London College of Accountancy and Management

EXTENDED DIPLOMA LEVEL 7

Unit 13: Managing Financial Principals and Techniques

Submitted TO: Rana Ejaz Mehmood

Submitted BY : Malik K.S Awan ( PB10439)
Programme: BTEC Extended Diploma in Strategic Management & Leadership

TASK 1 IDENTIFY AND ELABORATE DIFFERENT TYPES OF COSTS AND EXPLAIN THEIR IMPORTANCE TO AN ORGANISATION. FIXED COST Cost which remains fix in total but vary per unit is called fixed cost and it does not change as the level of production changed. VARIABLE COST Cost which remains fix per unit but vary in total and it changed according to the level of production. PRODUCT COST Cost which is a part of cost of product is called product cost. PERIOD COST A cost which relates with the specific period not with the product is called period cost. DIRECT COST Cost which is directly relates with the product is called direct cost. This is directly involved in the production of cost. INDIRECT COST Cost which in not directly part of product is called indirect cost.

USE DATA OF YOUR OWN CHOICE AND PREPARE INCOME STATEMENT BY USING MARGINAL AND ABSORPTION COSTING. See appendix A

SUGGEST IMPROVEMENTS WITH REASONS TO THE COSTING AND PRICING SYSTEMS USED BY AN ORGANISATION.

COST PRICING Cost pricing is a method in which variable cost charged to the each product and fixed cost is charged to the total contribution. It is also called variable/marginal or direct costing. Using this technique on the bases of result decisions are made. Fixed costs are not the part of product cost in this method. By using cost pricing it provides the cost classification of products and it is a easy way to calculate the cost per unit. It can help in profit planning for the short time period and it separate the fixed overhead expenses from the per unit cost. Performance of each product can be easily determined. If there is no opening or closing stock then the profit will not change in methods, variable or absorption costing.

ABSORPTION COSTING In this method all price whether variable or fixed is charged to the each product. Cost of each unit is reduced due to large scale production. Fixed cost is also known as period cost, because it relates to specific period. Usually it depends upon the strategy of the business that it should use marginal costing or variable costing. If company wants to control its cost then it uses absorption/full costing and if it wants to take decisions then it will use marginal costing. To measure the performance of the organisation absorption costing is used for the short term decision making, because management can decide whether to continue or discontinue the project during its life.

TASK 2 y IDENTIFY AND ELABORATE RELEVANT FORECASTING TECHNIQUES AND ALSO IDENTIFY AND APPRAISE VARIOUS SOURCES OF SUNDS AVAILABE THAT CAN BE OBTAINED BY ORGANISATION.

See appendix B  IDENTIFY AND ELABORATE RELEVANT FORECASTING TECHNIQUES AND ALSO IDENTIFY AND APPRAISE VARIOUS SOURCES OF FUNDS AVAILABLE THAT CAN BE OBTAINED BY ORGANISATION

FORCASTING TECHNIQUES Forecasting means to make a plan for the future time, on the bases of past experience or data. The following quantitative techniques can be used in order to forecast a plan for business. TIME SERIES FORCASTING It is a method in which past historical data and assumptions are taken into account to forecast future. In this technique average, trend movement etc. are focused. MOVING AVERAGE METHOD In this technique, average of past historical data for the specific period of time is calculated. WEIGHTED MOVING AVERAGE In this method weight age of past specific historical data is calculated. Weight of each period is calculated and on the bases of their weight future planning is done. SOURCES OF FUNDS If company needs funds then following sources are available to generate the revenue for the business. INTERNAL SOURCES If company needs funds for business then internally it can get finance from following ways/resources. y y Equity Issuing new shares

Retained earning Reserve

EXTERNAL SOURCES y y y Short/medium/long term loan Hire purchase Financial institutions

