Financial Decision Making for Travel and Tourism - Term Paper Example

FINANCIAL DECISION MAKING FOR TRAVEL AND TOURISM Table of Contents FINANCIAL DECISION MAKING FOR TRAVEL AND TOURISM 1 Table of Contents 2 Q1. Five source of finance 4 Ordinary (equity) shares 4 Loan stock 4 Retained earnings 5 Bank lending 5 Franchising 5 Q2. Behavior of cost and importance of CVP analysis 6 Fixed Costs: 6 Variable Costs: 6 Mixed Costs: 7 Q3. Various pricing strategies available within the context of travel and tourism industry 8 Marginal costing 8 Gross profit percentages and selling prices for products and services.  8 Selling prices for products and services prior to setting the selling price of the product, there is needed to understand the cost of running the business. Where the price of the product or service does not cover the cost, the cash flow will be negative and it will exhaust the financial assets of the company leading to failure. The very important thing is to include profits in the workings of cost. Consider profits as fixed cost since, no one are doing business just to break even. Since pricing commands the time and market study, the strategy of numerous companies is to set the price once. Nevertheless, this kind of polices risks the profits that are indefinable 9 Advantages and disadvantages of using absorption cost 9 Disadvantage 9 Absorption costing and marginal costing when pricing a product or service  10 Price skimming 11 From the graph above, it can be observed the Q1 depict the highest price of of p1, followed by Q2 at p2 then Q3 at p3 which is quite low. The implication is that, when the product is first introduced in the market, the price will be set high then subsequently reduced over time. This called price skimming and it is ideal in setting the selling price of the new product in the market. 11  Break Even analysis  11 From the graph of breakeven analysis, it can be observed that the company will make no profit or loss at 3000 units at a total cost of $18,000. This is the point of intersection between the total cost and the unit of sales and thus this best point of setting the selling price of the new product. 13 Conclusion 13 Bibliography 14 Q1. Five source of finance The following are the five source of capital for the business that might consider venturing in order to facilitate business expansion. The company must consider the cheapest source of capital in order to maximize returns within the shortest time possible. Ordinary (equity) shares The ordinary shares will only be provided to the existing shareholders of the business. In this regards, the ordinary shares depict no face value and the market value of the company’s shares depicts no association to their nominal value other than when the issues are issued for cash in which case, the price need to be same as the nominal value of the shares. The company can as well go for deferred ordinary shares (Albright, 2016). Under this approach to source of finance, it is a source of ordinary shares that are warrant to just dividend subsequent to some date or where profits grows beyond a specific amount. The voting right may as well be different from those attached to the ordinary shares. Loan stock This is long term debt capital for the company where the company is committed to repaying the principal amount and the interest on loan. The holders of the loan are hence long term creditors of the company. Loan stock depicts nominal value that is debt obliged by the business and the interest is paid at coupon yield of the loan value. Debenture is as well considering a form of loan to the company in form of loan stocks. It is acknowledged as a written receipt of the debt incurred by the business which entails the provision concerning the payment of interest as well as the subsequent repayment of capital (Butterfield, 2012). Retained earnings The retained earning depicts an impact on the amount of dividend. The profits re-ventured as retained earnings are the profits that might be paid as dividend. The main justifications to finance an expansion , instead of paying the highest dividend and then grow the new equity for the new venture is that, the management of the company considers that the retained Earnings are finance that doesn’t cost a thing since, using the retained earnings as a source of finance do not lead to cash payment and also, retained earnings as a source of finance is an attractive source of funding due to the fact that venture projects might be exercised devoid of engaging either the shareholders or any other external financiers (Damodaran, 2010). Bank lending Get finance capital from banks is a vital source of funding to the company. Bank lending is a short term to medium term lending institution. Medium loans range between 3-10 years. The rate of interest charged on loan by banks is a set margin, with size of margin placing dependence on the credit worthiness of the company. The loan might depict some fixed rate of interest or a variable interest rate, so that the rate of interest on loan is adjusted on a quarterly or half yearly basis in compliance with the base lending rate. Franchising This is an approach to business expansion on least cost of capital than might otherwise be required for appropriate business; it is an option to growing extra source of finance. In franchising plan, the franchisee imbrues the franchisor for the right to operate the business under the name of the franchisor that must bear some expense and will charge the franchisee a fee to cover the set up cost. Placing reliance on the subsequent normal payments by the franchisee for operating profits as a percentage of turnovers for the franchisee (Evans, 2012). Q2. Behavior of cost and importance of CVP analysis Cost behavior implies the manner to which diverse kind of production cost change with change in the production level. There are three key kind of cost as per their behavior. Fixed Costs: This is a cost that remains fixed with an increase the production level within an appropriate production range. Fixed cost will be incurred where there are units or no units produced and thus the fixed cost per unit declines with an increase in the level of production. Variable Costs: This is the cost that chance proportionally with the change in the level of production. This implies that the total grows with increase in production levels. Even thought the variable costs in total cost are fixed per unit (Cafferky, 2010). Mixed Costs: This is a cost with an attributed of fixed and variable cost. Telephone cost would qualify to be a mixed cost since, it normally entails the fixed constituents like the line rent and fixed subscription and variable cost incurred per minute cost. Because mixed cost numbers are not important in the raw form, as a result they are split into fixed and variable cost with the use of cost behavior assessment tool like the high low method, the scatter graph and the regression (Jerry, 2009) analysis. Importance of CVP analysis\Cost volume profit analysis (CVP) is a significant tool that point where less will be same as total cost which is also called the breakeven point. At this point, the business will incur no profit or loss and will only be covering the variable cost only which makes the business survive in a competitive market. The CVP is important since, it is used to make a decision concerning the products or service they produce and sell. As a result, the CVP analysis is important in managerial accounting since, it helps managers in making an informed investment decision that will lead cost effectiveness by determining theory contribution which is the amount that remains after sales every variables cost have been deducted. The remaining amount first covers the fixed cost and what remains is deem as retained profits (Jerry, 2009). Q3. Various pricing strategies available within the context of travel and tourism industry Marginal costing This is a change in total cost due to growth in the quantity of good produced as a result of an increment by a unit. It is the cost of producing a unit or more of a commodity. The analysis is segregated into short and long run situation so that over the long run, all cost will be marginal at every stage of production line whilst the cost that doesn’t change with production are deem fixed. Gross profit percentages and selling prices for products and services.  