FINANCIAL MANAGEMENT & CONTROL

MAIN BODY

Part (A)

1. Evaluation of the performance of Pro Bio plc in terms of different types of ratios.

• Profitability ratio- This is a type of ratio that is calculated by business entities in order to assess the efficiency of generating revenues (Chan, Chau, and Chan, 2012). Herein, some ratios are mentioned that are as follows:

(I) Gross profit ratio = Gross profit / Net sales * 100

Analysis- On the basis of above presented graph, this can be find out that above company has different amount of gross profit ratios in both year 2018 and 2019. In year, 2018 their gross profit ratio was of 55.06% which reduced in next year till 49.03%. It is indicating that company's efficiency of gaining gross revenue has been reduced in year 2019. The reason of decreasing in this ratio is increasing in value of cost of sales in year 2019 as compare to year 2018.

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(ii) Operating profit ratio = Operating profit / net sales * 100

Analysis- On the basis of above presented graph, this can be find out that above company has different amount of operating profit ratios in both year 2018 and 2019. In year, 2018 their operating profit ratio was of 36.95% which reduced in next year till 29.52%. It is indicating that company's efficiency of gaining operating profit has been reduced in year 2019. The reason of decreasing in this ratio is increasing in value of operating expenses in year 2019 as compare to year 2018.

(iii) Net profit ratio = Net profit / net sales * 100

Analysis- On the basis of above presented graph, it can be find out that there is huge gape in net profit margin in both of years. Like in year 2018, the net profit ratio was of 10.87% which reduced and next year till 3.00%. It is so because of lower amount of net profit in year 2019 that was of £580000 while in year 2018, its value was of £1945000. So in comparative manner, company's performance is poor in year 2019.

• Liquidity ratio- This is a type of ratio which is calculated in order to evaluate liquidity position of companies in terms of paying short term debts (Nicolăescu, 2013). It consists two types of ratios such as:

(I) Current ratio = Current assets / current liabilities

Analysis- On the basis of above presented graph, it can be find out that company's current ratio is not in ideal condition. This is so because the ideal current ratio is 2:1 and their ratio is below it. Like in year 2018, the current ratio was of 1.48 times which reduced in next year and became of 1.25 times. This is so because company's current assets are increasing with lower percentage but current liabilities are increasing with huge margin in year 2019.

(ii) Quick ratio = Quick assets / current liabilities

Analysis- Similar as the above current ratio, quick ratio is also lower ideal ratio that is of 1.5:1 times. In year 2018, this was of 1.09 times which reduced in next year and became of 0.80 times. It is so because decreasing in value of quick assets in year 2019 as compare to year 2018.

• Gearing ratio = Total debt / total equity

Analysis- On the basis of above presented graph, this can be find that company has different amount of gearing ratio which is of 0.93 in year 2018 and 1.24 in 2019. It is so because of variation in value of total debts and equities in both of years.

• Assets utilisation ratio- This ratio is calculated in order to assess efficiency of utilising assets by a company (Kober, Subraamanniam and Watson, 2012). It consists below mentioned ratios such as:

(I) Total assets turn over ratio = Net sales / average total assets

Analysis- On the basis of above presented graph, it can be find out that efficiency of utilising assets of this company has been decreased in year 2019 in compare to year 2018. Such as in year 2018, it was of 0.96 which reduced in next year and became of 0.85.

(ii) Fixed assets turn over ratio = Net sales / fixed assets

Analysis- On the basis of above presented graph, it can be find out that efficiency of utilising fixed assets of this company has been decreased in year 2019 in compare to year 2018. Such as in year 2018, it was of 1.21 which reduced in next year and became of 1.04.

• Investor potential ratios- This is a type of ratio which is used by investors in order to assess the efficiency of companies and to take investment decisions (Bodnar, Consolandi and Jaiswal"Dale, 2013). There are different types of ratios such as:

(I) Return on assets – Net income / total assets

Analysis- On the basis of above presented graph, this can be find out that efficiency of this company in order to generate return has been reduced in year 2019. Though, in both of years company failed to gain higher return. Such as in year 2018, it was of 0.1 which decreased in next year till 0.02.

(ii) Return on equity = Net income / shareholders' equity

Analysis- On the basis of above presented graph, this can be find out that efficiency of this company in order to generate return on equity has been reduced in year 2019. Though, in both of years company failed to gain higher return. Such as in year 2018, it was of 0.2 which decreased in next year till 0.05.

