5006FIN Finance and Accounting for Managers: Financial Statements

Questions:

BB Ltd’s Finance Department has prepared the following cash budget and budgeted income statement for the first 3 months of the 2021/22 budget year, a period in which the company is expected to return to profit.

Budgeted income statement

January

February

March

 Opening balance

10,056

(13,860)

(58,499)

 Cash sales

544,855

554,580

569,415

 Credit sales

1,260,000

1,273,145

1,297,722

 Total receipts

1,804,855

1,827,725

1,867,137

 Materials cash purchases

(571,699)

(598,922)

(626,529)

 Materials credit purchases

(235,668)

(229,000)

(223,457)

 Operating expenses

(288,368)

(299,903)

(310,339)

 Fixed overheads

(243,700)

(243,700)

(243,700)

 Production labour

(313,955)

(321,952)

(330,808)

 Administration costs

(175,380)

(178,888)

(176,991)

 Total payments:

(1,828,770)

(1,872,365)

(1,911,824)

 Net cash flow

(23,916)

(44,640)

(44,687)

 Balance c/f

(13,860)

(58,499)

(103,187)

Budgeted income statement

January

February

March

 Sales

1,818,000

1,852,302

1,903,755

 Cost of sales

(1,060,500)

(1,080,509)

(1,110,524)

 Gross profit

757,500

771,792

793,231

 Operating expenses

(299,903)

(310,339)

(319,533)

 Fixed overheads

(285,873)

(285,873)

(285,873)

 Administration costs

(175,380)

(178,888)

(176,991)

 Total expenses

(761,156)

(775,100)

(782,398)

 Operating profit/(loss)

(3,656)

(3,307)

10,833

The following information is relevant to the cash budget:

  1. Credit customers are allowed one month’s credit on sales;
  2. Credit suppliers allow one-month credit on raw materials purchases;
  3. Materials and production labour costs are included in the cost of sales in the budgeted income statement.

The following information from the budgeted Statement of Financial Position is also available.

Items

January

February

March

Trade receivables

1,273,145

1,297,722

1,334,340

Trade payables

229,000

223,457

216,888

Finished goods inventory

221,845

239,345

255,742

Raw materials inventory

385,126

431,448

478,752

The Production Department has come to me with an idea to increase automation in one of their main production processes – see the table below for the relevant information.  

If implemented, it will significantly impact the cost structure of one of their most popular lines of virtual reality headsets.  Current annual sales are steady around 12.000 units. 

Can you advise – and don’t forget to list any additional questions we should be asking them?

 

Current process

New process

Sales price (per headset)

£350.00

£350.00

Direct materials cost (per headset)

£225.00

£225.00

Direct labour cost (per headset)

£90.00

£70.00

Fixed manufacturing overheads

£100,000

£370,000

Fixed administrative overheads

£100,000

£80,000

Fixed selling and distribution overheads

£55,000

£55,000

Break-even point (headsets)

7,788

9,181

Profit at current sales levels (12.000 units)

£165,000

£155,000

 

Margin of safety at budgeted profit level

44.5%

28.4%

 

Unit sales (headsets) required to achieve the budgeted profit of £200,000

13,000

12,818

 Item 4 – Capital investment appraisal

BB Ltd is planning some new building to allow the re-organisation of certain production processes.  There are two building options using the same land within the current factory perimeter, Medium Build (MB) and Small Build (SB).  Big build was rejected at an earlier stage.  Both will bring a wide range of benefits but, as many are hard to estimate, the figures needed to be treated with even more caution than usual.  Not included in the calculations is that MB allows for future expansion in a way that SB does not.  10% of the initial cost is to be paid in year 3 as part of the retention process.  After year 5, indicated by the infinity symbol, ∞,  the gains flow in perpetuity (i.e. every year and in principle forever,).

The perpetuity has been turned into a capital value by the application of the I/r factor.  The information below about the cash flows and capital investment appraisal measures has been collected so far.  ABCD applies a cost of capital of 6%.for such projects, this being irrelevant to the Accounting Rate of Return (ARR) which ABCD does not use.  As the BB managers are most familiar with ARR, you need to identify why ARR is inferior to other appraisal methods.

 

 

Small Build

Medium Build

Year

6% DCF

Factor

Cash flow (£)

Present value (£)

Cash flow (£)

Present value (£)

0

1.0000

-1,500,000

-1,500,000

(1,900,000)

(1,900,000)

1

0.9434

100,000

94,340

120,000

113,208

2

0.8900

100,000

89,000

120,000

106,800

3

0.8396

-60,000

-50,376

-70,000

(58,772)

4

0.7921

120,000

95,052

130,000

102,973

5

0.7473

130,000

97,149

140,000

104,622

5+

0.7016

2,167,000

1,520,367

2,666,666

1,870,933

NPV

 

345,532

 

339,764

Payback period

14 years 3 months

14 years 10 months

Internal rate of return

7.33%

 

7.07%

Item 5 – Selecting the Builder

The technical and marketing staff have got together to get us to two options, two companies we can go with.  That’s good, but what worries me is the risk that whoever we pick might either go bust or get into such trouble that they go slow or leave the job half-finished or to try to squeeze more money from us.  I recall building companies being more likely than average to get into financial trouble.

ABCD subscribes to FAME, a financial database.  Attached are documents for you to use:
1. FAME reports on Novus and Harper (Appendices to this brief)

  1. Companies House links to their public details:
    – Harpers https://find-and-update.company-information.service.gov.uk/company/06892284 – Novus https://find-and-update.company-information.service.gov.uk/company/02403551 .

What I’d like you to do in 650 – 800 words are the following:

  1. Report on and explain what accounting ratios we can use to inform ourselves as part of guarding ourselves against the failure of those with whom we choose to work. There is gearing, the current and the quick ratios, but what else?  I don’t think people can cope with more than 10 ratios – anything up to another half dozen on top of these 3 should be fine.  And again, brevity/economy is good!
  2. Using all the ratios arising from Task 1 above, report on Novus and Harpers. Do they both pass the financial tests?  Please also comment on anything you find that needs to be drawn to the attention of senior management.
  1. Analyse and interpret core financial statements for sole traders and limited companies, in line with prescribed international accounting standards. Focus will be put on the use of annual reports of international real-world public companies.
  2. Evaluate appropriate management accounting techniques and use management accounting information to support business decision-making.
  3. Understand apply and evaluate management accounting concepts and techniques in decision making.

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