Financial Decision Based on Financial Information

Financial Decision Based on Financial Information 1

Financial Decision Based on Financial Information

Word Count: 3063

[Name of the Writer]

[Name of the institution]


Executive Summary

For an organization, finance is an essential element for consideration. The financial decision

based on financial information directs the path for an organization. Financial information of an

organization includes its cash budget calculation where the organization assesses and evaluates

their financial performance and working capital cycle. In addition to cash budget calculation, a

firm takes pricing decision for the products and services they offer to their target market. A cost

based pricing model is an effective model for an organization to decide that what is the total cost

of production and what percentage of profit could be added in the total cost to decide the price of

the products. This model also helps an organization to evaluate that at what position the cost

incurring on manufacturing of product can be minimized or controlled which could assist in

increasing the profitability margin of the organization or organization can stabilize their market

position. Investment appraisal tools and techniques could assist an individual or an organization

to take investment decision. Each of the investment appraisal tools has its own importance and

by applying the organization is able to assess that either the project is beneficial for the

organization or not. Financial statement is an essential document for an organization as this

document is a mean of communication in between the organization an investor. The presentation

of the financial statement plays an important role as it contain information that motivates the

investor to invest its funds in that particular organization and the assessment of financial

information presented in that financial statement is made by applying financial ratios. Financial

planning is beneficial for an organization as the organization is able to manage its financial

resources according to that planning. Benefits of a financial planning include expansion, growth

and stability of the organization or an organization can introduce new product to its target

market.


Table of Contents

Task 1...............................................................................................................................................4

Cash Budget Calculation.................................................................................................................4

Cash Budget Surplus and Deficit.....................................................................................................5

Task 2...............................................................................................................................................6

Financial Decision Related to Cost and Selling Price.....................................................................6

Task 3...............................................................................................................................................8

Investment Appraisal.......................................................................................................................8

Evaluation of Investment Appraisal Tools....................................................................................10

Task 4.............................................................................................................................................10

Purpose of Financial Statement.....................................................................................................10

Financial Statement According to the Size of Business................................................................11

Users of Financial Statement.........................................................................................................11

Financial Ratio Analysis for MKTG and FSA..............................................................................12

Financial Ratio Analysis................................................................................................................13

Task 5.............................................................................................................................................15

Sources of Finance.........................................................................................................................15

Impact of Sources of Finance on Business Control.......................................................................15


Cost of Finance..............................................................................................................................15

Impact of Sources of Finance on Financial Statement..................................................................16

Benefits of Financial Planning.......................................................................................................16

References......................................................................................................................................17


Task 1

Cash Budget Calculation

Cash budget is known as the expected inflow of cash and the expected cash outflow for a

specific period. The period specified may be a month, quarter, semiannual or annual period. Cash

budget assist organization to evaluate their expenditure incurring during the period, the income

generated during the period and the net cash holdings after the deduction of all expenditures for

the specified time period. A cash budget is also used to assess that among all expenditure which

department of an organization contains the majority expenditure and what is the result being

produced by that department in against the expenditure being incurred. Another advantage is also

availed from a cash budget that the organization is able to assess that either the organization has

to raise capital from an external source to maintain the working capital cycle or the working

capital cycle is generating funds for the organization (Investopedia, 2014a).

13-Jun 13-Jul 13-Aug 13-Sep

Opening Balance £38,000 £59,000 £94,000 £89,000

Sale £54,000 £56,000 £48,000 £64,000

Purchases £16,000 £11,000 £32,000 £36,000

Credit Purchases £0 £0 £8,000 £12,000

Rent £8,000 £0 £0 £8,000

Other Expenses £6,000 £7,000 £10,000 £14,000

Repayment of Bank Loan £3,000 £3,000 £3,000 £0

Cash Balance at Month end £59,000 £94,000 £89,000 £83,000

Cash Budget for Caledonian Limited

(Table 1: Cash Budget for Caledonian Limited)

The cash budget of Caledonian limited has been illustrated in Table 1. As per the given scenario

the organization contain the opening balance for the month of June, July, August and September

is £38,000, £59,000, £94,000 and £89,000 respectively. The sale for each month is recorded as

£54,000, £56,000, £48,000 and £64,000. The purchases are made on credit basis that if the


organization purchases raw material in the month of June then the organization will pay for that

expenditure in the month of august. On the basis of credit purchase policy, organization has

incurred purchase expenses in the month of august and September £8,000 £ and 12,000

respectively. After the calculation made on the basis of given scenario the net cash balance at the

end of each month was £59,000, £94,000, £89,000 and £83,000 for the month of June, July,

August and September respectively.

