Breakeven Analysis and Budgeting for Washbug Ltd: A Comparative Study

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Accounting and Financial Management
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Contents
Introduction...........................................................................................................................................3
Part A....................................................................................................................................................4
1.........................................................................................................................................................4
2.........................................................................................................................................................7
3.........................................................................................................................................................8
Part B.....................................................................................................................................................9
1).......................................................................................................................................................9
2).....................................................................................................................................................10
Part C...................................................................................................................................................11
1.......................................................................................................................................................11
2.......................................................................................................................................................11
3.......................................................................................................................................................12
Conclusion...........................................................................................................................................13
References...........................................................................................................................................14
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Introduction
Financial statements are prepared by the management to quantify the results of the business
operations of the company over a period of time. For management purposes, the financial
information contained in such statements is required to be manipulated and thus are made
more presentable and understandable for the decision-making process. Such changes are
made through the use of management accounting tools and techniques such that various
arithmetical and predictive tools are applied to such information. The purpose of the
assignment is to understand such tools and thus gain an understanding of the application of
such tools in different scenarios. Such management tools may be in the form of ration
analysis (cross-sectional and time comparison), enabling the company to assess and compare
the performance of the company or through the use of a breakeven model which provides the
company with the clear picture of profitability and cost structure of the business operations.
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Part A
1.
The purpose of the report is to discuss and analyse the performance of the Fridgefreeze PLC
and thus analysing their profitability and liquidity position over a period of 2 years. Financial
ratios help the company to understand and analyse the current company capabilities and
performance and hence help it compare it with its competitors and industry standards.
Profitability
Particulars 2018 2017
Net Margin 12.70% 26.06%
Operating Margin 19.42% 33.74%
Gross Margin 48.66% 53.56%
One of the essential financial indicators for the performance of the company e is the
profitability and the performance of the company over the year. It can be seen from the data
the profitability of the company has increased over the past two years. Gross margin of the
company has shown a marginal increase from 48.66% to 53.56%, indicating that the
company has increased its efficiency in regards to the manufacturing process. Operating
margin has also shown a significant increase from 19.42% to 33.74%, suggesting that the
administration efficiency e and business processes effectiveness has increased over the year.
The net margin of the company has increased two folds such that it is increased from 12.70%
to 26.06%, suggesting that it the overall profitability of the company e has shown a
significant increase over the years (Robinson, et. al., 2015).
Asset Utilisation
Particulars 2018 2017
Return on Asset 11.39% 23.61%
Asset Turnover
0.9
0
0.9
1
Asset utilisation is also shown an important key indicator of the operational efficiency of the
company. Such matrix will basically help the management to understand, how well the
company has been utilising the assets in its operations. Return on the asset has increased two
folds such that it is increased from 11.39% to 23.61% over the two years suggesting that the
company has been utilising assets at optimum efficiency enabling them to earn such high
return. Asset turnover ratio has, however, remained the same over the period of 2 years, at 0.9
, suggesting that the utilisation of asset in generating revenue has been consistent and
efficient over the period of 2 years (Brigham and Houston, 2012).
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Liquidity
Particulars 2018 2017
Current Ratio
1.4
3
1.4
0
Quick Ratio
0.7
0
0.7
9
Liquidity of the company helps the management to pay off its debts in a timely manner and
as and when required. Liquidity ratios help the management to ascertain the company's
ability to pay off its debts and thus its creditworthiness in the market (Grant, 2016). The
current ratio is the basic liquidity ratio suggests the company's solvency position and hence is
the most important factor in analysing the company's creditworthiness. To assess a company's
ability to pay off its debts immediately and on more short notice, liquidity ratio may be used.
From the above data, it can be concluded that the liquidity position of the company has
remained the same over the years as the current ratio and quick ratio I have remained the
same.
Investor Potential
Particulars 2018 2017
Earnings Per Share
0.1
9
0.3
2
Return on Equity 16.35% 30.68%
Dividend Pay-out
0.4
3
0.2
7
One of the main objectives of the company e is to increase its shareholder's value in the
market and thus, as a result, attract more potential investors for the company. For this
purpose, investors usually look into the earnings per share of the company. EPS of the
company e has increased from 0.19 to 0.32 over the year, suggesting an increase in the
investor's value over the period. Return on equity e has also increased from 16.35% to
30.68%, suggesting that the company has been providing investors with more return over the
period (Piotroski and So, 2012). But it is considered that the dividend payout has decreased
from 0.43 to 0.27, suggesting that the company has been paying less from its earnings, and
retaining the majority of its earnings for future projects and needs.