2. Calculation of working capital cycle.

Working capital cycle - The working capital period (WCC) is the time it takes for the net current assets and current liabilities to be converted into cash (Porras-Gómez, 2014). In the context of above company, calculation of working capital cycle is done below in such manner:

Working capital cycle -

For year 2018:

= Inventor days + Receivable days – Payable days

= (44+43-68) days

= 19 days

For year 2019:

= (40+50-51) days

= 39 days

Analysis- The above presented graph shows result about working capital cycle. The company's efficiency to convert cash is different in both of years. Like in year 2018, the company was taking 19 days in order to convert their current assets into cash. While in year 2019, this time period raised and became of 39 days. It is indicating that company's efficiency to converting current assets into cash has been reduced in year 2019 as compare to year 2018.

Working Note:

For year 2018

Inventory turn over ratio = Cost of good sold / Average inventory

= 9040/1092.5 {Average inventory: Opening stock+closing stock/2}

= 8.27

Receivable turn over ratio= Net sales/ account receivable

= 17890/2115

= 8.45

Payable turn over ratio = Total purchase/ accounts payables

= 8855/ 1655 {total purchase: cost of goods sold+closing stock-opening stock}

= 5.35

Inventory days = 365 days / Inventory turn over ratio

= 365 / 8.27

= 44.13 or 44 days

Receivable days = 365 days / receivable turn over ratio

= 365/8.45

= 43.19 or 43 days

Payable days = 365 days/ payable turn over ratio

= 365/5.35

= 68.22 or 68 days

For year 2019

Inventory turn over ratio = Cost of good sold / Average inventory

= 11340/1240 {Average inventory: Opening stock+closing stock/2}

= 9.14

Receivable turn over ratio= Net sales/ account receivable

= 19345/2650

= 7.3

Payable turn over ratio = Total purchase/ accounts payables

= 11820/ 1655 {total purchase: cost of goods sold+closing stock-opening stock}

= 7.14

Inventory days = 365 days / Inventory turn over ratio

= 365 / 9.14

= 39.93 or 40 days

Receivable days = 365 days / receivable turn over ratio

= 365/7.3

= 50 days

Payable days = 365 days/ payable turn over ratio

= 365/7.14

= 51.12 or 51 days

3. Limitation of ratio analysis for both cross-sectional and time-series comparisons.

Analysis of the ratio is an useful method to compare the public presentation of a corporation with other businesses. These correlations could be misdirected. Some of the disadvantages of cross-sectional correlation ratio review are listed below:

• Accounting policies- Accounting policies allows businesses to take accounting measures and use flexibility when setting precedent (Achleitner, Goergen and Hinterramskogler, 2013). Such an independence leads to gaps in company history. That distorts correlations of cross-sectional firms in bend.
• Historic cost - If there are businesses with various ages. A tax returns will also include non-current assets acquired at various times in the previous year that are usually reported at historical value.
• Different hazard profile- Companies have different profiles of financial and business threats. Numerous fiscal and competitive risks can be faced by businesses in the same sector. For comparison, a business with a lower debt ratio can imply a better fiscal position. But, banks may not keep loans issued to the business due to low credit worthiness or high tax risk profiling of the business.
• Qualitative factor- Analysis of the ratio does not see qualitative variables including consistency of course, quality of assets and many more (López, Rich and Smith, 2013).
• Inflation- When in any of the periods under examination the rate of inflation has changed, this may mean that perhaps the figures are not consistent over time. For example, if the inflation rate for one year was 100 percent, sales would seem to have increased over the previous year, when sales did not actually increase at all.
• Operational changes- A business could adjust its fundamental operating structures to such a degree that a ratio measured many years ago and contrasted to today's same ratio will result in a false conclusion.

Part (B)

1. Use of different types of investment appraisal techniques.

There are different types of techniques in order to asses the efficiency of different kinds of investment projects. It depends on companies that how well they are applying these techniques. Herein, below use of these investment appraisal techniques is done in such manner:

1. Payback period- It is defined as a type of technique that is associated with process of analysing time period that may occur in process of recovering investment cost (Arrondo-García, Fernández-Méndez and Menéndez-Requejo, 2016). This is very useful for those companies who are going to make large capitalised investment because by help of it they may become aware about estimated time to recover the investment amount. Below, usefulness of this technique is mentioned in such manner:

• Simplicity- This is one of the key benefit of payback period method as it is easy to use and calculate. It does not require any typical data gathering and calculation.
• Risk focus- In addition, this technique is beneficial for focusing on risk factors so that companies can do comparison between two projects on the basis of risks.

Example:

 Payback period: Investment/cash flows

Investment = 280000

Cash flow = 80000

Hence payback period = 280000/80000

= 3.5 years.

