How to Prepare Performance Report of a Company

Questions: Task 11. Prepare a performance report for the two companies for consideration by the directors of Chelsea Plc indicating which of the two companies you consider to be abetter acquisition, the directors require an analysis of these ratios and explanation2. Indicate what other information is needed before a final decision can be madeTask 21) Calculate the annual cash flows for each of the five years.2) Using the investment appraisal methods calculate the ARR, Payback, NPV and IRR 3) Advise the client on whether this project should be accepted or rejected based on methods used above.Task 31. You are required to prepare a cash budget for the four months August to November 2014. The opening cash balance at 1 August 2014 is 15,400.2. Budgeting is one of the areas that the management are keen to improve on, could you provide an explanation of why budgeting is beneficial to a business and whatcan be done to enhance the budgeting process? Answers: Solution to the Required Task 1 1. Chelsea Plc is considering two companies Kensington (K) and Wimbledon (W) as the target companies which we are required to compare and advice which one is the better target for acquisition. There is certain profitability, activity and liquidity ratios are given for both the companies as well as the industry standards, we need to analyze all such ratios and conclude the decision. Let us discuss and analyze each ratios one by one (Bodie, et al, 2011). Return on Capital Employed is computed by dividing the net operating profit with the employed capital. It denotes the profit earned for each of capital employed in the company. The more the profits for the company the better it is so the higher the ROCE ratio the better it is for the company. Here the industry average given for this ratio is 20 whereas the W (28) has higher of this ratio from both industry as well as of Ks (22) (Burns and Morris, 2014). Therefore both the company is better off but W is more profitable. (Return On Capital Employed) Return on equity is a profitability ratio from the investors point of view since it is the ratio of the net income earned from the shareholders fund. It reflects the efficiency of the company to use the shareholders money and earn profit from it. In this ratio also W has higher ratio then both K and Industry thus it is in better position (Cao, 2011). Acquiring W will help Chelsea gain more confidence from investors since they will have sense of security that there fund is utilized in creating shareholders wealth and not destroying it. (Return on equity ratio) Gross profit and Net Profit ratios are the ratios computed by dividing the respective profits by the sales. This ratio reflects the percentage of profit earned on certain level of sales. Here in the given case study gross and net profit ratio of K is better than industrys average but of W is worst which denotes that profitability of W is lower when compared to that of K. It may be due to mismanagement or unnecessary expenditures which can be corrected by Chelsea after acquisition. Therefore we can say that analyzing the profitability ratios Wimbledon is better target firm. (Gross Profit Ratio) (Net Profit Ratio) Total Asset Turnover ratio indicates Net sales divided by average total assets. The higher ratio is preferable since it indicates that company is efficiently using its assets to generate sales. Here also W is better off from K as well as from the industry standards. Non-current asset ratio is similar only difference being here only the fixed assets is considered and not the total assets. This denotes how efficiently the company is utilizing its fixed asset in generating income for the financers. W has a ratio of 12 whereas Industry and K has 5.1 and 2.3 respectively (Cherneva, 2012). Thus in both the above ratios W is surpassing all other comparisons. (Asset turnover ratio) (Fixed Asset Turnover Ratio) Receivables collection period are the credit period allowed to debtors. The time period it takes to realize the sales amount in cash is known as receivable collection period. This period is preferred to be lower since the faster the collection is made the sooner the cash can be rolled back into the operating cycle. Here as per the given data W has the lowest collection period and thus it is preferable. (Accounts receivable Collection Period) Inventory holding period is the period which is required to sell the product to the consumers kept in stock. Like receivable collection period lower inventory holding period will shorten the days to complete one operating cycle and thus will allow Company grab more opportunities (Clift, 2011). Here also the holding period of W is lowest and thus it is in better position. (Average age of Inventory) In all the liquidity ratios such as current ratio, acid test ratio and debt equity ratio which is considered lower the better W is in better position thus we conclude that in almost all the ratios W is a better acquisition target. (Current Ratio) These ratios help us to analyze how the various areas are being covered under the ratios and how the decisions can be based on that ratios. Such as debt equity ratios helps us to measure the amount that the company uses as debt for financing the capital and the debt burden also for the company. The various other ratios shows how the company is liquid enough t pay off the debts and the liquidity