Financial Principles and Techniques: Innovetec Ltd Case Study Report

This report examines the financial principles and techniques applied to Innovetec Ltd. It begins by analyzing the importance of costing in pricing strategies, designing a cost system, and exploring cost reduction ideas, including the potential use of activity-based costing. The report then delves into sources of finance, forecasting techniques for cost estimation, and budgeting processes, including variance analysis and budgetary monitoring. Investment appraisal techniques like payback period and net present value are calculated and recommendations are provided. Finally, the report includes a comparative analysis of financial statements from Tesco Plc and Sainsbury, offering recommendations and discussing the limitations of relying solely on financial information for decision-making. The report covers various aspects of financial management, providing a comprehensive overview of Innovetec Ltd's financial strategies and performance.

MANAGING FINANCIAL
PRINCIPLES AND
TECHNIQUES

TABLE OF CONTENTS
INTRODUCTION......................................................................................................................1
ACTIVITY 1..............................................................................................................................1
1.1 Importance of costing in to pricing strategy of Innovetec ltd.....................................1
1.2 & 4.1 Designing a cost system for Innovetec ltd and cost reduction ideas regarding
same..................................................................................................................................3
4.2 Potential use of activity based costing for Innovetec ltd............................................4
2.2 Sources of finance for Innovetec................................................................................5
ACTIVITY 2..............................................................................................................................6
2.1 & 3.1 Forecasting technique to estimate cost and expected return and setting a
budgetary target for an organization.................................................................................6
3.2 Budgeted cash flow for first six months.....................................................................7
3.3 Reasons due to variance comes when budget is compared with actual results..........8
3.2 Budgetary monitoring process....................................................................................8
Tasks 5.1 Calculation of Pay-back period and net present value...................................10
AC 5.2 Recommendations..............................................................................................12
AC 5.3 Commercial factors relevant to the investment decisions..................................12
ACTIVITY 4............................................................................................................................13
Comparative analysis of the company's financial statements........................................18
Recommendations...........................................................................................................19
AC 6.3 Limitations of decisions that are based on financial information only..............20
CONCLUSION........................................................................................................................20
REFERENCES.........................................................................................................................22
INDEX OF TABLES
Table 1: Mater budget................................................................................................................6
Table 2: Calculation of profits and cash flows...........................................................................8
Table 3: Calculation of profits and cash flows...........................................................................9
Table 4: Calcualtion of NPV....................................................................................................10
Table 5: Ratio analysis of Sainsbury........................................................................................13
Table 6: Ratio analysis of Tesco Plc .......................................................................................14

INTRODUCTION
Finance plays a very important role in the organization success. Every organization is
required to have adequate availability of funds to run the business operations in a possible
manner. The present report will helps us in identifying the finance sources available to the
Innovetec Company. Further, cost and pricing decisions and its role in the business success
are also analysed in this report. Moreover, the budgeting process, preparation of budget and
variance analysis also has taken place. Variance is computed through identifying the
difference between actual and budgeted results. It helps to take effective business decisions.
In addition to it, different investment appraisal techniques such as payback period method
and net present value method also discuss in this report. At the end of the report financial
statements are analysed of two retail sector companies Tesco Plc and Sainsbury so as to take
decisions for making investment.
ACTIVITY 1
1.1 Importance of costing in to pricing strategy of Innovetec ltd.
Costing plays a very important role in the pricing strategy of the firm. This is because
it is the cost by using which any firm determines its own pricing strategy. With change in cost
firm pricing strategy also change. If any firm adopt a cost control measures then its cost of
production of reduced. Consequently it’s also change its pricing strategy. Thus, it can be said
that cost has a very high importance to the pricing strategy of the firm. In highly competitive
business environment it becomes necessary for the firms to give stiff competition to the
competitors. Innovetec is operating in market in which there are many competitors which are
offering innovative products at a low price in comparison to features (Abernethy, Lillis,
Brownell and Carter, 2001). Hence, Innovetec is going to launch a new mobile which is
totally different in features and it also needs to launch its product at low price in order to
make its product acceptable in the market. Hence, this target indicates that cost has a due
importance in the pricing strategy of Innovetec ltd pricing strategy. In order to reduce cost
firm needs to generate economies of scale. It can be generated by using supply chain
management techniques and cost concepts. Economies of scale refer to saving in cost that
comes in existence due to purchase of raw material in bulk or implementing any cost
reduction technique in an organization (Attwell and Laughlin, 2001). According to
economics as a discipline total cost is a combination of variable and fixed cost. Fixed cost
refers to the cost that does not get changed with change in production. On other hand,
variable cost is a cost that changes with change in a production. This means that if production

will increase then variable cost will also increase vice-verse. So, most of the firm increase
their production level up to certain limit in order to reduce variable cost to maximum level
(Definition of economies of scale. 2015). Hence, as production increase variable cost of the
firm decline but fixed cost remain same. Due to this reason cost of production also reduced.
