Business Finance Assignment On Budgeting Methods
Question
Task:
Part 1
Mediterranean Delights Ltd (“MDL”) owns and operates 30 delicatessens throughout the South of England. It also supplies several chains of restaurants with its own range of imported products. The company last year had turnover in excess of £50 million. Two key corporate customers are Delios Ltd and San Pedro Ltd. The company is managed by Wade, who owns 25% of the shares in the company, while the remaining 75% is split between three other family members. The other shareholders are concerned about the business. Although there seems to be plenty of business coming in and the last year has been reasonably profitable (Operating profit was £5 million last year before interest and tax), the company’s debt has increased to £18 million from £16 million the year before. Wade has started talking about the need for the other shareholders to invest more money to reduce the debt. Towards the end of last year MDL acquired a 40% stake in an Italian company which produces a range of premium pasta. MDL invested £10 million in the company to acquire the shares and has agreed to pay an £8 million advance fee for exclusive supply of the products. The company is owed £1.5 million pounds for a series of large orders placed by Delios last year. There is also an outstanding dispute about a £2 million delivery to San Pedro completed in 2017. This has led to payment being withheld while negotiations continue between lawyers and industry consultants. There is a further problem that Wade believes the San Pedro issue arose due to the supply of sub-standard materials by a Maltese agricultural group, Valetta Ltd in 2017. He has refused to pay Valetta which is now threatening legal action. In the meantime, a large stock of materials and supplies has built up at the company’s London warehouse. Wade insists that the company needs to have this level of stock for when the dispute is sorted out. He is also reluctant to press his key customers too hard for payment. The other shareholders have approached MDL’s accountants to review the situation.
Requirements:
Prepare a report of up to 1,250 words for the shareholders addressing the following issues.
i. Using the reading list provided on the VLE, explain:
a. what is meant by Profit and Cashflow and how they are different
b. what is meant by Working Capital and, the meanings of Receivables, Inventory and Payables
c. how changes in Working Capital affect Cashflow (25 marks)
ii. Apply the concepts in (i) above to this company to show how the way the company is being managed might affect its financial results. (10 marks)
iii. Analyse and recommend what steps should now be taken to improve this company’s cashflow through better Working Capital management. (15 marks)
Part 2
Second Sight Plc is an international company which produces prescription glasses and sunglasses for a number of leading international brands. The company has been operating for 25 years and had revenues last year of £250 million. It was listed on the London Stock Exchange 10 years ago and has a market capitalisation of £300 million with debt of £50 million. The founder, Nasser, is the CEO and owns 15% of the shares. The company headquarters is located in Manchester which accommodates 40 staff including management, sales, finance, HR and administration. It has a production centre in the UK and another in France. In these centres it employs 250 staff. The company is planning to open a new facility in the Netherlands and is considering a joint venture project with an Indian company. If the Indian venture goes ahead it would involve setting up a facility in Chennai which is expected to employ 800 staff. The company has always used a traditional budgeting system. The Finance Director, Bridget, joined 3 years ago but is concerned that this approach might not be the most appropriate. However, if a change of budget approach is going to be made, she thinks it should happen in time for next year’s budget process. That way any “bugs” can be ironed out before the company goes through more significant changes in the following years. Requirements: Prepare a report of up to 1,250 words for the board addressing the following issues:
i. An understanding of the purposes of preparing a budget; anexplanation of
a) traditional budgeting approaches and b) the following alternative budget methods: rolling budgets, zero based budgets and activity-based budgets, explain their relative strengths and weaknesses (25 marks)
ii. Demonstrate the application of these methods showing how they might be used to plan future cost management for this specific business. Illustrate your answer with examples of how products and processes for this business would be budgeted for in a traditional approach and using the alternative methods (10 marks)
iii. Analysing whether a traditional or alternative budgetary system is appropriate to all or any parts of the business in its planned future form
Answer
Executive summary
The first part of the Business finance assignment talks about Mediterranean Delights Ltd which is a large company yet facing trouble regarding its outstanding payment in the market. Despite profiting in a large scale it is not being able to clear off the payments. The Business finance assignment derives the solution and what pros and cons the company should maintain.
Part 1
i. elaboration of the concepts
a. Profit and Cashflow: Differences
When all the expenses are met and deducted from the revenue, the remaining sum is called profit. In order to sustain for the longer time, a business or an organization is bound to be profited. However, at times, the production cost or the ideas of producing something new or the business investment can increase which may result in reduction of the profit in the short term.
