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Transcript of Finance Assignment
Report on Managing Finance for the Mayor Ltd.-2009
Submitted To
Mr. Dan Sookun (Lecturer)
Icon College of Technology and Management
Submitted By
Mashukur Rahman
Id. 4098
Page 1 of 45 Managing Finance Mashukur Rahman Id: 4098
Table of Content
Serial No. Topic Page Number
1 Overview of Organisation 03 to 03
2
Outcome 01 04 to 18
Sources of Finance (04 - 16)
Factors to be Considered Before Deciding Sources of Finance (17 - 18)
3
Outcome 02 19 to 25
Cash Budget (19 - 19)
Benefits and Significance of Cash Budget (19 - 20)
Projected Cash Flow Statement (21 -21)
Function of Preparing Budget (22 - 23)
Implication of Preparing the Budget at the Lower Level of Management
(24 - 25)
4
Outcome 03 26 to 32
Steps of Project Implementation (26 - 27)
Projects Appraisal Techniques (NPV, IRR, Payback Period) (28 - 30)
Projects Analysis Through NPV, IRR, Payback Period (31 - 32)
5
Outcome 04 33 to 37
Types of Ratio Analysis (33 - 35)
Limitation of Ratio Analysis (35 - 35)
Comparative Analysis of Ratio with Industry (36 - 37)
6 Bibliography 38 to 39
7 Appendix 40 to 45
Page 2 of 45 Managing Finance Mashukur Rahman Id: 4098
Overview of Organisation
Mayor Ltd is a private limited company that produces baby foods. All of its share are
generate by the Mayor family. Recently Mayor Ltd has got a three-year contract to
Doratex Plc with a range of products. As a supplier, Mayor Ltd. needs more current assets
for keep available stocks (inventory financing) as well as credit sales. Because Doratex Plc
already given the condition that, required orders must delivered within two days and also
always pay the money after three months of received the order.
Therefore, it is needs to be sufficient funds for Mayor Ltd. starting and running the
business with Doratex Plc and also those funds is of critical importance. If Mayor Plc. will
failure that issue might be fall in liquidity difficulties.
Page 3 of 45 Managing Finance Mashukur Rahman Id: 4098
Outcome: 1.0
The finance available for a business may be divided by two types-
Internal
External
Internal sources
This is a source of finance, which comes from owner’s equity, owner personal savings or
selling assets, business angels (owners family and friends) and owner's business activities
(retained profits).
Advantages of internal sources of finance
Flexibility: Internal sources of finance usually have the advantage that they are
flexible, because this sources are might use current assets financing as well as
long term financing also it will be use for future invest proposal.
Immediate arrange: This sources are obtained very quickly-particularly for
working capital finance.
No Interest: Using this sources no need to required to paying any interest.
No third party and cost: It could be arrange without any cost and compliance
of other parties. The business owners have power to the profits without
agreement of the shareholders.
According to McLaney et al (2005) (PG-515), “Internal sources mean sources that
do not require the agreement of anyone beyond the directors and managers.”
Page 4 of 45 Managing Finance Mashukur Rahman Id: 4098
Finance
Internal(Retained profits, Owner’s equity, Business angels)
External(Selling share,
Bank over drafts, Trade credits,Loan, Finance leases,
Hire purchase, Govt. grants etc.)
Internal sources includes following:
Retained Profits
Retained profits are the major source of internal finance for most business.
Retained profits consider an internal source because owner has a power to retain
profit without agreement of the shareholders. In financial year-2007, Mayor Ltd.
was made profit £50,000 (Financial Statements-2007). That is the retained profits f
or Mayor Ltd. This amount might be use as internal sources of finance for raising
the funds.
Owners Equity
This is the fund provided by its owners that does not have to be repaid as long as
organisation continues as a going concern. The business owners finance in the
business by own cash as well as personal savings. It is a cheapest form of finance
since it carries no obligation to pay any interest. On the other side, equity is
expensive forms of finance because of owners are expected that dividend will be
higher than the interest rate.
Business Angels
Business angels means that family members and friends of a business owners who
are a common source of finance for a private limited company. They are most likely
to invest due to their relationship with the business owner. Family members and
friends provide a small amount of equity funding. Although, it is relatively easy to
obtain money from family members and friends without paying any interest.
Page 5 of 45 Managing Finance Mashukur Rahman Id: 4098
Internal Sources
Retained Profits
Owners Equity Business Angels
Advantages and disadvantages of business angels
If the business owners finance in the business by get the money from family
members and friends, than business will be benefited because against that money
no need to paid any interest.
Sometimes family members or friends may want to get the business share also
want to get the profit of the business against their money. In these circumstances,
the relationship between business owners and business angels will be fall.
All sources of finance, there are positive and negative aspects. The Mayor Ltd
should carefully consider the effect of the investment on the family members or
friends before accept the money. Otherwise, if the relationships between business
owners and family members or friends fall in hardship, that might be the result of
business fall.
External sources
Generally, external sources of finance are sources that come from outside the business.
When internal funds are no longer sufficient, small business turn to a variety of external
sources. External sources includes the increase shareholders by selling share, bank loan,
bank overdrafts, debentures, trade credits, hire purchase (HP), finance leases,
governments grants etc.
“This is finance that comes from outside the business. It involves the business
owing money to outside individuals or institutions.” (http://www.teachnet-uk.org.uk)
The Mayor Ltd. is not listed on a recognised stock exchange. Mayor Ltd also decided
that they does not wish to raise new capital by issuing new shares. As a result sources of
selling shares and debentures are not apply for the finance.
Page 6 of 45 Managing Finance Mashukur Rahman Id: 4098
External sources of finance includes the following:
Overdrafts
Overdraft financing is provided when businesses make payments from their
business current account exceeding the available cash balance. An overdraft
facility enables businesses to obtain short-term funding - although in theory the
amount loaned is repayable on demand by the bank. The bank may also charge
interest as an overdraft facility fee. Interest is charged on the amount overdrawn - at
a rate that is above the Bank Base Rate.