Cash Budget Surplus and Deficit

Cash budget of an organization has two conditions at the month end. The first condition is when

the closing balance of cash budget is in surplus. The second condition is that when the closing

balance of cash budget of organization is in deficit. In both of these conditions organization takes

certain steps either towards growth, stability and expansion or organization can consider certain

external sources of finance to raise the cash budget into surplus (WBG. 2014).

In the first condition when the organization cash budget for the specified period is in surplus.

This condition arises when the organization has increased sales or the accounts receiving of the

organization has been increased. When an organization has cash budget surplus then the

organization can avail certain alternatives. These alternatives include expansion activity, growth

of the organization, maintain sustainability in the market, introduce a new product or a service,

and settle off any previous debts that could assist in improving the financial performance of the

organization. Budget surplus means that the organization has increased its performance or a

change in the policy has appreciated the organization’s financial strength (Investopedia, 2014b).

On the other hand there is another condition in which the organization suffers losses, that

condition is known as budget deficit. Budget deficit is that when the organization cash budget for

the end of the period specified is negative. This negative budget reflects the flaw in the policies

and procedures of the organization because the sales of the organization are lesser than the

expenditure organization incurred during the specified period. Another reason is that the

organization sales have been decreased or the amount of bad debts has been raised. In condition

when an organization bear a deficit in the cash budget then organization takes certain steps to

eliminate the deficit in the cash budget. These steps include raising finance from an internal or


external source. External source of finance includes bank overdraft or loan on the short term

basis. The internal source of finance includes disposal of an asset or investing capital or

increasing the sales of products and services.

Task 2

Financial Decision Related to Cost and Selling Price

The selling price of a product is determined on multiple bases. An organization has multiple

alternatives of setting up the price of their products. Among all of the alternatives, an

organization setups their price by applying the cost based pricing model. The cost based pricing

model is an effective model for setting up the price of products.

Table 2 presents the total cost calculation of each product. As per the given scenario, the cost of

each product is the sum up of its fixed and variable cost. The variable cost of each product is £20

and the fixed cost of each product is £10 which makes the sum up cost of each product is £30.

Veriable Cost 20Fixed Cost 10Total Cost 30

(Table 2: Cost calculation of Each Product)

As presented in the scenario, the selling price of each product is based on a certain percentage of

the total cost of each product. This pricing approach is known as cost based pricing model. The

organization has fixed their selling price as an addition of 30% in the total cost of the project.

This addition has determined the selling price of £39 per product. The calculation for the profit

of each product and total profit earned on sales has been presented in the table below (i.e. Table

3).

Total Profit earnd on sle of 500 unitsSelling price 39Unit slod 500Revenue 19500Total Cost 15000Profit 4500


(Table 3: Profit calculation of Each Product)

The above table presents that the organization has earned the profit of £4500 after selling 500

units. The total cost incurred on the selling of 500 units is £15000 and the revenue generated by

selling units is £19500.

Total Fixed cost @ 500 unitsFixed cost 10Units 500Total Fixed Cost 5000

(Table 4: Total Fixed Cost Calculation of 500 units)

The total fixed cost for the production of 500 units is £5000 and as illustrated in the scenario that

the senior management of the organization is informed that the organization covers its fixed cost

after the production of 500 units and any additional unit produced after the production of 500

units does not adds the fixed cost element in the production cost of a product. As the

organization is following the cost based pricing methodology, which means that reduction of

fixed cost will also affect the price of each product.

