The current assignment is based on a scenario, in which the junior accountant of a retail group is needed to provide some valuable financial information that would assist the regional director of Finance in producing a leaflet. The main aim of producing a leaflet is to provide information to few new board members as a part of the induction pack. The different financial aspects and tools of management accounting would be covered in this paper like flexed budget, variance analysis, reconciliation statement, break-even analysis, absorption costing and variable or marginal costing. Finally, the assignment would shed light on evaluating the four different projects by using the techniques of investment appraisal.
As a retail organisation, it is always crucial to remain organised. It would become impossible for any business organisation, if it needs to look for paperwork along with important files continuously (Atanasov and Black 2016). Maintaining financial records would help in serving the purposes and requirements of the retail group, which are enumerated briefly as follows:
According to these requirements, it is necessary for the owners to follow certain business rules, regulations and laws for conducting their business operations. As commented by Collier (2015), almost all business organisations have some kind of legal rulings and the retail group is not an exception to this rule. There are some specific forms, licences as well as other documentations that need to be field with the local and the state government offices for carrying out the business operations effectively. Such documentations for the retail group constitute of shareholders, tax forms and payments. In the absence of these documentations, the retail organisation would not be able to conduct its business operations.
For all types of business organisations, it is essential to pay tax and such payment relies on the business structure, which is called tax requirement. For the retail group, the tax payment depends on the amount of profit earned in a particular year, business quality and business type.
In the words of Eiteman, Stonehill and Moffett (2016), internal controls could be described as the policies, mechanisms and procedures utilised for minimising business risk. For the retail group in order to restrict the staffs and other members from committing unfair acts, the control needs to be broad. This would help the retail organisation to function effectively along with accomplishing business goals and maintaining healthy relationships with all the business staffs.
In order to ensure business growth and profit, it is crucial for the accountants to maintain financial records or information. Some techniques to record financial information are demonstrated briefly as follows:
This is an accounting procedure, in which each transaction is recorded as a debit and a credit.
The book maintaining an account of purchases and sales made in each day is termed as a day book. For instance, day books prevalent in retail firms include sales day book, purchase day book, sales return day book, purchase return day book and others. On the contrary, ledger is a final entry accounting book, in which different accounts are used for listing different transactions. For instance, ledger in the retail group includes purchase ledger, sales ledger and general ledger.
Trial balance denotes totalling the credit and debit balances to ensure that the total debit amount is identical with the total credit amount. With the help of trial balance figure at the end of the year, it would become possible for the retail group to prepare the balance sheet of the organisation for representing the financial position at a particular period.
Manual accounting system indicates those transactions that the organisations enter manually for carrying out their business operations. This system contains high risk, as the chances of making mistakes are high. Before computerised software and spreadsheets, the accountants used paper pads printed with columns. The initial left column is generally narrow and it is utilised for dates. On the other hand, the second column having the highest page width is utilised for descriptions (Fields 2016). There are four or more columns in the accounting pads, in which the double lines separate each column. These pads are printed in white stock or light green having a space for each digit for reducing handwriting-related confusion. The pad lines signify business transactions like inventory or sales transactions. For facilitating this system, journals are used in specific purpose pads. For instance, when any sale takes places, it could be posted in the journal in the form of a single line item. However, by the month end, all transactions could be added and one journal entry could be passed in general ledger by debiting cash account and crediting sales account.
Moreover, there needs to be a strategy for finding and rectifying errors in an effective fashion. Primarily, an error could be detected at the time of compiling trial balance when debits and credits are not identical. In such situation, it needs to be ensured that the journal balances and journal entries are correct. A calculator tape could be used and it needs to be attached to each journal and general ledger page (Fisher, Garnsey and Hughes 2016).
Computerised accounting system indicates those transactions that are stored with the help of computers. This system is used widely due to its safety and lower chance of making mistakes. A computerised accounting system has to be adapted on the part of at least first and second user groups. The system constitutes of host accounting system, host report system, overlay system and overlay report system. The host accounting system enables the users in storing transaction data depicting financial transactions (Gippel, Smith and Zhu 2015). The overlay system enables the users in second user group for storing overlay adjustment data depicting adjusted journal entries pertaining to financial transactions. The host report system assists the users in generating host reports depending on transaction entries. Finally, the overlay report system helps the users in second user groups in generating overlay reports depending on transaction entries and overlay journal entries.
