BSc Business Finance Case Study: Performance Indicators and Pricing

This case study examines investment appraisal techniques and financial performance analysis for a business. It begins with an overview of investment appraisal methods, including the Accounting Rate of Return (ARR), Payback Period, Net Present Value (NPV), and Internal Rate of Return (IRR), providing calculations and interpretations for each method. The case study then delves into risk assessment using accounting ratios, covering current ratio, quick ratio, net profit ratio, creditors turnover ratio, inventory turnover ratio, accounts receivable turnover ratio, debt-equity ratio, and interest coverage ratio. Each ratio is calculated, and its implications for the company's financial health are discussed. Furthermore, the case study analyzes and compares performance indicators, highlighting the role of pricing on business performance, emphasizing the importance of optimal pricing strategies for sales, profit margins, and overall financial success. The analysis is supported by references to relevant financial literature.

Case study

TABLE OF CONTENTS
Assignment 2: A Case Study......................................................................................................3
Investment appraisal techniques............................................................................................3
Risk assessment using accounting ratios................................................................................6
Analysing and comparing the performance indicators.........................................................10
Role of pricing on the business performance.......................................................................10
REFERENCES.........................................................................................................................11

Assignment 2: A Case Study
Investment appraisal techniques
Accounting rate of return
Accounting rate of return is also known as average rate of return, is a financial ratio
used in the process of capital budgeting for evaluating the profitability of the investment
(Sampaio Filho, Vellasco and Tanscheit, 2018). ARR is very easy to use. It considers net
operating income which is used by creditors and investors for evaluating the performance of
the management.
Average
investment
£22500
Year
Cash
inflows
1 15000
2 15000
3 5000
4 5000
5 35000
Depreciation 35000
Total profit 40000
Average profit or cash
inflow 8000
Average initial
investment 22500
Average initial
investment [(initial
investment + scrap
Initial investment +Salvage value
2
£ 40000+ £ 5000
2

value) / 2]
ARR 36%
Thus, the accounting rate of return is the 36% by investing in the new project.
The payback period
It is the amount of time in which the amount invested in the project is expected to be
recovered (Sarwary, 2020). It determines the break-even point after which company starts
earning profits.
Year Total cash
flow
Cumulative
cash flow
0 -15000 -15000
1 1500 -13500
2 2750 -10750
3 4000 -6750
4 5700 -1050
5 7500 6450
Payback period 4.14 years
The payback period of the project that ABC Limited is willing to invest in acquiring
the new machine is 4.14 years. This indicates that the company should not go with the project
as the life of the project is 5 years and the payback period is 4.14 years which is much higher.
The net present value
It is one of the capital budgeting techniques which is calculated by determining the
difference between present value of both cash inflow and cash outflow (Benamraoui and
et.al, 2017). It is used for analysing the profitability of the projected investment. The positive
NPV means that investment can be made as projected earnings exceeds the anticipated cost.
Year Cash inflows
PV factor @
15%
Discounted
cash inflows
1 1500 0.870 1304

2 2750 0.756 2079
3 4000 0.658 2630
4 5700 0.572 3259
5 7500 0.497 3729
Total discounted cash
inflow 13002
Initial investment 15000
NPV (Total discounted
cash inflows - initial
investment) -1998
Since, NPV of the project is negative it means that the ABC Limited should not
acquire the new machine as it is not feasible as well as profitable.
The internal rate of return
This technique is used in estimating the profitability in association with the potential
investment. IRR is the discount rate which makes NPV of the undertaking equivalent to zero
(Patrick and French, 2016). It is significant for organizations to take a look at IRR for taking
decisions in relation to the future growth and expansion.
Year Cash inflows
0 -15000
1 1500
2 2750
3 4000
4 5700
5 7500
Internal rate of
return (IRR) 10%