Overdrafts are generally meant to cover short-term financing requirements that
are not generally meant to provide a permanent source of finance. Many
Businesses use an overdraft for support to working capital; helping buy stock, pay
staff, etc in order for business to function. It is ideal for business day-to-day
expenses, particularly uses in cash flow problems.
Page 7 of 45 Managing Finance Mashukur Rahman Id: 4098
External Sources
Overdrafts
Bank Loan
Hire Purchase
Finance
Leases
Trade Credits
Govt. Grants
As per Watson et al (2007) (PG-70), “An overdrafts is a flexible source of
finance in that a company only uses it when the needs arises. However, an
overdrafts is technically repayable on demand, even though a bank is likely in
practice to give warning its intention to withdraw agreed overdrafts
facilities. .......
Overdrafts interests are only paid on the amount borrowed, not on the agreed drafts
limits.”
Advantages of overdrafts
Interest: Customer only pays interest when overdrawn amount borrowed not the
agreed overdrafts limits.
Flexibility: Bank gives the flexibility to review and adjust the level of the
overdraft facility, perhaps on a short-term basis.
Immediate arrange: Overdraft effectively and immediately could be used as a
source of finance for raises working capital.
Financial gearing: Being part of short-term debt, the overdraft balance is not
normally included in calculations of the business’ financial gearing.
Quick: Overdrafts are easy and quick to arrange, providing a good cash flow
backup with the minimum of fuss.
Disadvantages of overdrafts
High interest rate: Overdrafts carry high interest rate and fees, it is too much
higher then the bank loan.
Not suitable: Overdrafts is not suitable for long-term finance because an
overdraft is likely to cost and expensive more than a bank loan.
Security: Using overdrafts may need to be secured against business assets,
which put them at risk if the business cannot meet repayments.
Page 8 of 45 Managing Finance Mashukur Rahman Id: 4098
Bank Loan
Bank provides a specified amount of money to business organisation (customers)
for finance in the business as a form of loan. And that amount must needs to be
repaid with interest before fixed date.
Bank loan includes the following:
Specified sum of money
Repayments date (period of loan- short-term/long-term)
Rate of interest
Consumers instalments, overdrafts, credit cards
Residential mortgage
Security
Direct financing leases
According to Gallati (2003) (Pg-130), “ A 'loan' is a financial assets resulting from
the delivery of cash or other assets by a lender to a borrower in return for an
obligation to repay on a specified date or dates, or an demand, usually with
interests.”
Advantages of Bank Loan/Debt Financing
For raising the fund it is cheaper method than the issue of new share to the
shareholders.
In inflation borrower might be beneficial because the value of interest payments
will diminish.
Bank loan interests are expenses, which is assumed before corporate tax is
assessed, while dividend is accumulated after corporate tax. In this
circumstances, bank loan is the better than the issuing new share for the Mayor
Plc.
There are no dilutions of ownership with debt/loan financing.
Page 9 of 45 Managing Finance Mashukur Rahman Id: 4098
Disadvantages of Bank Loan/Debt Financing
Loan is one kind of contract between lender and borrower. This contract represents
that, borrower commitment to pay the lender the principle amount with interests. If
the borrower is unable or fail to make its repayments on due time, then it can face
serious consequence such as foreclosure. Foreclosure can result in the liquidation
of the business. When the business is liquidated, government agencies and other
creditors are at the front of the line when the businesses are converted into cash.
The owners of the business get the table scraps if any exist when the liquidation is
completed.
Another disadvantage is any loan charge must be paid irrespective of business
performance. And also excessive finance by loan may affect business flexibility.
Finally, Debt or loan must be repaid even when a business looses/decline the profits
or costs rises unexpectedly.
Trade Credits
Many businesses rely on their creditors as a form of short-term finance. Because
most of the suppliers allows their customers to take somewhere between one and
three months to pay for goods supplied, the debtor company can use what is
effectively an interest free loan of up to 90 days to pay others bills. Creditors will
often give incentives in the form of cash discount if payment is made earlier, but by
delaying payment, the debtor can use money owned to finance other current assets.
This is the most important and suitable source of short-term finance for Mayor Ltd.
According to Watson and et al (2007) (Pg-70), “ Trade credit is an agreement to
take payments for goods and services at later date than that on which the goods
and services are supplied to the consuming company. It is the common to find one,
two or even three months credit being offered on commercial transactions and trade
credit is a major source of short-term finance for major companies.”
Page 10 of 45 Managing Finance Mashukur Rahman Id: 4098
Advantages of Trade Credit
Reduced capital requirements: This source is very useful to someone who
has very little amount of money but has a good idea about starting a new
business. So, Mayor Ltd could be using this source for short-term finance.
Improve cash flow: Trade credit with improves the cash flows and therefore
provides smoother operation for the business.
Buy now pay later: This mean that, if the business organisation don't have
sufficient money, at first purchase the product/raw materials by credit. Then after
the sell business make the payments and profits have been made.
Disadvantage of Trade Credit
No discount: If the Mayor Ltd finance by using trade credit, then as a debtor
company Mayor Ltd may does not get any discount on purchase from creditors.
Finance Leases
A lease is an agreement between two parties- one is lessor other is lessee. The
lessor owns a capital asset, but allows the lessee to use it. The lessee makes
payments under the terms of the lease to the lesser, for a specific period of time.
Leasing is, therefore, a form of rental. Leased assets have usually been plant and
machinery, cars and commercial vehicles, but might also be computers and office
equipments.
The business pays a regular amount for a period of time, but the item belongs to the
leasing company. Most owners’ cars are leased to business. The business pays the
monthly fees for using the car.
