Accounting and Finance Management: Report to the Board of Directors (Coursework Sample)

Accounting and Finance Management
Name
Institution
Part A: Grooves Ltd
1. Report to the Board of Directors
From the analysis of the company’s financial statement, we have been able to establish its level of profitability, liquidity, gearing and asset utilization. Profitability is a critical element in an organization, and it is the ability of a business entity to earn a profit. Key profitability ratios include the net profit margin, return on assets and return on equity. In finance, liquidity of a business can be assessed from the perspective of its ability to meet its financial obligations when they become due. Common liquidity ratios include current ratio and acid test ratio. A company’s financial leverage is equally important is making rational financial decisions. Gearing or financial leverage shows the extent with which the company is financed by shareholders versus lenders. The company’s financial leverage can be captured by two key ratios: debt-to-equity ratio and debt ratio. The company management’s ability to make the best use of the available resources can best be assessed by primarily focusing on asset utilization. Major asset utilization ratios include fixed assets turnover, inventory turnover and accounts receivable turnover.
Table 1: summary of Grooves Ltd’s financial ratios for 2013-2014
Ratios

Formula

2013

2014

Profitability




1. Net profit margin

=Net profitSalesX100

=2250001770000X100
=12.71%

=1605001800000X100
=8.92%

2. ROA

=Net profitTotal assetsX100

=2250001462500X100
=15.39%

=1605001462500X100
=10.97%

3. ROE

=Net profitSh.equityX100

=225000750000X100
=30%

=160500750000X100
=21.4%

Liquidity




1. Current ratio

=current assetscurrent liabilities

=379500298500
=1.27

=594000357000
=1.66

2. Quick ratio

=CA-inventorycurrent liabilities

=379500-222000298500
=0.53

=594000-354000357000
=0.67

Gearing




1. Debt to equity ratio

=Total debtTotal Sh.equity

=3285001134000
=0.29

=4320001192500
=0.36

2. Debt ratio

=Total debtTotal Assets

=3285001462500
=0.22

=4320001624500
=0.27

Asset utilization




1. Fixed assets turnover

=Total salesTota fixed assets

=17700001083000
=1.63 times

=18000001030500
=1.75times

2. Inventory turnover

=Cost of sales Av.inventory

=1020000 222000
=4.59 times

=1125000 288000
=3.9times

3. Accounts receivable turnover

=Credit salesAv.alcs receivables

=1770000153000
=11.57times

=1800000193500
=9.3times

From the computations, it is clear that the company’s profitability was relatively higher in 2013 than in 2014. This can be deducted the fact that all the company’s profitability ratios (net profit margin, ROA and ROE) were higher in 2013 than in 2014. However, the company’s liquidity level seems to be relatively higher in 2014 compared to 2013. This is because; all the company’s liquidity ratios (computed in table 1) are higher in 2014 than in 2013. Equally, the company’s financial leverage (gearing ratios) seems to have increased in 2014 presenting a higher financial risk. There seems to be a mixed result on the level of the company’s asset utilization based on the compuations. In terms of current asset utilization, the company seems to have been more efficient in 2013 compared to 2013. Although it can be argued that the company’s efficiency (in fixed asset utilization) was higher in 2014 relative to 2013.
2. Assessing the company’s working capital cycle is an integral part of financial management. According to Tennent (2010), working capital cycle refers to the time take to convert a company’s working capital (current assets and current liabilities) into cash. WCC is given by:
WCC=Inventory turnover (in days) + Days in account receivable –Days in accounts payable
Table 2: The Company’s WCC for 2013 and 2014
Particulars

2013

2014

Inventory tunover (in days)

=Av. inventorycost of goods soldX365
=2220001020000X365
=79.44days

=Av. inventorycost of goods soldX365
=2880001125000X365
=93.44days

Days in accounts receivable

=Av. accounts receivableAnnual credit sales X365
=1530001770000 X365
=31.55days

=Av. accounts receivableAnnual credit sales X365
=1935001800000 X365
=39.24days

Days in accounts payable

=Av. accounts payablecost of salesX365
=900001020000X365
=32.21days

=Av. accounts payablecost of salesX365
=1020001125000X365
=33.09days

WCC

=78.78=79 days

=99.59=100days

In computing the above WCC, some assumptions have been made. First, since the beginning amounts for inventory, trade receivables and trade payables for 2013 are not available; their end year figures have been taken to represent the average inventory, average trade receivables and average trade payables. Besides, since the information on net annual purchases is not available in both years, the cost of sales is used instead. We also assume that all sales were on credit.
From the above computations, it is clear that the company’s WCC (in days) is higher in 2014 than in 2013. This implies that the company’s liquidity position in 2014 has dropped from the previous year.
Part B: Goodfella’s Ltd
Question 1
* Payback period
Payback period=Initial investmentAnnual net cash inflow
Net annual cash inflow=Annual cash inflow-annual cash outflow
Net annual cash inflow= £580,000 - £130,500
Net annual cash inflow= £449500
Payback period=£1,500,000. £449500
Payback period=3.337 years
Depreciation of the machinary has been ignored since it is a non-cash item.
* The accounting rate of return
Accounting rate of return=Average profitAverage investment
Annual depreciation = (Initial investment-salvage value)/Useful of machine
Annual depreciation = (£1,500,000-£150,000)/6 years
Annual depreciation = £225000
Average profit= Net annual income-Annual depreciation
Average profit= (£449500-£225000) = £224500
Average investment= (Cost of machine+residual value)/2
Average investment= (£1,500,000/2) =£750000
Accounting rate of return=£224500£750000X100
Accounting rate of return=29.93%
* Net present value
Since taxes are not considered, depreciation will be ignored.
Year

Net cash inflow

PV Factor at 8%

PV

1

449500

0.926

416237

2

449500

0.857

385222

3

449500

0.794

356903

4

449500

0.735

330383

5

449500

0.681

306110

6

599500

0.630

377685



Total

2172540

NPV=PV of net cash inflows-Initial investment
NPV= (£2172540-£1500000) = £672,540
* Internal rate of return
IRR=Ra+NPVaNPVa-PNVb(Rb-Ra)
Where:
Ra=Lower discount rate with positive NPV
Rb=Higher discount rate with negative NPV
NPVa= Net present value at Ra
NPVb= Net present value at Rb
Let Rb be 22% and Ra be 21%.
Therefore, NPVa will be given as follows.
Year

Net cash inflow

PV Factor at 21%

PV

1

449500

0.8264

371467

2

449500

0.6830

307009

3

449500

0.5645

253743

4

449500

0.4665

209692

5

449500

0.3855

173282

6

599500

0.3186

191001




1506194

NPVa= (£1506194-£1500000) =£ 6194
NPVb will be calculated as follows:
Year

Net cash inflow

PV Factor at 22%

PV

1

449500

0.8196

368410

2

449500

0.6719

302019

3

449500

0.5507

247540

4

449500

0.4514

202904

5

449500

0.3700

166315

6

599500

0.3033

181828



Total

1469016

NPVb= (£1469016-£1500000) =£ -30984
IRR=21%+£ 6194£ 6194+£30984(22%-21%)
IRR=21%+0.1667
IRR=21.17% (Two decimal places)
Question 2
Capital budgeting technniques are arguably coupled with a numb...