Role of Financial planning
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The proper management of financial resources is highly essential element for success of the business unit. Moreover, the business unit needs to take various financial decisions from time-to-time. It is essential for the organization to adopt appropriate financial and analysis techniques for the purpose of supporting appropriate decision making process (Lewellen, 2004). The report proposed herewith emphasizes on application of various financial techniques. The report helps in developing a deep understanding of various financial techniques and manner in which financial decisions within the organization are supported. The report deals with various cases and financial techniques to be adopted so as to support the analysis.
Task 1 Business Performance & decision making process
1. Performance report of two companies
The case presented herewith deals with acquisition of Kensington & Wimbledon on part of Chelsea Plc. It is essential for the business unit to select better acquisition option on basis of financial indicators. The performance of both of two business unit needs to be analysed through various ratios such as profitability, activity and liquidity ratios. On the basis of various ratios estimated, an in-depth analysis is conducted so as to select the better option. The analysis of different ratios estimated is presented underneath so as to identify suitable option for investment purpose.
Profitability ratios: The profitability ratios indicate organization’s capacity to earn more amount of return (Weil, 2012). It is seen that business units should earn minimum of 20% as a return on capital employed as per industry average. Moreover, both of the organizations are able to meet industry standards. Nevertheless, Wimbledon is earning return of 28% as compared to that of Kensington who earns return of approximately 22%. Return on equity is said to be earned at 22% by Wimbledon and 18% by Kensington. The industry average is met by both of the organizations. It is seen that
Wimbledon on one hand is earning sufficient amount of return on the amount invested. On other hand, the business unit is unable to meet industry standard for net profit margin and gross profit ratio.
The industry average for net profit margin is 7%. Kensington earn net profit margin of 11% which is above industry standard. Wimbledon on other hand earns net profit margin of 5% that is below industry average. The same is case with gross profit margin which is earned at adequate levels on part of Kensington. As per the analysis, it is seen that the Wimbledon is able to earn sufficient level of return on capital employed and equity. However, the organization is unable to meet industry standards for net profit margin and gross profit margin. On the basis of profitability ratios, it is suggested that the
Chelsea Plc should acquire Kensington. It is the organization that is able to meet industry standards in all of the cases. The business unit although lacks behind Wimbledon in case of return on capital employed and return on equity. It is highly efficient in conducting operations as indicated from net profit and gross profit margin. Henceforth, Kensington ltd. is regarded as highly valuable for acquisition purpose on part of Chelsea Plc.
Activity ratios: The activity ratios such as total assets turnover, non-current assets turnover, receivables collection period and inventory holding period are estimated in order to understand efficiency with which business unit is operating (Helfert, 2004). It is seen that Kensington is unable to meet industry standards for total assets turnover and noncurrent assets turnover ratio. However, the business unit has highly efficient in collecting payments and managing inventory as indicated from receivables collection period and inventory holding period. On other hand Wimbledon is able to meet industry standards for total assets turnover and noncurrent assets turnover ratio. The organization is unable to meet industry standards for receivables collection period and inventory holding period. It can be said that the Wimbledon is efficient in making utilization of its assets. Kensington on other hand is efficient in managing its operations. The business unit should therefore decide to acquire Kensington which is highly efficient in conducting its operations.
Liquidity ratios: These are the ratios that help in analysing amount of liquid cash available with the business unit. It is seen that current ratio is higher in case of Kensington due to adequate level of liquidity (Drake and Fabozzi, 2012). In case of liquidity ratios both of the organizations are unable to meet industry standards. It is seen that liquidity is optimum in case of Kensington and Wimbledon. As per the debt-equity ratio it can be said that Kensington has employed sufficient amount of equity. It can be therefore suggested that the Chelsea plc should acquire Kensington due to high efficiency associated with the business unit.
2. Information required for final decision making
The acquisition strategy of organization is said to be highly important in nature. In order to take appropriate decision the range of financial information is required on part of the business unit. The financial information that helps in supporting decision making process of the organization is described below in detail.
Forecasted cash flows: The business unit needs to estimate cash flows generated as a result of acquisition strategy. It can be claimed that the organization is able to judge the feasibility of acquisition strategy through appropriate estimation of forecasted cash flows. Henceforth, the business unit needs to have access to information related to forecasted cash flows.
Trend in profitability: The organization needs to ascertain profitability of the businesses that are planned to be acquired. It is through proper estimation of trend followed for profitability in past that the business unit is able to take appropriate decisions (Arnold, 2005). It can be therefore said that the organization needs to analyse trend for profitability for businesses. This in turn helps in supporting acquisition decision for Chelsea Plc so as t support efficiency in long run.
Legal obligations: Chelsea Plc needs to gather information related to all pending suits for the businesses into consideration. The pending legal obligations and suits help in selecting the suitable option for the acquisition purpose.
Task 2 Capital budgeting decision
1 Annual cash flow for five years
The annual cash flow for five years of duration is estimated for Riverside Motorcycle Components Ltd. It is through estimation of net cash flow earned on annual basis that the business unit is able to effectively support its investment decisions (Anderson and Coleman, 2000). The cash flow that is estimated for five years of duration is presented in table underneath.