structure of the company. The ROCE and ROE is one of the valuable measurements to measure the companys profitability ratio. By calculating the ROCE for both the companies W and K, it has been observed that the ROCE of W Company is 28 and the ROCE of K Company is 22 (Zhang et al., 2011). This shows that the profitability ratio of W Company is more than the K Company. So, acquiring W will be better for Chelsea to earn more profit from the market. The ROE of W Company is much better than K Company, so it would be better to acquire W by Chelsea Plc. So the Chelsea Plc Company should acquire the W Company to earn huge amounts of profit from market. If the company had more profitability ratio then the observation reflects that the company has more equity value as compared with the debt value of the company. It has been also found that the average borrowing rate is much less for the W Company (Glantz, 2014). So, the management of Chelsea Plc Company should merge with the W Company. 2. Final Decision cannot make only based on some ratios. Certain other aspects should be considering before deciding. These are as following in nature: Shares issued by the company Numbers of shares that are issues by the company to generate the funds for the operational activities of the company are mainly base on the final decision making strategies of the organization. Acquisition activities of the company Acquisition of a new or popular product in the company is also primary factors that are required to be considering during the final decision taken by the organization. The acquisition activities of the company are mainly base on the decision-making criteria of the particular organization. Research Activities Researches of several articles by independent analysts are also required and essential for the decision-making strategies of the organization are mainly base on the certain activities of the company is support the organization to take beneficial decision about the company. Borrowings of the company There are several debt amount which is taken by the company which is required to be settle after acquisition activity of company which is mainly based on the capabilities of the organization to fulfilled their organizational obligations which is based on the financial capabilities of the organization. Legal Obligations The legal obligations that are mainly base on the several activities of the company as per the pending legal obligations of the company. Moreover, those are required to sort out the company rules and policies measured by the company. There are certain value addition activities which are required for the decision making activities of the organization which is based on the maintaining the goodwill of the company. Human Resource Activities The decision-making activities of the company that is mainly based on the expenditures and the employees retrenchment activities that are mainly base on the certain activities of the organization as per the compatibility of the product line of the organization. Product price affordability The products price affordability of the company is base on the different purpose of the company decision-making activities of the organization. The decision-making strategies of the organization are mainly base on the several strategies follow by the organization. Mode of Payment The decision-making strategies of the company are mainly base on the several essential activities of the organization for choosing the proper mode of payment of the organization. this is the one of the most famous decision-making aspects of the organization in compare to the others aspects of the organization. Work Culture Environment The objectives behind the research on the work culture of the company are mainly base on the organizational decision and which is base on the certain activities of the company. The company is mainly depends upon the certain activities of the cultural factors of the company. Merger Activities The earnings after merger should evaluate to decide acquisition of the company is mainly support the company to take essential decisions about the organization about their financial and operational activities of the company (Gowthorpe, 2011). Task 2 1. As per the research of the Riverside Motorcycle Components Ltd. Company can provide some standard service which has been recently developed by them. For the service provision it requires special machinery which costs 100,000 with a residual value of 20,000 after 5 years. The companys cost of capital is 12% which can set as the benchmark to achieve this target at least to check the projects viability in some of the appraisal methods. We have been asked to prepare the annual cash flows each year given the data of estimated sales in units each year (Guiso and Rustichini, 2011). These cash flows are calculated by multiplying the contribution per unit amount with the units per year given. The following table shows the computation of annual cash flows each year: Annual Cash Flows Particulars Details Years 1 2 3 4 5 Units Sold - 5,000 10,000 15,000 15,000 5,000 Amount (in ) Annual Cash Inflow SP @ 12per unit 60,000 120,000 180,000 180,000 60,000 Annual Cash Outflow VC @ 8 per unit 40,000 80,000 120,000 120,000 40,000 Net Cash Flows - 20,000 40,000 60,000 60,000 20,000 2. The company requires us to compute the investment appraisal methods using different methods such as accounting rate of return, payback