Veriable cost after 500 units 20Fixed cost after 500 units 0Total cost 20

(Table 5: Total Fixed Cost Calculation after the production of 500 units)

Selling preice after 500 unit with Markup of 30% on costSelling Price 26Per unit Profit 6


Since the organization is following the cost based pricing strategy and the contribution of fixed

cost is neglected after the production of 500 units. So after neglecting the effect of fixed cost on


total cost and price of each product, the price of each product is £26 which is 30% of the total

cost (i.e. £20 per product).

Total profit Earned by additional 200 unitsUnits for Sale after 500 units 200Selling cost 26Revenue 5200Profit per unit 6Total Profit on additional 200 units 1200


According to the calculation of price of each product after eliminating the affect of fixed cost on

the total cost presented in table 7 and also it’s affect on the price of each product, the

organization produces 200 additional units after covering the fixed cost of each product. As

presented in the table above, the organization produces additional 200 units and sells those

products at the price of £26. The revenue generated by the organization was 5200 and after

deducting the total cost from revenue, the organization earned the profit of £1200.

Task 3

Investment Appraisal

For making an investment decision in a project, it is necessary to perform analysis of that

particular project. Analysis of that particular project elaborated the financial strength of that

business and the expected benefits that could be gained from that particular business (ICBGlobal,

n.d).

Following are the investment appraisal of project alpha and beta to assess that which one of the

following business is an appropriate project for investment. Two tools are applied for the

investment appraisal and these two tools are net present value and payback period. Each of these

investment appraisal tools has its own importance and both of the tools are considered for

assessment before making investment (ICBGlobal, n.d).


0 1 2 3 4 5

(120,000) 60,000 60,000 30,000 15,000 15,000

1.00 0.91 0.93 0.75 0.68 0.62

(120,000) 54,540 55,560 22,530 10,245 9,315

NPV 32,190

PayBack 2

Project Alpha Cash Flow Statement

(Table 8: Cash flow Statement of Project Alpha and Project Beta)

0 1 2 3 4 5

(150,000) 30,000 45,000 75,000 75,000 50,000

1.00 0.91 0.93 0.75 0.68 0.62

(150,000) 27,270 41,670 56,325 51,225 31,050

NPV 57,540

PayBack 3

Project Beta Cash Flow Statement

(Table 9: Cash flow Statement of Project Beta)

Year DCF Cum. Cash Flow

0 (120,000) (120,000)

1 54,540 (65,460)

2 55,560 (9,900)

3 22,530 12,630

4 10,245 22,875

5 9,315 32,190

Net Present Value of Project Alpha

(Table 10: Net Present Value Calculation of Project Alpha)

Year DCF Cum. Cash Flow

0 (150,000) (150,000)

1 27,270 (122,730)

2 41,670 (81,060)

3 56,325 (24,735)

4 51,225 26,490

5 31,050 57,540

Net Present Value of Project Beta

(Table 11: Net Present Value Calculation of Project Beta)


As per the calculation presented above in table 8, 9, 10 and 11, it is illustrated that the net present

value of project beta is greater than project alpha (i.e. NPV = 57,540). On the other hand the

payback period of project alpha is lesser than project beta (i.e. Pay Back Period = 2 Years). The

investment appraisal tools extracts that project beta has the advantage over project alpha in net

present value but project alpha has the payback period of 2 years. On overall basis project beta is

the most appropriate investment appraisal for investment compared with project alpha.

Evaluation of Investment Appraisal Tools

According to ICB Global (n.d.), payback period is one of the investment appraisal tools that are

used to evaluate the investment decision of a particular business. The investment appraisal

illustrates that either this investment decision should be made or not. The payback period is

required to assess that after how much passage of time, the initial investment will be returned

from a particular project. By applying this tool result can be extracted in years that but on the

other hand this method does not elaborates the cash flows after the recovery of initial cash flows

and this method also does not elaborates the cost of capital incurred on that particular project

(ICBGlobal, n.d; IFAC, 2013).

The second tool used for the investment appraisal is the net present value. The net present value

is the most preferred investment tool as this investment tool is the most weighted tool in terms of

evaluating the decision of making investment in a particular project. The net present value means

the present value of future cash flows. On the comparative basis, that business that has the higher

net present value is considered to be an appropriate alternative for investment (ICBGlobal, n.d;

IFAC, 2013).