Financial reporting requirements are necessary for all types of business organisations and these requirements are mainly for partnerships, sole traders, limited firms and public limited firms. The financial reports are those documents or records reflecting the amount of revenue earned, the amount of expenses incurred and the costs likely to be incurred. In other words, it is the money transaction documents of all purposes, in which an organisation invests its money. Financial statements or reports are of different kinds. The cash flow statement is an overview of the real inflows and outflows of cash in an organisation over an accounting period, which might be a month, a quarter or a year. The income statement reflects the amount of profit earned or loss suffered by an organisation. The balance sheet statement, on the other hand, lays emphasis on the assets owned by the organisation, payments for the assets and gain or loss made on the asset disposals at the end of the year (Gitman, Juchau and Flanagan 2015).
In addition, financial reporting intends to provide the above-stated information to the various stakeholders of the business organisations. All types of business organisations have two types of stakeholders, which include internal stakeholders and external stakeholders. Therefore, financial reporting needs to be a part of the necessary contract between the organisations and their stakeholders. The shareholders have the right to know regarding the spending of their money within the organisations for evaluating their overall return on investment (Lara, Osma and Penalva 2016). Moreover, such disclosure of information would enable the stakeholders in knowing the profit or loss situation of the organisation, sources of funds and use of the funds received, profit reinvestment plan and availability of capital for future growth.
The stakeholders of an organisation comprise of external stakeholders and internal stakeholders. The external stakeholders include government, suppliers and creditors, public, consumers, government and media. The internal stakeholders include managers and directors, shareholders and employees (Lev and Gu 2016). As evaluated above, the financial statements include income statement, balance sheet statement and cash flow statement and these statements play a crucial role in the decision-making process of the stakeholders. The financial statements are useful for each of these stakeholder groups due to the following reasons:
In this section, Al Hokair Fashion Retail is chosen as the organisation, which has become the biggest franchise retailer in Saudi Arabia, Caucasus and Central Asian regions. The company mainly involves in selling fashion products like cosmetics, shoes and accessories, menswear and entertainment goods (Fawazalhokairfashion.com 2018). In order to enhance the quality of the financial analysis, Al Othaim has been selected as the major competitor of the organisation. The major components of working capital for the organisation have been explained with the help of ratio analysis, which are illustrated in the form of a table as follows:
According to the above table, it could be stated that the current ratio of Al Hokair has fallen from 1.44 in 2016 to 1.24 in 2017; however, it has increased to 1.30 in 2018. This is due to the significant fall in current liabilities and decline in inventory base. The similar trend could be observed in case of Al Othaim; however, the decline is significant due to lower amount of cash and bank balances. On the other hand, according to quick ratio, the trend is declining over the years, as the organisation has adequate amount of cash stuck in the form of inventory, even though there is reduction in inventory base. As a result, the working capital availability of the organisation has declined from SAR 1,179 million in 2016 to SAR 760 million in 2017 and the decline is further to SAR 749 million in 2018. In case of Al Othaim, since there is no inventory base, the quick ratio has remained the same like that of current ratio and it is more in contrast to Al Hokair. Thus, due to zero inventory bases, it has better liquidity position. However, the working capital is observed to be negative for Al Othaim due to increase in short-term liabilities and thus; in terms of working capital, Al Hokair is placed in a favourable position.
