PGBM01 Finance Management

ASSIGNMENT COVER SHEET

UNIVERSITY OF SUNDERLAND

MASTER OF BUSINESS ADMINISTRATION (MBA)

Student ID: 139098196

Student Name: T NARISH TAMILARASAN

Module Code: PGBM01

Module Name / Title: Financial Management

Centre / College: SEGI COLLEGE

Hand in Date: 20th January 2015 Due Date: 20th January 2015

Assignment Title:

PGBM01 Financial Management - Assessment November 2014

Students Signature: (you must sign this declaring that it is all your own work and all sources of information have been referenced)

PGBM 01 Financial Management

Student ID: 139098196

Student Name: T NARISH TAMILARASAN

Centre / College: Segi College, Penang

Table of Contents

No Contents Page Number

1. Part A Ratio Analysis 1

2. Profitibality 1

4. Liquidity 1

5. Gearing 2

6. Efficiency/ Asset Utilization 2

7. Part B Break even point 3

8 Marigin of safety 3

9. Key assumptions of break-even analysis 4

10. Restrictions in break even-analysis 4

Part C

11. Section 1 5-6

12. Section 2 7-9

13. Bibliography 10

14 Appendices 11-16

1

Part A Sterling Plc

Sterling Plcs company performance

Profitability

In order to know your business performance, monitoring and observing profitability is very

important. Attached is the information on income statement for the year ended 31 December and

statement of financial view of Sterling Plc, this report has discussed and calculated four relevant

ratios of profitability performance: Return on capital employed (ROCE), Return on equity (ROE),

Gross profit margin (GRM) and Net profit margin (NPM). From the results of these ratios, Sterling

have a bad profitability performance in 2013 year, the ROCE, ROE and NPM both has the significant

decline. The ROCE and ROE has the big change, ROCE has decline 13.89% and ROE has decline

19.30%. The main reason is the ordinary shares in equity increase 700,000 and net income

decrease by 850,000. Although the sale price and volumes can change significantly, but the gross

profit margin is usually quite stable, the GRM of 2012 to 2013 looks quite stable, 2012 GRM is

47.24%, 2013 is 42.50%, but due to the increase of the variable expenses that reduce to the

operating profit before interest and tax, the NPM also fall by 7.87%. Sterling Plc needs to think

about why the sales revenue increased 2,230,000 but the net profits has decline 850,000 at 2013

years.

Liquidity

Liquidity ratios are often used to determine a companys ability to meet its short-term debt

obligations. The rations calculation of liquidity includes current ratio, quick ration and working

capital cycle. From the results of calculation that shows Sterling Plc has a relatively low level of

liquidity, the current & quick ratio both has the minimal change between 2012 and 2013. But it

shows very low index. Current ratio has decrease by 0.08 times and quick ratio decrease 0.06 times.

It is worth nothing that the significant change on working capital cycle, it is the negative change

from -8 days of 2012 changed to 25 days of 2013, the trade receivables days from 56 days increased

to 65 days and the trade payable days from 94 days decreased to 70 days, it means company get

back the trade capital slows down but they need to faster pay the money for suppliers.

2

Gearing

These ratios concentrate on the long-term health of a business. Particularly the effect of the

capital/finance structure on the business: gearing ratio and interest cover ratio. According

to the results can indicates Sterling Plc have a stable gearing ratio, although have decline by

4.97%, but this is the common change at the company development, it is due to the

increased of equity. Stable gearing ratio can shows that Sterling Plc managers still effectively

to use the shareholders capital, it can help the shareholders a larger scale operation with

fewer funds. A problem can be find in the interest cover ratio, company had 845,000 bank

overdraft at 2013 year, it takes the increased of interest payable directly. The interest cover

ratio has decline by 2.21 times from 2012 to 2013, it reflects debt-paying ability of Sterling

Plc has changed weaker. Of course, the increased of variable expenses also contributed to

the change.

Efficiency / Asset utilization

The ratios calculation of efficiency can given an insight into how efficiently the company is

employing those resources invested in fixed assets and working capital. Stock (inventory)

turnover days, accounts receivable collection period (ARCP) and accounts payable payment

period (APPP) has calculated in this areas. It is similar same with the working capital cycle

calculation. From the results of these ratios can know Sterling Plc have a bed cash flow. The

stock turnover days is 40 days in 2012 and 35 days in 2013, it can indicates a good stock

management of company. However, the big problem reflects on ARCP and APPP. It takes the

negative change at 2013 year, ARCP times increased 6 days and APPP times decreased 24

days. The reason for these changes are increased the sale revenue and credit purchase.