According to Geoff Black (2005) (Pg-136), “ A finance lease means by which
companies obtain the right to use assets over a period time. The ownership of the
assets never passes to the actual users of the assets.”
Page 11 of 45 Managing Finance Mashukur Rahman Id: 4098
Advantages of Finance Leases
Cheaper in the short run investment. Cash flow management easier because of regular payments.
Disadvantages of Finance Leases:
More expensive in the long run, the leasing company charges fees that make the total cost greater than the original cost.
Hire Purchase
Hire purchase is a form of instalment credit. It is similar to leasing, with the
exception that ownership of the goods passes to the hire purchase customer on
payment of the final credit instalment, whereas a lessee never becomes the owner
of the goods. Hire purchase agreements usually involve a finance house.
The Mayor Ltd may use the hire purchase finance from a finance house in order to
purchase the fixed asset. Goods bought by businesses on hire purchase include
company vehicles, plant and machinery, office equipment and farming machinery.
In hire purchase system buyer gets only physical possession of goods but not gets
the ownership. The price of goods is agreed to be payable in easy instalments with
interest. After finish all instalments of price of goods, and then buyer gets the
ownership of that product.
According to Rao (2005) (Pg-736), “ Hire purchase is a methods of sale under
which the seller undertakes to sale the goods with an agreement to receive cash
price in convenient instalments. The physical possession goods are delivered at the
time of agreement.”
Page 12 of 45 Managing Finance Mashukur Rahman Id: 4098
Advantages of Hire Purchase
A hire purchase agreement allows a consumer to make monthly/quarterly/yearly
repayments over a pre-specified period of time.
The hire purchase agreement allows a consumer to purchase the goods when
they are not in a position to pay in cash.
The rate of acceptance on hire purchase agreements is higher than other forms
of unsecured borrowing because the lenders have collateral.
Disadvantage of Hire Purchaser
In hire purchase agreements, buyer needs paying more money than the original
price of product.
If buyer miss any instalment, the result is might be lose the product with what he
already paid.
If the buyer breaks or lost the purchase items, he still has to pay all instalments
of those items as well having to replace the items.
Government Grants
The government provides finance to companies in cash grants and other forms
such as lotteries of direct assistance, as part of its policy of helping to develop the
national economy, especially in production related industries and in areas have a
high unemployment opportunity. The Mayor Ltd may take this financial source for
short-term as well as medium-term financing. Mayor Ltd have a opportunity for get
a government grants because of they are producing company.
Page 13 of 45 Managing Finance Mashukur Rahman Id: 4098
On the basis of duration or period, sources of finance may be three types (Short-Term,
Medium-Term and Long-Term) those are appearing in diagram in following:
Short-term Finance
Short-term finance is finance that uses for a period of less than a year. It is required to
provide working capital for the business. The working capital is needed to purchase of raw
material, payment of wages, salaries, and keeping stocks and meeting day-to-day
expanses of the business.
In short-term period Mayor Ltd may use the following sources:
Retained Profits
Business Angels
Bank Overdrafts
Trade Credits
Short-term Bank Loan etc.
Page 14 of 45 Managing Finance Mashukur Rahman Id: 4098
Finance
1. Retained Profits 2. Hire purchase (HP) 3. Finance leases 4. Govt. grants
Short Term Medium Term Long Term
1. Retained Profits 2. Business Angels 3. Bank Overdrafts 4. Trade Credits 5. Short-term bank loan
1. Retained profits 2. Long-term bank loan 3. Financial Institution
Medium-Term Finance
In financial language “medium-term” can be thought as consulting a broad and ill-defined
border between short-term and long-term finance. Medium-term finance is a finance that is
uses for more than one five years. Sources of medium-term finance is include the following
those are can be uses by Mayor Ltd:
Retained profits
Finance leases
Government grants
Hire purchase (HP) etc.
Long-Term Finance
Long-term sources of finance are those that are needed over a longer period of time -
generally over five years. For example, to invest in the new project organisation should be
uses long-term finance.
Mayor Ltd should be takes the long-term finance for investment in the new project
appraisal and their fund may be raises by using following sources:
Long-term Bank Loan
Retained Profits
Owners equity
Other financial Institutions etc
Page 15 of 45 Managing Finance Mashukur Rahman Id: 4098
Summary of finance sources
Sources Terms Internal
External
Short-term Retained ProfitsBusiness Angels
OverdraftsTrade CreditsShort-term Bank Loan
Medium-term Retained Profits Hire PurchaseFinance LeasesGovt. Grants
Long-term Retained ProfitsOwners Equity
Long-term Bank LoanOther Financial Institution
Page 16 of 45 Managing Finance Mashukur Rahman Id: 4098
Factors to be considers before deciding appropriate sources of finance:
Organisation financial planning should be related with organisation's goals and objectives
and then it would be developing ways achieving goals. To be able to do this, financial
manager must have realistic knowledge about finance within the organisation, for example
when need to raise the finance, how much and which sources will be use for the finance
etc.
The Mayor Ltd should consider into following factors before deciding how to satisfy its
financial requirements:
Structure of Organisation
Decision about finance may determine the type of business structure on
organisation takes.
Length or Period of Finance
Before financing it is very important for Mayor Ltd that for what times fund will be
taken- (short-term / long-term / medium-term).
Cost of Fund
It is also be considered that the cost of finance before financing in the business. The
Mayor Ltd should take the decision that which sources they use for financing. For
example, cost of equity finance is more than high then the debt finance.
Risk of the Finance
Generally, short-term sources of finance are riskier then the long-term sources from
the borrowers points of view in that they may not be renewed or may be renewed on
less favourable terms. Another risk for the short-term borrowers is that interest rate
of short-term loan is not a constant the long-term loan and this risk is
compounded if floating rate short-term debt such as overdrafts is used. So, Mayor
Ltd should consider this factor before finance.