TASK 3 y Identify and briefly explain different types of budgets. Budget is a quantitative plan which is prepared for the upcoming period of time. There are different types of budgets, which are discussed as below: Departmental Budget A budget which is prepared by an organisation for its different departments separately it called departmental budget. Functional Budget Organisations operate under different functional heads e.g., sales, production, marketing etc. Budget prepared for each function is called functional budget. Operating Budget This budget is prepared to cover the daily expenses normally for 1 year. Capital Budget Capital budget is prepared according to the plan of investment. Such type of budget normally prepared for medium or long term time period. y Elaborate the master budget and compare actual expenditure and income to the master budget with an example. Master budget is usually prepared in the start of the accounting period which contains the estimated revenue and expenditures, and some variance in the budget and actual performance is expected, as future is unpredictable. There is example of master budget and actual result of revenue and expenditure. NOTE: all amounts are in 000

PARTICULERS MASTER BUDGET SALES COST OF GOODS SOLD GROSS PROFIT 8890 (5210)

ACTUAL RESULT 8350 (5013)

VARIANCE

-540 -197

3680

3337

-343

ADMIN EXPENSES MARKETING EXPENSES INTEREST PROFIT BEFOR TAX TAX PROFIT AFTER TAX

(730) (1650)

(650) (1800)

-80 150

(100) 1200 (360) 840

(70) 817 (245) 572

-30 -383 115 -268

As shown in the above table, difference between master and actual result is negative which means company could not fulfil its targets which were set to be achieve. y Explain briefly the budgetary monitoring process of an organisation.

Once the budget has been prepared for the upcoming period then company should take a due care of its implementation. Because master budget is set on the bases of different facts and figure which were provided on the bases of past data. So the process of budget monitoring must be conducted as follows. y y y y y y Company should see the target market for which budget is prepared. Expertise must take extra care of allocation of resources/budget. Unexpected changes should be observed. Strategy must apply to cope with changes. Actual result of expenditures must be critically analysis. Due changes should brought towards the variance analysis.

TASK 4 y Explain briefly the cost reduction process and elaborate how a cost reduction could be managed in an organisation.

Cost Reduction Process: In the current competitive market, a company can get the market share either become cost leader or by producing best quality products. Normally companies contain three major heads of cost which are Material, Labour and Overhead. Organisations can reduce its production cost or reduce the material cost. It also can be achieved by producing quality products at the cheapest price and getting the economies of scale. Value Analysis and Value Engineering methods can be use to cut the cost. Companies can purchase cheap material by strong bargaining power in bulk quantity or by hiring expertises in the business. Just In Time, ABC and Total Quality Management techniques can be used to control the cost. Just in time technique was firstly used by Japanese in production of Toyota car. They used to produce the cars as in time. Total Quality Management based on, doing the right things at the right time at the right place. Cost can be reduced by quality planning and assurance, Training, Cost appraisal and reducing the internal and external failure cost. y Importance of activity-based-costing. ABC costing is a good technique to reduce the cost. Before this method all cost of production to the one head and the exact cost of specific product was hard to find. Producers were producing the narrow range of products. Later on activity based costing was being used by organisation. There were different heads of each activity and cost was charged to relative head of activity, which helped to reduce the cost and its identification. Customers become demanding and a variety of products were being produced. Industry became more machine intensive. Merits of ABC: It identifies value added activities and eliminates the non-value added activities. It shows the relation between cause and its effects. It finds the cost driver to get the exact cost of product. Ignore the under or over pricing in order to decision making.

Limitation of ABC: It does not give explanation in detail. As a result of ABC costing proportion of overheads, compared to direct cost increased. In the fast market of competition the innovative products based company can survive and the product`s specification became more complicated. So in order to fulfil the customer`s demand companies are using ABC costing to reduce the cost of product and to become the cost leader in the market.