It is seen that the business unit is earning sufficient amount of annual cash flow during five years of time. The investment in machine is going to generate adequate level of cash inflow for the organization into consideration.
2 Capital budgeting techniques
The capital budgeting techniques are devised as a tool to support investment decisions of the organization. It is through adoption of capital budgeting techniques that the business unit is able to make appropriate investment decision. The outcomes generated by way of adoption of various capital budgeting techniques are presented below in detail.
Accounting rate of return: The accounting rate of return aims at estimating annual return that is to be generated by making investments into the project selected (Dayananda, 2002). It is through adoption of formula mentioned below that the accounting rate of return for new project can be estimated.
The table presented above indicates that the investment into new project is going to generate sufficient amount of cash flow. The positive and adequate amount of return indicates that the business unit should make investment in project into consideration.
Payback period: The payback period is calculated in order to ascertain duration in which initial investment is recovered (Anthony, 2012). The formula through which payback period can be estimated is presented underneath.
The business unit is going to recover initial investment within 2.67 years as estimated through payback period. The organization since is able to recover investment in short duration, it is suggested to make purchase of machinery into consideration. Henceforth, the lower payback period indicates that the business unit should purchase new machinery so as to expand business operations.
Internal rate of return: The internal rate of return is estimated in order to ascertain rate of return at which net present value equals zero (Leung, 2011). It is the rate that is generated on part of business unit through investment into new machinery.
As per the values estimated, it can be said that the organization is able to earn internal rate of return of 29%. The sufficient level of return supports business decision to make investment into new project or machinery.
Net present value: Net present value is estimated to ascertain value of the project into consideration at present date (Gibson, 2008). The net present value that is estimated for present project is indicated in table underneath.
As per the table proposed herewith, the business unit should make investment and purchase new machinery. The project into consideration is said to generate sufficient amount of positive cash flow. Henceforth, it can be said that investment decision is highly feasible in nature.
3 Suggestion for project acceptance or rejection
As per the values estimated the business unit should make purchase decision. The organization is able to earn sufficient amount of profit. It can be said that the business unit is going to earn sufficient amount of money through investment into new machinery. All capital budgeting techniques suggests that the business unit should make investment so as to support operations in long run. The investment decision is going to add positive value to the organization. Henceforth, as per capital budgeting analysis it is suggested that the business unit should make investment in project into consideration.
Task 3 Cash budget & budgeting
1. Cash budget for four months
The cash budget for four months is prepared for Pedrosa Plc. in two forms: considering the amount of depreciation as non-cash and cash expenditure. The cash budgets in two forms are presented underneath.
The cash budget presented above indicates that cash balance increases on continuous basis. The business unit is generating sufficient amount of cash on monthly basis which in turn indicates that the operations are conducted in an efficient manner.
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2 Benefits of budgeting and aspects for improvement
Budgeting is considered to be highly important element for the business unit. The process of budgeting is regarded to support operations in long run. The importance of budgeting is described below in detail.
Guidance to business operations: The budgets prepared at beginning of year is said to provide guidance to operations of the organization (Shim, Siegel and Shim, 2011). The process of budgeting is considered to be highly significant in nature since it provides guidance to all operations within business unit.
Optimum utilization of resources: The budgeting process helps in making optimum utilization of resources. The business unit is able to allocate resources in an efficient manner and make optimum utilization of resources (Irani and Love, 2002). It can be therefore said that the budgeting process helps in making optimum utilization of resources.
Future forecasting: The organization is able to appropriately forecast profits and cash flows for future operations. It can be said that budgeting techniques help in making appropriate estimations and forecasts for supporting future operations within the organization.
In order to make improvement in business operations, the organization needs to consider following areas.
Reviewing previous financial condition: It is through analysing past trend that the business unit is able to prepare appropriate budget. Henceforth, the organization needs to review past data for purpose of formulation of effective budget.
Prioritizing activities: An efficient budget is prepared by prioritizing various activities. It can be claimed that the organization is able to allocate resources appropriately when priorities for different departments and activities are clear (Brigham and Houston, 2009).
Evaluating industry scenario: Budgets should be prepared in accordance with industry standards. Henceforth, in order to improve quality of budget the business unit should conduct evaluation of scenario prevailing within industry.
The report proposed herewith emphasizes on evaluating various aspects related to financing and investment decisions. It is seen that the business unit needs variety of monetary and non-monetary information for the purpose of undertaking effective decisions. Moreover, the organization needs to adopt appropriate capital budgeting techniques for the purpose of selecting suitable investment option. Finally, it is seen that preparation of budget is beneficial to business units in variety of ways.
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- Arnold, G., 2005. Corporate Financial Management. 3rd ed. Financial Times/Prentice Hall.
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- Drake, P.P. and Fabozzi, F.J. 2012. Analysis of Financial Statements. 3rd ed. John Wiley & Sons
- Gibson, G., 2008. Financial Reporting and Analysis: Using Financial Accounting Information. Cengage Learning.
- Helfert, A. E., 2004. Techniques of Financial Analysis. Tata McGraw-Hill Education.
- Lewellen, J., 2004. Predicting returns with financial ratios. Journal of Financial Economics.
- Shim, K. J., Siegel, G. J. and Shim, I. A., 2011. Budgeting basic and Beyond. John Wiley &Sons.