The concept of inflow and outflow of money from a business mentioned in the Business finance assignment is called Cash flow. Companies are bound to manage cash flow very regularly to run daily operations, pay taxes, pay the employees and the other expenses (Watson Head, 2016). It helps the company to keep a track of how much actual cash is available in the company at any time.
Profit involves revenue less expenses or could be called the total earning of an organization whereas cash flow is the money that flows in and out of a business in a mentioned time period. Profit shows the immediate success of an organization and cash flow is more focused on determining the company’s long term financial outlook. For example, if a small company sells wholesale products to a big company, the bigger company is supposed to pay the product expenses to the smaller company. Now, if the payment is delayed, the smaller company will not be able to pay its employees but still be profitable in the market. Therefore, despite reaching profitability, a company may face issues regarding cash flow.
It is stated herein Business finance assignment that at the end of the day, cash flow and profit are the two separate units measuring different things of an organization. Profit is the goal of the company, taking care of the financial health. Now cash flow is the lifeblood of an organization which helps in keeping track of each and every activities happening in the company every day. So, it is important for the companies, mostly the bigger companies to maintain the scale of both the cash flow and the profit.
b. Working Capital: Receivables, Payables and inventory
“Working Capital” mentioned herein Business finance assignment is the indicator of the interim economic position of an organization. Even, the “working capital” measures the company’s overall efficiency. Working capital could be addressed by writing off the prevailing culpabilities from the present credit. It also helps in deriving whether the company has enough revenues to fulfill its abbreviated arrears. Working capital indicates the different levels of the company in order to manage the everyday costs. It also covers the cash, inventory, receivable, payable and the due debts. There are various theoretical frameworks that poses significant relationship between firms’ performance and working capital (Aktas, Croci, Petmeza, 2015).
Receivables: Accounts Receivable refers to the debts owed to a company by its consumers. The consumers may have been delivered with the products but not paid the bill. This overdue bill are the receivables of the company.
Inventory: The available product for sale and the raw materials that have been used to manufacture the goods for sale is called “Inventory”. It serves the primary sources of revenue generation and the earnings for the company’s shareholders (Atrill, 2014).
Payables: Companies often purchase goods on credit. Which means, they are yet to pay the amount in a brief time span. This overdue debt is called the “accounts payable”. It is brief deficit to be paid to bypass evade.
c. What is the impact of working capital on cash flow in the context of Business finance assignment?
A company’s “cash flow” can be affected by the change of the company’s “working capital”. If an organization purchases a fixed property like an apartment, there will be a down flow of the organization’s “cash flow”. The “working capital” will also curtail as liquidate apportion of the recent property will be subtracted. Only the “current liabilities” will still be the same since it is a long term debt. On the contrary, if the company sells of its fixed asset, both the cash flow and the working capital will increase. Now, if an organization buys “inventory” using cash the working capital will be unchanged because both the “inventory” and the “cash” are the present equity. But, since it has been purchased with cash, the “cash flow” of the organization will curb. The “working capital” of a company funds its regular operations. It is important for the company to keep track of both the “working capital” and “cash flow” to determine the time period of the financial activities. An over decrease of the “cash flow” and the “working capital” may not result in a positive way if the organization opts out a long haul debt which is unable to bring about the “cash flow” to clear the payment (Aktas, Croci, Petmeza, 2015). On the contrary, the same situation outlined herein Business finance assignment may turn out to be positive if the organization is able to use the revenue to lend in long term immovable capitals which are able to generate revenues in the coming year.
ii. Financial results of Mediterranean Delights Ltd
An international company, Mediterranean Delights Ltd mentioned in this segment if Business finance assignment owns and operates delicatessens in the whole Southern part of England. The company supplies number of chains of restaurants with its own range of imported goods. The organization had an uplift of £50 million last year. But, the organization owes £1.5 million pounds for an array of big orders placed by one of the corporate customers last and there is still an outstanding payment of £2 million which has been taken back in 2017. These payables are causing negative impact on the company and the negotiation between the lawyers and the industry consultants are still on. This issue highlighted in the v has occurred because one of the corporate customers delivered substandard product and the management body of the company refused to pay for that. Now this has become a legal threat for the company currently. The company needs to focus on its cash flow over profiting. Although it has been profited in a large scale since last year, the investment plan has not been fruitful. The company has acquired a 40% stake in an Italian company and that’s what affected its working capital and they are unable to pay off the debts. Other than concentrating in profiting, the company needs to keep track of its cash flow regularly. It will help the company to have an insight about its capital and where to spend that. The company chosen to prepare this section of Business finance assignment needs to invest on fixed assets in order to generate revenues for the long term and will be able to clear out all the debts in the market.
