Financial Analysis Of Management: Concepts, Measures, Data, And Results

Investment appraisals and long-term forecasting

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In order to judge whether a capital investment project is feasible and will give higher returns over its costs, the economists undertake various investment appraisals.

Investment appraisals are made up of two factors—stream of expected returns and total cost outlays. Comparing these two factors a cost benefit analysis is done. This calls for long-term forecasting.

 Certain capital assets having a long life are purchased and put to use in an investment appraisal in a standard capital cost involving project. These assets are used for several months and years to gain value in terms of net return, i.e. difference between payoffs less costs and depreciation. Towards the asset’s end life, it may be sold at a reduced price in the market (Dilshad, 2013). For example, vehicles and printing machines often possess a high residual value.

Often in long trm forecasting, values for net returns turn out to be inaccurate and hence utmost care should be taken in evaluating the right hidden price of the capital cost project.

The business strategy should be carefully planned out and any wildly optimistic assumptions should be done away with. All assumptions must be clearly laid out so that the project manager can successfully carry out the cost benefit analysis and give the clear picture of net returns and whether to undertake the capital cost project or not (Ghosal and Sokol, 2013).

Two important appraisal techniques undertaken are Retturn on Capital Employed (ROCE) and Payback.

Return on Capital Employed (ROCE)

ROCE is also expressed as accounting rate of return.

Formula

The formula for calculating ROCE is:

ROCE= Profits/ Initial costs *100

Payback= Initial cost/ cash inflow per period *100

The decision rule for ROCE is:

If the calculated ROCE for investment is greater than the hurdle rate, then the investment should be undertaken.

Profitability Index (PI) – also called the value investment ratio and profit investment ratio it judges a capital cost project in terms of value of investment. This measure is a ratio of amount of capital invested to profit of the project.

Payback Period –

a measure that calculates total number of years to receive initial investment. Projects with a lower pay back period are usually preferred than projects with higher payback period.

Actual sales	13500.0	Total sales	539932500.0
Price	39995.0	Total est sales	1599800000.0
Estimated sales	40000.0	ROCE act	-55.0
Total cost	1200000000.0	ROCE est	33.3
Profitability act	2.2	Payback act	2.2
Profitability est	0.8	Payback est	0.8

 In this question, actual car sales are 13500 units compared to estimated 40000 units. As price per car is $39995, total sales are calculated.

Concepts and measures: ROCE and Payback

 ROCE act= (Total sales- Total cost)/Total cost=( 539932500- 1200000000)/ 1200000000= – 55.005625

ROCE est= 33.31

Payback est= Total cost/ Payoff= 0.75

Payback actual= 2.22

 Analysis

So, ROCE actual is negative. This means that the outlay is not profitable and costs outweigh benefits. But ROCE estimated is positive and moderately high. According to payback period actual, it will take 2.22 years to break even . Profitability index act is 2.2 while estimated is 0.8.

There are two other measures of feasibility check called NPV or Net Present Value and IRR or Internal rate of return. These cannot be applied to the model given in this question but  a brief glance at the definitions is worth it.

Net Present Value (NPV) – The streams of future incomes are discounted   by a discount rate which is generally a ten year gilt yield, and from this total costs are deducted. Thus, we get the NPV.

Internal rate of return (IRR) – The discount rate that equates the net present value of future streams of income with total costs gives the IRR. If Costs >< NPV, IRR<>0 and accordingly the project has to dropped/ carried out.

The actual sales are 13500 which is less than estimated 40000. This means total sales value actual, is less than total cost outlay of $1.2 billion. This arouses some concern that the ROCE being negative is whether therefore right or wrong.  But as per the data, the calculations are done and the estimated ROCE is positive. Here we are assuming that on top of actual, estimated figures are also calculated.

Hewlett-Packard (HP) autonomy is a multinational enterprise software company which was founded in Cambridge, UK in 1996. Actually, the company was specialized in the analysis of the large scale of unstructured big data. It became the largest and the most successful software company in 2010. It used to take into account the several research results conducted by the University of Cambridge. It used to develop several enterprise searches and various knowledge management applications in conjunction with adaptive pattern of recognised techniques which were concerned on the Bayesian inference and several traditional techniques. It used to maintain an aggressive approach of entrepreneurial marketing (Jeffrey, 2013). This company was featured as ‘rod of iron’, as it tolerates a zero percent and used to fire 5% of its sales workers each quarter. It also keeps the best efficient staffs like rock stars.

Data and Results: ROCE, Payback, Profitability, and Sales

Autonomy was gained by HP in October, 2011. The deal value of Autonomy was $11.7 billion and the premium was 79% over the market price. This decision was largely criticised by so many critiques. Critiques called it as a chaos decision and absurdly high attempt. But within a year HP was able to gain $8.8 billion of its Autonomy’s value. HP showed the following reasons behind this were misrepresentations, disclosure failures and accounting improprieties.

HP recruited Robert Young johns, the ex-Microsoft president in North America for taking over the HP Autonomy in September, 2012. He had worked for the turnaround by the expansion of the information management.

Now for several quarters, the financial situation of HP is not bright enough. The main reason behind this is mainly the sharp decline in the sales of computer worldwide. The HP CEO wanted to break the past practices. The failure of the acquisition of the Autonomy for $11.2 billion was actually overpaid.