On the comparative basis among all the investment appraisal tools, net present value is

considered to be most preferable investment appraisal tool as this tool elaborates that what is the

present value of the future cash flow of that particular project. If the net present value of both

businesses is said to be equal then the payback period will be considered to prioritize on the basis

of other investment appraisal tools (i.e. payback period). The payback period also has its own

importance as it evaluates that when the project will refund the initial investment. If the payback


period is less then that funds could be invested in another business (ICBGlobal, n.d; IFAC,

2013).

Task 4

Purpose of Financial Statement

An organization or an enterprise that perform business activities in order to achieve the main

objective on the basis of which an organization or an enterprise is established (i.e. to earn and

maximize profitability by utilizing minimal resources available) formulates their financial

statement. The central idea that pursues an organization or an enterprise to establish their

financial statement is to inform and communicate with their investors and stake holders. Another

purpose is served by the financial statement of an organization that is to evaluate the financial

strength and performance of the organization (Best, 2014).

Financial Statement According to the Size of Business

There is no unified format for the formulation of the financial statement for every business. The

format of the financial statement varies from business to business. There are three different types

of business and the financial statement of each business serves different purpose for its

formulation. Financial statement of large business serves the purpose of information to the stake

holders of the organization and the format of the financial statement is according to the rules and

regulations of the concerned authority and the international format applicable for the formulation

of the financial statement (Kamnikar, Kamnikar and Burrowes, 2012).

Users of Financial Statement

Financial statement of an organization serves different purposes and provides information to its

users. Information of the financial statement includes the overall performance of the

organization, the liquidity on short term basis, solvency on long term basis, profitability margin

of the organization, leverage assessment and working capital cycle of the organization for the

fiscal year. Each of the above mentioned sections contains the information that is needed by

different users of financial statement (Best, 2014).


Information related to profitability and leverage of the organization is needed by the investors

and stock holders in order to assess the organization performance in terms of profit margin and

how much the organization is leveraged. In addition to the above two sections, information

related to two other elements of financial statement (i.e. working capital cycle and long term

solvency) is needed by the financial institute. The financial institute utilizes this information to

evaluate the financial strength and solvency in the long term and also the profitability of the

organization. This evaluation is necessary by financial institute before allocating funds as debts

(Best, 2014).


Financial Ratio Analysis for MKTG and FSA

Following are the income statement and balance sheet of MKTG and FSA in table 12 and table

13respectively. The following financial information of MKTG and FSA is used to perform

financial ratios analysis and compare these two businesses.

MKTG FAS£ £

30,570 16,280 (26,470) (9,110)

4,100 7,170 (3,660) (6,480)

440 690

Income Statement

SalesCost of SalesGross ProfitOverheadsNet Profit

(Table 12: Income Statement of MKTG and FAS)

Balance Sheet£ 000 £ 000 £ 000 £ 000

Fixed Assets 3,440 5,550 Current AssetsStock 2,420 2,370 Debtors 60 2,690 Bank 30 10 Total Current Assets 2,510 5,070 Total Assets 5,950 10,620

Capital 2,000 4,500 Long Term Loans 2,000 3,170 CurrentLiabilities 1,950 2,950 Total Liabilities 3,950 6,120 Total Capital & Liabilities 5,950 10,620

MKTG FAS

(Table 13: Balance Sheet of MKTG and FAS)


MKTG FAS

Gross Profit Margin 13.4% 44.0%

Net Profit Margin 1.4% 4.2%

Current Ratio 1.2871795 1.71864

Quick Ratio 0.0461538 0.91525

Gearing 66% 58%

Financial Ratios

(Table 14: Financial Ratio Analysis of MKTG and FAS)

Financial Ratio Analysis

Financial ratio analysis of MKTG and FAS is illustrated in the table above (i.e. Table 14) and

according to analysis it is concluded that the company FAS has the advantage in the financial

performance on comparative basis. In terms of profitability, FAS gross profit margin is 3 times

higher than MKTG and similarly the net profit margin of FAS is 3 times greater than MKTG as

presented in table 15. In liquidity and leverage, the performance of FAS is greater than MKTG.