Apart from this, firm can make change in its supply management strategies. This will help
firm in reducing its transportation or logistics cost (Blocher, Chen and Lin, 2008). Due to
adoption of these measures cost of production per unit will be reduced for then firm. Hence, it
can be said that Innovetec ltd can adopt these techniques in order to reduce its production
cost.
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1.2 & 4.1 Designing a cost system for Innovetec ltd and cost reduction ideas regarding same
Cost system refers to the process which a firm is using to compute cost of production
for its products. A costing system is mainly used by the management to monitor their cost of
production. It is also used to ensure that cost is incurred in line to the standards determined by
the management. In management accounting there are several costing systems and some of
them are as follows
1. Job order costing- This cost system is used when a firm is producing a multiple
products. In this costing system separate cost is prepared for each and every product
line. Firms mostly use this costing system when its multiple products produced are
different from each other on usage and features (Cagwin and Bouwman, 2002). This
costing system is also used when firm is receiving orders for production of goods. In
other words, it can be said that mentioned costing system is used by the firm when
they receive order for production of specific quantity of goods from various clients.
Due to this unique feature mentioned costing system is widely used by the business
firms.
2. Process costing- This costing system is entirely different from batch costing because
in this mode of costing on process basis cost of production is determined. Means that
for producing a specific product many steps are performed (Dey, 2006). So in this
costing system cost of each and every step of production is considered for computing
final cost of production. In this costing system cost of production is determined in a
legitimate manner and due to this reason this method of costing is popular among
manufacturing firms.
3. Traditional costing system- This is old method of costing under which a rate is used
to determine cost of production. Means that different departments are involved in the
production process. So rate is determined for each of these departments and by suing
same cost of each department is determined by the cost manager. This feature is major
limitation of the costing system. With change in business environment cost of raw
material also changed (Drexler, Black and Sparks, 2013). These changes taken place
overnight. But overnight it is difficult to determine new rates of costing for each
department. Due to determination of wrong percentage wrong cost will be calculated
and due to this reason firm may face heavy loss in the business. Hence, due to this
limitation this technique is not used by the companies at the workplace.
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4. Activity based costing- This is unique costing system in which cost of each and every
activity performed for producing specific product is determined by the cost
accountant. After identification of activity cost for each and every activity that is
performed in production process is determined by the managers. Cost for these
activities is determined on the basis of use of resource done by these departments.
On the basis of evaluation of these costing system it can be said that activity based costing is
better for the firm (Garrison, Noreen and Brewer, 2003). This is because in mobile
manufacturing several tasks are performed in sequence. Hence, by determining cost of all
these activities cost of production can be determined. Hence, it can be said that this costing
system will be suitable for Innovetec ltd.
There are many ways that can be adopted in order to reduce cost. Some of them are as
follows.
 Analysis of activities- In activity based costing several activities are performed. In
this method of cost reduction each and every activity will be analyzed. Main focus
will be on identifying sub unproductive task in each activity. Elimination of these
activities from production process will reduce both time and cost for the firm. In this
way cost of production will be reduced for the firm (Healy, 2002).
 Management audit- It is a technique in which top managers analyse costs where firm
makes extravagance. After identification of such kind of costs managers identify the
reason due to which these over expenses co0mes in to existence. After identification
of reasons management identify the ways that can be adopted in order to prevent
repetition of such kind of mistakes (Horngren and et.al, 2002). Hence, this technique
is also very effective in cost control.
4.2 Potential use of activity based costing for Innovetec ltd
There are many uses of activity based costing and due to this reason this method is
widely used by the business firms. This technique compute cost of production in proper
manner in comparison to other costing techniques. This is because for producing goods
resources are required and these resources may be people working in an organization and
resources that are used for producing goods at the workplace (Huber, 2011). Basically
resources are used for producing goods and computation of their cost directly helps firms in
calculating cost of production. So, due to this reason this method of costing is assumed better
than other costing techniques. On other hand, by analyzing previous months activity based
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costing data managers can identify resources whose consumption is increasing, decreasing or
remain stable in the production. Hence, on the basis of analysis of these trends managers gets
lots of information (Kaplan and Atkinson, 2015). They also get a direction on which they
need to work in order to control cost of production. So, it can be said that this costing
technique has a varied use for the business firms.