From the above table, it is inherent that the inventory turnover of Al Hokair has fallen over the year due to sudden rise in market demand. On the other hand, Al Othaim has not maintained any inventory level over the years; due to which inventory turnover ratio for the organisation could not be computed. The receivables turnover for Al Hokair, even though increased in 2017; decline is inherent in 2017 in order to increase cash and working capital availability. The trend is declining over the years for Al Othaim in order to offset negative working capital. Thus, both the organisations have adopted stringent credit policies to collect the amounts owed from the debtors. Finally, in terms of payables turnover, Al Hokair has managed to increase its terms with the creditors due to the favourable brand image in the market. On the other hand, Al Othaim makes cash payments to its suppliers at the time of purchase due to which it has no payables turnover. Based on the overall evaluation, Al Hokair is placed in a better position in the UAE retail sector compared to Al Othaim.
For effective working capital management, the retail group could use the following techniques:
In order to ensure success, it is necessary for the retail group to implement knowledge performance indicators on working capital, which needs to be understood by the management members. If necessary, it is necessary to deliver specialist training for sharing identical overview on financial management.
Timely payment to suppliers:
The timely payment to the suppliers would ensure flexibility in terms of pricing structure and business. Suitable negotiation is critical to all business organisations and it is necessary to distribute all the suppliers with named contracts developing close working relationship (Horngren et al. 2014).
The retail group might ignore small expenditures. However, this is not a sound practice, since they could increase considerably while having substantial impact on the working capital of the business. When there is clear setting of norms for travel and entertainment, the difference is made, while the initiation of corporate card program would enable the management in viewing expense in detail along with undertaking remedial actions rapidly, in which the rules are bended by the staffs.
Close watch on stock:
Additional stock holdings could tie large amounts of capital. Frequent overbuying leads to ineffective communication between departments and this could be mitigated by quarterly or monthly stock checks (Li and Lang 2014). They need to be followed up with remedial actions and it is necessary to avoid shortages of stock as well.
Initiation of e-procurement:
There could be substantial minimisation of costs with the help of e-procurement. The selection of suppliers having longer payment terms would signify large boost to the working capital of the retail group. In addition, this technique takes into account thorough authorisation procedure, which could help in minimising unexpected expenses and protecting working capital.
Flexed budget and variance analysis of Evergreen Plc:
Variance analysis generally refers to the examination of variations in financial performance from the established standards explained in organisational budgets (Mao and Renneboog 2015). This acts as a control mechanism, in which the organisation could identify the possible causes of deviation and it helps in recommending certain techniques through which deviation could be avoided. In case of Evergreen Plc, favourable variance could be observed in terms of revenue by £1,000 due to increase in production volume and rise in market demand. However, there is presence of unfavourable variance in case of direct material, as £935 additional amount has been incurred than the budgeted amount. This is mainly due to the rise in number of units produced, which has lead to additional purchase of raw materials. In case of direct labour, favourable variance is observed due to fall in anticipated idle time and fall in wage rate. As a result, positive profit margin is observed, since it is well above the budgeted margin.
Reconciliation statement:
Break-even analysis:
The break-even of Evergreen Plc has been conducted, since it could be used for the following purposes:
In business organisations, there are three various kinds of costs. For pricing purposes, it is necessary for the industries to categorise these costs like indirect costs, direct costs and fixed costs. All these cost categories have distinct units (Drury 2015). In case of costing and pricing, an organisation is needed to compute unit cost for identifying the overall costs. After this, it needs to deal with overheads like utility, raw materials, rents and others. Based on such dealings, it has to ensure regarding pricing; however, it relies on the average costs and the opinions of the customers regarding the product values.
In case of pricing purposes, few significant costs are needed to be computed like cost plus pricing, marginal cost and price takers. Here, the organisation needs to identify those contractors paid for the incurred costs and they are paid a certain percentage of costs in the form of contractor profit. This is termed as cost plus pricing (Lin 2016). Along with this, it is necessary for a retail organisation to compute marginal costs, since it assigns variable costs like direct labour, direct materials and other direct costs coupled with variable production overheads. However, it fails to take into consideration the fixed production cost. This kind of costing lays emphasis on differentiating between variable costs and fixed costs (Loughran and McDonald 2016). However, it is to be borne in mind that majority of the investors are considered as price takers, since their actions in purchasing, holding and selling shares are not adequate in changing prices. Moreover, it is noteworthy to mention that an organisation could be adjudged as a price taker, if price setting and goods manufactured do not exert any effect on actual market value.