TASK 5 y Use Fingo and justify the investment decision using investment appraisal techniques. See Appendix C Please identify and discuss the advantages and disadvantages of using various investment appraisal techniques. INVESTMENT APPRAISAL TECHNIQUES Investment appraisal means to assess a specific investment project, whether it will be worthwhile for the business or not. The following types of investment appraisal can be used. PAYBACK PERIOD, INTERNAL RATE OF RETURNE, ACCOUNTING RATE OF RETURN and NET PRESENT VALUE. 1. PAYBACK PERIOD METHOD. Payback period is method in which we assess the length of time in which initial cost/investment can be recovered. Payback period is not commonly used as it is not the bases of a critical decision ADVANTAGES It may increase the company`s liquidity position. It is reliable if decision concern with short term period. Calculation of payback period is very simple It is easy and understandable method. DISADVANTAGES Investment may tied up. It does not consider time value of money. It does not take cash flows after payback period into account. 2. NET PRESENT VALUE. In this method time value of money is considered on the bases of inflation or interest rate, how much would we need today to get the desired money in the specific future time period? If the NPV is positive then project will be favourable and vice versa. ADVANTAGES y It considers the time value of money. y All relevant cash flows are taken into account. y It gives the clear ground for decision making. DISADVANTAGES y It is bit complex to convert the future cash flows into present value. y Using this technique the nature and size of the proposal is ignored.

y y y y y y y

3. INTERNAL RATE OF RETURN. IRR is a discounted cash flow rate of return which a company wants to achieve. If internal rate of return is greater than the required rate of return then the project will be accepted. ADVANTAGES y IRR considers the time value of money y IRR considers all the cash flows DISADVANTAGES y Calculation of IRR depends upon discounted cash flows y It is a complex procedure then other techniques

TASK 6 FINANCIAL RATIOS ( All amounts are in millions) 1. LIQUIDITY RATIOS CURRENT RATIO: The current ratio means the ratio between the current asset and current liabilities of the company. It indicates that the current assets over the current liabilities. =Current assets / current liabilities PARTICULARS Current assets Current liabilities Current ratio Conclusion and recommendations: In this ratio as compared to last year result was slightly better than current year. Assets has been reduced along with liabilities but reduction in the assets was more then liabilities. The company should increase its current assets to set off the liabilities. 2010 11392 16015 0.71 13081 17595 0.74 2009

2. Quick ratio This is ratio between current assets excluding stock to current liabilities. =Current assets - stock / current liabilities PARTICULARS Current assets stock Current liabilities Quick ratio 2010 8663 16015 0.54 10412 17595 0.59 2009

In this ratio there is not major change in the quick ratio. It means company`s level of stock was less than 2009 year which may reduce the stock holding cost and may benefit for the company. If the level of stock was high in 2010 as increase in the sales so as compared with the last year which result in increase in the level of stock. Company should not hold high level of stock which impact adversely on the quick ratio. 3. NETWORKING CAPITAL Working capital is the excess of current assets over current liabilities. =Current Assets - Current Liabilities PARTICULARS Current Assets Current Liabilities Net working capital 2010 11392 16015 -4623 13081 17595 -4514 2009

Company is in adverse condition as concern of working capital, which is necessary to meet the day to day requirement in both years. Company should increase investment in current assets to increase its ability to pay liabilities. 4. Average Collection Period = Debtors/Credit Sale * 365 2010 = 1888/56910*365 = 1820/53898*365 12 days 12 days 2009

Company had same debtor collection period in both years which is healthy sign. In both years Collection Department is doing better. Company should maintain its high performance of collection department as it is working with current collection period.

PROFITABLITY RATIOS: Net profit ratio: It shows the percentage of net profit from its sales. Net Profit Ratio 2010 2009 = PBIT/SALE * 100 = 3755/56910* 100 = 6.59% = 3395/53898 * 100 = 6.29%

As shown in the ratio company earned more profit in 2010. Company should increase its sale or reduce its cost in order to keep PBIT as increase in 2010. Gross Profit Ratio = Gross Profit/Sale * 100 2010 2009 = 4607/56910 * 100 = 8.09% = 4185/53898 * 100 = 7.76%

Gross profit ratio is much better than last year which means company has good bargaining power to reduce its costs and good strategy to increase the sales. So Purchases department should be more empowered to get economies of scales.

Mark up ratio 2010 2009

= Gross Profit/Cost of Goods Sold* 100 = 4607/52303 * 100 = 8.81% = 4185/49713 * 100 = 8.41%

Companies cost of sales has been increased and as a result its mark-up has gone up along increase in gross profit. Companies sale should be increased and to keep its gross profit high more work should be done by purchasing department in cost effectiveness, ROCE 2010 2009 = PBIT/Capital Employed*100 = 3755/30008 *100 = 12.51% = 3395/27969 *100 = 12.13%

There has been increase in rose of company as compared to last year which is a clear indication that company is investing in its capital which is a good indication as performance of company to boosts the level of sales.

