UGB163 Introduction To Accounting And Finance

Part A

In the Book of DRYWALL LIMITED

Income Statement for the year ended 31.12.2014
Particulars	Amount Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	Amount
Revenue:
Sales		323,000.00
Total Revenues		323,000.00
Expenses
Cost of Goods Sold		202,000.00
Cost of Sales		121,000.00
Depreciation		5,000.00
Employee Benefit Expenses		46,950.00
Other Expenses:
Rent	40,000.00
Rates	2,350.00
Electricity Charges	2,900.00
Van Running Exp	14,000.00
Bad Debts	800.00	60,050.00
Total Expenses		435,000.00
Profit / (Loss)		(112,000.00)
Balance Sheet as on 31.12.2014
Particulars	Amount	Amount
Shareholders Fund
Equity Share Capital		90,000.00
Reserves and Surplus:
Loss during the year		(112,000.00)
Liabilities
Sundry Creditors		45,000.00
Creditors for Cost of Sales		121,000.00
Wages Outstanding		950.00
Total		144,950.00
Assets
Non-Current Assets
Delivery Van	25,000.00
Less: Depreciation	5,000.00	20,000.00
Current Assets
Bank		1,300.00
Rent in Advance		10,000.00
Rate in Advance		450.00
Sundry Debtors	90,000.00
Less: Bad Debts	800.00	89,200.00
Closing Stock		24,000.00
Total		144,950.00

Working Note:
Computation of Closing Stock
Opening Stock	–
Add: Purchases	226,000.00
Add: Cost of Sales	121,000.00
Less: Sales	323,000.00
Closing Stock	24,000.00

Working Note:
Computation of Closing Stock
Opening Stock	–
Add: Purchases	226,000.00
Add: Cost of Sales	121,000.00
Less: Sales	323,000.00
Closing Stock	24,000.00

Return on Capital Employed
Formula:
Return on Capital Employed	=	Net Operating Profit
		Capital Employed
Particulars		2014	2015
	Amount	Amount
Net Operating Profit		198.00	145.00
Capital Employed		764.00	825.00
Return on Capital Employed		25.92%	17.58%

Operating Profit Margin
Formula:
Operating Profit Margin Ratio	=	Operating Profit	X 100
		Sales
Particulars		2014	2015
	Amount	Amount
Operating Profit		198.00	145.00
Net Sales		1,490.00	1,550.00
Operating Profit Margin Ratio		13.29%	9.35%

Gross Profit Margin Ratio
Formula:
Gross Profit Margin Ratio	=	Gross Profit	X 100
		Sales
Particulars		2014	2015
	Amount	Amount
Gross Margin		600.00	560.00
Net Sales		1,490.00	1,550.00
Gross Profit Margin		40.27%	36.13%

Quick Ratio
Formula:
Quick Ratio	=	Cash+Receivables+Current Investments
		Current Liabilities
Particulars		2014	2015
	Amount	Amount
Quick Assets		113.00	181.00
Current Liabilities		240.00	266.00
Current Ratio		0.47	0.68

Settlement period for Trade Payables
Formula:
Settlement period for Trade Payables	=	Average Amount of Payables X 365
(Days)		Cost of Sales
Particulars			2015
		Amount
Average Amount of Payables			79.00
Cost of Sales			990.00
Settlement period for Trade Receivables			29.13

Calculation of Inventory Turnover Ratio of Apple Inc.
Formula:
Inventory Turnover Ratio	=	Cost of Sales
		Average inventory
Particulars			2015
		Amount
Cost of Sales			990.00
Average Inventory:
Opening Stock			149.00
Add: Closing Stock			266.00
Average Inventory {( Op St + Cl St. ) / 2 }			207.50
Inventory Turnover Ratio			4.77

Return on Capital Employed is the kind of financial ratio that shows the profit which the organization earns per pound of capital employed. It is a kind of profitability ratio which measures the efficiency with which a company generates profits from its capital employed. A higher return on Capital Employed is preferred as it shows that more profits can be earned from the capital employed. The ideal percentage of ROCE can be decided as per the industry norms. The Return on Capital Employed of the Company has decreased since the last year. There has been a decrease in the profits and an increase the capital employed due to which there is a decline in the ROCE.

