Accounting Information for Business: Fresh IT Plc - Case Study Example

Accounting information for Business Fresh It Plc Report Name Course University Date Table of Contents Introduction 2 Financial Analysis 3 Operating Cash flow 3 Schedule of Cash Flow 3 Net Present Value 4 Summary of Investment Appraisal Findings (see appendix for calculations) 4 Decision for the Project 4 Usefulness of the appraisal techniques 6 Balance Scorecard 7 Developing a Balance Scorecard 7 Appendices 8 Appendix 1: Internal Rate of Return (IRR) 8 Appendix 2: Pay Back Period 9 Appendix 3: Profit Index 9 Reference List 9 Introduction Investment appraisal techniques are the methods that are used in any company to make a decision due to a firm investment of its current funds in long-term projects most efficiently expecting future benefits to flow to a business over some years. Good investment appraisal should consider the time value of money of the cash flows related to a project by discounting. It should have an option about whether to accept or reject any project. It should also provide a ranking of various projects and be flexible to enhance the economic desirability. Also, it should use cash flows whether inflow or outflows. Furthermore, it must have the preference on the largest cash flows than the smaller ones. There are various investments appraisal techniques, these includes, net present value (NPV), Profitability Index (PI), Payback period (PBP), internal rate of return (IRR) and the accounting rate of return (ARR) (Almarri 2014, p.g 856). The choice of any method of appraising differs from one enterprise to another, but some methods are considered superior to others. From the example, the primary investment appraisal techniques will apply. Before using these techniques, the following calculations needs to be done. Financial Analysis Operating Cash flow Operating Cash flows Year 1 2 3 4 5 Sales units 170000 185000 200000 195000 180000 £ £ £ £ £ Sales (Selling price*sales units) 102000 111000 120000 117000 108000 Variable costs: Raw materials 25500 27750 30000 29250 27000 Packaging 8500 9250 10000 9750 9000 Bonus 8500 9250 10000 9750 9000 Marketing 10000 5000 5000 5000 3000 Distribution cost 8000 16000 24000 32000 40000 Contribution 41500 43750 41000 31250 20000 Less Fixed Costs Depreciation 8000 8000 8000 8000 8000 Profit before interest and tax 33500 35750 33000 23250 12000 Less Tax (20%) 6700 7150 6600 4650 2400 Profit After Tax 26800 28600 26400 18600 9600 Add Depreciation back 8000 8000 8000 8000 8000 Cash flow 34800 36600 34400 26600 17600 Schedule of Cash Flow Schedule of cash flow Year 0 1 2 3 4 5 £ £ £ £ £ £ Operating cash 34800 36600 34400 26600 17600 Initial cost of project: 0 0 0 0 0 Appointment cost 15000 0 0 0 0 0 Branding and production 8000 0 0 0 0 0 Working capital 15000 0 0 0 0 15000 Machinery 50000 0 0 0 0 0 Salvage value 0 0 0 0 10000 Total cash flow 88000 34800 36600 34400 26600 42600 Net Present Value Year Cash Flows (£) Discounting Factor (12%) Present Value (£) 1 34800 0.893 31076.4 2 36600 0.797 29170.2 3 34400 0.712 24492.8 4 26600 0.636 16917.6 5 42600 0.567 24154.2 Total present value 125811.2 Cost of the project 88000 Net Present Value 37811.2 Summary of Investment Appraisal Findings (see appendix for calculations) Appraisal Method Decision criteria Decision NPV 37811.2 (positive) Accept IRR 25.15% > cost of capital/internal return Accept PBP 2 years 4 months Accept P1 1.43 (Greater than 1.0) Accept Decision for the Project The company should invest in the production of new snack bars. The investment appraisal provides an undoable insight into the viability of the project. With our critical and financial analysis skills, we were able to evaluate the project based on the approved appraisal methodologies, such as net present value, internal rate of return, profit index and payback period. The project presents positive cash flows throughout the five years. While there is an indication of a drop in the annual cash inflow, the variation of price and the variable cost of production needs to be monitored so as to ensure sustainability of the project. Nonetheless, positive cash flow and the expected insignificant deviations year-on-year of the investment gives a positive net present value. In addition, the NPV is not just positive but also presents a huge margin in the difference between total present value of the cash flow and initial cost outlay. However, the impact of internal rate of return should be considered before deciding on carrying on the project. The IRR is higher than the cost of capital and it is quite above the ROCE. It is important to note that the management’s rate of return should not surpass the investment’s IRR. Notably, the analysis indicate that the project’s internal rate of return is almost equal to the company’s ROCE. This interesting result makes the investment suitable as it is within the organizational policies regarding returns. Furthermore, the IRR is greater than the cost of capital and therefore, the project guarantees returns that incorporate the cost of investment. The Payback period is crucial in determining the time factor that the investment shall have recovered the initial cost. Even though it is sensible to use it when comparing more than one projects, it is equally crucial to apply PBP so as to ascertain the reasonability of investing in the project. Importantly, the profit index of the project is more than 1. The value if arrived at by getting the ratio between the net present value cash inflow and the present value of cash outflow (see appendix.3). The management should invest in the project due to the following reasons: The project has a positive NPV The IRR is greater than the cost of capital and ROCE. The payback period is reasonably less. The profit index is 1.43. Usefulness of the appraisal techniques The various investment appraisal as already under the discussion above includes the net present value. The regularly used technique is the net present value. To arrive at NPV, the initial investment is deducted from the total present value of cash flow. Net present value method of appraising is always consistent with the shares of the company and the inflows of the firm. It also has priority when appraising as it maximizes the wealth of the shareholders. Despite the advantages, this method has some limitations such as the challenge that arise when using it as it requires the services of an expert. It also ignores risks and