iii. Analysis and Recommendation
The company is indebted to a whole seller and refuses to pay off as it supplied substandard goods. Also, it has an outstanding payment of £1.5 million since 2017. The main problem with the company noted herein Business finance assignment is that, it focuses on the profit and not the cash flow. The company needs to stop purchasing with cash as it affects the cash flow. It has to come up with a new decorum where raw materials will be bought on credit and the debt will be paid back monthly by using the working capital. Or the company needs to focus on purchasing fixed assets which will generate revenue regularly. This will help the company get rid of all the overdue payments in the market. It has to keep track of the inflow and the outflow of the money. Based on that, it needs to decide what is to be purchased or which asset may help in generating the daily revenue of the company.
Executive summery
The second part of Business finance assignment deals with Second Sight Plc which is indecisive about which method of budgeting they should follow and the discussion leads to the conclusion. Part 2 of Business finance assignment illustrates various method of budgeting that would be analyzed based on the case study provided. A comparative approach has been adopted to analyses budgeting methodologies to understand the strengths, weaknesses and impact.
Part 2
i. Concept associated with budget preparation
The implementation, operation and the designing process of monetary planning is called budgeting. As per the investigation on Business finance assignment, it is considered to be the highest level of accounting to secure the future, covering a specific time period. In the cases of most of the companies, the budget they make is their profit plan which shows the planned activities in order to achieve its profit goals (Weetman, 2010). The essential factor to be remembered is that, forecasting and budgeting are the two different issues altogether.
The purposes of budgeting are (Drury, 2016),
- to coordinate the short-range plans of the company
- To motivate managers in achieving the profit goals
- To evaluate the performances of the different departments of the company
- To control the on-going events of the company
- To communicate and pass the plans to the respective managerial body.
- To make the standard costing and budgetary controls more effective.
a. Traditional budgeting approaches
Traditional budgeting takes last year’s income and expenses in account as a parameter to inspect the current year’s expenses and income. This approach illustrated in the Business finance assignment pulls out the last year’s data together. It chooses a spreadsheet program to make data entry and changes that are easier to input.
b. The alternative budget method.
· Zero based budget
Accounting and preparing the budget from the scratch or a zero base is called zero based budgeting. It starts from the zero unlike the traditional budgeting that deals with the data of the previous year. The process evaluates every line item of cash flow statement and justify all the expenditure which is to be sustained by the respective unit. The zero based budgeting aims to reduce the unnecessary expenses by identifying the areas to cut off the costs from. Other than the managerial body, this process needs the involvement of the employees.
- Rolling budget
The concept of rolling budget can be described in the context of Business finance assignment as the continuous budgeting method that need to be updated regularly when the previously formulated budget expires (Atrill, 2015).
· Activity based budget
Identifying, analyzing and observing the activities that determine the cost of the company, is the primary objective of the Activity based budgeting. To be precise it is the process of cost accounting of an organization. This process helps the organizations to save money by increasing the production and reducing the production period. It also helps the management to keep an eye on all the activities that are taking place in the company. This process enables the chances where the management body get well-accustomed with the production procedure entirely which may lead to much more than just cost saving. When a management body is aware of its production procedure, it becomes easier to come up with new ideas which may flourish in the market and generate better revenues.
· What is the strength and weaknesses of the alternative budget method mentioned in the Business finance assignment?
The alternative budgeting systems have both strengths and drawbacks.
Advantages of the zero based budgeting are a) It insists every department of the organization to recheck each and every item of the cash flow and compute their operation expenses. This helps in giving a clear picture of the company’s expenditure. b) Since, the procedure does not look at the previous year’s numbers, it gives an accurate calculation of the business costs. c) It identifies and justifies every line items hence, incremental budgeting can be avoided. d) It helps in the coordination and communication within all the units of the organization and encourage all the employees by involving them into the procedure
The disadvantages of the zero based budgeting mentioned in the Business finance assignment are a) The process is extremely time consuming as it starts from the scratch and examines all the factors in a detailed manner. b) Making an entire budget from zero needs a lot of employee’s involvement. It becomes difficult for some companies to provide with such huge number of manpower. c) The organization need to train the managers before examining every line item and every cost. Sometimes it is difficult to offer such training (Drury, 2016).
