Task 1 In this report as the general manager of Pooma Sports Ltd a company that focuses on the distribution of sports clothing and equipment. Pooma Sports Ltd income statement shows the firms experiencing negative financial performance with the lack of profitability in recent years. The firm is consistently making losses for the last 6 years with the most recent loss in 2016 (-£346,000).
Furthermore, the firms turnover is on the decline of 68% since the peak turnover of £5.2m in 2011. In addition, the firm is keeping afloat by the support of the firm’s parent company of whom it owes a total of £10,039,000. In order for the firm to improve the financial performance of the company, management is considering to implementing income generating, cost-saving and efficiency measures. With the objective to improve the long-term profitability, the firm is considering the capital investment for the introduction of new Rugby boot to market. If successful in launch into the consumer market the sales from the rugby boot will contribute to the firms business objectives with the target of achieving the budgeted profit of £250,000. In conclusion, the firm is heading in the right direction towards making the management decisions to turn around the financial performance.
Currently, the financial forecast is unstainable in the long-term, the time to act is sooner. If the firm continues with the implementation of budgets and strategic planning process when making management decisions specifically, for the launch of the new product line, capital investment and full absorption costing, this would allow the firms to improve the financial performance and profitability. Task 2 Budgets is the financial plan set by management to outline the firm’s objectives. Usually the budget period typically focuses on the short term yearly basis with the exception of continuous budgets. In the context of management the purpose of the budget is to promote the efficient use of resources and promoting support for critical functions. In addition to the improving the allocation of resources, budgets contain quantitative information that is vital for the strategic decisions process in order to achieve the firm’s objectives. Furthermore, budgets act as control device for management in order to control human behaviour in the context of working towards staff conforming to the firm’s plan and objectivesBudgets can help firms communicate, cooperate and coordinate between the various departments and business functions in the organization. Budgeting process requires the departments to coordinate together in order improve accuracy in the budget plan or else in the case of Pooma Sports Ltd instances where purchasing department may miscalculate quantity of raw materials thus causing production stoppage.
Budgets is fundamental in motivating management to improve performance the use of budgets sets the benchmark for staff meet targets. However this works when the budget is achievable or else if budget is difficult this may result in dysfunctional behaviour.Budgets may be inaccurate with lack of adapting to fast pace changes in the business environment and products life cycle. Management focuses on using the budgeting process in order to achieve short terms financial objectives, the quantitative aspect of budgets doesn’t necessary factors other metrics of value. For example, customer satisfaction, innovation, brand loyalty and competition.
In addition, budgets encourage incremental thinking Task 2 Fixed cost are those which do not change in relation to the level of production, Fixed costs will incur irrespective of whether the output is high or low. Examples of fixed costs are rent expenses, salaries, insurance, depreciation and utilities. Variable cost are costs which change with the level of production. High level of production equals higher variable costs and low level of production equals lower variable costs. Example, of variable costs, includes raw materials, packaging and piece rate labour. Fixed costs do not usually change in relation to the level of output, however, the exemption to this rule is when making reference to stepped fixed costs that result in increased fixed costs at the point when the high and low thresholds on the level of production is exceeded.
For example, the introduction of new production facility or distribution system. Operation gearing measures the relationship between the firms fixed costs and variable costs. Higher fixed costs equal greater operational gears vice versa.
Higher gearing makes firms profits more sensitive to the changes in sales. Lower gearing makes firms profits less sensitive to the changes in sales. Operating gearing is important in the decision-making process to identify the ideal solution to meet the firm’s objectives. In addition to the understanding the level of risk for the project.
Pooma Sports Ltd, the initial fixed cost of in-house manufacture is equal to £190,000 in relation to the outsourcing which is equal to £90,000. Furthermore, operation gearing for in-house manufacture is greater than outsourcing. In addition, this would imply that the in-house manufacture higher gearing suggests profits are more sensitive to the changes in sales than outsourcing. Initially, the break-even point for in-house manufacture is 4,223 Units and Outsourcing is 3,000 Units, this shows the sales required to return initial capital investment is less with outsourcing, however, the higher unit cost buy-in at £50 in contrast to in-manufacture cost for each pair at £35. Primarily, the lower break-even point for outsourcing is the result of £100,000 in fixed overheads or in-house manufacture.
Furthermore, the margin of safety for outsourcing is greater than the in-house manufacture, this suggests that the higher safety margin will likely reduce the risk to the firm. My recommendation would be to consider the outsourcing methods on the basis of the lower risk factor and lower gearing that will make the project less sensitive to market changes specifically changes to consumer demand. In addition, the £100,000 left from taking the outsourcing option may allow the firm to allocate funds to other departments such as marketing. Task 4Net cash flow and operating profit are both financial measures in accounting. Operating profit measure the firm’s sustainability by deducting the overheads from the gross profit. Net cash flow measures the firm’s ability to pay for company expenses when payments are due. Many firms make the assumption that positive cash flow equals profitability vice versa, as evidenced by Pooma Sports Ltd Cash budget and Income statement which states net cash flow is the sum (-£66000) and operating profit is the sum £5000. It should be stated that neither net cash flow or operating profit are linked.