3

Part B Grantham Ltd

Break-even point (BEP)

Break-even point (BEP) is a point that neither profit nor loss, that is, the activity breaks even. Where

the volume of activity is below BEP, a loss will be incurred because total cost exceeds total sales

revenue. When the volume of activity above BEP, there will be a profit. (Atrill and McLaney, 2011).

According to the BEP, the further of activity is below BEP, it could get the loss; the further of activity

is above BEP, it could get the profit. Followed the calculated break-even point for Grantham Ltd, it

can knows the break-even point in units sold is 128,571 units and the break-even point in revenue

45,000,000 in 2012 year; the 2013 year BEP in units is 61,429 units and BEP in revenue is 645,000.

It was a large movement from 2012 to 2013. At 2013 year, Freezer can more easy and quickly to

above the BEP and get the profits. The key movement reason is that management has decided to

increase the selling price by 20%, the selling price at 2013 is 420, it makes 70 increased of unit

contribution margin than 2012; at the same time, the increased of 1,950,000 in fixed costs also as

the important factors to effects the BEP. The decreased of BEP indicates Freezer has a strong anti-

risks of business operation.

Margin of safety

Usually, manager can be consider to uses the margin of safety with the break-even point. Margin of

safety is often used to ensure the safety of the sales when knows the BEP, it can be set to detect

whether company can avoid the loss of profits. When Freezer knows the BEP with its sale, it can

easy to set to the margin of safety. For example, in 2013, the calculated for the margin of safety in

units is 238,571 units, in revenue is 125,355,000. The set to margin of safety can not lower than

these data, it could insure when the sale above margin of safety, company can make profits.

4

Key assumptions of break-even analysis

There are three key assumptions that affect the applicability of break-even analysis The

average sales price per unit: Which takes into account the sales discounts and special offers

Managers need to predict this numbers for the unit price from sales, in some company not

base on the unit, it should be a percentage to show that the per earnings unit in per unit of

cost. (Lynch, 2005). This is the most common problems in the same product sales market, so

managers need to predict the BEP according to the sales prices. Variable unit cost: this is

based on the production costs When use to the BEP, managers need to clearly determine

which cost belongs to the production cost It can calculate the contribution margin per unit,

it reflects the profit per unit produce by one sales product. Monthly fixed costs: Monthly

fixed costs includes the machine's depreciation, administrative costs and other fixed costs

that must paid by each month Technically, a break-even analysis defines fixed costs as costs

that would continue even if it went broke.

Restrictions in break-even analysis

Used to the break-even analysis can evaluate the economic of a project, it can determine the

financial benefit of the merits for several projects, which filter out the optimal solution.

Although the break-even analysis is only to discuss the impact of price changes uncertainties,

yield, variable costs, fixed costs, such as profit and loss generated by the project, but it can

not judge the profitability of project. On the other hands, break-even analysis is a static

analysis, it is not consider to the time value of money, the magnitude of change is

uncertainties by artificial, so it has some limitations.

(All the analysis data used from Appendix 2, it includes the relevant break-even point and

margin of safety calculations and a summary table for both 2012 and 2013 year.)

5

Part C

Section 1

As the famous proverb says, Those who fail to plan, plan to fail is very true when it comes

to plan a business specifically on the budgeting aspect. There are many business owners

failed in their business due to a poor budget planning. Budget is the most prominent

element for a successful business plan. In fact, budget shows a detailed analysis on how an

organisation should spend money in future time periods. A typical budget helps the business

to plan its own strategy and to reach the goal of the organisation. At the same time, making

sure the earning income is in control of the cost related to that income keeps the business

owner on the right track in achieving the business goal. (Tracey Loubser, 2014)

Control expenditures

One of the undeniable benefits of budget is the ability to control or to limit on the cash flow

spent on certain departments within an organisation. Since, an accurate budget accounts

can show the expenditures of the departments, the management can plan a strategy to

control that cash flow so it can be channeled to some other needs within a company.

Literally, it refrain the company from wasting its capital and limits the economic resources.