The current ratio and quick ratio of FAS is 1.71 and 0.91 as presented in table 16 which is

greater than MKTG (i.e. 1.28 and 0.046 respectively). Company MKTG is also 66% geared

which does not reflect an attractive image of the organization because on comparative basis

company FAS 58% geared. Company FAS is less geared which means that company FAS has

higher chances of raising finance from external sources as presented in table 18. Overall

financial performance of FAS is greater than MKTG which illustrates that for investments,

company FAS is the better alternative rather than MKTG.


1 20.0%5.0%

10.0%15.0%20.0%25.0%30.0%35.0%40.0%45.0%50.0%

Gross Profit MarginNet Profit Margin

(Table 15: Profitability Ratio Analysis)

1 20

0.20.40.60.8

11.21.41.61.8

2

Current RatioQuick Ratio

(Table 16: Liquidity Ratios Analysis)

1 252%54%56%58%60%62%64%66%68%

Gearing

Gearing

(Table 17: Gearing Ratio Analysis)


Task 5

Sources of Finance

According to Riley, (2012) there are two different sources of finance namely internal and

external source of finance. Each source of finance has its impact on the performance, strength,

profitability and leverage of a business. Among all available sources for finance, it depends upon

the scenario and the situation of the business that illustrates which source of finance to be

utilized. Internal source of finance includes capital investment, selling of asset, debt utilization

and other personal sources. External source of finance includes bank loan, joint venture, bank

overdraft and angel financing. Personal sources for business include borrowing from a non

professional institute (Riley, 2012; Hofstrand, 2013).

Impact of Sources of Finance on Business Control

Each financial source has its impact on the business control. Certain financial source have a

negative impact on business control like in joint venture the business controller has to share his

authorities with another personnel as that investor owns an equivalent partnership in the

business. On the other hand business that avail external source of finance like if the business

avails bank loan alternative then the business has to inform the concerned bank about the

performance of business and upcoming plans for the future. Certain source adds value in the

control of business like business owner raise finance from personal source or internal source

rather than external source then the individual does not have to share his authorities with any

other individual (Ngongang, 2007).

Cost of Finance

Cost is an important element to consider when availing any source of finance because if the cost

of a particular source of finance is high then the benefits for the utilization of that source are

affected. There is a minor probability of uncertainty situation that arises in which the cost

element is not considered when availing a source of finance. On the other hand if the cost of

finance is high then another alternative should be evaluated in order to minimize the cost of

finance. Cost of internal source of finance is the cost that incurred for raising finance by availing


an internal source like disposal of an asset. Cost for external source of finance includes the

interest payment, security against the loan, documentation cost etc (Ready Ratios, 2014; IMF,

2012).

Impact of Sources of Finance on Financial Statement

Raising finance by utilizing different sources affects different sections and element of financial

statement. Raising finance from an internal source has no negative impact on the financial

statement of the organization because organization’s strength is evaluated by the liquidity on the

short term and solvency on the long term. Both of these assessments contain two elements (i.e.

assets and liabilities). When an organization avails an internal source then the liability of the

organization is not raised which results an addition of stimuli in the financial strength of the

organization. On the other hand if an organization avail an external source of finance then a

negative stimuli is added in the financial statement that affects overall financial position of the

organization (Ready Ratios, 2014; IMF, 2012).

Benefits of Financial Planning

An entrepreneur evaluates the financial position and overall performance of a business or an

organization in order to determine the future aspects of that business. Future aspects of a

business include growth, expansion or stability of a business in the presence of severe

competition. To assess the future aspects of a business the entrepreneur has to execute financial

planning for its business. The financial planning of a business includes the sources through

which a business will raise its required capital. The second element of a business financial

planning includes distribution of finance within the organization by using different approaches

and the assessment of result expected after the allocation of required funds (Credit Suisse, 2014;

Elahi, 2008).


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Documents

Financial Decision Based on Financial Information