The strength of the activity-based budget are a) This process looks after the wellbeing of the company. Which means, it observes the performances and determines what can be improved and how. b) It is a more practical approach in budgeting by fixing accountability of the different activities performed in the company. c) It helps in changing the situation of the company by observing the current market positions.
The weaknesses of the activity-based budgeting are a) It is a lengthy process requiring a lot of time and resources. b) Requires talented and expert individuals and at times, some companies fail to offer such training. c) In this budgeting system as noted in the Business finance assignment; there is a chance of shifting the focus into solving the short term problems which may hamper the big issues of an organization.
ii. Application Of the methods
· Budget structure of the mentioned business in traditional approach using the alternative methods
The international company Second Sight Plc produces prescription glasses and sunglasses for various international brands. It is a 25-year-old company which generated a revenue of £250 last year. In the headquarter of the company, there are 40 staffs. The company has other branches that consist of 250 staffs. Now, it aims at opening a new branch in Netherlands and plans for a joint venture project with an Indian company. So, the company is setting up a faculty in Chennai to accommodate 800 staffs.
For example, Second Sight Plc has always used traditional budgeting system, but, currently, the finance director thinks that this isn’t the adequate method for such a huge structure. If the company goes on with traditional budgeting system, it is going to be very difficult for them to keep records. Since, the company is big and getting bigger by the time, the alternative budgeting system could be applied here in the case of Business finance assignment. Other than following the traditional budgeting method, a combination of zero based budgeting and activity based budgeting can be taken into account. This combination will allow all the employees be updated about their respective units which will help the managerial body to observe all the activities before proceeding to budgeting. Since, the alternative method keeps an eye on every line item of cash flow statement and the expenditure of the company, there are possibilities that the budget plan would not fail once finalized. It will help reducing the unnecessary expenses by identifying the overrated areas. The alternative budgeting method enables the management body to follow up the entire production process which may lead to a greater success than just cost saving.
iii. Analysis and comparison of Traditional and alternative budgeting system
In the traditional budgeting, it is clear in the Business finance assignment that the costs are not minimal as it takes last year’s expenditure as the benchmark. Whereas alternative budgeting methods either start from the scratch or follow every activity happening in the company and make the budget accordingly. A company makes a budget plan in order to sense what may happen in the future. So, assuming an the basis of the previous year’s expenditure is not enough convincing while there is an alternative method which does not assume but analyses from the scratch to figure out what is going to be beneficial for the company. Although, the alternative method is a little complex, it encourages the cost effectiveness of the company. Whereas traditional method just looks at the previous expenditure and encourages the similar costing.
The traditional budgeting is quite backdated and do not serve the company’s purposes entirely. The alternative budgeting involves the performances of all the departments of the company and follows up the activities happening there. It has one spreadsheet that contains all the finance and activity related information of the company. It ensures the cost effectiveness and detailed knowledge that helps a company generate more revenues.
Since, Second Sight Plc is a big company, the alternative budgeting in this case of Business finance assignment is more effective. It also has the infrastructure to provide the employees with proper training.
Reference List
Aktas, Croci, Petmeza, 2015. Is Working Capital Management Value-Enhancing. Journal of Corporate Finance 30, pp. 98-113. [pdf] Available through ARU, VLE: Business finance reading list
Atrill 2014. Financial Management for Decision Makers. 7th ed. London FT Prentice Hall. Chapter 10 - Working Capital. [pdf] Available through ARU, VLE: Business finance reading list
Atrill, 2015. Management Accounting for Decision Makers. 8th ed. London Pearson. Chapter 6 Budgeting.[pdf] Available through ARUL, VLE: Business finance reading list
Drury, 2016. Management Accounting for Business. 6th ed. London Cengage. Chapter 9 The Budgeting Process. Business finance assignment [pdf] Available through ARU, VLE: Business finance reading list
Watson Head, 2016. Corporate Finance. 7th ed. London Pearson. Chapter 3 - Working Capital. [pdf] Available through ARU, VLE: Business finance reading list
Weetman, 2010. Management Accounting. 2nd ed. London FT Prentice Hall. Chapter 13 Preparing a budget. [pdf] Available through ARU, VLE: Business finance reading list