Creates financial roadmap

When the year passes, budget review is a must for organisations. Its an essential activity for

companies to know where they spent the most and where they spent the least especially

when it comes to their operations. At times it makes them to come up with new budget

policies for the interest of the company.

Plan for future growth

On the other hand, it is very norm for companies to plan for future business development

and growth. Capital of the business is really saved on regular business expenditures where

the thougt of investing them into another business or needing them for business expansion

is a practice in business provided the companies has the budget plan . Budgeting for future

growth opportunities ensures that companies have capital on hand when needing to make a

6

quick decisions for expanding business operations. This capital may also be used during slow

economic times as a safety net for paying regular business expenses.

Conclusion

Budgeting is very essential and an important activity for an organisation in the sense of

stabilsing the companys financial strength and not forgetting that planned and controlled

budgets always helps the organisation during a slow economic prgression. In order to

sustain in todays business competency , no matter what is the business nature but adopting

budgeting habit within an organisation or business will lead to a healthy financial growth.

(Tracey Loubser, 2014)

7

Section 2

When it comes to financing business there are many times of business financing. They are

capital markets, which are more likely issuing the new shares. Stock market listing is one of

how capital market functions. The other financing methods are like, loan stock, retained

earnings, bank borrowing, government sources, and business expansion scheme funds,

venture capital and franchising. (Basic finance for marketers. 2014. [ONLINE])

Ordinary share

Ordinary shares are issued to the owners of a company. They have a nominal or 'face' value,

typically from a dollar to 50 cents. The market value of a priced company's shares bears no

liaison to their nominal value. A company can obtain additional equity funds through stock

exchange quotation. Apart from that, right issue provides a way of floating new share

capital by giving an offer to existing shareholders by inviting them to subscribe cash for new

shares in ratio to their existing holdings. On the other hand, preference shares have a fixed

percentage dividend where any dividend is paid to the normal shareholders. From the

companys point of view, preference shares dividends do not have to be paid in a ear where

the profits are poor while this is not the case with interest payments on long term debt.

(Basic finance for marketers. 2014. [ONLINE])

Loan stock

Loan stock is long-term debt capital extended by a company for which interest is paid.

Holders of loan stock are therefore long-term creditors of the organisation. Debentures are

a form of loan stock, legally defined as the written acknowledgement of a debt incurred by a

company, normally enclosing requirements about the payment of interest and the eventual

repayment of capital. (Basic finance for marketers. 2014. [ONLINE])

Retained earnings

For any company, the amount of incomes retained within the business has a direct effect on

the amount of dividends. Profit re-invested as engaged earnings is profit that could have

been paid as a share. The main reasons for using reserved earnings to finance new assets,

rather than to pay higher dividends and then raise new equity for the new investments like

8

the organisation of various companies thinks that retained earnings are the finance which

do not cost anything although this fact is just a myth. But, it is factual that the use of

enclosed earnings as a source of funds which dont lead to a payment of cash. (Basic finance

for marketers. 2014. [ONLINE])

Bank lending

This is a very famous source of finance that available for business. Borrowings from banks

are an important source of finance for companies. Bank offering is still mainly short term,

although medium-term lending is quite usual these days.

Short term lending may be in the form of:

a) An overdraft, which a company should keep within a limit, set by the bank. Interest

is charged (at a variable rate) on the amount by which the company is overdrawn

from day to day;

b) A short-term loan, for up to several years which is very subjective according to the

banks.

Leasing

A lease is an contract between two parties, the "lessor" and the "lessee". The lessor owns a

capital asset, but permits the lessee to use it. The lessee makes payments under the terms

of the lease to the lessor, for an indicated period of time.

Leasing is, therefore, a form of rental. Leased assets have usually been plant and machinery,

cars and commercial vehicles, but might also be computers and office equipment. There are

two basic forms of lease: "operating leases" and "finance leases".