The gross profit percentage is worked out by depicting the proportion of revenue entailing the cost directly linked to either the goods sold or service provided so as to create revenue. The business profitability is keenly controlled over time to observe whether some likely aspects are affecting business Profitability. Where the business characteristically sales products, then the gross margin percentage will as follows Sales - (Factory overhead + direct materials + direct labor) Sales Selling prices for products and services prior to setting the selling price of the product, there is needed to understand the cost of running the business. Where the price of the product or service does not cover the cost, the cash flow will be negative and it will exhaust the financial assets of the company leading to failure. The very important thing is to include profits in the workings of cost. Consider profits as fixed cost since, no one are doing business just to break even. Since pricing commands the time and market study, the strategy of numerous companies is to set the price once. Nevertheless, this kind of polices risks the profits that are indefinable Advantages and disadvantages of using absorption cost Absorption costing is GAAP compliant and commands reporting to the internal revenue services. As much as business selects the variable costing for in house accounting reasons, it must work out the absorption costing to file the tax. Absorption costing also considers the cost of production, not merely the cost of operation such as employee’s wages and utility bills. Absorption costing is as well as important in appraising the company’s profitability and establishing the price for the product since, the company will be having an absolute data of cost per unit of the product. Disadvantage Absorption costing might lead to business of level being better unlike the reality at a given financial period which might be misleading. This is as a result of fixed cost not being deducted from the sales unless every manufactured goods are sold. Furthermore, skewing the profit and loss statement will lead be misleading to company management and the stakeholders. Absorption costing doesn’t provide a better assessment of the cost and sales volume as variable cost does. Fixed cost are specifically large part of total production cost, it is hard to establish variance in the cost that exist at diverse production levels. This as results will make it hard for the management to make the best verdict for effectiveness of the business operations. Absorption costing and marginal costing when pricing a product or service  Absorption costing entails the accumulation of the cost linked to the production prices and allotting the cost to each product. The product might absorb a wide range of fixed and variable cost. The costs are not recognized as expense each month when a business pays for the product. Rather, it remains in the inventory as an asset until the time of sales of the inventory when it is charged in the cost of goods sold. Under marginal costing, the price is set at slightly above the variable cost of producing the product. This methodology characteristically relate to short timer price setting circumstance. The graph of semi variable and fixed cost From the above graph, it is evident that the fixed cost is constant at $500, while the variable cost change with change units produced proportionality from $1000 at zero units to $4000 at 3000 units. The mixed cost is a combination of variable and fixed cost as depicted in the graph above. Price skimming This is a pricing strategy where the market will set the price relatively high for the product or service initially, then lowers the price as time goes by. It is a sequential version of the price biasness or yield control From the graph above, it can be observed the Q1 depict the highest price of of p1, followed by Q2 at p2 then Q3 at p3 which is quite low. The implication is that, when the product is first introduced in the market, the price will be set high then subsequently reduced over time. This called price skimming and it is ideal in setting the selling price of the new product in the market.  Break Even analysis  This is an assessment to establish the point at which sales will be same as cost linked to sales. Break even analysis works the margin of safety, the amount that sales surpass the breakeven point. This is the amount that sales might declines whilst still staying beyond the breakeven point. The concept of break even analysis is important in determining the least selling price, which is below which the seller will start to lose money on the revenue. The information is important when acting in response to clients needs the least possible prices. The breakeven price is arrived as follows Breakeven price= (Total fixed cost / Production unit volume) + Variable cost per unit This is the price at which the business will realize no profit or loss. The assumption is that the units sold are certain. In reality, the real number of units sold will vary from anticipation; hence the breakeven price might prove to be somehow diverse. From the graph of breakeven analysis, it can be observed that the company will make no profit or loss at 3000 units at a total cost of $18,000. This is the point of intersection between the total cost and the unit of sales and thus this best point of setting the selling price of the new product. Conclusion In making an investment decision, the company need to consider the cheapest source of capital to finance it business expansion as well as undertake the cost volume profit analysis in order to ascertain the level of sales that the company will make before it break even. This investment decision and analysis goes together with the best pricing strategy which must be incorporated together in making an informed investment decision to increase the returns within the shortest time possible at low cost to the business. Bibliography Albright, C. (2016) Business Analytics: Data Analysis & Decision Making - Page 230, London : Cignage Learning. Butterfield, J. (2012) Problem-Solving and Decision Making: Illustrated Course Guides, New York: Cingage Learning. Cafferky, M. (2010) Breakeven Analysis: The Definitive Guide to Cost-Volume-Profit Analysis, New York. Damodaran, A. (2010) Applied Corporate Finance - Page 552, New York: Cingage Learning. Evans, N. (2012) Strategic Management for Travel and Tourism, London. Jerry, W. (2009) Managerial Accounting: Tools for Business Decision Making, London: Jonh Wiley. Kinney, M. (2012) Cost Accounting - Page 747, London. Read More