period, internal rate of return and net present value method. In the accounting rate of return method average accounting profit of all the years involved in the project is computed and then it is divided by the amount of initial investment resulting in a return percentage (Sagner, 2014). It is also called simple rate of return because it is easy to compute and also simple ratio. ARR is used in investment appraisal it helps in deciding whether the project is viable to adopt or not. The following steps show the computation of the ARR. Since this is rate of return therefore higher the return more viable is the project in this method. (Jan, 2013) Accounting Rate of Return (ARR) Step 1: Computing Annual Depreciation Initial Investment 100000 Salvage Value 20000 No of years 5 Annual Depreciation 16000 Step 2: Computing Average Accounting Profit Years Cash Flows Depreciation Accounting Profit 1 20,000 16,000 4,000 2 40,000 16,000 24,000 3 60,000 16,000 44,000 4 60,000 16,000 44,000 5 20,000 16,000 4,000 Total Accounting Profit 120,000 Salvage Value 20,000 Average Accounting Profit 28,000 Step 3: Computing Accounting Rate of Return Average Accounting Profit (in ) 28000 Initial Investment (in ) 100000 ARR (in %) 28 Particulars Years 0 1 2 3 4 5 Initial Investment (100,000) - - - - - Cash Flows - 20,000 40,000 60,000 60,000 20,000 Cumulative Cash Flows (100,000) (80,000) (40,000) 20,000 80,000 100,000 Fraction Calculations - n/m n/m 0.66666667 0.33333333 4 Payback Period (in yrs) 2.667 Payback period is the method which determines the time period in which the initial investment can be recovered resulting profits in further years. Here in the mentioned question the company has an initial investment of 100,000 which will be recovered in the next 5 years since the project lifetime is such. The payback period can be computed in many alternate ways but here we have calculated by using the excel formulae (Ramsden, 2011). After dividing the absolute value of the last cumulative negative cash flows with the cash flow of the first positive cumulative cash flows, we have added it to the number of years before the first positive cumulative cash flows (Harris, 2013). The following table shows the payback period computation with the help of excel formulae in the excel sheet. The worksheet has been attached. (Ajay, 2013) There are many investment appraisal methods but Net present value method is very prevalent and commonly used. It includes the effect of time value of money thus making the method more effective and appropriate for decision making. In the project the present values are computed by discounting the cash flows each year. The sum of these present values is subtracted with the initial investment to compute the net present value (Peterson, et al, 2012). If the NPV is positive then the project is viable and if it is negative it is not viable. Sometimes the salvage value is also given that gets realized at the end year of the project, in that case we add up the present value of the salvage value with the cash flows of that year and compute the NPV accordingly (Holton, 2012). The following table shows the computation of the NPV of the given problem with help of excel formulae. (NPV IRR, 2013) Particulars Discounting Rate 12% Years 0 1 2 3 4 5 Initial Investment (100,000) - - - - - Cash Flows - 20,000 40,000 60,000 60,000 20,000 Salvage Value - - - - - 20,000 Present Values (100,000) 17,857 31,888 42,707 38,131 22,697 NPV 53,280 Since the NPV is positive in the above calculation thus the project is viable for the company. Internal Rate of Return is the method which compares the inflows and the outflows making it equal. The discounting rate at which the inflow gets equal to outflow is the IRR. The project with the greater IRR should be selected since it is better to have higher IRR. The project is considered viable if the IRR is greater than the hurdle rate. The below table shows the IRR computation using the Excel formulae: (Formulae for calculating IRR in excel) Particulars Years 0 1 2 3 4 5 Cash Flows (100,000) 20,000 40,000 60,000 60,000 20,000 Internal Rate of Return (IRR) 27% Since the above IRR is greater than the companys hurdle rate of 12% we consider the project is viable. In the absence of further information we assume the companys cost o capital to be its hurdle rate for the IRR computation. (Formulae for computing NPV in Excel) From the above calculation, it has been observed that the company has invested 100,000 Pound in purchasing a new machine for their manufacturing process. In the first year, the management of the Riverside Motorcycle Components Ltd has a cash inflow around 17,857 Pounds in the first year. In the second year, the management of the firm has received a cash inflow of 31,888 Pounds from the machine installed for the production purpose. In the third year, the company has received around 42,707 Pounds and has a cash inflow of 38,131 Pounds and 22,697 Pounds in the fourth and fifth year respectively. It has been observed from the calculation that the total cash inflow from the machine is 153,280 Pounds in the last five years. The total net present value of the cash inflow is 53,280 Pounds (Media, 2012). As the net present value of the cash flow is positive, the management of the Riverside Motorcycle Components Ltd should invest in the machine to earn more profit. If we compare the NPV, IRR a nd ARR, it has been observed that the NPV is positive; IRR is more than the hurdle rate of the project (IMA., 2012). The ARR value is 28 % which is very healthy foer the investors to get back the money from the investment. It can be stated that the management of the company can invest in the machine. 