2.2 Sources of finance for Innovetec
There are many sources of finance and these sources may be divided in to two
categories one is internal and second is external sources of finance. These categories of
sources of finance are described below.
Internal sources of finance Retained earnings- It is a part of profit that remains after paying all expenses from
the revenue. There is cost of this source of finance and due to this reason this source
of finance is widely used by the firms. Sale of asset- Sale of asset is another common internal source of finance that is
widely used by the firms when an asset is not generating sufficient returns for the firm
or it remain idle for the firm for long time period (Kaplan and Schoar, 2005). There is
not cost of this source of finance which is major reason due to popularity as a source
of finance among large corporations.
External source of finance Equity- Under this source of finance firm raised a capital from the market by bringing
IPO or FPO. For doing this it needs to pass some criteria that are determined by the
recognized stock exchange. In this source of finance cost can be adjusted and due to
this reason this source of finance is widely used by the firms. Debentures – It is a written acknowledgment of debt taken by the firm from the
public. In return firm need to pay interest to the debenture holders. In this source of
finance, finance cost cannot be adjusted (Kennedy and Affleck-Graves, 2001). Due to
this reason equity is mainly prefer above debentures.
 Hire purchase agreement- Under this agreement firm takes an asset on lease. It pay
lease amount on regular interval. If lease amount cumulatively become equivalent to
the price of the leased asset then it is amused to be purchased by the lessee (Koltai
and et.al, 2000). So, it can be said that in this source of finance by making payment in
instalments an asset can be purchased by the firm.
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ACTIVITY 2
2.1 & 3.1 Forecasting technique to estimate cost and expected return and setting a budgetary
target for an organization
Forecasting technique that Innovetec can use in the business is as follows. Cash flow forecast – In order to estimate cost and revenue for upcoming time period
technique of preparing a cash flow statement can be used by the Innovetec. Under this
technique a projection for cost and revenue is prepared. For this a technique of
financial modelling is used by the firm in which by using old data forecast for
upcoming month or year is prepared by the finance manager. In order to predict
output economic environment is analyzed by using economic data like GDP, IIP and
PMI. On the basis of output estimation revenue amount is envisaged by the firm (Lee,
Ellenbecker and Moure-Ersaso, 2004). After that first old data is taken and some
calculations regarding same is done. Cost covers a fixed percentage of sales. Even
sales increase or decrease this proportion remains same. Hence, in this technique
Innovetec will use revenue that it computes in early stage. After doing this it will use
cost percentage that was determined by doing calculation on old data to compute or
predict cost for upcoming time period. In this way cost and revenue will be
determined by the firm under this forecasting technique.
 Forecasting prices movement of metals using indices- Innovetec is using metals for
producing mobiles. Thus, change in price of these metals brings changes in the cost of
production of the firm. Due to this reason it becomes necessary for the firm to predict
price changes because it directly affects firm cost and revenue. In order to forecast
changes in price of base metals managers can review change in LME indices of base
metals (Marginson and Ogden, 2005). Changes in the price of these indices will
indicate the direction in which price of these metal may go. In order to confirm this
trend manager can use concept of open interest. It is a terminology that is used in
commodity market. This terminology indicates the number of fresh contracts that are
newly opened in the market. Increase in open interest indicates that fresh money is
introduced in the market. Similarly, decrease in open interest indicates that fresh
money is coming in market at slow pace. Means that in upcoming months price may
fall or grow at a slow rate (Maskell and et.al, 2007). By using such kind of data cost
of raw material can be estimated and by using this cost of raw material will be
determined. On other hand, increase in cost cannot be passed to consumers. Hence,
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trends in price change can be used to predict firm revenue. In this way, index helps
firm in determining cost and profit of then firm.
Setting a budgetary target requires determination of cost and revenue of the firm.
Revenue of the firm is directly affected by the economic environment. Hence, change in
economic environment affects revenue of the firm. Due to this reason before preparing a
budget economic environment must be analyzed. On the basis of analysis revenue amount
must be determined in the budget (Mayer, Schoors and Yafeh, 2005). Firm must consider old
budget performance and economic data of GDP, PMI and IIP for estimating accurate amount
of revenue for the budget. By using economic data and previous month cost sheet firm can
estimate cost for the budget. Hence, in this way budgetary target can be set for an
organization.
