UGB 163: Financial Analysis, Break-Even & Investment Appraisal Report

This report provides a comprehensive financial analysis of Tom and Jerry Ltd, including the preparation of an income statement and balance sheet for the year ending December 31, 2020. It calculates the break-even point and margin of safety, evaluates a new business strategy, and discusses the underlying assumptions of the break-even model. The report also assesses a potential investment using payback period, accounting rate of return (ARR), and net present value (NPV) techniques, offering a detailed analysis of their merits and limitations to inform investment decisions. Desklib provides access to similar solved assignments and study resources for students.

UGB 163 Introduction
to Accounting and
Finance

INTRODUCTION
Accounting simply means to record the day to day activities of business. On the other
hand, finance refers to a broader term which focuses on handling of assets and liabilities of
business. Both the terms are equally important for the business as they are the base of financial
position of company. Accuracy in these helps it in knowing the accurate knowledge of the
performance of business through it can take its strategic decisions (Abernathy, And et.al., 2019).
The report is divided into three parts. The first question deals with the preparation of income
statement and balance sheet. The second part provides solution for the calculation of break even
point and the margin of safety, along with checking out that whether different types of budgets
are relevant for all types of businesses or not. Third section analysis a project for deciding that
the offer should be accepted or not, in addition to evaluating about merits and disadvantages of
different techniques of investment appraisal. It also provides pros and cons of budget in making
plan of company.
TASK
Question 1: Produce an income statement and balance sheet of Tom and Jerry Ltd.
Profit and loss account of Tom and Jerry Ltd. for the year ending 30st December, 2020
Particulars £ £
Sales revenue 633000
- Cash sales 504000
- Credit sales 129000
Less: Cost of goods sold 644175
Purchases (486000 + 39000) 525000
Wages 117000 119175
Add: Outstanding 2175
Add: Closing Stock 228000
Gross Profit 216825
Less: Operating Expenses 148200

Depreciation on Van 9600
Electricity bill 5700 7725
Add: outstanding 2025
Rent 112500 90000
Less : Prepaid rent 22500
Rates 6900 5775
Less: Prepaid rates 1125
Van running expenses 33600
Provision for doubtful debts 1500
Net Profit 68625
Statement of financial position of Tom and Jerry Ltd. as on 30st December, 2020
Assets £ £
Delivery van 60000 50400
Less: Depreciation 9600
Current Assets 597525
Prepaid rates 1125
Prepaid rent 22500
bank 281400
Inventory 228000
Trade receivables 66000 64500
Less : Provision for doubtful debts 1500
Total 647925
Liabilities and capital £ £
Equity 180000 248625

Less: Profit 68625
Long term Borrowing 302100
Current Liabilities 97200
Wages outstanding 2175
Outstanding electricity bill 2025
Trade payables 93000
Total 647925
Working Notes:
 Prepaid rent = 112500 – 90000 = £ 22500
 Prepaid rates for the time period of 1st January, 2021 to 31st March, 2021
Prepaid rates = 4500 * 3 / 12 = £1125
 Depreciation on van = (Price – scrap value) / Number of years
= (60000 – 12000) / 5
= 48000 / 5
= £ 9600
 Calculation of cash at bank
Balance in beginning = £ 180000
less: paid for inventory = £ 39000
Add: cash sales = £ 129000
Add: cash received from trade receivables = £ 438000
Less : paid to trade payables = £ 393000
Less: Van running expenses = £ 33600
Balance = £ 281400
 Calculation of trade receivables
Credit sales = £ 504000
Less: received £ 438000
Balance = £ 66000
 Calculation of trade payables

Inventory bought in credit =£ 486000
Less : paid = £ 393000
Balance = £ 93000
 Calculation of inventories
Purchased on credit = £ 486000
Add: Bought on cash = 39000
Less: Sold on credit = £ 243000
Less: Sold on cash = £ 54000
Balance = £ 228000
Question 2: Calculate the following:
(a) Calculate the contribution made by each kettle for covering fixed costs
Number of units = 53000 units
Sales price per unit = £ 13
Total sales = 53000 * 13 = £ 689000
Variable costs
Material cost = 53000 * 5.25 = £ 278250
Labour cost = 53000 * 2.95 = £156350
Variable cost = 53000 * 1.85 = £ 98050
Total variable cost = £ 278250 + 156350 + 98050 = 532650
Contribution = Sales – Total variable cost
= 689000 – 532650
= £ 156350
Contribution per unit = Contribution / Number of units sold
= 156350 / 53000
= £ 2.95
Contribution made by per unit of electric kettle towards covering fixed cost = £ 2.95
(b) Determine break even point and margin of safety in terms of units and revenue both.
Fixed cost = 59000 + 47600 = £ 106600
Variable cost per unit = 5.25 + 2.95 + 1.85 = 10.05
Break even point in units = Fixed cost / (Sales price per unit – Variable cost per unit)
= 106600 / (13 – 10.05)