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Gearing
Particulars 2018 2017
Debt/Equity
0.1
5
0.0
5
Degree of Financial Leverage
1.2
9
1.0
4
Gearing suggests the company's preference of procurement of funds such that it gives more
preference to one method than the other. Debt equity ratio helps in identifying the proportion
of debt over equity and hence helps in analysing the finance cost burden on the company. It
can be seen that the company has reduced its debts and thus debt-equity ratio as shown a
marginal decrease over the year. Degree of financial leverage helps the company to analyse
its ability to cover its finance cost through its earnings. Degree of financial leverage as also
shown a slight decrease over the year, due to the reason that the company has been paying off
its debts (Schrand and Zechman, 2012).
From the above analysis, it can be concluded that the company FridgeFreeze PLC has been
performing well for the period and that its stability and performance over the years have
increased over the years (Bragg, 2012). The liquidity position of the company has remained
the same as last year, and thus, the company has been consistent in its policies and strategies.
The profitability of the company has increased over the year, suggesting that the company
has been performing well and holds a dominant position in the market.
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2.
Working Capital Cycle (in Days):
Particulars 2018 2017
Current Assets 12,125 8,935
Current Liabilities 8,480 6,375
Working Capital 3,645 2,560
Annual Sales 38,550 29,950
Working Capital Cycle 0.09 0.09
No. of Days 365 365
Working Capital Cycle (in Days) 34.51 31.20
Working Capital is the funds allocated into the business for carrying out operations and
processes and hence requires procurement and allocation of funds as per the requirements of
the company. Different companies have different working capital requirements, and it
depends on the nature and size of the company. In the given question, the company' working
capital cycle has decreased from 34.51 days to 31.20 days, suggesting that the production
cycle of the company has decreased and the company is now able to pay off the acquired
funds few days before then the last year (Wang, 2014).
Liquidity of the company has no shift from the last year, suggesting that the company has
been consistent in regards to the liquidity position in the given period. Liquidity of the
company can be measured through the current ratio, and quick ratio and both have shown
minimal change over the year. Although the company has maintained the same level of
liquidity, it has been able to increase its sales, suggesting an increase in productivity and
operational efficiency.
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3.
Ratio analysis helps the company to analyse its performance over the years and compare it
with that of the other companies and to the industry benchmarks as a whole. Such analysis
helps the company with cross-sectional comparison (comparison with other companies over a
period of time) or time comparison (with own past performance). But it’s not necessary such
analysis, yields true and accurate results and hence such analysis face certain limitations:
Limitation of Cross-Sectional analysis:
 Size of the Business: Companies differ in sizes and complexities, and hence, it
becomes difficult for them to compare on the basis of the ratio analysis. Conclusions
about the one ratio calculated may or may not apply for all the companies. For e.g.,
one company may be benefiting from economies of scale and thus incurring fewer
costs than other companies (Zeller and Metzger, 2013).
 Different Industries: Company from one industry may not be compared with the
company of another industry as different industries are susceptible to different
circumstances and practices and thus the results of ratio analysis may not apply to
different industries evenly. E.g. working capital requirements and the period for
which the company requires blocking funds in its working capital.
Limitation of Time Comparison analysis:
 Different Market Conditions: A company operates in a dynamic environment such
that the market conditions are ever-changing and thus it doesn't make sense to
compare the past results and to entirely depend on such results to measure the current
performance of the company.
 Historical Analysis: A company follows certain accounting principles and standards
while preparing accounts and hence any change or modification and thus will render
the use of ratios and their comparison to the past ratios ineffective, as it would not
lead to a true and accurate analysis of the company performance (Tsofa, et. al., 2016).
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Part B
1)
Particulars
2017 2018
Amount pu Amount pu
Sales 1,35,00,000 300 1,62,00,000 360
Less: Variable Cost
Direct Material 56,25,000 125 67,50,000 150
Direct Labour 2,25,000 5 2,70,000 6
Manufacturing Overheads 9,00,000 20 10,80,000 24
Selling expenses 6,75,000 15 8,10,000 18
Admin Expenses 4,50,000 10 5,40,000 12
Contribution 56,25,000 125 67,50,000 150
Less: Fixed Costs
Manufacturing Overheads 16,50,000 36.67 16,50,000 36.67
Selling expense 28,50,000 63.33 28,50,000 63.33
Admin Expenses 9,30,000 20.67 9,30,000 20.67
Additional Fixed Costs - - 14,50,000 32.22
Profit 1,95,000 4.33 (1,30,000) (2.89)
Break Even Point (units) 44,350 45,361
Break Even Point (in value) 1,33,05,000 1,63,30,000
Margin of Safety (in units) 650 (361)
Margin of Safety (in value) 1,95,000 (1,30,000)
From the above calculations, it can be seen that the company is incurring a loss in the 2nd year
owing to the increase in the fixed costs, but at the same time is sales price is not increasing in
the same proportion and hence costs increases more than the benefits generated. In 2017,
BEP was achieved at 44,350 units such that the company will attain a position of no profit no
loss at this level of output (Ghahremani, et. al., 2012). On the other hand, it can also be said
that the additional 650 units enable the management to achieve profit and hence can also be
termed as the margin of safety. In 2018, the company was short of 361 units to achieve the
breakeven point, and hence an additional unit sold above that level will be considered as the
margin of safety.