Net Profit Margin is the type of financial ratio that indicates the profitability of the company. It measures the efficiency with which the company manages its cost and production. A more efficient company has a higher net profit ratio. The ideal percentage of gross profit margin is determined by the industry norms. Although in general, a higher net profit margin ratio indicates that the company controls its costs efficiently and vice versa. The Net Profit Margin of the company has decreased since the last year. This indicates that the net margin of the company has lowered a bit.

Gross Profit Margin is the type of financial ratio which indicates the profitability of the company. It measures the efficiency with which the company manufactures and distributes its products. A more efficient company has a higher gross profit ratio. The ideal percentage of gross profit margin is determined by the industry norms. Although in general, a higher gross profit margin is a sign that the company a good profit and vice versa. The Gross Profit Margin of Goldwing Limited has decreased slightly since the last year. This shows that the gross margin of the company has lowered a bit.

Current ratio is a kind of liquidity ratio which depicts the ability of a company to pay off its current liabilities by comparing it to the current assets of the company. A current ratio of 2:1 is considered as an ideal ratio. The higher is the current ratio; the better is the operation efficiency of the company. Thus, from the above calculations we can clearly see that current ratio of the company has improved since the last year.

Quick ratio is a type of liquidity ratio which depicts the ability of a company to pay off its current liabilities by comparing to the short-term liquid assets of the company. A current ratio of less than 1 is considered to be unfavorable. It would mean that the company has no liquidity to pay off its current liabilities. If the quick ratio of a company is lower than its current ratio by a high amount then it would mean that the company is highly dependent on its inventories to pay off its current liabilities. Thus, from the above calculations we can clearly see that the quick ratio of the company has improved since the last year. But the subtraction of the current ratio and the quick ratio is very high which shows the dependency on the inventories to pay off the liabilities.

Settlement Period for Trade Receivables is the average collection Period in which the receivables of the company will be recovered. Lower is the number of days in which the amount due from the receivables can be recovered the better it is for the company. It indicates the average number of days between the credit sales date and the date of receipt of payments from the debtors.

Average amount of Receivables will be calculated using the sum of the opening and closing accounts receivable and dividing it by 2.

From the above, we can see that the average settlement period of the Accounts Receivable of Goldwing Ltd is 32.73 days which can be rounded off to 33 days.

Settlement Period for Trade Payables is the average payment Period in which the company will be able to pay its trade payables. The lower is the number of days in which the amount due to the payables can be paid the better it is for the company. It indicates the average number of days between the cost of sales date and the date of payments to the creditors.

Average amount of Payables will be calculated using the sum of the opening and closing accounts payables and dividing it by 2.

From the above, we can see that the average settlement period of the Accounts Payables of Goldwing Ltd is 29.13 days which can be rounded off to 30 days.

Inventory Turnover Ratio is a type of efficiency ratio and in that we measure the number of times the inventory of the company is sold and replaced during the financial year. It measures the liquidity of the stock in the company. Inventory turnover ratio should be compared with the ratio of the industry in which the company operates. The inventory Ratio should not be very low or very high. The inventory Turnover Ratio of the company is low which might indicate that there is overstocking of the inventory or lower sales or poor planning of the stock etc.

Thus, we can conclude that the overall performance of the company Goldwing Limited has deteriorated over the last year in terms of the profitability, liquidity and efficiency ratios computed and the analysis of the same. The company is unable to perform in the utmost efficient manner. The Board of Directors needs to take corrective actions for the same and either make new policies or change the existing policies so as to improve the overall profits, performance and efficiency of the company.

(A)

Computation of Payback Period
Payback Period	=	Initial Investment
(years)		Cash Inflow per period
	=	24,000,000.00
		7,000,000.00
	=	3.43

 

Computation of Accounting Rate of Return
Accounting Rate of Return	=	Average accounting Profit
		Initial Investment
	=	2,800,000.00
		24,000,000.00
	=	0.1167
	=	11.67%
Working Note:
Average Accounting Profit:
Cash Inflow		7,000,000.00
Less: Cash Outflow		1,200,000.00
Less: Depreciation		3,000,000.00
Profit		2,800,000.00
Depreciation:
Cost		24,000,000.00
Less: Salvage Value		6,000,000.00
Depreciable amount		18,000,000.00
Useful Life (years)		6.00
Depreciation		3,000,000.00

 