By looking at the IRR it can be said that it is not feasible for the company to acquire
new machine as the internal rate of return is lower than the cost of capital.
Risk assessment using accounting ratios
Current ratio
The current ratio is used to measure the liquidity position of the company. It helps in
analysing the ability of the business in meeting its short-term obligations against its current
assets (Kahn and Baum, 2020). It determines whether the company is required to take
additional funds to for settling its current liabilities. The current ratio of ABC Limited is 2.5
times which means that the company is having sufficient amount of current assets for
discharging its current liabilities.
Quick ratio
The quick ratio is similar to current ratio but it is even more conservative as it takes
into consideration the more liquid current assets and excludes inventory and prepaid
expenses. Higher the quick ratio more favourable it is for the company (Purnomo, 2018). The
quick ratio of ABC Limited is 1.50 times which is low and indicates that the most of the
current assets of the company lies in it inventory. This may also mean that the company is not
able to sell out its inventory quickly.
Liquidity ratio
Current
assets
£150
00
Current
liability
£600
0
Invento
ry
£600
0
Quick
Assets
£900
0
Curren
t ratio
Current
assets /
current
liabilitie
s
2.50

Quick
Ratio
(Current
Assets -
Inventor
y) /
Current
Liabiliti
es 1.50
Net profit ratio
It is the profitability ratio which helps in measuring the profitability of the business
with respect to the net sales. It is calculated by dividing net profit with net sales. This ratio
helps in identifying what percentage of sales is used for paying off the operating and non-
operating expenses and also how is left to be paid to the shareholders or to retain in the
business for further business development (Al Hayek, 2018). Higher the ratio better it is for
the company. The net profit margin ratio of ABC limited is 3.33% which is very low and the
company needs to work on increasing its net profit by reducing or controlling its operating
and non-operating business expenses or default in its pricing strategies.
Profitability ratio
Net
Income 2000
Sales 60000
Net
profit
ratio
net
income/
Net
Sales 3.33%
Creditors turnover ratio
This ratio measures on an average how many times the creditors of the company are
paid during a specific period. This ratio indicates the creditworthiness of the organization.

The higher ratio depicts that the company is very effective in making prompt payment to its
creditors within the set time frame (Fazzini, 2018). The low ratio means that company is not
able to pay its creditors on time, causing delay. The ratio also depends upon the credit terms
of the suppliers. The creditor turnover ratio of ABC Limited is 48 times in a year which
means that the company is efficiently in making payment to its supplies and vendors for
credit purchase of the goods.
Inventory turnover ratio
This ratio measures how many times company has sold and replaced its inventory in a
specific period. It is favourable to have higher ratio which indicates that the company is
effective in selling its goods (Kwak, 2019). The inventory turnover ratio of ABC Limited is
8.6 times which is very low, thus, company is required to take actions to increase its sales or
else it will have an impact on its liquidity and also it will increase its cost.
Account receivable turnover ratio
This turnover ratio indicates how efficiently company is able to recover the amount
from its debtors (Tissen and Sneidere, 2019). The accounts receivable turnover ratio is 15
times in a year which means that the company is not effective in collecting the due amount
from its customer within the time. This has huge the risk of affecting the liquidity of the
company. Company needs to be effective in its collection process.
Efficiency Ratios
Inventory 6000
Trade
Receivabl
es 4000
Cost of
Sales
5160
0
Sales
6000
0
Total
purchases
5760
0
Accounts
payable 1200

Creditor
s
turnover
ratio
Total
purchase/accou
nts payable
48.0
0
Inventor
y
turnover
ratio
Sales /
Inventory 8.60
Account
receivabl
e
turnover
ratio
Sales /
Accounts
Receivable
15.0
0
Debt equity ratio
This ratio shows the proportion of debt and equity in the capital structure of the
company (Akhtar, 2019). It measures the degree to which ABC Limited is financing its
business operation and shows the ability of shareholder’s equity to cover all the debts during
times of downfall. The higher ratio indicates higher risk to shareholders. The debt equity ratio
of the company is 1 which means there is an equal proportion of debt and equity and the
company is at less risk of leverage.
Interest coverage ratio
It measures the ability to pay off the interest liability of the business with its operating
profit (Cable, Healy and Sun, 2018). The interest coverage ratio is 4.76 which indicates that
the company can make payment of interest at least 4 times over a specific period which is a
good indicator.
Solvency ratio
Debt
2000
0
Equity
2000
0