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2)
The breakeven model helps the management to analyse costs on the basis of variable and
fixed costs and hence helps the company to analyse its profitability and productivity for the
given period. However, such model operates on several assumptions which may not be true in
real-life situations and hence may yield inaccurate results. Such assumptions are necessary
for adopting this model as it makes its usage easy and less complicated but may require some
vigilance on management's part. Such assumptions may be:
 The breakeven model works on the assumption that the costs can easily be classified
as variable and fixed costs, which may be highly unrealistic in real-life situations.
Normally, it is difficult for the company to segregate the costs as there are various
uncertainties involved in their incurrence and nature. E.g. Company cannot overlook
semi-variables costs, which are fixed in nature but vary with equal levels of output.
 It also forces the company to assume that the fixed costs will remain constant
throughout, which is not true at all. In the case where machinery is operated
exceeding its capacity limit, and overused will depreciate faster, and hence, this will
lead to an increase in the fixed costs of the company for the period (Marcel, 2014).
 The assumption that the variable cost will always increase in proportion to the sales
price is completely invalid and inaccurate from the economics concepts point of view.
As the output will increase, the company will start incurring less cost due to the
economies of scale, whereby a company is benefitted from the increased production
and thus costs decrease over the period of time.
 Also, such a model does not take into consideration the technological changes and
other unforeseen factors such as disasters, break-downs etc. which are a reality and
common to the business operations. The breakeven model works on the assumption
that the activities will be carried out normally without considering the factors of
uncertainty and accidents.
 Another assumption that operates on is the availability of the labour and at the same
rate over the years. Labour at cheaper cost nowadays is hard to find and varies from
period to period, and hence from business environment perspective constant labour
rate is a wrong assumption and changes invariably from time to time.
 Under the breakeven model, a company assumes that the level of production and sales
is the same, and hence, there is no closing stock at the year-end (Prohorovs, 2014).
This is completely incorrect, as it is very difficult to sell off its goods and very rarely
such a thing occurs. Also, the model fails to incorporate the possibility of wastages
and spillages, which are again the outcome of normal business operations and thus are
required to be considered for accurate results and analysis.
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Part C
1.
A company requires financing to generate funds for carrying out business operations and
processes in order to generate income and hence increase shareholders' value. Finances may
be generated through external sources and internal sources and depend on the nature of
requirement and size of the company.
A most common external source of financing is the Issue of Share Capital (Equity and
Preference) by the company. Equity Shares issue involves the issue of shares in exchange of
the money from the investors and in substance giving them the portion of the company's
management and profits proportionately in accordance with the number of shares and portion
subscribed. Such shareholders are then entitled to dividends in accordance with the profits
earned over the year. Preference shareholders have no such power over the company matters
and receive the benefit of fixed preference shares dividend over the years, not restricted by
the profitability of the company. It is the most efficient way of procuring funds such that it is
the cheapest and hassle-free form of finance. One major drawback of this method is the
dilution of control of the management, which may cause inefficiency in the management of
the company (Robinson, et. al., 2015).
Retained Earnings is the most common form of an internal source of income. It is basically
the ploughed in profits earned by the company over the past years. At the year-end, when a
company earns profits, the company instead of giving it out to shareholders, decided to retain
it for future needs and requirements such as project implementation, business expansion etc.
Instead of the complete amount, the company decides to pay out only a portion of the profits
and hence retains the remaining amount. Retained earnings help the company to bring costs
under control as the already earned profits are utilised for financing. One major drawback
that it faces is the dissatisfaction among the investors of the company owing to the fall in
their value and less dividend pay-out (Brigham and Houston, 2012).
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2.
Budget is the process of the formulating and preparing benchmarks for the company
operations and processes at the beginning of the year, such that the actual performance is
compared with these benchmarks and hence deviations are identified. Such identified
deviations are then analysed, and according to the analysis, corrective company policies and
strategies are formulated and implemented.
Strategic objectives are the long term objectives of the company such that these objectives
help the company to achieve its strategies and thus an effort to achieve the benchmarked
company performance and position in the market. A strategic plan is the written document of
the above mentioned strategic objectives such that it helps the company to set the
groundwork for the future activities and processes and hence enable the company to keep
track of such activities and verify the operations are carried on according to the predefined
plan and strategies. These deviations are then corrected according to the needs and
requirements of the company (Grant, 2016).
Budgets and strategic plans and objectives are closely related such that the budgeting helps
the company to compare the actual results with the benchmarking set in the planning phase of
the formulation of strategic objectives. Such budgets play an important role in the later phase
of the strategic planning process such that it helps in the control measures to be taken.
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