= 106600 / 2.95
= 36136 units
Break even point in revenue = Fixed cost / Contribution Margin
= 106600 / 156350
= £ 0.68
Margin of safety in units = Actual units – Break even units
= 53000 – 36136
= 16864 units
Margin of safety in Revenue = Margin of safety in units * Price per unit
= 16864 * 13
= £ 219232
(c) Profit of Stockstone Ltd. if it produces and sells 48000 units if electric kettle at £ 13
per unit.
Calculation of profit
Particulars £ £
Sales 624000
Less : Variable cost 482400
Material 252000
Labour 141600
overheads 88800
Contribution 141600
Less: Fixed cost 106600
Production 59000
Selling 47600
Net Profit 35000
The profit at sale of 48000 units would be £ 35000.

(d) Analyse whether the new strategy of firm is good or not for Stockstone Ltd.
New sale units = 53000 + 53000* 17 % = 62010 units
Selling price per unit = 13+ 13* 9% = £ 14.17
Particulars £ £
Sales 878681.7
Less : Variable cost 623200.5
Material 325552.5
Labour 182929.5
overheads 114718.5
Contribution 255481.2
Less: Fixed cost 151600
Production 59000
Selling 47600
Marketing 45000
Net Profit 103881.2
From the above income statement, it has been driven that the firm would make £
103881.2 by selling 62010 units even after paying £ 45000 as marketing expenses. This means
that the firm can opt for continuing with the new strategy.
(e) Identify and explain the underpinning assumptions attached to the break-even model
including analysing whether the model can successfully be utilised by a range of differing
businesses.
Break-even point is based on the following assumptions which are as follows:
 Consideration of only fixed & variable costs: BEP consists of stable & variant costing.
It is examining only the two specific given values not the semi-variable amounts. But it is

not showing sufficient possibility in every business because they cannot do filtering of
values in the different categories of the workings (Bryson, 2018).
 Fixed costs will remain constant at all volume of outcome: In BEP, the cost of the
fixed items will not changes with the output level. It is also an operating activity but also
consider as independent entity. But sometimes, it's changing scenario depends upon the
business productivity level. It's not always seen perfectly constant manner because
increase or decrease in the production level may vary this costing.
 Variable costs will move in direct quotient to volume of output: In this, BEP values
always modify with the changes in variability of costing in relate with the sales or direct
expense or other administrative expenditures. This assumptions are always true in all the
businesses because every business may have changes along with variable costing.
 Selling price will remains constant: BEP considers selling price at consistency level
(Durocher and Fortin, 2021). But it is the myth only because every organization should
do changes in selling cost with any reason either maintain the stability or growth in
market share or other competitive advantages may arises or fallen in the pricing stage.
 Product mix will remain unchageable: BEP take assumptions regarding the production
mix scenario that it cannot be chnaged. But it has some other perspective that it depends
upon the demand & supply of the output volume. When the concern demanding level
hasfluctuate with different factors such as technology, demographics and competitors of
the external market area, the level of the product-mix automatically changes.
Productivity per worker will remain unchanged: BEP shows the working criteria of the each
workers or employees to determine the per member productiveness (Harris, Hoang and Ngan,
2017). But not every organization may consists of this factor because they might only believe in
the per person productivity.
Question 3: Provide solution for the investment appraisal technique
(a) Initial Investment = £ 40000000
Annual cash inflow = £ 17000000
Annual cash outflow = £ 6400000

Payback period = Initial Investment / Net annual cash flow
= 40000000 / 10600000 = 3.774 years
Accounting Rate of Return = (Annual cashflow – Annual Depreciation)/ Initial Investment * 100
= (10600000 – 7000000) / 40000000 * 100 = 9%
Net present Value = present value of annual cash inflow – present value of annual cash outflow
= (1.43 * 17000000) – (1.43 * 6400000)
= 24310000 – 9152000 = £ 15158000
The firm can accept the offer as the net present value of business is more than the
investment of machines . Also, the ARR of project is very high. So, it is profitable to purchase
the project.
(b) Produce a report that explains and analyses the key merits and limitations of the
differing
investment appraisal techniques.
Pay back period- it is a simple technique to assess the investment by the time's length it
would take to repay it (Krishna, Pandey and Thimmalapura, 2017).
 Merits- At the time of calculating PBP, it take into account the value of money.
 It is very simple process to calculation and easy to understand by the firm.
 It is less time consuming and decisions are made very quickly.
Disadvantage-
 It ignore the time value of money
 after paybacks time period , it ignore the cash flows
 it is biased against the long term project.
 It is failed to determine that whether investment will increase the value of firm or not.
Accounting rate of return- It is used to measure the profit expected from an investment and it
express net accounting profit arising from an investment as a % of this capital investment
(Lonie, Nixon and Collison, 2018).