EBIT 4000
Interest 840
Interest
coverag
e ratio
EBIT/
Interest 4.76
Debt
equity
ratio
Debt/
Equity 1
Analysing and comparing the performance indicators
The internal performance indicators or the accounting ratios can be used to compare
the performance of the competitors in the same industry. It helps in identifying the risk the
competitor is facing what are its strengths and weaknesses in financial terms based on which
business planning and strategies can be implemented. It helps in analysing and comparing the
financial position and performance of the business in terms of liquidity, solvency,
profitability and efficiency.
Role of pricing on the business performance
Pricing has an important use in the performance of the business. The business is
required to implement. It has a huge impact on the sales and profit margin of the company.
Optimum price level is required to be attained as sometimes higher price leads to higher
profits but it also causes decrease in sales (Skarmeas and et.al, 2016). Price has the most
impact on the profitability of the company as it has a direct influence on the sales, cost of
production or sales, inventory of goods and if company is not effective in managing it
appropriately it will lead to decrease in the profitability of the company. Thus, pricing plays
an important role in maintaining the performance of the company.

REFERENCES
Books and Journals
Akhtar, S., 2019. Empirical Testing of Cyclicality of Debt Equity Ratio: A Case Study of
Selected US Firms (Doctoral dissertation, CAPITAL UNIVERSITY).
Al Hayek, M. A., 2018. The Relationship Between Sales Revenue and Net Profit with Net
Cash Flows from Operating Activities in Jordanian Industrial Joint Stock
Companies. International Journal of Academic Research in Accounting, Finance and
Management Sciences. 8(3). pp.149-162.
Benamraoui, A. and et.al, 2017. Net Present Value Analysis and the Wealth Creation Process:
A Case Illustration. The Accounting Educators' Journal. 26.
Cable, R. J., Healy, P. and Sun, N., 2018. The Changes in Cash Flows from Operating
Activities and Related Debt and Interest Coverage Ratios of Fortune 200 Companies–
An Analysis of FASB's Proposed Accounting Standards Update. International
Research Journal of Applied Finance. 9(5). pp.232-240.
Fazzini, M., 2018. Financial Statement Analysis. In Business Valuation (pp. 39-76). Palgrave
Macmillan, Cham.
Kahn, M. J. and Baum, N., 2020. Basic Accounting and Interpretation of Financial
Statements. In The Business Basics of Building and Managing a Healthcare
Practice (pp. 13-18). Springer, Cham.
Kwak, J. K., 2019. Analysis of Inventory Turnover as a Performance Measure in
Manufacturing Industry. Processes. 7(10). p.760.
Patrick, M. and French, N., 2016. The internal rate of return (IRR): projections, benchmarks
and pitfalls. Journal of Property Investment & Finance.
Purnomo, A., 2018. Influence of The Ratio of Profit Margin, Financial Leverage Ratio,
Current Ratio, Quick Ratio Against The Conditions and Financial Distress. Indonesian
Journal of Business, Accounting and Management. 1(1).
Sampaio Filho, A. C. D. S., Vellasco, M. M. and Tanscheit, R., 2018. A unified solution in
fuzzy capital budgeting. Expert Systems with Applications. 98. pp.27-42.
Sarwary, Z., 2020. Strategy and capital budgeting techniques: the moderating role of
entrepreneurial structure. International Journal of Managerial and Financial
Accounting. 12(1). pp.48-70.
Skarmeas, D. and et.al, 2016. Pricing Capabilities: Drivers and Effects on Performance.
In Marketing Challenges in a Turbulent Business Environment (pp. 323-324). Springer,
Cham.
Tissen, M. and Sneidere, R., 2019. TURNOVER RATIOS AND PROFITABILITY RATIOS
CALCULATION METHODS: THE BOOK OR AVERAGE VALUE. Scientific
Programme Committee. p.851.