Financial Principles and Management (Essay Sample)

MANAGING FINANCIAL PRINCIPLES AND TECHNIQUES
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Table of Contents
 TOC \o "1-3" \h \z \u  HYPERLINK \l "_Toc424659826"
1 Introduction  PAGEREF _Toc424659826 \h
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2 Task 1  PAGEREF _Toc424659827 \h
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2.1 Importance of costs in the pricing strategy of Tesco  PAGEREF _Toc424659828 \h
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2.2 Designing a costing system for Tesco  PAGEREF _Toc424659829 \h
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2.3 Improvements to the current costing and pricing system  PAGEREF _Toc424659830 \h
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3 Task 2  PAGEREF _Toc424659831 \h
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4 Task 3  PAGEREF _Toc424659832 \h
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5 Task 4  PAGEREF _Toc424659833 \h
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5.1 Cost minimization techniques  PAGEREF _Toc424659834 \h
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5.2 Potential for activity based costing  PAGEREF _Toc424659835 \h
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6Task 5  PAGEREF _Toc424659836 \h
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7 Task 6  PAGEREF _Toc424659837 \h
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7 Conclusion  PAGEREF _Toc424659838 \h
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Bibliography  PAGEREF _Toc424659839 \h
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1 Introduction
The ability to evaluate or appraise an investment is crucial in reducing the risk associated with making poor investment decisions. It is also necessary for potential investors to utilize different investment appraisal methods since each of the methods have their own drawbacks and assumptions. However, most of the financial decisions in investing should not be made without a thorough knowledge of the investment and its potential in generating the envisaged income. Investment appraisal enhances the ability of a business to assess the amount or level of the returns that are expected from the investment. The returns are evaluated against the expenditures that will be incurred so as to establish whether the investment is worth or not. It is also necessary to estimate the expected future costs of the investment and also its benefits. This makes the final investment decision made to be optimal thereby increasing the level of certainty towards its success. The primary aim of any business is to make profits amongst other market goals such as higher market share and customer satisfaction. In order to maximize costs, a business must track and control its costs of doing business. It must also evaluate the sources of financing for its projects such that such financing makes a positive contribution towards attainment of the goals of the business. It is also prudent for a business to evaluate the cost reduction measures that are in place. There is also the need to put in place budget monitoring mechanisms so as to ensure the approved budgets are strictly adhered to especially in the area of costs. Such monitoring exercises allows the production of periodical budget monitoring reports that reveal the trend of the various functional units of the business in adhering to the set budgetary provisions. Any anomalies are timely addressed and if need be the budget is revised to avoid any detected flaws.
2 Task 1
2.1 Importance of costs in the pricing strategy of Tesco
Costs play a crucial role in the pricing strategy of Tesco (the company). They determine the profit margins the company makes on the wide range of products and services it offers to its customers. Costs also ensure the company retains most of its customers in the face of intense competition it faces in the market. The company adopts various pricing approaches based on the market dynamics and costs play a central role in this process.
One of the pricing strategies used by Tesco is cost-based pricing. The company establishes the fixed and variable costs of each of its products and services on offer. After determining the cost, the firm adds a profit margin to the total costs in order to determine the price the customers pay to access the product or service. The main advantage of this approach is that it ensures all the costs incurred by the firm are recovered and there is a guarantee of earning a profit. However, the approach has a draw back since it does not give credence to external factors such as competition and ability of customers to pay the set prices (Welsch & Hilton 2009).
The firm also adopts absorption-based costing where all the costs the business incurs in its operations and other activities are allocated equitably to all its products and services to determine their prices. The costing strategy facilitates the determination of whether a product or service has a profit potential or not. The firm’s profit levels are then based on the level of sales volumes it makes for the products on offer.
The firm also uses marginal costing technique to determine the contribution each of its products makes to the profits realized by the firm. Marginal costing requires the separation of variable and fixed costs since the fixed costs do not change while variable costs change depending on the sales levels. The use of this approach in determining the contribution margins of each product portfolio is vital in enhancing quality decision making at the retailer.
2.2 Designing a costing system for Tesco
Due to the huge amounts of transactions and products on offer at Tesco, it is prudent for the retailer to adopt activity-based costing so that prices are assigned to products based on their demands for overhead costs. The use of activity based costing at the retailer would increase the price-competitiveness of its products and assert its market leadership position.
The first stage in the designing of activity based costing for the retailer is process value analysis. This stage involves the identification of various activities that are performed in the processes that take process in the organization on a daily basis. It is usually prudent to aggregate activities that are related so as to avoid any confusion of the objectives of the entire process. The activities that add value to the retailer should be clearly outlined to facilitate further procedures (Berry & Jarvis 2005).
The next step in the process is creation of activity centers. These are clusters of activities that are related and are essential in providing information on related activities. Costs are then assigned to these activities through activity cost pools that further facilitates the assignment of these costs to individual products. In order to reduce the costs of the system, related activities are integrated into one cost center since it is uneconomical to designate each activity as an independent cost center.
The third step is defining the resource drivers. The defining of the resource drivers is necessary in the determination of resources that are consumed by each of the activities identified earlier. When defining a resource driver, one must consider the ease and reliability of collecting data relating to the resource driver.
2.3 Improvements to the current costing and pricing system
Tesco has previously relied on cost-based pricing to determine the prices of its products and services. However, there is a need of adopting competition-based pricing whereby the firm analyzes the prices being charged by its competitors for similar products and services. It is the discretion of the management to determine whether to set the price at a level that is higher, lower or equal to the price being offered by the competition (Pettinger 2000). Such a decision will be based on demand and supply factors of specific products. The adoption of competition-based pricing will ensure Tesco retains most of its consumers especially after the devastating impacts of the last financial crisis where most household incomes reduced due to high inflationary pressures.
The retailer must also conduct periodical analyses of the market in order to determine the reactions of other retailers in the industry towards its decisions and make suitable adjustments. As mentioned earlier, the retailer should adopt activity based costing. The system permits the allocation of product costs based on the demands for each of the products before they are sold to customers.
3 Task 2
Forecasted income statement
Item Current i.e. 2014 (£m)Percentage increaseForecasted amounts for 2015 (£m)Total revenue 645395%67766Costs of goods sold592782%60464Gross profit 52617302Administrative & other general expenses 16343%1683Operating income 36275619Interest expense 417-417Net income32105202Tesco has been instrumental in its international expansion activities where it wishes to establish operations in more international markets. One of the sources of funds that the retailer can use to finance this expansion is through equity financing. First, the company can choose to use its substantial amounts of retained earnings to finance the expansion project. Retained earnings provide a suitable source of financing since there are no interest expenses that come with such funds. These are the earnings due to the shareholders of the company but have been retained to cater for its financial obligations. Secondly, the company can choose to raise the amounts needed for expansion through a rights issue to its current shareholders (Welsch & Hilton 2009). Through this approach, the company issues additional shares in an equitable way based on the number of shares each of the shareholders has in the company. Such additional shares provide an avid source of funding for the expansion project since there are no mandatory requirements for the company to pay interest to the buyers since...