A merge is when a company assumes or takes all the assets and liabilities of another company. The firm which acquires is able to retain with its identity, but the firm which has been acquired, ceases to exist. Merger is nothing but one type of acquisition. Any type of acquisition is held with the hope of gaining profits. Actually the two firms which were involved in the merger hope to gain more than they could gain apart. Some of the potential benefits of acquisition are getting tax advantage, combining the resources, eliminating the in efficiencies etc (KIM and PARK, 2012). A merger and acquisition also helps in increasing the economies of scale. This also includes increase in the market powers by purchasing competitors, providing new opportunities for developing the career of the managers, developing in a new geographic region, reducing the weaknesses in the key areas of business etc. However, it also includes so many difficulties also, such as, evaluation of the total transactions, accounting the costs and benefits associated with, handling various legal issues etc.

Many researches which were conducted over the decades have shown that the rate of failure is around 50%. Several surveys conducted in recent years have shown that the percentage of companies failed in the acquisition is around 83%. Research results have also shown that companies intending in acquisition have grown over 20 years.

The basic reasons for the failure of acquisition are it is very easy to merge but it is really very difficult to perform in merger and accusation. In general, lack of proper planning, differences in organisational culture, limited synergies, and difficulties in implementing proper strategies causes the failure of acquisition (Milliou and Pavlou, 2013). Lack of knowledge of the managers is a common factor for failure of acquisition.

Some additional points to note

HP and Compaq Computer Corporation came to a definitive merger agreement on 3^rd September, 2001 to create $87 billion and become a leader in the global technology (Rosenbaum and Pearl, 2013).

Managing working capital ensures smooth flow of business operation without falling into financial problem such as either making short-term obligation payments, purchasing raw materials or payment of overhead, salary and wages. Moreover, adequate working capital support organizations in maintaining business solvency by ensuring uninterrupted production flow. On the other hand, right management of working capital enables organizations to face crisis such as depression (Baig and Akhter, 2013). Therefore, the organizations could be able to effectively manage their business and smoothly perform their operation. As a result, the firms would be able to generate enough capital and flow of capital in the business would be effective (Baylis, Gong and Wang, 2013). The working capital management can be better explained with the following example;

Balance Sheet of ABC Company
Cash	70000	Accured Expenses	24000
Account Receivable	43000	Accounts Payable	35000
Marketable Securities	15000	Current Portion Long Term Debt	12000
Inventory	60000	Notes Payable	8000
Total Current Assets	188000	Total Current Liabilities	79000
Working Capital	109000

Table 1: Positive Working Capital

Stock	20000	Trade Creditors	35000
Cash	30000	Dividends	5000
Prepayments	5000	Taxation	10000
Trade Debtors	2000	Short Term Loans	15000
Total Current Assets	57000	Total Current Liabilities	65000
Working Capital	(8000)

Table 2: Negative Working Capital

It can be seen from the above two figures of working capital calculations that one has positive working capital and other has negative working capital. The ABC Company has been successful in managing their current assets over their current liabilities which ensures that their operating cycle is in better place. It means that the company is able to clear their dues on time and has well-managed inventory. Therefore, the company is better position to generate cash and management of flow of cash (Brigham and Houston, 2013). On the other hand, the other firm, PQR Company has not been able to gain positive working capital. The reason would be the company’s inability to clear their bills on due time, overstocking and overtrading. As a result of that the value of current liabilities are higher in comparison to value of current assets (Heesen and Moser, 2013). It can also be mentioned that PQR Company is not able to make balance between cash inflow and cash outflow. Due to that the company is facing working capital issue. If the company continues with negative working capital then it can lead to shut down of the business or company can become insolvent (Brooks, 2013).

On the other hand, it can be seen that Textile Small-Medium Enterprise of India is facing huge trouble due to mismanagement of working capital. Due to that the company has fallen under debt trap. The reason behind such fall was lack of qualified and experienced working capital. The accounting personnel were not able to handle the finance of the company (Jain, Singh and Yadav, 2013). Therefore, the production and operational cycle was not managed effectively and capital was excessively used. Apart from that, it has also been observed that due to mismanaged working capital, statutory payments such as income tax, Provident Fund and TDS has slowly fallen into arrears that indicated problem in cash flow.

Reliability of data

Furthermore, Vora (2013) discussed that mismanaged working capital can have potential impact in the shareholder wealth. Due to mismanagement, the firm is not able to ensure enough capital for their operation which leads to further loss. The earning of the shareholder would decrease and would be able to receive return on due time. Moreover, the shareholder would develop negative attitude towards the company and would not be willing to deal with the company (Zeballos Avila and Seifert, 2013). On the other hand, the company would not be in a position to declare dividend or right amount of return to the shareholders. As a result of that, the shareholder would face loss and would not be further interested to invest in the company. This would severely impact on the earning of the company and the company would become insolvent. As a result of that, the company would have to put down all their operation (Michalski, 2014).

It can be discussed that working capital has to be managed and given priority by the organizations. Managing working capital would ensures better flow of work and the firm would be able to generate more benefit from their current assets which will help in meeting current liabilities (Baños-Caballero et al. 2014).

References

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