Merits- it consider all savings over the entire time period of investment.
It helps in measuring the benefits in the percentage, which make it very easy to compare with
other projects., because it is based on the accounting profit.
Limitations
 There is no need of separate calculation
 Income's overcoming ignore the time value of money.
 It does not consider risk associated with each and every project
 For appreciating the projects, it uses accounting profit.
Net present value- It allows a company to make an informed decisions and allowing them to
consider time value of the money. It's calculation require, all cash flows associated with
investment be included.
Merits
 It helps in increasing shareholder's wealth by giving money.
 The value of firm is increased by the investment (Murata and Pan, 2018).
 It take into account the time value of money and cash flows.
Limitations
 it is very complex to calculate and explain.
 Result is depend on rate of discount used and the expectation of interest rates can be
inaccurate.
Internal rate of return- It is the interest rate which equate present value of expected future
receipt to the cost of investment outlay.
Merits
 It is very simple to communicate the project's value to someone.
 It consider the time value of money at the time of calculating IRR.
 It is very simple and easy to interpret and easy to visualize by management.
 It consider the risk of future cash flow.
Limitations
 It require capital cost for the decisions.

 There is a mixture of future's positive and negative cash flows (Seifzadeh And et.al.,
2020).
 It lead to inaccurate decisions in comparison of mutually exclusive investment.
Profit ability index- This index define about how much a business will earn per dollar of their
investment. It is calculated by dividing present value of future expected cash flows by initial
investment amount in projects.
Merits
 It is useful in the capital rationing and easy to communicate.
 It ascertain the exact ROI of a project.It is closely related to the NPV and leading to the
identical decisions.
Limitations
 It may lead the incorrect decisions in the comparisons of mutually exclusive investment.
 If two project have different useful life, then it is difficult to calculate the profitability
index.
(c) Produce a report that identifies and explains the key benefits and limitations of using
budgets as a tool for strategic planning.
A budget is a financial document which is used by the management to project future
income and expenses. It basically plans for future expenses and ascertain where a business can
reduce its spending (Soka, 2020). It allocates the financial resources to different uses. After the
end of a financial period, the management can then compare the actual spending to the proposed
projected ones and can ascertain where the business stands, and can work on any improvement,
is required.
Budgeting is a great tool for the management to plan strategically and tap the most beneficial
sources of income. It plays an important role in effective use of resources and achieving overall
organisational goals.
The key benefits that can be driven by using Budgets are:
 Turns strategic plan into action- Budget specifies the resources, tasks and activities
required to carry out the strategic plan for the coming year.

 Resource allocation- It improves resource allocation as all requests are clarified and
justified. It also works as a tool for corrective action through reallocations.
 Plan for spending- It works as a plan for spending as it create means of controlling
income and expenditure of a business.
 Cost consciousness- It develops an attitude of cost consciousness among the
management as it put the resources to the effective use. It ascertains how much should be
spent to achieve a goal.
 Problem solving- it provides a organized and controlled approach to the problems that
may arise in the organisation.
The limitations of using budgets are:
 Judgement based- Budgets are made on the judgement of the management. Planning,
budgeting or forecasting is not exact science. It may not be cent per cent accurate as the
future is ascertain.
 Cooperation- The success of a budget highly depends upon the coordination and
cooperation of all the members of the management of an organisation. Budgeting has
failed miserably because the top management has only given lip service to its execution
(Tannen, 2020).
 Tool- It is only a tool and it does not take place of the management. Management has to
execute the plans accordingly to have effectiveness in the organisation.
 Budget allowance- At the end of the budget period, if the actual expenses have not met
the projected expenses, employees may be tempted to spend excessive amounts in order
to use the budget allowance (Vagner, 2020). It may create losses for the company.
Reduces initiative- A rigid budget may reduces initiative and innovation, making it impossible
to obtain money for new ideas. It can also reduce creativity among lower levels of management.
CONCLUSION
From the above analysis, it can be concluded that the various tool of finance helps in
evaluating the performance of business. Financing reports helps in developing knowledge about
the position of company along with its profitability. It is also useful for various external and