Introduction to Accounting and Finance Sample Assignment

Statement of financial position

Part B - Reckturk Plc

a. What is the contribution that each wardrobe makes towards covering fixed costs if it is sold for £40?

Below is the computation done for the contribution of Reckturk Plc that per unit of wardrobe manufactured within it would cover its fixed costs -

Price of selling = £ 40.00 per unit

Variable expense for each wardrobe = £5.55 + £8.85 + £15.75 = £30.15

Contribution

= Price of selling - Variable expense for each wardrobe

= £40.00 - £30.15

= £9.85

b. What is the break-even point and margin of safety in terms of both units of wardrobe and revenue if each wardrobe is sold for £40?

Below is the computation done for the derivation of the point of breakeven of Reckturk Plc -

Contribution = £9.85 per unit

Total fixed expense = £ 142800 + £ 177000 = £ 319800

Price of selling = £ 40.00 per unit

Hence, point of breakeven (revenue) = £319800 ÷ £ (9.85 ÷ 40.00) = £319800 ÷ £0.2462 = £1298680.20

Conversely, point of breakeven (sales) = £319800 ÷ £9.85 = 32467.005 units or 32467 units

Based on the determination of the point of breakeven above,

Margin of safety of Reckturk Plc

= Current revenue - Point of breakeven (revenue) x 100 ÷ Current revenue

= £2400000 - £1298680.20 x 100 ÷ £2400000

= £110131980 ÷ £2400000

= 45.8883 or 45.89%

Hence, computations yield that the margin of safety in Reckturk Plc would be 45.89% while the point of breakeven of the company will be £1298680.20 and 32467 units respectively.

c. Calculate the profit the company makes if it produces and sells 54,000 wardrobe at £40 per wardrobe.

Keeping the price of selling of Reckturk Plc at £40.00 itself while selling 54000 units of wardrobes will be ending up with the amount of profit that has been shown below -

Total revenue gathered = £40.00 x 54000 units = £2160000

Net costs incurred = Fixed expense + Variable expense = £319800 + 54000 x £30.15 = £319800 - £1628100 = £1947900

Profits earned in Reckturk Plc = Net revenue gathered - Net costs incurred = £2160000 - £1947900 = £212100.00

Hence, Reckturk Plc’s profit that it would be ending up earning, in case if it makes a sale of 54000 wardrobes is £212100.00.

d. Reckturk Plc is considering whether to spend £135,000 on marketing and advertising but consequently raising the selling price by 8%. At this new sales price and with the advertising, sales level (in units of wardrobe), as planned in (c) above will increase by 15%. Analyse whether this is a good strategy for Reckturk Plc?

If the enterprise Reckturk Plc invests for advertising and marketing, this expense can be categorised as the fixed expense of the enterprise, which would amount to £135000.00. However, if the enterprise starts paying for advertising and marketing, the price of selling would be increasing by 8% while its level of sales will be improving by 15%. Depending on these aspects, the costs and sales of the enterprise would be as follows -

Total fixed expense to be incurred = £319800 + £135000 = £454800

Total variable expense to be incurred = 60000 units x £30.15 = £1809000

Price of selling = £ 40.00 per unit + 8% of £40.00 = £40.00 + £3.2 = £43.20

Total number of units to be sold (as planned in c) = 54000 units + 54000 * 15% = 54000 + 8100 = 62100 units

Thus, revenues earned = £43.20 x 62100 = £ 2682720

Therefore, net profit = £ 2682720 - £ 1809000 - £ 454800 = £ 418920

Hence, with the means of consideration of the strategy that has been proposed within Reckturk Plc, one can find out that the enterprise will be ending up profits amounting to £418920 while the total revenue that the enterprise would be earning is £2682720 in case if it spends £135000 for advertising and marketing. The profit that the enterprise would be earning is £418920 if the strategy is adopted. However, without the adoption of this strategy, the profit that Reckturk Plc would be earning is £212100, which is £206820 lower than the one that the enterprise would end up with by considering this strategy. Thus, as the sales level and revenues of the enterprise would increase along with increasing its profits, it is said that it would an effectual strategy for Reckturk Plc to adopt.

e. Identify and explain the underpinning assumptions attached to the break-even model including analysing whether the model can successfully be utilised by a range of differing businesses.

As stated by Markytan et al. (2018), an effectual model or tool utilised globally for the management of an entity’s financial management is the breakeven analysis, also known as the BEP analysis. However, there are a number of assumptions, on which the BEP analysis is based. As explained by Khouri et al. (2018), in the points mentioned below, the basic assumptions upon which the BEP analysis is based have been elucidated -

• Business costs are only of two kinds and can be segregated into variable ones and fixed ones. It does not account for any sort of semi-variable expense or semi-fixed expense.
• The amount of fixed expense made by a business concern stays unchanged and static no matter whatever change occurs in the level of output of the concern.
• Changes might be occurring within the variable expense that a business concern incurs. However, this change is directly proportionate with the number of outputs of the business concern.
• No changes or alterations take place in the amount at which the goods are sold in a business concern (the selling price of the goods).
• Businesses have only one product mix and this product mix does not undergo any kind of change or alteration.
• The number of units that every employee or labour in a business concern also stays unchanged no matter whatever circumstances arise within the concern.
• Lastly, the closing inventory as well as the beginning inventory of a business concern is nil. Whatever produced within it is sold off during that period itself.