Operating leases are more to rental contract between the lesson and the lessee where the

lesson supplies the equipments or instruments to the lessee and the finance leases are lease

contract between the user of the leased asset (the lessee) and a provider of finance (the

lessor) for the most. (Basic finance for marketers. 2014. [ONLINE])

9

Government assistance

The government provides financing aids in the form of loan with the lower interest

comparing to any private loan financing agencies to companies in cash grants and other

forms of direct assistance, as part of its policy of helping to develop the national economy,

especially in high technology industries and in areas of high unemployment. (Basic finance

for marketers. 2014. [ONLINE])

Venture capital

Venture capital is the investment money put into an enterprise which may all be lost if the

enterprise fails to earn profit or to reach its goal. Normally, a businessman starting up a new

business will invest venture capital of his own, but he will probably need extra funding from

a source other than his own sourcing. However, the term 'venture capital' is more

specifically associated with putting money, usually in return for an equity stake, into a new

business, a management buy-out or a major expansion scheme. (Basic finance for marketers.

2014. [ONLINE])

Franchising

Franchising is a method of expanding business on less capital than would otherwise be

needed. For suitable businesses, it is an alternative to raising extra capital for growth.

Franchisors include Budget Rent-a-Car, Wimpy, Nando's Chicken and Mc Donalds. Under a

franchising arrangement, a franchisee pays a franchisor for the right to operate a local

business, under the franchisor's trade name. (Basic finance for marketers. 2014. [ONLINE])

10

Bibliography

Atrill, P, and McLaney, E. (2011). Accounting and Finance for Non-specialists with

Myaccountinglab. United Kingdom: Prentice Hall Financial Times.

Lynch, R. (2005). Corporate strategy. 3rd ed. United Kingdom: Financial Times Prentice Hall.

Chron. 2014. Why Is it Important for a Business to Budget?. [ONLINE] Available at:

http://smallbusiness.chron.com/important-business-budget-385.html. [Accessed 30

December 14].

Basic finance for marketers. 2014. Sources of finance . [ONLINE] Available at:

http://www.fao.org/docrep/W4343E/w4343e08.htm. [Accessed 16 December 14].

TRACEY LOUBSER . 2014. Why budgets in business are a must have. [ONLINE] Available at:

http://www.efinancialmanagement.com.au/accounting/why-budgets-in-business-are-a-

must-have/. [Accessed 23 December 14].

11

Appendixes Appendix 1: Part 1 - Sterling Plc Profitability

Ratios Formula 2012 2013 Return on capital employed (ROCE)

Operating profit / Share capital + Reserves + Non-current liabilities * 100%

5285 / 5900 + 1985+5105 * 100% = 40.70%

4435 / 6670 + 2550+7325*100% = 26.81%

Return on equity (ROE)

Profit after tax & interest & preference dividends / (ordinary share capital + reserves) * 100%

3095 / 5900 + 1985 * 100% = 39.25%

1840 / 6670 +2550 * 100% = 19.95%

Gross profit margin (GRM)

Gross profit / sales * 100%

8150 / 17,250 * 100% = 47.24%

8280 / 19,480 * 100% = 42.50%

Net profit margin (NPM)

net profit before interest and tax / sales * 100%

5285 / 17250 * 100% = 30.63%

4435 / 19,480 * 100% = 22.76%

Liquidity

Ratios Formula 2012 2013 Current ratio

current assets/current liabilities

4105 / 3245 = 1.26 times

4560 / 3875 = 1.18 times

Quick ratio

(current assets - inventory) / current liabilities

3120 / 3245 = 0.96 times

3495 / 3875 = 0.90 times

12

Gearing

Ratios Formula 2012 2013 Gearing ratio

loan capital/ share capital + reserves + long-term loans * 100%

5105 / 5900 + 1985 + 5105 * 100% = 39.3%

7325 / 6670 + 2550 +7325 * 100% = 44.27%

Interest cover ratio

operating profit/interest payable

5285 / 1110 = 4.76 times

4435 / 1745 = 2.54 times

Efficiency/ Asset Utilization

Ratios Formula 2012 2013 Stock (inventory) turnover days

Inventory/cost of sales * 365 days

985 / 9005 * 365 days = 40 days

1065 / 11200 * 365 days = 35 days

Accounts receivable collection period (ARCP)

trade receivables/credit sales revenue * 365 days

2650 / 17250 * 365 days = 56 days

3495 / 19480 * 365 days = 65 days

Accounts payable payment period (APPP)

accounts payable/credit purchases * 365 days

2260 / 8750 * 365 days / 7000 = 94 days

2165 / 11280 * 365 days = 70 days

Investor

Ratios Formula 2012 2013 Earnings per share (EPS)

earnings available to ordinary shareholders / number of ordinary shares in issue

3095 / 5900 shares = 0.52

1840 / 6670 shares = 0.28

Dividend yield ratio

dividend per share / market value per share * 100%

1220 / 5900 shares * 100% = 0.20 %

1275 / 6670 shares * 100% = 0.19 %

13

Part 2 - Sterling Plc Working capital cycle Working for Part 2

Average inventory holding period + average settlement period for trade receivables - average settlement period for trade payables