3.2 Budgeted cash flow for first six months
Table 1: Mater budget
Particulars Price(£) Jan(£) Feb(£) Mar(£) Apr(£) May(£) Jun(£)
Number of units 24000 2000 2100 2200 2500 2600 2900
Cash from sales 400 800000 840000 880000 1000000 1040000 1160000
9600000
Variable Costs
Direct material 50 100000 105000 110000 125000 130000 145000
Direct Labour 20 40000 42000 44000 50000 52000 58000
Selling Costs 10 20000 21000 22000 25000 26000 29000
Total Variable
costs 160000 168000 176000 200000 208000 232000
Fixed Costs
Production OH 450000 37500 37500 37500 37500 37500 37500
Administration OH 288000 24000 24000 24000 24000 24000 24000
Selling OH 180000 15000 15000 15000 15000 15000 15000
Total Fixed Costs 76500 76500 76500 76500 76500 76500
Total Costs 2838000 236500 201500 201500 201500 201500 201500
Net cash flow 6762000 563500 638500 678500 798500 838500 958500
Opening balance 0 563500 1202000 1880500 2679000 3517500
Closing Balance 563500 120200 1880500 2679000 3517500 4476000
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0
Interpretation
On analysis of budget it can be seen that management think that with passage of time
sales of the firm will increase. Due to this reason it increases its production of goods. With
increase in production cost keeps on changing which is variable in nature. But fixed cost is
same with change in level of output. Due to continue increase in sale and stability in growth
rate of cost of the firm closing balance is increasing. Hence, it can be said that firm is
performing well.
3.3 Reasons due to variance comes when budget is compared with actual results
Mostly it has been seen that when budget is compared with actual results variance
comes in existence. This variance may be positive or negative in nature. It is very difficult to
predict change in economic environment in accurate manner. With change in economic
environment cost of raw material and sales of the firm also get changed. Hence, actual results
do not come in line to budget prepared (Mestry and Naidoo, 2009). If variance is positive
then there is no problem but if variance is negative then management needs to take action
immediately in order to ensure that mistakes will not committed again which was responsible
for variance in the budget.
3.2 Budgetary monitoring process
Following is a process that is followed for monitoring a budget. Determination of standard- In this stage a standard is prepared for the budget. These
standards are determined by the managers by considering various economic data and
company past performance in several business situations (Olawale, Olumuyiwa and
George, 2010). These are use by the firm in later stage in order to identify company
performance. Measurement of performance- After a specific time period performance of the
company is identified on the basis of values or unit. This period may be three months
or a year. Comparison with standard- In this stage actual figures that were identified in earlier
stage is compared with budgeted figures in order to identify that company perform
better or worse.
 Taking corrective action- In this stage if variance is negative then corrective actions
are taken in order to make sure that mistakes committed in this stage will not be
committed again in future (Panayotidis, Montesanto. and Orfanidis, 2004).
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ACTIVITY 3
As per the given scenario, Innovetec has an investment propsoal that requires initial
investment amounted to 600000£ for production of expa4. The revenue and operating cost for
five years are given. Therefore, the profits can be calculated by subtracting the business cost
to its total revenue. Further, for calculating the cash flows, amount of depreciation will be
added to the profits.
Calculation of annual depreciation as per the straight line method
Depreciation = Total initial investment – Scrap value/ Estimated life
Total Initial investment = 600000£
Scrap value = 50000£
Estimated life of the project = 5 year
Annual depreciation = (600000£ - 50000£) / 5 year
= 550000£/5
= 110000£
Calculation of profits and cash flows:
Table 2: Calculation of profits and cash flows
Year Revenue
Operating
cost Profit Depreciation Cash flow
1 250000 110000 140000 110000 250000
2 350000 115000 235000 110000 345000
3 450000 115000 335000 110000 445000
4 250000 150000 100000 110000 210000
5 250000 150000 100000 110000 210000
Total 910000
Tasks 5.1 Calculation of Pay-back period and net present value
Different types of investment appraisal techniques are available to organization for
taking effective decisions (Carmichael, 2011). It includes pay-back period method and net
present value method that are described as below:
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Pay-back period = It is the time period that the project will take to get an initial investment
of 600000£. Lower the pay-back period of investment, to a high extent, the proposal will be
good for company (Irani, 2010). The pay-back period for the given scenario is calculated here
as under:
Table 3: Calculation of profits and cash flows
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