Company should invest to raise its capital which boosts in running of the business.

EFFICIENCY RATIOS: Fixed Asset Turnover = Sale/Tangible Assets 2010 2009 = 56910/46023 = 1.23 = 53898/45564 = 1.18

This ratio is in satisfactory position as companies investment in its assets is increased as its level of sales increased. To supports its level of sale more investment in capital is required. Asset Turnover = Turnover/Capital Employed 2010 2009 = 56910/30008= 1.89 = 53898/27969= 1.92

Companies is seems to be doing slightly same as last year but not more increment in the sale compare to investment in capital as in 2009. Company should increase its investments in capital to support its level of sale increase. Stock Turnover = Sale/Closing Stock 2010 2009 = 56910/2729 = 20.85 = 53898/2669 = 20.19

Company ratio is increased as compared to last year but its level of stock is not in satisfactory position which gives rise to holding cost. Company should keep its level of stock same and ordering department need to more efficient. Stock Turnover Period = Closing Stock/sale*365 2010 2009 = 2729/56910*365 = 17.5 days = 2669/53898*365 = 18.07 days

Company seems to be doing better in turnover ratio as compare to last year which might be due to increase in sales , Companys level of sale should be maintained to keep the turnover period up to level.

SOLVENCY RATIO: Gearing Ratio = Debt/Equity + Debt

2010 2009

= 31342/46023= 0.68 = 32658/45564= 0.71

It shows the dependency of the company on borrowing. Higher the ratio higher the borrowings. So in 2010 company`s ratio is better then 2009, the dependency on debts is reduced in 2010. It Company should issue more shares rather than debenture or loan notes to increase the equity. Debt to Equity Ratio = Debt/Equity 2010 2009 = 31342/14681= 2.13 = 32658/12906= 2.53

It shows the proportion of company`s financial resource contains on debt and equity. In 2010 debt were paid and company`s dependency on equity became strong. So company should keep more focus on depending its equity.

Long term Debt to Equity = Long term Debt/Equity 2010 2009 = 15327/14681= 1.04 = 15063/129 06= 1.16

Long term debts are greater than its quality, which shows company is more focusing on long term debts rather than its equity. It does not show the short term borrowings. Company may offer its creditors for to convert their debentures into shares to increase its equity. The overall performance of the company is good and its ratios show that company is growing gradually but it still needs to maintain its cash flow requirements. y Internal and external factors, which may have impact on the selected company.

SWOT analysis of tesco provided us the following factors which may have impact on the companys performance.

o o o o o o

Cultural factor Economical factor Technological factor Legislative factor Threat of new entrance Market competition

And following are the internal factors which may have their impact on company. y y y y y Brand name Good will Bargaining power Supply chain management Variety

APPENDIX

Absorption Costing Income Statement Sales (5,000 units$20 per unit) Less cost of goods sold: Beginning inventory Add Cost of goods manufactured (6,000 units$12per unit) Goods available for sale Less ending inventory Cost of goods sold Gross Margin ($100,000 $60,000) Less selling and administrative expenses Variable selling and administrative expenses (5,000 3) Fixed selling and administrative expenses

$100,000 --------$0 $72,000 $72,000 $12,000 ---------$60,000 ---------$40,000 ---------$15,000 $10,000 --------$25,000 ---------$15,000 ========

Net operating income ($40,000 $25,000)

Variable Costing Income Statement Sales ($5,000units$20 per unit) Less variable expenses: Variable cost of goods sold: Beginning inventory Add variable manufacturing costs (6,000 units$7 per unit) Goods available for sale Less ending inventory (1,000 units$7 per unit) Variable cost of goods sold variable selling and administrative expenses (5,000 units $3 per unit)

$100,000

------------

$0 $42,000 ----------$42,000 $7,000 --------$35,000 $15,000 --------50,000 ---------50,000 ---------$30,000 $10,000 --------$40,000 --------$10,000 =======

