security if it is not converted into cash, and
maturity risk premium reflects interest rate risk (Carr and Yu, 2012.).
c) Four basic financial statements, including formats and purpose
Statement of financial position: It is also called as Balance sheet which purposes at
providing information about financial position of a business entity at the end of specific time
period. It includes information about assets, shareholder equity and liabilities owned by a
business (Healy and Palepu, 2012)
Statement of Income /Profit and Loss Account: The main purpose of preparing profit
and loss account is to gain information about business profitability for a specific time span. It
provides information in respect with incomes and expenses and main components are gross
profit, net profit and operating profits.
Cash flow statement: The cash flow statement aims to offer information regarding
inflows and outflows of a business for a particular time period. The major components of cash
flow statements are activities such as financing, investing and operating (Fridson and Alvarez,
2011).
Statement of shareholders' equity: This financial document highlights changes in
shareholders’ equity within a specific time period. The main purpose of identifying the increase
and decrease owners or shareholders fund.
d) Ratio analysis of Marks and Spencer for 2014
Ratio Analysis for Marks and Spencer for 2014 £m
Liquidity ratios
Current assets 1,368.50
Current liabilities 2,349.30
Current ratio Current Assets / current 0.6

Liabilities
Asset management
ratios
Net revenue 10310
Total Assets 7903
Total Assets turnover
ratio
(Net revenue/ Total
Assets) 1.30
Debt management
ratios
Debt 2,847
Equity 2706
Debt Equity Ratio (Debt/ Equity) 1.05
Market value ratios
Price to book value
Stock price per share /
shareholder equity per
share 2.8
(Annual report of Marks and Spencer, 2014)
Question 4
a) Importance of capital budgeting decisions and purpose of use
In general scenario, capital budgeting is a process which is used by corporate entities to
evaluate and rank the potential expenditures or investments and to choose the optimal one. The
main purpose of using capital budgeting tactics is to calculate future accounting profit of each
investment projects while considering the time value of money. The importance of capital
budgeting decisions is in identifying the viability of investment project so that a profitable
investment can be chosen (Bierman and Smidt, 2012). The capital budgeting decision are
important in maximizing future profits of business.
b) Use of net present value (NPV) technique to make investment decisions
Net present value is a famous capital budgeting tactic which is used to assess the
viability of projects. The importance of this tactic is because it considers time value of money of
a project. To calculate net present value two input are taken including projected net cash flows

in upcoming period and targeted rate of return (Wiesemann, Kuhn and Rustem, 2010). It also
consider projects costs and returns so as to determine if it will give positive return.
Formula of calculating NPV
In case of even cash inflows
NPV = R
×
1 − (1 + i)-n
− Initial Investment
i
In case of uneven cash inflows
NPV
=
R1
+
R2
+
R3 + ..
.
− Initial Investment
(1 + i)1 (1 +
i)2 (1 + i)3
c) Yield curve including the reasons why yield curves differ
Yield curve, in general words is termed as the "structure of interest rates," is a graph
which shows the yields of similar-quality bonds against to their maturities. It moves from
shortest to longest durations. It can be positive and negative, as a yield curve indicates that a
higher rate of return is required by investors which will add the risk of lending money in longer
time span (Bowsher and Meeks, 2012). The major reason of differing Yield curve is the
different interest rates.
d) Selection of project on the basis of Net present value tactic.
Table 1 NPV for Project A

Years
Projec
t A($)
Discounting
rate of 10%
Present value for
discount factor
rate for Project
A ($)
Year 1 15,625 0.909 14,203
Year 2 15,625 0.826 12,906
Year 3 15,625 0.751 11,734
Year 4 15,625 0.683 10,672
Year 5 15,625 0.62 9,688
Total
present
value
59,203
Initial
investment 50000
Net
Present
value
9,203
Table 2 NPV for Project B
Years
Projec
t B($)
Discounting
rate of 10%
Present value for
discount factor rate
for Project B ($)
Year 1 0 0.909 0
Year 2 0 0.826 0
Year 3 0 0.751 0
Year 4 0 0.683 0
Year 5 99,500 0.62 61,690
Total
present
value
61,690
Initial 50000

investment
Net
Present
value
11,690
The Net present value method is used to assess o asses the viability of two mutually
exclusive projects. The value of calculation represents a higher Net present value for Project B
i.e. ($) 11900 on the other hand, NPV for Project B is ($) 9203. According to Net present value
method, the project with higher NPV method is to be selected. Here, in respect with present
case, Project B is to be selected because it has higher Net present value as compared to Project
A.

REFERENCES
Books and Journals
Arestis, P., 2011. Fiscal policy is still an effective instrument of macroeconomic
policy. Panoeconomicus. 58(2). pp.143-156.
Armendáriz, B. and Morduch, J., 2010. The economics of microfinance. MIT press.
Baker, H.K., Singleton, J.C. and Veit, E.T., 2011. Survey research in corporate finance:
bridging the gap between theory and practice. Oxford University Press.
Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of
investment projects. Routledge.
Blanchard, O., Dell’Ariccia, G. and Mauro, P., 2010. Rethinking macroeconomic
policy. Journal of Money, Credit and Banking. 42(s1). pp.199-215.
Bowsher, C.G. and Meeks, R., 2012. The dynamics of economic functions: modeling and
forecasting the yield curve. Journal of the American Statistical Association.
Carr, P. and Yu, J., 2012. Risk, return, and Ross recovery. Journal of Derivatives. 20(1). p.38.
Chen, Z.L., 2010. Integrated production and outbound distribution scheduling: review and
extensions. Operations Research. 58(1). pp.130-148.
Fridson, M.S. and Alvarez, F., 2011. Financial statement analysis: a practitioner's guide (Vol.
597). John Wiley & Sons.
Healy, P.M. and Palepu, K.G., 2012. Business Analysis Valuation: Using Financial Statements.
Cengage Learning.
Sinclair, D.R., 2010. Capital budgeting decisions using the discounted cash flow
method. Canadian Journal of Anesthesia/Journal canadien d'anesthésie. 57(7). pp.704-
705.
Verdelhan, A., 2010. A habit‐based explanation of the exchange rate risk premium. The Journal
of Finance. 65(1). pp.123-146.
Wiesemann, W., Kuhn, D. and Rustem, B., 2010. Maximizing the net present value of a project
under uncertainty. European Journal of Operational Research. 202(2). pp.356-367.
Online
Annual report of Marks and Spencer, 2014. [Pdf]. Accessed from <
http://corporate.marksandspencer.com/investors/b73df1d3e4f54f429210f115ab11e2f6Acc
essed on: 27th July 2016]
Pettinger, T, 2008. Shift in Demand and Movement along Demand Curve. [Online]. Accessed
from < http://www.economicshelp.org/blog/581/economics/changes-in-demand/>.
[Accessed on: 27th July 2016]

Pettinger, T, 2013. Income substitution effect. [Online]. Accessed from <
http://www.economicshelp.org/blog/glossary/income-substitution-effect/>.[Accessed on:
27th July 2016]
UK SIC Code. 2016. [Online]. Accessed from < http://siccode.com/en/pages/what-is-a-uk-sic-
code>.[Accessed on: 27th July 2016]