Waist of Financial

7/28/2019 Waist of Financial

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Partc profitability Operation also shows a decline. Although any standard is not

given still it can be conclude that there in low efficiency in managing purchases

sales and inventory as well as low productivity because less funds are available

to meet other expenses .Because of celining trend in ROCE co will it difficult to attract fresh funds from

the lenders and owners . Much funds will not be available for appropriations

and there be less increase in net worth.

Discounted payback

Discounted payback period is able to distinguish investment with different

timing of cash flows.

Risk is reflected through the discount rate ,risk is explicitly incorporated .

Demerits: Discounted payback does not give information about how profitablean investment is, as it ignores everything after the breakeven point. Hence it is

not consistent with maximisation of owners wealth.

NPV Merits. It recognises the time value of money.The net present value

method is able to distinguish among investments whose cash flows have

different risk .Secondly ,it also fulfils the second condition of a sound method of

appraisel in a way that it considers the total benefits arising out of the proposal

over its lifetime.Thirdly, a changing discount rate can be built into the NPV

calculations by altering the denominater. This feature becomes important as

this rate normally changes because the longer the time span, the lower is the

value of money and the higher is the discount rate. This method is instrumental

in achieving the objective of financial management which is the maximisation of

the shareholder wealth.The discount rate that is used to convert benefit into

present values is the minimum rate at which the present values of cash inflows

is equal to the initial outlay or when the NPV=0There would ,therefore be no

change in the market price of shares.When the present values exceeds the

outlay or the NPV>0, the return would be higher than expected by the

investors.It would ,therefore ,lead to an increase in share prices.A problem

related with the present value method ,is that it involves the calculation of the

required rate of return to discount the cash flows. The discount rate is very

important because different discount rates will give different present values.

(d) Assumptions of breakeven analysis

This analysis presumes that cost can be divided into fixed and variable

category.This is very difficult practice.


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This analysis presumes an ability to predict cost at different activity volumes in

practice a lot of experience may be required to develop this ability.

A series of breakeven charts may be necessary where alternative pricing

policies are under consideration. Therefore differential price policy makes

breakeven analysis a difficult exercise.

It assumes that variable cost fluctuates with volume proportionally, while in

practical life the situation may be different.

This analysis presumes that efficiency and productivity remain unchanged in

other words this analysis present a static picture of a dynamic situation.

This breakeven analysis either covers a single product or presumes that product

mix will not change. A change in njix will significantly change the result.

This analysis disregards that selling price are not constant at all levels of sales. A

high level of sales may only be obtained by offering substantial discounts on the

competition in the market.

Stocks changes effects income. The breakeven depicts that volume of

production of sales and thus ignores the effect of changes in stock volume .

As a matter of fact, it is assumed that stock changes will not affect the income.


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As we see breakeven analysis can provide some useful insights to the important

relationship between fixed cost, variable cost and the volume of activity. It does

however have its weakness.

Nonlinear relationship. The normal approach to break-even analysis assumes

that the relationships between sales revenue, variable costs and volume are

strictly straight line ones.

In real life this is unlikely to be so.

This is probably not a major problem, since break-even analysis is normally

conducted in advance of the activity actually taking place. Our ability to predict

future cost, revenues and so on in somewhat limited: hence what are probably

minor variation from strict linearity are unlikely to be significant.

Stepped fixed cost. Most fixed costs are not not fixed over all volume of

activity. This means that in practical circumstances, great care must be taken in

making assumption about fixed costs. The problem is particularly heightened

because most activities will probably involve fixed costs of various types ( rent,

supervisory salaries, admission costs) all of which are likely to have steps at

different point.

Multi-product businesses. Most businesses do not offer just one product or

service. This is a problem for break even analysis since it raises problem of the

effect of additional sales of one product or service on sales of another of the

business or product. There is also problem of identifying of fixed cost of one

particular activity. Fixed cost tend to relate to more than one activity for

example two activities may be carried out in the same rented premises. There

are ways of dividing fixed cost between activities, but these tend to be

arbitrary, which calls the value of break even analysis. Into question. (peteratrill

&eddie mclaney2001 p.193)

Preference share offers investors a lower level of risk than ordinary shares.

Provided there are sufficient fund available, preference share will normally be

given a fixed rate of dividend each year, and preference dividends will be paid

before ordinary dividend are paid. Where the company is wound up,preference share holders may bew given priority over the claims of ordinary


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shareholders. (The document of incorporation will determine the precise rights

of preference shareholders in this respect.)

DEMERITS: Because of the lower level of risk associated with this foam of

investment, investors will be offered a lower level of return than that normally

expected by ordinary share.

If a company is not in a position to pay the preference dividend due for a

particular period, the preference share holder loses the right to receive the

dividend. (peter atrill &Eddie mclaney 2001p 333)

Merits: Equity shareholders have limited loss laibity, based on the amount they

have agreed to invest, the potential returns from their investment are

unlimited. Ordinary shareholders will also have control over the company. They

will be given voting rights, which will give them the power to elect the directors

and to remove the directors from office. From the company prospective,

ordinary shares can be a valuable foam of financing as, at times , it is useful to

be able to avoid paying a dividend. In the case of a new expanding company , or

a company in difficulties, the requirement to make a cash payment to investorcan be a real burden. Where the company is financed by ordinary shares, this

problem need not occur.

DEMERITS: The cost of underwriting is much higher than the issue of debenture

and preference share. (peter atrill &Eddie mclaney 2001 p332)

: Investors will normally view loans as being less risky than preference share or

ordinary share. Lenders have priority over any claims from shareholders andwill usually have security for their loans

Debenture share holders are on less risk than preference share holder or equity

share holder .

The reinvestment of profit rather than the issue of new ordinary shares can be a useful way

of raising equity capital .There is no issue cost associated with retaining profit, and the

amount raised is certain, once the profit has been made.


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The use of budgets as a means of planning and controlling the various

business activities

Budgeting plays a key role in a Organisations financial control. The literature

of management accounting emphasises that budgeting is an essential

technique for planning and controlling the activities of an organisation. Drury

(1993).

It is vitally important that business develop plans for the future . whenever a

business is trying to achieve , it is unlikely to achieve unless its manager have

clear in their minds what the future direction is going to be . Atrill(2008) The

budget is essentially a financial plan for short term .It is unlikely to be expressed

mainly in financial terms, and its designed to convert the long the long term

plan into an accountable blueprint for the future. The will define precise targets

for

Sales and expenses, cash receipt and payment , short term credit to be given or

taken, stock in trade requirement and personal requirement.

Budgetary control: when the actual results for a period are compared with the

budgeted results and it is seen that there are material differences thencorrective action must be taken to ensure that future results will conform to

the budget. This is the essence of budgetary control. It has several important

features.

Responsibilities: Managerial responsibilities are clearly defined

Action plan. Individual budgets lay down a detailed plan of action for a

particular sphere of responsibility.

Adherence. Manager has a responsibility to adhere to their budgets once the

budgets have been approved.

Monitoring the actual performance is monitored constantly and compared with

the budgeted result.

Correction: Corrective action is taken if the actual results differ significantly

from the budget.

Approval: Departures from the budget are only permitted if they have been

approved by senior management.

Variances: Those that are uncounted for are subject to individual investigation.


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Any variance that occur should be investigated carefully. The current actual

performance will be immediately bought back into line with the budget if it is

considered necessary. Sometimes the budget item will be changed e.g. if there

is an expected increase in sales. Such changes may of course, have an effect on

the other budget and so cannot be done in isolation

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