Contribution margin ($100,000 $50,000) Less fixed expenses: Fixed manufacturing overhead Fixed selling and administrative expenses

Net operating Income ($50,000 $40,000)

APPENDIX B
Period Starting: year 1 year 2 year 3 year 4

Sales Sales Total Sales 9,150,000 10,065,000 11,071,500 12,178,650

9,150,000

10,065,000

11,071,500

12,178,650

Less Cost of Goods Sold Materials Labor Overhead Other Total Cost of Goods Sold 195,600 205,600 305,690 95,620 802,510 215,160 226,160 336,259 105,182 882,761 236,676 248,776 369,885 115,700 971,037 260,344 273,654 406,873 127,270 1,068,141

Gross Profit Operating Expenses Salaries and wages Employee benefits Stationary Rent Utilities Repairs and maintenance Insurance Travel Telephone Postage Office supplies Advertising Marketing/promotion Professional fees Training and development bank interest Depreciation Miscellaneous Other Total Operating Expenses

8,347,490

9,182,239

10,100,463

11,110,509

11,000 5,460 1,500 20,500 5,000 1,550 3,298 2,183 990 509 729 904,682 758,620 8,590 6,040 4,089 5,000 1,550 968 1,742,258

12,100 5,460 1,650 20,500 5,500 1,705 3,628 2,401 1,089 560 802 995,150 834,482 8,590 6,644 4,639 5,000 1,705 1,065 1,912,670

13,310 5,460 1,815 20,500 6,050 1,876 3,991 2,641 1,198 616 882 1,094,665 917,930 8,590 7,308 5,189 5,000 1,876 1,171 2,100,068

14,641 5,460 1,997 20,500 6,655 2,063 4,390 2,906 1,318 677 970 1,204,132 1,009,723 8,590 8,039 5,739 5,000 2,063 1,288 2,306,151

Operating Income

6,605,232 3,050 1,605 4,655 6,609,887

7,269,569 3,050 1,605 4,655 7,274,224

8,000,395 3,050 1,605 4,655 8,005,050

8,804,358 3,050 1,605 4,655 8,809,013

Interest income (expense) Other income (expense) Total Nonoperating Income (Expense)

Income (Loss) Before Taxes

Income Taxes

330,494 6,279,393

363,711 6,910,513

400,252 7,604,797

440,451 8,368,563

Net Income (Loss)

APPENDIX C
FINGO YEAR SALES D. Material Variable cost Advertisment Fixed Cost Total Cash flow Tax @30% 1 000 3750 (810) (900) (650) (600) -------790 (237) -------553 60 -------61.3 0.909 -------557.2 ===== 61.3 0.833 -------Present value 510.6 2 000 1680 (378) (420) (100) (600) -------182 (55) -------127 60 -------187 0.826 -------154.5 ===== 187 0.694 -------129.8 3 000 1380 (324) (360) (600) -------96 (29) -------67 60 -------127 0.751 -------95.4 ===== 127 0.579 -------73.5 4 000 1320 (324) (360) (600) -------36 (11) -------25 60 -------85 0.683 -------58.1 ===== 85 0.482 -------41

Tax benefits Net cash flow @ 10% Present value Net cash flow @20%

*Fixed cost will remain the fix.

NET PRESENT VALUE

Amounts are in 000 @ 10% Total present value = 865.2 Initial investment = (800) ----------Net Present Value 65.2 Net Present Value @20% Total present value = 754.9 Initial investment = (800) ------------ (45.1)

IRR CALCULATION
IRR = 10% + [(65.2)/(65.2+45.1)]*(20% - 10%) IRR = 15.9% or 16%

Recommendations
Since the net present value is positive @10% so we will accept the project and invest money on the bases of financial grounds.

REFRENCES            www.tesco.co.uk www.factoidz.com www.financeideas4u.blogspot.com www.quickmba.com www.netmba.com www.investopedia.com www.accountingformanagement.com www.accaglobal.com NCERT (2005), financial analysis using financial statements, Vol. 1. Philip E. Fess (2000), Corporate financial accounting, 2nd Ed. Marco Rustmann (2010), Unified financial analysis the missing links of finance, pp 456-458