Page 17 of 45 Managing Finance Mashukur Rahman Id: 4098
Effect of Gearing
If the organisation arranging finance by taking more debt then may affect business
flexibility and also the company might be fall in serious difficulties such as bankrupt.
Usually interest has to be paid on the debt. Debt or loan must be repaid even when
a business looses/decline the profits or costs rises unexpectedly.
Page 18 of 45 Managing Finance Mashukur Rahman Id: 4098
Outcome: 2.0
Cash Budget
Definition
Cash budget is a one of the important business planning mechanism or tool which aid to
the managers anticipate the expected cash inflows that means cash receipts and outflows
that mean cash payments for a budget period. Cash budget ensure and makes the
provision for minimum cash balance has to be maintained all time.
According to Horne et al (2008) (Pg-180)“ A cash budget is arrived at through a
projection of future cash receipts and cash disbursements of the firm over various
intervals of time. It reveals the timing and amount of expected cash inflows and
outflows over the period studied.”
Benefits and Significance of Cash Budget
Planning Tool
Cash budget is a planning tool. The major benefit of the statement of cash flows is
that users may get the reasonably detailed picture of a company's operating,
investing and financing transactions involving cash.
Forecasting the Future Needs
Cash budget forecasts the future needs of funds, its time and the amount well in
advance. It, thus, helps planning for raising the funds through the most profitable
sources at reasonable terms and costs.
Maintenance of Cash Balance
Cash is the basis of liquidity of the enterprise. Cash budget helps in maintaining the
liquidity. It suggests sufficient cash balance for expected requirements and a fair
margin for the contingencies.
Page 19 of 45 Managing Finance Mashukur Rahman Id: 4098
Controlling Cash Expenditure
Cash budget acts as a controlling device. The expenses of various departments in
the firm can best be controlled so as not to exceed the budgeted limit.
Evaluation of Performance
Cash budget acts as a standard for evaluating the financial performance.
Bank Purpose
The management demonstrate of the ability of company its working capital ability.
Its also represents the lifeblood of a company. Many lenders and or creditors lend
the money to the company after reviewing the company's cash budget. So, to
getting loan company should be prepared and maintain the cash budget statement
regularly.
Page 20 of 45 Managing Finance Mashukur Rahman Id: 4098
The Mayor LtdProjected Cash Flow Statement
(From January-2010 to June-2010)
Months Jan-2010 Feb-2010 Mar-2010 Apr-2010 May-2010 Jun-2010
Cash Receive
Receipts from cash sales £60,000 £63,500 £55,000 £52,000 £65,000 £68,000
Cash from debtors £35,000 £40,000 £38,000 £30,000 £45,000 £40,000
Cash from selling furniture --- --- --- --- --- £6,000
Total Collection £95,000 £103,500 £93,000 £82,000 £110,000 £114,000
Payments
Purchase Materials £27,000 £25,000 £29,500 £27,000 £25,500 £30,000
Purchase Fixed Assets --- --- --- --- £22,000 ---
Staff Salary and wages £24,000 £25,500 £24,500 £23,500 £27,000 £22,500
Administrative Expenses £12,000 £11,700 £9,800 £14,500 £17,000 £16,500
Miscellaneous Expenses £5,000 £4,500 £5,500 £5,000 £5,700 £4,500
Tax --- --- --- --- --- £15,000
Other Equipment --- --- --- --- £30,000 ---
Total Payments (£68,000) (£66700) (£69,300) (£70,000) (£127,000) (£88,500)
Surplus (Deficits) £27,000 £36,800 £23,700 £12,000 (£17,000) £25,500
Cash in Bank (£35,000) (£8,000) £28,800 £52,500 £64,500 £47,500
Closing Balance (£8,000) £28,800 £52,500 £64,500 £47,500 £73,000
Page 21 of 45 Managing Finance Mashukur Rahman Id: 4098
Function of Preparing a Budget
Budget is a integrated part of long-term planning process for business organisation.
Budgeting is concern with the implementation of the long-term plan for the following year.
Budgets are a clear indication of what is expected to be achieve during the budget period
whereas long-term plans represent the broad directions the top management intend to
follow. For implementing budget, top management should follow the following steps:
Planning
The budgeting process ensures that managers do plan for future operations, and
that they consider how conditions in the next year might change and what steps
they should take now to respond to these conditions. This process encourage
managers to anticipate problems before they arise, and hasty decisions that are
made on the spur on the moment.
Coordination
The budget serves as a vehicle through which the actions of the different parts of
an organisations can be brought together and reconcile into a common plan.
Without any guidance, managers may each make their own decisions, believing that
they are working in the best interests of the organisation.
Communication
Through the budget, top management communicates its expectations to lower-level
management, so that all members of organisation may understand organisation's
expectations and objectives and can coordinate their activities to attain them.
Motivation
The budget can be useful device for influencing managerial behaviour and
motivating managers to perform in the line with the organisational objectives. A
budget provides a standard that under certain circumstances, a manager may be
motivated to strive to achieve. If individuals have have actively participated in
preparing the budget, and it is used as a tool of assist managers in managing their
departments, it can act as a strong motivational device by providing a challenge.
Page 22 of 45 Managing Finance Mashukur Rahman Id: 4098
Control
A budget assists managers in managing and controlling the activities for which they
are responsible. By comparing the actual results with the budgeted amounts of
different categories of expenses, managers can ascertain which costs do not
conform to the original plan thus require the attention.
Performance Evaluation
A manager's performance is often evaluated by measuring his or her success in
meeting the budget. Most of the organisation give award or promotion on the basis
of an manager's or employee's ability to achieve the targets specified in the budget
period. So, the use of budgets as a methods of performance evaluation also
influences human behaviour.