Therefore, the organisation could be compelled to move ahead with the market price. Any individual customer could be considered as a price taker, as any purchase made by the customer does not have any impact on the product prices of the organisation. There is another significant costing method, which is taken into account as break-even. Although there is no profit no loss situation, this could be observed after the costs are balanced.
The two investment appraisal methods that have been chosen for evaluating the provided projects include NPV and IRR. A higher and positive value is always favourable for both the methods. In this case, it could be stated that the NPV of all the four projects are positive and the highest NPV could be observed in case of Project 4 followed by Project 2, Project 3 and Project 1. The similar is the case with IRR, as the maximum IRR could be observed for Project 4 followed by Project 3, Project 2 and Project 1 and all the IRR values are greater than the cost of capital of 4.5%. In terms of payback period, a lower timeframe is always desirable and in this case, Project 3 has the lowest payback period. In terms of accounting rate of return, the project having the greater return is favourable and in this case, Project 4 has the greatest return followed by Project 1, Project 2 and Project 3. Therefore, in terms of viability, all four projects would help in maximising the overall return on investment for the organisation. The
NPV could be defined as the sum of the present values of positive as well as negative cash flows associated with a particular project and it is expressed in absolute terms. In other words, it indicates the surplus from any project by considering the cost of capital and thus, it aids in the decision-making process of the management (Wood and Sangster 2012). The primary benefit of NPV is that it takes into account the cost of capital and the risks evident in making future projections. However, in this method, certain estimations are needed to arrive at the cost of capital and a lower cost of capital would lead to suboptimal investments.
On the other hand, IRR is defined as a rate, in which the discounted cash inflows become identical with the discounted cash outflows and it is expressed in percentage terms. It represents no profit no loss situation (break-even point) and thus, it is not much valuable in the decision-making process. This method provides an exact rate of return for a project in contrast to the investment cost, which allows the investors to obtain an overview of the potential project returns. However, it fails to take into consideration various factors like project duration, project size and future costs.
Payback period is used for ascertaining the number of years that a project takes to recover the initial investment. This method helps in project selection for the executives, as the projects are ranked in relation to their economic benefits without additional complications. However, this method completely ignores the cost of capital, which is extremely significant in undertaking effective investment decisions. Accounting rate of return (ARR) is a method of contrasting the profits expected to be earned from an investment to the capital employed. This method is extremely easy to understand and a higher ARR denotes attractive investment. However, it is dependent on profits rather than cash flows and hence, the rate of depreciation might have significant impact on ARR.
As evaluated above, Project 4 has the maximum ARR, IRR and NPV. Hence, it is recommended to the Marketing Director to select Project 4, as it would increase the return on investment for the organisation.
For financing Project 4, the organisation could raise funds from two sources, namely, debt financing and equity financing. Debt financing implies raising a portion of the needed money by seeking long-term loan from bank. This would help in fulfilling the organisational requirements, if it is suffering from cash shortage or lack of funds (Yazdanfar and Öhman 2015). Along with this, it could issue new equity shares in the market in order to collect a portion of the funds from the investors. This would assist in minimising the increasing burden of debt on the organisation relatively. In this case, 60% of the initial cost needs to be funded by debt financing and the remaining 40% by equity financing. This is because excessive reliance on equity financing would increase the cost of capital for the organisation. Moreover, the organisation could use retained earnings or sale a portion of its fixed assets to raise funds.
Conclusion:
Based on the above discussion, it could be evaluated that an organisation needs to maintain financial records for ensuring effective business operations either through manual or computerised accounting system. However, it needs to adhere to the legal and organisational requirements for ensuring fair and transparent overview of financial information to the stakeholders. Moreover, it has been found out that budgets play a crucial role in decision-making process, as it would help in identifying any variances and accordingly, remedial measures could be undertaken. Finally, it has been analysed that NPV and IRR are the two most significant investment appraisal techniques to assess the feasibility of a project and in order to fund the project, an organisation could use debt financing and equity financing.
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