However, the appropriateness of the BEP analysis depends over the type of business concern within which it is being applied. There are different sorts of business concerns wherein the BEP analysis turns out being unsuitable and this unsuitability of the model is because of the loopholes of the model arising from the assumptions over which it is based (Fraser‐Mackenzie et al., 2018). For example, for the application of the BEP model, business concerns are needed having only one product mix and one sort of product needs being sold. However, enhancement and diversification of the product portfolio is a necessity for all businesses and having one product mix is not possible for all businesses. The model of BEP is also dependent over the fact that a business concern ends up selling all the units it has manufactured and no stock is left in hand, which is yet another unrealistic assumption (Barletta et al., 2018). It is not possible for a business concern to have production equalling sales without any inventories in hand and wastage. As a result, these are the few primary reasons because of which it is said that the BEP model is not a suitable or appropriate one for every business concern.

Part C - Roseville Plc.

a. Calculate the Payback Period, the Accounting Rate of Return, and the Net Present Value of the machine, and provide recommendations as to whether Roseville Plc should buy the machine.

Roseville Plc’s payback period

Depending upon the cumulating cash flows found above,

Payback period = Ending period of negative cumulating cash + (Amount of cumulating cash flow in the period ÷ Actual cash flows within the year successive to this period)

= 3 + £ (1640000 ÷ 21200000)

= 3 + 0.7735

= 3.7735 or 3.77 years

Roseville Plc’s accounting rate of return

Depending upon the net cash in hand within Roseville Plc,

Net amount of cash in hand or cash flows in the 5years = 5 * £ 2120000 = £10600000

Net profit earned in these 5 years = £ (10600000 - 7000000) = 3600000

Profit earned in average = £ 3600000 ÷ 5 = £ 720000

On the other hand, investment made on an average = £ (8000000 + 1000000) ÷ 2 = £4500000

Hence,

Accounting rate of return = Profit earned in average ÷ Investment made on an average

= £ (720000 ÷ 4500000)

= 0.16 x 100

= 16%

Roseville Plc’s net present value

Depending upon the net inflows derived in the section above, it can be seen that the present valuation of the future cash inflows of Roseville Plc = £8246060.678

On the other hand, present valuation of total cash outflow = £8000000.00

Hence, net present value = Present valuation of the future cash inflows - Present valuation of investment

= £8246060.68 - £8000000

= £246060.68

Recommendations for Roseville Plc regarding the investment

For making decisions on the investment of an enterprise, it is necessary to choose an investment for which the payback period is low (Gorshkov et al., 2018). On the other hand, when accounting rate of return is being considered for decision-making of investment, an investment that has the ARR higher than the return expected and the cost of capital needs being chosen (Christodoulou et al., 2016). Similarly, in the words of Hopkinson (2017), the NPV rules states that investments, which are of positive NPV are acceptable in nature since they give an indication of profitability. In case of the current investment that the entity Roseville Plc is taking into account, one can be finding out that, the investment is not only acceptable but is highly feasible. This is because there is a low payback period of this machine while its ARR is much higher than its cost of capital. On the contrary, the NPV of the machine is considerably high. Therefore, with the considering of all these techniques and aspects, positive recommendations are provided to Roseville Plc and it is said to be accepting the investment.

b. Produce a report that explains and analyses the key merits and limitations of the differing investment appraisal techniques.

Introduction

All investment techniques and methods comprise of their benefits as well as loophole (Harris, 2017). This report would be discussing about their presence in accounting rate of return, net present value along with payback period.

Merits and loopholes of differing techniques for investment appraisal

Below is an elucidation of the varying merits and loopholes present in the three key investment appraisal techniques -

Table 1: Merits and loopholes of differing techniques for investment appraisal

(Source: Learner)

Conclusion

Hence, the loopholes and advantages of three key techniques relating to investment appraisal have been derived.

c. Produce a report that identifies and explains the key benefits and limitations of using budgets as a tool for strategic planning.

Introduction

Strategic planning with enterprises is largely conducted using budgets (Steiss, 2019). This report would be discussing on the benefits of utilisation of budgets as a key mode of strategic planning while examining its loopholes.

Merits and loopholes of conducting strategic planning with budgets

In financial management, budgets act as a tool for planning. They are the financial plans business concerns prepare considering the anticipated future costs while forecasting the revenues and earnings in the forthcoming year (Ansoff et al., 2018). However, when it comes to strategic planning, there are certain key benefits of applying budgets along with certain drawbacks, which have been examined below -

Table 2: Merits and loopholes of conducting strategic planning with budgets

(Source: Learner)

Conclusion

Thus, budget effectiveness in strategic planning along with its disadvantage for being used a strategic planning tool has been evaluated.

Conclusion

This study has indicated the fact that preparation of financial statements is an important part of financial management. Financial statements show the true view of the financial position or condition of the company during a certain period. The study has also indicated that calculation of breakeven point can help the organization in determining the required quantity of production and sales. On the other hand, considering the findings in this study, it is also understandable that the investment appraisal techniques are highly important for understanding whether the company should invest in a particular project. The suitability of the investment is easily understandable through these calculations.

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