Page 23 of 45 Managing Finance Mashukur Rahman Id: 4098
Implication of Preparing the Budget at the Lower Level of Management
Organisational Structures are represent by pyramid:
Behavioural Aspects of Budgeting
Communication
The budget can helps the different division, departments and different levels within
organisation to communicate their plans and needs to each other and it can helps
managers at all levels to anticipate potential problems. This communication activity
is one of the most important benefits of the budgeting process.
Motivation
The budget can be useful device for influencing managerial behaviour and
motivating managers to perform in the line with the organisational objectives. Lower
level employee of organisation will be motivated when they participates in
implementing the budget.
Page 24 of 45 Managing Finance Mashukur Rahman Id: 4098
Strategic Level
Mid-level Management
Lower Level Management
Goal Congruence
When implementation of budget, all employee of organisation, that means lower
level to top level, will follow the same directions i,e everybody follow the how to
achieve organisation's goals and objectives.
Target
Budget is setting of future target of organisation. As a result, by setting of budget all
employee of organisation known that what will be next production target or sales
target.
Slack
When the budget contains easy targets, its described as containing slack.
Page 25 of 45 Managing Finance Mashukur Rahman Id: 4098
Outcome: 3.0
Methods of New Projects Appraisal
Projects
A project is a specific plan or design presented for consideration. A project can be long
term or short term, limited or comprehensive, single sector concentrated or multi sector
concentrated.
As per United Nations Industrial Development Organisation (1998), “A project
as a proposal for an investment to crate and or develop certain facilities in order to
increase the production of goods/services in a community certain period of time.”
Steps of Project Implementation
Identifying the Project
The first phase of project management is the concerned with identifying the project
to achieve the desired objectives. The initial task coming under project identification
is to find out the sources of the project.
Project Analysis
The factors included under project need analysis are the, problem, solutions,
beneficiaries and decisions. The problem should exhibit an immediate intervention.
The focus should be to identify the beneficiaries. The solutions should be based on
the original problem. The decision to take up the project lies on how these three
factors problem, solutions and beneficiaries are important to project intervention.
Project Planning
Project planning is a scientific and systematic process in which logical linkages are
clearly established among the various elements of projects. Successful
implementation of the project depends on effective project plan. Based on the
anticipated goals and objectives the project planning to be made.
Page 26 of 45 Managing Finance Mashukur Rahman Id: 4098
Project Budget
This project budget is to calculate the cost of each project out put. The estimation
of the project cost should be made on fairly realistic sense of financial values. In the
multi year projects the inflation rate also to be anticipated in advance.
Financial Feasibility Analysis
One of the very important factors that a project team should meticulously prepare is
the financial viability of the entire project. This involves the preparation of cost
estimates, means of financing, financial institutions, financial projections, break-
even point, cash-flows, pay back period, ratio analysis, profitability analysis by
NPV, IRR etc.
Environmental Analysis
Environmental appraisal concerns with the impact of environment on the project.
The factors include the water, air, land, sound, geographical location etc.
Project Implementation
This is the period in which all the activities that are planned in the initial phases of
the project get materialized through operation. It is the task of the project managers
to apply different techniques like as PERT (Programme Evaluation and Review
Technique), CPM (Critical Path Method) for implementing the project.
Evaluation
The final stage is the evaluation of the project. Upon the conclusion of the project
success in attaining the goals, and to determine how future projects could be
managed. Here the effectiveness of the degree of the objective achievement, the
efficiency of the financial, human, and time resources to be observed by
performance appraisal, work audit, result evaluation, cost benefit evaluation, impact
analysis etc.
Page 27 of 45 Managing Finance Mashukur Rahman Id: 4098
Projects Appraisal Techniques
There are different types of techniques are uses for analysis of new project financial
feasibility such as Pay-back period, Net Present Value (NPV), Internal Rate of Return
(IRR) etc.
Payback Period
Generally, pay-back period means the length of time required to pay back the
original investment. This methods focus on the recovering period of cost of
investment.
As per Berman et al (2006)(Pg-187), “The payback method is probably the
simplest to evaluate the future cash flow from a capital expenditure. It measures the
time required for the cash flow from the project to return the original investment.”
Advantages
It is easy to calculate.
Manager can take the decision instantly.
Considers timing of cash flows.
Disadvantages
It does not consider profits of the project.
It does not take into consideration time value of money. It ignores taxes and
inflation.
Net Present Value (NPV)
Generally, Net Present Value (NPV) is the sum of all discounted cash flows.
Broadly, NPV is an amount which is the result of difference between present value
of cash inflows and present value of cash outflows. This amount is the expected
result of investment. NPV is used in capital budgeting to analyse the profitability of
an investment or project. If the present value of a project's future cash inflow is
greater than the initial investment, that project should be undertaken for future
investment.
As per Horne et al (2005)(Pg-323), “The net present value (NPV) of an investment
proposal is the present value of the proposal's net cash flows less the proposal's
initial cash outflow.”
Page 28 of 45 Managing Finance Mashukur Rahman Id: 4098
Formula of NPV is following below:
Here,
I-0 mean initial investment or cash outflows
I-1 mean cash inflows in first period or first year
I-2 mean cash inflows in 2nd period
'n' mean the last number or year to investment
and r mean discount rate of factor.
Advantages of Net Present Value Method
It consider time value of money.
It also consider all relevant cash flows rather than the net earnings.
The NPV method is capital budgeting, therefore, should ultimately lead to more
wealth for the owner of the company.
Disadvantages of Net Present Value Method
NPV is calculated with consideration of predicted cash flows. Overestimation or
underestimation of future cash flows may lead to the acceptance of project that
should be rejected, or the rejection of project that should be accepted.