Ratios Formula 2012 2013 Average inventory holding period

((Opening Inventory + Closing Inventory) / 2) * 365 days / Cost of Sales

[(1240 + 985) / 2] * 365 days / 9005 = 45 days

[(985 + 1065) / 2] *365 days / 11200 = 33.5 days

Average settlement period for trade receivables

Trade Receivables * 365 days / Credit Sales Revenue

2650 * 365 days / 17,250 = 56 days

3495 * 365 days / 19,480 = 65.5 days

Average settlement period for trade payables

Trade Payables * 365 days / Credit Purchases

2260 * 365 days / 8750 = 94 days

2165 * 365 days / 11,280 = 70 days

Working capital cycle

Average inventory holding period + Average settlement period for trade receivables - Average settlement period for trade payables

45 days + 56 days -94 days = 7 days

33.5 days + 65.5 days - 70 days = 29 days

Summary table 2012 2013 2012 - 2013 change Return on capital employed (ROCE)

40.70% 26.81% - 13.89%

Return on equity (ROE)

39.25% 19.95% - 19.30%

Gross profit margin (GRM)

47.24% 42.50% - 4.74%

Net profit margin (NPM)

30.63% 22.76% - 7.87%

Current ratio

1.26 times 1.18 times -0.08 times

Quick ratio

0.96 times 0.90 times -0.06 times

14

Gearing ratio

39.30% 44.27% -4.97%

Interest cover ratio

4.76 times 2.54 times -2.22 times

Stock (inventory) turnover days

40 days 35 days -5 days

Accounts receivable collection period (ARCP)

56 days 65 days +9 days

Accounts payable payment period (APPP)

94 days 70 days -24 days

Earnings per share (EPS) 0.52 0.28 - 0.24

Dividend yield ratio

0.20% 0.19% - 0.01%

Working capital cycle 7 days 29 days + 22 days

15

Appendix 2: Part B - Grantham Ltd 2012: Unit Contribution margin = Sales revenue per unit - variable cost per unit 225 - 125 - 45/3 - 20 - 15 - 10 = 40 Break-even point in units sold = Fixed costs / unit contribution margin (1,100,000 + 1,450,000 + 675,000) / 40 = 3,225,000 / 40 = 80,625 units Contribution margin ratio( CM ratio) = Contribution margin / sale 40 / 225 = 17.8% Break-even point in revenue = Fixed costs / CM ratio (1,100,000 + 1,450,000 + 675,000) / 10% = 3,225,000 / 10% = 32,250,000 Margin of safety in units = total sales units - Break-even units 220,000 units - 80,625 units = 139,375 units Margin of safety in revenue= Total sales - Break-even sales 225 * 220,000 units - 32,250,000 = 49,500,000 - 32,250,000 = 17,250,000 2013: Unit Contribution margin = Sales revenue per unit - variable cost per unit [225 + (225 * 25%)] - 125 - 45/3 - 20 - 15 - 10 = 281.25 - 125 - 45/3 - 20 - 15 - 10 = 96.25 Break-even point in units sold = Fixed costs / unit contribution margin (1,100,000 + 1,450,000 + 675,000 + 1,450,000) / 96.25 = 4,675,000 / 96.25 = 48,571 units Break-even point in revenue = Fixed costs / CM ratio (1,100,000 + 1,450,000 + 675,000 + 1,450,000) / 10% = 4,675,000 / 10% = 467,500

16

Margin of safety in units = total sales units - Break-even units 220,000 units 48,571 units = 171,429 units Margin of safety in revenue= Total sales - Break-even sales 281.25 * 220,000 units - 467,500 = 61,407,500

Summary table

2012 2013

Break-even point in units sold 80,625 units 48,571 units

Break-even point in revenue 32,250,000 467,500

Margin of safety in units 139,375 units 171,429 units

Margin of safety in revenue 17,250,000 61,407,500

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