Computation of Net Present Value
Particulars		Amount
Cash Inflow		7,000,000.00
Less: Cash Outflow		1,200,000.00
Less: Depreciation		3,000,000.00
Profit		2,800,000.00
Add: Depreciation		3,000,000.00
Cash Flows		5,800,000.00
Present Value of Cash Flows	=	Cash Flows X PVIFA(I,n)
	=	5800000 X PVIFA(6%,6)
	=	5800000*4.9173
	=	28,520,340.00
Present Value of Salvage	=	SalvageX PVIF(I,n)
	=	6000000 X 0.7050
	=	4,230,000.00
Net Present Value	=	32,750,340.00

(B) Capital Investment Appraisal is also called Capital Budgeting. It may be defined as a type of process for planning which helps an organization to ascertain the investments for  long term as well as for short term. The various components which fall under the capital investment include plant, property, equipment, research and development, advertisement campaigns etc.

The investment increment factors are used and determined on the basis of the decision making management and the stakeholders of the organization. There are various techniques for the capital investment appraisal each having its own advantages and disadvantages. The various techniques are discussed below which help in the capital budgeting or capital appraisal:

• Net Present Value
• Accounting Rate of Return
• Internal Rate of Return
• Modified Internal Rate of Return
• Adjusted Present Value
• Profitability Index
• Equivalent Annuity
• Payback Period
• Discounted Payback Period
• Real Option Analysis

 Some of the techniques are discussed in details below:

Net Present Value Method is also called Discounted Cash Flow Method. It a widely used capital budgeting technique and it is computed taking into consideration the time value of money. Net present Value is the difference between the present value of inflows and present value of outflows from an investment project. Net Present Value can be negative, positive or nil. A positive Value indicates that the inflows from the project are more than the outflow resulting in an overall profit for the organization from the project and hence, the project should be accepted. On the other hand, a negative NPV indicates that the inflows are lower than the outflows which mean that there is an overall loss in the project and hence the project should be rejected. And lastly, a zero NPV means that the project can be either accepted or rejected depending on the other factors taken into consideration.

 Net Present Value Method has the advantage that it takes into consideration the time value of money. The disadvantage of Net Present Value Method is that it is very complex and difficult to compute. It takes the assumption that all the cash flows generated in one year are reinvested which may not hold well in all the cases.

Accounting rate of Return is similar to the internal Rate of return. The difference is that the Accounting rate of return uses the net operating income whereas in the Internal Rate of Return we use the cash Flows of the profit. There is consideration of non-cash items of the income and expenses in the Accounting Rate of Return Method. An accounting rate of return which is greater than the desired rate of return is considered to be feasible.

The advantages of accounting rate of Return are that it is simple to compute and it also considers all the non-cash items which help the stakeholders to evaluate the overall performance of the company. On the other hand, the demerits of the Accounting Rate of Return are that it uses net operating income instead of the cash flows. Also, it does not remain stable over the years of the life of the project so it is difficult to determine the feasibility of the project from one period to another.

Internal Rate of Return is the analysis of an investment decision by the method of computation of the minimum required rate of return of the project. The internal Rate of Return of the project is also called as the yield of the project. It is the return which is generated from a project in its useful life.  The Internal Rate of Return is the discounting rate at which the Net present Value of the Project turns out to be zero. The Internal rate of return is usually computed using the hit and trail method. The management fixes the minimum required rate of return which is usually taken as the cost of capital of the company.

The advantages of internal rate of return are that it provides the accurate rate of return of the project and also it considers the time value of money. The disadvantages of IRR method are that it does not take into consideration the duration of the project, size of the project or future costs etc.

The Modified Internal Rate of Return is a modification in the IRR which gives ranking to the mutually exclusive projects. The major base behind the Modified Internal Rate of Return is that cash outflows from the project are discounted at the Internal Rate of Return and the inflows are reinvested at the reinvestment rate of return of the project.  A project whose Modified Internal Rate of Return is more than cost of capital should be chosen.

Modified Internal Rate of Return has the advantage that it gives a realistic view by reinvesting all the inflows at reinvestment rates. The main disadvantage of Modified Rate of Return is that the reinvestment rate of the project is mostly lower than the cost of capital which creates a conflict with the Net Present Value of the Project.

Profitability index method is like a modified form of the net Present Value Method with the difference that Net Present Value Method is an absolute measure while the Profitability Index is the relative measure of the cash flows of the project. Profitability Index is the measure of the profits earned per one pound of initial investment. This method has the advantage that it gives the same outcomes as the NPV Method. However, for a mutually exclusive project it can give a result which us different from the NPV method.