The NPV method also assumes that the predicted discount rate which is the
same over the whole period of the project. The discount rate of project like as
the interest rate, which is changes from one year to another. Opportunities of
reinvestment future cash flows , future interest rate and the cost of raising new
capital can all affect the discount rate.
NPV method is more difficult to calculate, needs table of discount factor.
Page 29 of 45 Managing Finance Mashukur Rahman Id: 4098
�
I0 +I1
(1+r)1+
I2
(1+r)2 +........ +In
(1+r)n
Internal Rate of Return (IRR)
Internal Rate of Return (IRR) is the discount rate that results in the net present
value of zero for a series of future cash flows. It is the measure of the rate of
profitability.
According to Groppelli et al (2000)(Pg-159), “ IRR is the discount rate that makes
the present value of cash flows equal to the initial investment.”
Advantages of Internal Rate of Return (IRR) method
It gives consideration to the time value of money.
Considers all relevant cash flows.
Disadvantages of Internal Rate of Return (IRR) method
Difficult to calculate.
Less understand by non-financial managers.
Assumes that all intermediate cash flow's are reinvested at company's internal
rate of return.
Page 30 of 45 Managing Finance Mashukur Rahman Id: 4098
Result of NPV, IRR and Pay-back Period for project 'X' and 'Y' in following below:
(See appendix for calculation)
Project ' X ' Project ' Y '
Net Present Value (NPV at 10% ) £63235 £14074
Internal Rate of Return (IRR) 22.85% 13.83%
Payback Period 2.89 Years 3.67 Years
Since as per NPV method, both project would be profitable because both project NPV is
positive. But project 'X's NPV is higher then the project 'Y'. It means project 'X' will be more
profitable then the project 'Y'. Therefore, project 'X' should be preferred for future
investment appraisal to Mayor Ltd.
As per IRR method, project 'X' also should be preferred for future investment. Because
project 'X' will give the more then 22 percents return on the initial investment. While project
'Y' will give only 13.83 percents return on the investment.
Based on Pay-back method, if the Mayor Ltd will invest £200000 on project 'Y' then Mayor
Ltd recover the initial investment after 3.67 years where as project 'X' will give to return it
within 2.89 years. So, Pay-back Period method represents that project 'X' should be better
for future investment than the project 'Y'.
Since, among the all project appraisal method project 'X' is better and more profitable
comparing with project 'Y'. Therefore, if the Mayor Ltd want to finance by investing in the
project, project 'X' would be recommended for future investment.
Page 31 of 45 Managing Finance Mashukur Rahman Id: 4098
Chart No. 01
This line chart represents that, when discount rate is 10% that time project (X) NPV is
£63235 and with 30% discount rate, NPV is (-£35145). And Internal Rate of Return (IRR)
of project X is 22.85%. Where as, when discount rate is 10% that time project (Y) NPV is
£14074 and with 30% discount rate, NPV is (-£59419). And these two NPV were intersect
on discount rate line which value is 13.83%, this percentage would be called IRR for
project 'Y'.
Page 32 of 45 Managing Finance Mashukur Rahman Id: 4098
IRR(Y)=13.83%
IRR(X)=22.85%
Discount Rate
NPV
Outcome No. 4.0
Ratio Analysis
Ratio analysis is businesses performance measurement tools which analyse and
investigate the financial health of business by considering information of financial
statements, balance sheet as well cash flows statements. Ratios are calculated from
current year numbers and are then compared to previous years, other companies, to other
industry, or even the economy to judge the performance of the company.
“Financial ratio analysis is the calculation and comparison of ratios which are
derived from the information in a company's financial statements. The level and
historical trends of these ratios can be used to make inferences about a company's
financial condition, its operations and attractiveness as an investment”.
http://www.finpipe.com/equity/finratan.htm
Ratio might be grouped into four categories, each of which relates to a particular aspects
of financial performance or position.
Strengths of Business Organisation
Profitability, Liquidity, Gearing and Efficiency are strengths of any business organisation.
When all four strengths are exists in an organisation that organisation would be called very
good organisation. An business organisation may measure these four strengths by using
ratio analysis.
Page 33 of 45 Managing Finance Mashukur Rahman Id: 4098
Financial Gearing
ProfitabilityLiqu
idity
Eff
icie
ncy
Profitability Ratio
Profitability Ratio concerned with the firm's effectiveness at generating profits. This
ratio use for margin analysis and show the return on sales and capital employed.
The profitability ratio demonstrate that a firm's business performance during a
financial period. Profitability ratio includes the Gross Profit Margin (GPM), Net Profit
Margin and Return on Capital Employed.
As per Nikolai et al (2007)(Pg-279), “ Profitability ratios are used to evaluate how
effective a company has been in meeting the profit (i.e, return) objectives of its
owners.”
liquidity ratio
liquidity deals with the amount of cash a firm can manage quickly in order to
immediate debts or short-term obligation. Liquidity ratio concerned with the ability to
meet short-term debt. Liquidity ratio may includes the current ratio, acid test.
According to Floyd (2004)(Pg-83), “Liquidity ratio help establish whether a firm is
over drafting, expanding without sufficient long-term capital. This puts pressure on
its working capital, the excess of current assets over current liabilities.”
Financial Gearing
Gearing ratio illustrate the level of debt a firm have taken to finance for its
activities. Gearing ratio concern with the relationship between equity and debt
financing. This strength may measure by the gearing ratio and interest coverage
ratio.
As per Elliott et al (2007) (Pg-659), “ The gearing ratio represents that proportion of
capital employed which is accounted for by long-term fixed interest debt. The
gearing structure of a company refers to the amount of borrowings compared with
the amount of shareholders funds.”