The discrepancy between the operating profit and net cash flow is the result of timing differences. In the case of Pooma Sports Ltd, the cash budget shows the majority of sales transactions are through credit sales allowing customers one month to make payment Also, the firm’s payments transactions are primary credit purchases instead of cash purchases with the similar term of one month of credit. Furthermore, the difference between the negative cash flow and profitability is the result of the payment being received after one month, once customers pay credit balance. Cash budget focus on sales once the payments for the transaction is complete (paid or received) therefore credits sales will show on the cash budget one month later in comparison to the Income statement which will show the same credit sales once sale is complete, not necessary when payment is received Task 5 In order from Pooma Sports Ltd to benefit from the full cost absorption, the apportionment basis chosen might be appropriate on the basis of overheads being equally distributed between the departments. Initially, the maintenance and administration departments indirect labour (employees) was zero in terms of overhead costs, this figure does not indicate full cost absorption for the cost centre as the indirect cost wasn’t factored into the departments. Furthermore, the equal distribution of overheads to the maintenance and administration departments reduces the total apportioned overhead costs of both Sports clothing and Sports equipment both of which are struggling with sales and profitability. This allocation of to the basis is appropriate because initially both maintenance and administration have relatively lower overheads, therefore, providing the flexibility for other departments to reduce costs and improve financial performanceOverhead absorption is the indirect costs such as rental expenses, marketing costs and utilities that are included in the unit price of goods/services. Indirect costs are usually referred to as overheads.
The purpose of the overhead absorption is for firms to set the price products to increase profitability, without overhead absorption manufacture may make the mistake of setting prices on the basis of only direct costs of manufacturing goods this will results in the firm setting lower sales price resulting in the overhead costs (indirect costs) reducing the profit margin. Therefore, it is common practice to include overheads in the sales price of goods/services to offset indirect costs. The impact of following the Sales director’s proposals is contrary to the negative use of overhead absorption, which usually increases the price of goods by consumers incurring the overheads costs in the price of goods. The sales director is proposing the opposite by reducing the overheads costs by the various departments.
Initially, the Sports Clothing and Sports Equipment department both of which are struggling to increase sales and profitability thus the reduction in overheads costs and reduction of price will expect the increase sales and profitability. Task 6 Initially, the capital investments appraisal outlines the plan for the acquisition of new manufacturing equipment, either Gluemaster or Superstiticher. The objective of the investment is for Pooma Sports Ltd to achieve cost reduction and efficient production.
The investments appraisal methods use NPV, Payback period, Accounting rate of return and Internal rate of return. In order to me to make a recommendation, I’m going to discuss the difference appraisal methods with reference to figures in (Document 6 – Capital Investment Appraisal). In the findings, Super Stitcher’s return is favoured by the methods Net Present Value (£158,844) and Account Rate of Return (14.0%) in comparison Gluemaster is favoured by the Payback Period (3 yrs 4 Months) and IRR (9.6%). This shows that both pieces of equipment hold merit in different circumstances, therefore, making decisions will require the assumption on the superior of appraisal methods to meet the firm’s objectives. Payback Period measures the time period for the return on capital.
For example, the finding shows Super Stitchers (4 yrs 5 months) and Gluemaster (3yrs 4 Months) which suggests that Gluemaster will return the initial capital 1 year 1 month earlier than SuperStitchers. Payment Period is relatively simple with the metric allowing firms to use time period to compare risk. Generally, the changes in business environments and product cycles may distinguish the firm’s approach to risk-averse or risk takers.
Risk-averse prefer shorter Payback period and Risk-takers consider longer payback period if the returns are greater.Net Present Value is the methods of measuring the discounts value of the net cash flow from the initial investments risk. NPV values the time of money in the calculation by discounting the cash flow. Initial capital investments are known, but the future forecast on the cash flow is the basis of estimates, therefore the 5% factors represent the opportunity cost of capital. Furthermore, Net Present Value is the only methods of appraisals that analyses the shareholder’s wealth and equity.
Companies such as Roll Royce plc applies NVP for assessing new projects in order to ensure they create shareholder wealth. In the findings, this implies that Superstitichers NPV (£158,844) is greater than Gluemaster NVP (£140,775). Accounting rate of return is the methods of measuring the profitability of the project in the form of a percentage. Superstitichers ARR (14.0%) and Gluemaster ARR (9.0%).
The findings show that the for each pound (£) invested in the project this will recoup 14% (Superstitichers) and 9% (Gluemaster). Generally, the higher the ARR the more attractive the project becomes. Similar to Payback period this method ignores the timing of cash flows. Internal Rate of Return (IRR) is the methods of measuring the discount rate that when applied to the cash flows of a project causes it to have a zero NPV. It measures the average percentage return on the investments taking into consideration of the cash flow in various time periods. Similar to other methods the greater the IRR the more attractive the project becomes. Payback Period and Accounting Rate of Return are simple methods of analysing investments appraisals both methods don’t focus on the time value of money in the calculation. Forecasts may be inaccurate by ignoring the timing of cash flows.
In addition to assuming the average return values are consistently the same throughout the time period (annually). Furthermore, the use of both NVP and IRR are known for being far more superior investments appraisal methods by including time value of money. Financial forecasts in calculating the appraisal methods on the basis of estimates. Therefore, forecasts could be wrong with future forecasts showing discrepancy with the actual forecasts. The results of incorrect forecasts will cause inaccuracy for the measurement of the methods of appraisal. The negative outcome of the wrong forecasts could cause the firm to experience negative financial performance and reduce shareholder wealth this could question the firm’s future sustainability.
In order for the firms to mitigate any mistakes on future forecasts, the firm should take prudence concept on the forecasts to reduce the risk factors in the event the forecasts are wrong. Refernces