The Equivalent Annuity method is used to rank mutually exclusive projects with unequal project life. The annuity with the project life and internal rate of return is computed and it is divided by the net present value to get the Equivalent Annuity of the projects. The Project with the highest Equivalent Annuity is considered to be feasible.  The disadvantage of the Equivalent Annuity is that it considers that the cash flow of the project is constant which is not feasible in the real life.

The payback period method is the type of investment appraisal technique which shows the period within which the organization will be able to recover its initial investment made in the project from the annual cash inflows of the project. There is no involvement of the time value of money in this method. The project which gives the lowest payback period is considered to be the most feasible as it requires the minimum time period for the recovery of the initial investment made and the project will start earning profits immediately after the recovery of the investment amount.

The advantages of Payback Period Method are it improves the liquidity of the project and the business and is very easy to compute. It minimizes the risk of losses which a company might incur due to the changes in the economic conditions. On the other hand the disadvantages of the payback period method are that it doesn’t consider the time value of money and also it doesn’t considers the cash flow after the payback period.

A real option is the right and not the obligation of the organization to undertake a particular project or investment option. There are various kinds of real options like the option to expand, option to contract, option to abandon, sequencing option, deferment or initiation option, operating cycle option etc.

The limitations of a real option are the market characteristics are not always favorable to consider this technique and that it is very complex to understand and compute the benefits from it.

(C) There are various sources of finance which may be available to the company. Each source if finance has its own advantages and disadvantages. Hence, it is very important for the company to take into consideration the merits and the demerits before taking up any source of finance:

• The rate of interest is fixed for the entire period of the loan
• There is no obligation to the Bank who is the lender once the loan is repaid

• There is mortgage of assets of the company in most of the cases.
• The rate of interests are very high
• There is long procedures of scrutiny before the grant of loans
• Debts- Business Angels

• There is no requirement of any collateral security
• There is no repayment of amount or interest
• There is freedom to make fast investment plans and decisions

• They take up shares of the company
• It is very difficult to find an business angel
• There is a lot of paperwork involved

• There is no voting rights to the debenture holders

• It is costly as it involves high cost of raising funds and very high stamp duty charges
• The interest must be paid in full irrespective of profits and losses
• Changes in the earnings can become very dangerous for the company

• It is useful in raising long term finances
• It is helpful in expansion and growth of the business
• There is no obligation on payment of dividend even in case of losses

• There is control over the business by the owners
• The stockholders are to be reported for each decision of the company
• Risk free plans are wanted by the stockholders

• It a self generated source of finance and there is no need to depend on anyone
• There is cost savings as there is no interest costs
• There is maintenance of confidentiality of the business records.

• The shareholders will not be distributed profits if it is used in financing
• It can be mis-utilised by the management of the company
• There can be over capitalization of funds which can be harmful for the business

https://accountingexplained.com/managerial/capital-budgeting/payback-period

Accounting Rate of Return: Formula. Website. Retrieved from

https://accountingexplained.com/managerial/capital-budgeting/arr

Investment Appraisal: Techniques. Website. Retrieved from

https://www.capital-investment.co.uk/capital-investment-appraisal.php

Net Present Value Method. Website. Retrieved from

Net present value (NPV) method

Internal Rate of Return Method. Website. Retrieved from

https://study.com/academy/lesson/internal-rate-of-return-advantages-disadvantages.html

Modified Internal Rate of Return Method. Website. Retrieved from

https://financialmanagementpro.com/modified-internal-rate-of-return-mirr/

 Payback Period Method. Website. Retrieved from

Payback method

Accounting Rate of Return Method. Website. Retrieved from

Accounting rate of return method

 Profitability Index Method. Website. Retrieved from

https://financialmanagementpro.com/profitability-index-pi/

Equivalent Annuity Method. Website. Retrieved from

https://financialmanagementpro.com/equivalent-annual-annuity-eaa/

 Real Option Method. Website. Retrieved from

https://en.wikipedia.org/wiki/Real_options_valuation

 Sources of Finance: Advantages and disadvantage. Website. Retrieved from

https://www.studyblue.com/notes/note/n/advantages-disadvantages-of-sources-of-finance/deck/8309037