Page 34 of 45 Managing Finance Mashukur Rahman Id: 4098
Efficiency
Efficiency ratio may be used to measure the efficiency with which particular
resources have been used within the organisation such as stock or inventory,
debtor, creditor etc. There are different types of ratio are uses for measuring the
firm's efficiency such as stock turnover ratio, debtor turnover ratio, creditor turnover
ratio, fixed assets turnover ratio, debtor collection period etc.
Limitation of Ratio Analysis
Although the ratio analysis may may provide useful information concerning firm's
operations and financial conditions, however it does have some limitations that necessitate
care and judgment those are given below:
Ratio analysis consider only financial figure but it does not consider other
environmental factors.
Many large firms operate different divisions in different industries, such as Virgin,
for such company's it is difficult to develop a meaningful set of a industry
average. Therefore, ratio analysis is more useful for small, narrowly focused
firms than for large, multi-divisional ones.
Ratio analysis does not identify short-term fluctuation within one year in assets
and liabilities as appraisal is based on a balance sheet which provides value of
assets and liabilities as at a point in time.
A ratio does not indicate the quality of its components.
Page 35 of 45 Managing Finance Mashukur Rahman Id: 4098
Profitability Measurement of Mayor Ltd Compared with Industry
(See appendix for calculation)
Ratio Mayor Ltd (2007) Industry (2007) Industry (2006)
Gross Profit Margin 48.14% N.A N.A
Net Profit Margin 7.00% 5.00% 5.00%
Return on Capital Employed 12.50% 10% 10%
The gross profit margin of Mayor Ltd was 48.14% in 2007 financial year which is
very good for any business firm. However, net profit margin was only 7% over the
sales revenue which is huge declined comparatively gross profit margin. This was
probably caused by high operating expenses which was £300,000 in one financial
period. So, Mayor Ltd should try to give more consideration to minimise the
operating cost.
The Industry's gross profit margin is not available, therefore it is not possible to
compare the results. However, the net profit margin of Mayor Ltd is
comparatively better by 2% than the Industry's net profit margin.
In 2007 financial year the Mayor Ltd's return on capital employed (ROCE) was
12.5%, it means Mayor Ltd got the 12.5 pence on each pound investment. In
relation, Mayor Ltd's ROCE (2007) is the quite better by 2.5% than the Industry's
ROCE (2006 &2007).
Liquidity Measurement of Mayor Ltd Compared with Industry
(See appendix for calculation)
Ratio Mayor Ltd (2007) Industry (2007) Industry (2006)
Current Ratio 2.05:1 1.2:1 1.5:1
Acid test 1.10:1 1:1 1:1
The Mayor Ltd's current ratio was 2.05:1, it means, for every pound liabilities there
are more than 2 pounds current assets available. This also means that, Mayor Ltd's
will have no difficulty in raising short-term finance either credit sales or keeping
stock. Mayor Ltd's current assets were more than sufficient to cover its current
liabilities. In relation, Mayor Ltd's current ratio looks very good compare to Industry's
current ratio, which was 1.2:1 in 2006 and 1.5:1 in 2007 financial period.
Page 36 of 45 Managing Finance Mashukur Rahman Id: 4098
On the other hand in acid test, Mayor Ltd was very strong on the liquid assets.
Mayor Ltd's no difficulties to handle the current liabilities. For every pound liability
there are 1.10 pound quick assets were available. On the basis of acid test, Mayor
Ltd is quite good than the Industry acid test.
Gearing Measurement of Mayor Ltd Compared with Industry
(See appendix for calculation)
Ratio Mayor Ltd (2007) Industry (2007) Industry (2006)
Gearing Ratio 15.00% N/A N/A
The gearing ratio illustrate that, level of debt a company have taken to finance of its
activities. In 2007 financial year, gearing ratio of Mayor Ltd was 15%. It means the
level of gearing is quite low. And the Mayor Ltd's will not have problem in
increasing long-term debt. Because the Industry's gearing ratio is not available, so it
is difficult to compare a sound judgement with Mayor Ltd.
Efficiency Measurement of Mayor Ltd Compared with Industry
(See appendix for calculation)
Ratio Mayor Ltd (2007) Industry (2007) Industry (2006)
Debtor Turnover Ratio 31.52 times N/A N/A
Creditor Turnover Ratio 15.24 times N/A N/A
Fixed Assets Turnover Ratio 1.80 times N/A N/A
Page 37 of 45 Managing Finance Mashukur Rahman Id: 4098
Bibliography
Berman, K., Knight, J. and Case, J.(2006), Financial Intelligence, 1st Edition (Pg-
187), Harvard Business School Press.
Black, G. (2005) Introduction to Accounting and Finance.1st Edition (Pg-136)
Elliott, B. and Elliott, J.(2007), Financial Accounting and Reporting, 11th Edition,
(Page-659), Pearson Education Limited.
Floyd, D.(2004), Business Studies, 2nd Edition, (Page-83), Letts Educational
Chiswich Centre.
Gallati, R. (2003) Risk Management and Capital Adequacy (Pg-130)
Groppelli, A.and Nikbakht, E.(2000), Finance, 4th Edition (Page-159), Berron's
Education Series, Inc.
Horne, J. and Wachowicz, J. (2008), Fundamentals of Financial Management. 13th
Edition (Pg-180),Pearson Education Limited.
Horne, J. and Wachowicz, J. (2005), Fundamentals of Financial Management. 12th
Edition (Pg-323), Pearson Education Limited.
Mclaney, E. and Atrill, P. (2005) Accounting: an introduction. 3rd Edition (PG-515)
Nikolai, L., Bazley, J. and Jones, J.(2007), Intermediate Accounting, 11th Edition,
(Page-279), South-Western Cengage Learning.
Rao, M. (2005) Advanced Accounting.1st Volume (Page-736)-New Age International
(P) Ltd.
United Nations Industrial Development Organisation (1998), Manual For Evaluation
of Industrial Projects, Oxford and IBH New York.