3. Since as per the above calculations we get that all the methods give a positive indication towards the project thus the project is completely viable. In the ARR the rate of return earned is quite high i.e. 28%. Similarly in payback period method the years computed is 2.67 years for a five year project which is almost half the total time period which is a positive sign. The company will be able to recover its investment soon and invest in some other new project reaping only profits from this project in further years. The NPV and IRR are also giving good appraisal since the NPV is positive with the good margin and the IRR is greater than the double of the hurdle rate. Thus considering all of the above methods we advise the client to accept the project. Task 3 1. The bookkeeper of the Pedrosa Plc has fallen sick and the new staff is inexperienced. Therefore the directors of the company wishes if we can help them in anyways. It requires preparing a cash budget for the period of four months from the period Aug to Nov 14. Some information is provided to us by whom we will have to prepare the budget. There are sales and purchase value for the six months period is given. 40% of the total sales constitute cash sales which are realized immediately whereas 60% of the sales are credit sales with a one month credit period given to the debtors (Kimmel, et al, 2011). Similarly the suppliers also provide 1 month credit period which means this months purchase will be paid in the next month. The depreciation charge of 2,500 per month is non cash expenditure and thus will not be included in the cash budget. The following tables show the cash budget for four months and the appendix attached. Cash Budget For the period Aug '14 to Nov '14 Particulars Details August September October November (in ) (in ) (in ) (in ) Opening Cash balance given for Aug 15,400 37,240 43,390 48,930 Inflows Cash Sales Appendix 1 27,060 24,160 23,400 22,200 Collection from debtors Appendix 1 39,180 40,590 36,240 35,100 Rent Income Given 9,000 9,000 9,000 9,000 Total Inflows (A) 90,640 110,990 112,030 115,230 Outflows Payment to Suppliers Appendix 2 35,400 33,600 32,600 34,750 Wages Appendix 3 18,000 18,000 18,000 19,080 Dividend Given - 16000 - - Payment for Machinery Appendix 4 - - 12,500 6,250 Total Outflows (B) 53,400 67,600 63,100 60,080 Closing Balance (A-B) 37,240 43,390 48,930 55,150 Appendix 1 Sales Months Particulars Details July Aug Sept Oct Nov Dec Sales Volume given 65,300 67,650 60,400 58,500 55,500 64,600 Cash sales 40% of sales above 26,120 27,060 24,160 23,400 22,200 25,840 Credit Sales 60% of Sales 39,180 40,590 36,240 35,100 33,300 38,760 Collection From Debtors 1 month credit period - 39,180 40,590 36,240 35,100 33,300 Appendix 2 Purchases Months Particulars Details July Aug Sept Oct Nov Dec Purchase Amount given 35,400 33,600 32,600 34,750 35,650 35,600 Payment to suppliers 1 month credit period - 35,400 33,600 32,600 34,750 35,650 Appendix 3 Wages Months Particulars Details July Aug Sept Oct Nov Dec Wages 6% inc. from nov onwards 18,000 18,000 18,000 18,000 19,080 19,080 Appendix 4 Machinery Months Particulars Details July Aug Sept Oct Nov Dec Installments Payment 25% in Oct, rest in 6 months (Cost= 50,000) - - - 12,500 6,250 6,250 2. Budgeting is the process of managing and approximating the expenditure and the income. It is a plan prepared for future to keep a balance between the income and expense. Budgeting is also very vital in fulfilling the financial needs of the company as they have the plan at hand ready to work on different situations accordingly. Preparation of budgets such as cash budget, purchase budget, sales budget etc helps in proper evaluation of the companys performance. Any deviation from the budget will alert the management to take necessary actions and work accordingly. (What is Budgeting?) (Nordmeyer) There can be various ways to enhance the budgeting process. Not achieving it alerts the management and makes them pay more heed to such process. Corporate Performance Management (CPM) and Performance Based Budgeting (PBB) are the ways to enhance the budgeting process (Marney and Tarbert, 2011). The cost benefit analysis is significant in this budgeting process. Thus we conclude that for every organization preparing a budget is crucial part in its management process. (Performance Based Budgetting, 2015) Bibliography Accounts receivable Collection Period. (n.d.). Retrieved 2015, from Accounting Tools: https://www.accountingtools.com/receivables-collection-period Ajay. (2013, April 4). Calculating Payback period in Excel. Retrieved June 6, 2015, from Techtites: https://techtites.com/calculating-payback-period-in-excel/ Asset turnover ratio. (n.d.). Retrieved 2015, from my accounting course: https://www.myaccountingcourse.com/financial-ratios/asset-turnover-ratio Average age of Inventory. (n.d.). Retrieved 2015, from Investopedia: https://www.investopedia.com/terms/a/average-age-of-inventory.asp Current Ratio. (n.d.). Retrieved 2015, from My accounting course: https://www.myaccountingcourse.com/financial-ratios/current-ratio Debt-Equity Ratio. (n.d.). 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