2. Net present value- It is a type of technique which is related with process of calculating profitability of different types of investment projects (Lappalainen and Niskanen, 2012). This is being computed by making difference between PV of cash in & outflows of a particular time period. In most of the business entities this technique is used in order to assess current value of their projects and on the basis of it they take decisions whether they should make investment or not. It has below mentioned importance which are as follows:

• This technique is useful for companies in order to take better decisions and by help of it they can save funds.
• In addition, under it time value of money factors is considered which makes results more reliable and useful.

Example:

Hence the value of net present value will be as:

NPV = 297828-275000

= £22828

3. Accounting rate of return - According to this process, the estimated rate of return (ARR) of the investment is calculated by dividing the estimated annual net operating income by the original investment and then applied to the required rate of return of the managers to accept or decline a plan (Richard, Kirby and Chadwick, 2013). If the estimated rate of return of the asset is approximately equal to the expected rate of return of the company, the plan will be adopted. Otherwise it will be ignored. The rate of return is determined using the equation as follows:

Accounting rate of return = Incremental accounting income / Initial investment

This technique has some key benefits for companies which are as follows-

• This approach alone takes into consideration the income accounting principle to measure the return rate. In fact, the accounting income can be determined accurately from the financial statements.
• This approach accepts the concept of net earnings, i.e. after tax and depreciation. This is a critical factor in assessing a plan for a project.

Example:

Initial investment= 275000

So,

 ARR = 33541.67 / 275000*100

= 12.19%

4. Internal rate of return- The Internal Rate of Return (IRR) is the rate of interest that helps make a plan zero's net present value (NPV). In other words, on a project or investment, it is the anticipated compound annual return rate that will be gained. Companies invest in various projects to create value and improve the wealth of their investors, which is only feasible if the projects they invest in earn a return higher than that of the required rate of return expected by capital suppliers. It has some importance which are as follows:

• First and foremost, the internal rate of return method takes into account the value of money when determining a plan (Clinton, Pinello and Skaife, 2014). As well as by estimating the rate of interest at which PV of future cash flows is equivalent to the necessary investment, users can calculate IRR.
• The most attractive feature about this approach is that when the IRR is measured, it is very easy to interpret.

Example:

Internal rate of return =

Lower discounted rate + NPV at lower discount rate / (NPV at lower discount rate- NPV at higher discount rate) * Higher discount rate- lower discount rate

Part (C)

2. Use of various kinds of traditional budgeting methods.

Traditional budgeting technique- This can be defined as a type of technique of preparing the budgets in which past years' financial activities are considered as base. Under it, new activities are not justified, budgets are prepared by making some corrections in last years budgets (Kavulya, 2017). In this budgeting, only those items needed to be justified whose value is lower or higher from the last years' budgets. This method of budgeting is variant from zero based budget but it is much more similar as incremental budgeting method. Most of the companies are using this technique of budgeting because it is less cost and time consuming. Herein, below some key advantages of this budgeting technique are mentioned which are as follows:

• This budgeting technique is useful in better decision-making. It is so because by help of budgeted activities, this becomes easier to find out the issues. As well as users can make modifications in the budgeted when actual value of expenditures exceeds estimated amount of expenses.
• In addition, this budgeting approach is that it is useful for obtain financing. It becomes possible because managers and financial department gather key information regards to needed amount of funds. On the basis of it, companies acquire financial resources.

Alternative method of budgeting:

Apart from the traditional budgeting, there are some other budgeting techniques which are as follows-

Zero based budgeting - Zero-based budgeting involves justifying spending above a zero base and calculating costs for various production and service levels, i.e. justifying all expenditure, not just incremental expenditure (Ben Slama Zouari and Boulila Taktak, 2014). The main advantage of zero-based budgeting is that all planned expenditures can be accurately measured and that possible and contingent activities can be investigated more closely. It has some advantages which are as follows:

• It is beneficial for companies in order to make an effective allocation of resources.
• As well as by help of this budgeting technique, managers become able to find out the cost effective ways in order to enhance the activities.
• In addition, by help of this budget communication and coordination also increase.

So, these are some key benefits of above mentioned budgeting technique for business entities.

CONCLUSION

On the basis of above project report, it has been concluded that management of financial resources is too crucial in order to generate higher amount of revenues. Under the report, financial position of ProBio company is assessed. As accordance of ratio analysis, it can be concluded that their performance is not so effective in year 2019. As well as their efficiency to convert current assets into cash is also better in year 2019. Apart from the above calculations, some theoretical concepts are also described such as limitation of ratios. Along with critical evaluation of investment appraisal techniques like payback period method, NPV etc. In the end part of report, role of traditional budgeting and zero based budgeting is concluded in a detailed manner.

Read more - Unit 12 Introduction to Management Level 4 CBC College

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