Watson, D. and Head, A. (2007) Corporate Finance: Principle and Practices. 4th
Edition (Pg-70)
Page 38 of 45 Managing Finance Mashukur Rahman Id: 4098
http://www.finpipe.com/equity/finratan.htm
http://www.teachnet-uk.org.uk/2007%20Projects/Biz-GCSE
%20Finance/sources/external.htm
Page 39 of 45 Managing Finance Mashukur Rahman Id: 4098
Appendix
1) Calculation of Net Present Value (NPV)
Formula of NPV=
Here,
I-0 mean initial investment or cash outflows
I-1 mean cash inflows in first period or first year
I-2 mean cash inflows in 2nd period
'n' mean the last number or year to investment
and r mean discount rate of factor which is 10%.
NPV of Project 'X' =
= £63235 [ using calculator]
NPV of Project 'Y'=
= £14074 [ using calculator]
Page 40 of 45 Managing Finance Mashukur Rahman Id: 4098
�
−200000 +40000
(1 + 0.1)1+
80000
(1 + 0.1)2 +90000
(1 + 0.1)3 +100000
(1 + 0.1)4 +40000
(1 + 0.1)5
�
I0 +I1
(1+ r)1+
I2
(1+ r)2 +........ +In
(1+ r)n
�
−200000 +80000
(1+ 0.1)1 +40000
(1+ 0.1)2 +40000
(1+ 0.1)3 +60000
(1+ 0.1)4 +60000
(1+ 0.1)5
2) Calculation of Internal Rate of Return (IRR)
IRR of project 'X'
For calculating IRR, its need to another NPV with different discount factor.
Let, guess a discount factor is 30%
So, New NPV=
= -35143
Formula of IRR=
=
= 22.85%
IRR of project 'Y'
For calculating IRR, its need to another NPV with different discount factor.
Let, guess a discount factor is 30%.
So,New NPV=
= -59419
Formula of IRR=
=
= 13.83%
Page 41 of 45 Managing Finance Mashukur Rahman Id: 4098
�
−200000 +80000
(1+ 0.3)1 +40000
(1+ 0.3)2 +40000
(1+ 0.3)3 +60000
(1+ 0.3)4 +60000
(1+ 0.3)5
�
−200000 +40000
(1+ 0.3)1 +80000
(1+ 0.3)2 +90000
(1+ 0.3)3 +100000(1+ 0.3)4 +
40000(1+ 0.3)5
�
Lowerdiscountfactor +(HigherNPV
HigherNPV - LowerNPV)Higherdiscountfactor - Lowerdiscountfactor
�
10%+(63235
63235 - (- 35143 ))30%- 10%
�
Lowerdiscountfactor + (HigherNPV
HigherNPV - LowerNPV)Higherdiscountfactor - Lowerdiscountfactor
�
10%+(14074
14074 - (- 59419 ))30%- 10%
3) Calculation of payback period
Formula of Pay-back Period =
Last year with the negative cash flow + ( ) × 12 months
Cash flows of project 'X'
Year Cash flow Amount left to recovering
0 -200000 -200000
1 40000 -160000
2 80000 -80000
3 90000 10000
4 100000 110000
5 40000 150000
So, Pay-back Period of project 'X' = 2 years +(80000/90000)× 12
= 2 years 10 months and 20 days or 2.89 years
Cash flows of project 'Y'
Year Cash flow Amount left to recovering
0 -200000 -200000
1 80000 -120000
2 40000 -80000
3 40000 -40000
4 60000 20000
5 60000 80000
So, Pay-back Period of project 'X' = 3 years +(40000/60000)× 12
= 3 years and 8 months or 3.67 years
Page 42 of 45 Managing Finance Mashukur Rahman Id: 4098
Total amount paid back in final year
Amount left to pay back in final year
4) Calculation of Profitability
Formula of Gross Profit Margin = × 100
= × 100
= 48.14%
Formula of Net Profit Margin = × 100
= × 100
= 7%
Formula of Return on Capital Employed (ROCE)= × 100
= × 100
= 12.50%
5) Calculation of Liquidity
Formula of Current ratio =
=
= 2.05:1
Page 43 of 45 Managing Finance Mashukur Rahman Id: 4098
Gross profit
Sales Revenue
£3,49000
£725,000
Net profit
Sales Revenue
£50,000
£725,000
Net Profit
Net Assets
£50,000
£400,000
Current Liabilities
£107,000
£52,000
Current Assets
Formula of Acid test =
=
= 1.10:1
6) Calculation of Gearing
Formula of Gearing Ratio = × 100
= × 100
= 15%
7) Calculation of Efficiency
Formula of Debt Turnover =
=
= 31.52 times
* [N.B: There are no credit sales figure in Financial Statements of Mayor Ltd, so sales revenue considered as a credit sales.]
* [N.B: There are no opening balance of debtors in Balance sheet of Mayor Ltd, so ending balance of debtors has been considered as a average debtors.]
Formula of Credit Turnover =
=
= 15.24 times
Page 44 of 45 Managing Finance Mashukur Rahman Id: 4098
Current Liabilities
£107,000 - £50,000
£52,000
Current Assets - Stock
£60,000
£400,000
Long-term Liabilities
Total Assets
Average Debtor*
£725,000
£23000
Credit Sales*
Credit Purchase*
Average Creditors*
£25000
£381,000
* [N.B: There are no credit purchase figure in Financial Statements of Mayor Ltd, so purchase considered as a credit purchase.]
* [N.B: There are no opening balance of creditors in Balance sheet of Mayor Ltd, so ending balance of creditors has been considered as a average creditors.]
Fixed Assets turnover ratio =
=
= 1.80 times
Page 45 of 45 Managing Finance Mashukur Rahman Id: 4098
Turnover
Fixed Assets
£725,000
£405,000