the payback period of an investment. Profitability index is because of dividing the present value of cash flow by the initial cost of investment. Its simplicity makes it be a preference by businesses. The fact that it applies the time value of money and recognizes it makes this method quite useful. The internal rate of return is simple to use where there is a constant cash flow, if not so using it will involve approximations of various values (Cuthbert 2016, p.g. 135). It is a rate that equates the initial cost of investment and the present value of cash flow. The net present value is zero at IRR. Some reasons why some business finds it useful are like how it prefers the time value of money and go in hand with the shareholders’ value maximization objectives. Furthermore, due to its consideration of the cash flow of the entire life of a project, appraising become more relevant. Various circumstance may arise where the internal rate of return differs with the net present value. These includes variations in the cash flows, where they may rise and fall after some time. If the initial capital inflows are differing, then a conflict will be inevitable. Also, the occurrence of conflict might be evident due to different live of the projects. Conventional cash flows also contribute to the conflicting scenarios. Conventional is whereby the cash outflows and cash inflows pattern differs. In case the situation arises, NPV outdoes the internal rate of return due to its emphasis on the shareholders' wealth maximization objective. The other methods of investment appraisal are also used but not by most firms. Balance Scorecard The balanced scorecard is used in business, nonprofit making organizations and government strategically for management and planning order to ensure that the strategy and vision of groups are as per with the alignment of the business activities. It is used to monitor the performance of a firm and enhance both external and internal communications. Balanced Scorecard has become full measures of the management system and strategic planning from a very simple method of measuring performance. It makes the organization strategic plan to be only attractive but also that match with the daily functioning of an organization. A scorecard is very useful in providing links that can help to transform a business. The balance scorecard may involve various areas such as translation of the company vision, communication and creating relationships, business planning, feedback, and learning. Although many people consider this method as outdated, it is still useful in the day-to-day management of organizations. Developing a Balance Scorecard In developing the balanced scorecard of Fresh It Plc, which is a food manufacturing company, four perspectives are applied. These includes the learning and the growth perspective, the business process perspective, customer perspective and the financial perspective ( Hoque 2014, pg 50). The learning and growth perspective should include the training of the employees and the cultural attitude of the corporate and individual. It is necessary in today’s world for the workers to be in a continuous learning mode to be able to cope with the emerging issues. The business process perspective provides information on how the business is learning and the product and services it offers. The customer perspective should emphasize on how the business is according to the customers. It is the image of the firm. The financial perspectives should focus on the data available and accurate findings and the cost management. Balance scorecard Perspective Objective Measures Initiatives Learning and growth Improving and retaining talents and skills Retention rate Turnover rate Skills Staff Morale Training and development program. Business process Reduce cost by enhancing efficiency of business internal operations. Customer satisfaction Quality of materials Operational cost Post sales services Green initiatives. Customers’ feedback evaluation. Inventory management. Customer To ensure that the market share grows. Customer retention Satisfaction Market share Revenue Coming up with very strong brands, which will enhance quality and their welfare. Financial To ensure the financial position of the company improves in every financial year. Growth rate Business value Return on capital Leverage Cash flow Sales growth rate Establishing strong internal and accounting control systems. Appendices Appendix 1: Internal Rate of Return (IRR) NB: Since the net present value is a positive figure, it was recalculated using a higher rate of return of 20%. Year Cash Flows (£) Discounting Factor (20%) Present Value (£) 1 34800 0.833 28988.4 2 36600 0.694 25400.4 3 34400 0.579 19917.6 4 26600 0.482 12821.2 5 42600 0.402 17125.2 Total present value 104252.8 Cost of the project 88000 Net Present Value 16252.8 IRR= 25.15% IRR= IRR= Appendix 2: Pay Back Period Year Accumulated Cash flow 1 34800 2 71400 (Year before full recovery) 3 105800 4 132400 5 175000 PBP= PBP= Appendix 3: Profit Index PI= Reference List Almarri, K., & Blackwell, P. 2014. Improving risk sharing and investment appraisal for PPP procurement success in large green projects. Procedia-Social and Behavioral Sciences, 119, 847-856. Baum, A.E. and Crosby, N., 2014. Property investment appraisal. John Wiley & Sons. Cuthbert, J.R. and Magni, C.A., 2016. Measuring the inadequacy of IRR in PFI schemes using profitability index and AIRR. International Journal of Production Economics, 179, pp.130-140. Gibbons, R. and Kaplan, R.S., 2015. Formal Measures in Informal Management: Can a Balanced Scorecard Change a Culture?. Hoque, Z., 2014. 20 years of studies on the balanced scorecard: trends, accomplishments, gaps and opportunities for future research. The British accounting review, 46(1), pp.33-59. Kaplan, R.S. and Atkinson, A.A., 2015. Advanced management accounting. PHI Learning. Keyes, J., 2016. Implementing the IT balanced scorecard: Aligning IT with corporate strategy. CRC Press. Shu, S.B., Zeithammer, R. and Payne, J.W., 2016. Consumer preferences for annuity attributes: Beyond net present value. Journal of Marketing Research, 53(2), pp.240-262. Willcocks, L., 2013. Information management: the evaluation of information systems investments. Springer. Wood, D.A., 2016. Comparing the publication process in accounting, economics, finance, management, marketing, psychology, and the natural sciences. Accounting Horizons, 30(3), pp.341-361. Read More