7/28/2019 Waist of Financial
1/6
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.
7/28/2019 Waist of Financial
2/6
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.
7/28/2019 Waist of Financial
3/6
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
7/28/2019 Waist of Financial
4/6
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.
7/28/2019 Waist of Financial
5/6
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.
7/28/2019 Waist of Financial
6/6
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
Top Related