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Marks and Spencer is undoubtedly one of the UK's leading retailers - with an average of 21million customers visiting one of their 600 stores nationwide each week. Named as the world's 43rd largest retailer (Deloitte Global Retailer Survey), the company made history in 1998 to become the first UK retailer to make a pre-tax profit of over £1 billion (Deloitte Global Retailer Survey), one of the most recognized names in terms of quality.
1.1 Determining how to obtain financial data and assess its validity:-
The financial data is considered an important element for the financial management of every organization. Financial data can be derived from many sources like internal sources and external sources. Internal sources include accounting system, other managers, directly from customers, directly from suppliers, and spreadsheets. The external sources are including company's house, online, database of financial information, libraries and research documents. there is many people involve in this procedures so we should make sure that the data should be accurate and up to the mark and it should be at right time, other wise the organization may suffer in the shape of delay in decisions that could leads to losses.
Accuracy of data is a critical for accounts and finance department and without audit we can not relay on the accuracy of data. Internal auditor is a specialized watch dog for this purpose and he/she can check the accuracy and validity of the financial data. for example. Company buy an instruments and pays £500 for this, and account department will post this entry in the accounts. the auditor has to check the demand order, different quotations, approval of the particular quotation, purchase order and verify the payment voucher.
LO 1.2.Applying different types of analytical tools and techniques to a range of financial documents and formulate conclusions about performance levels and needs of stakeholders.
Technique used by concerned parties like creditors, investor and management to appraise the previous, current, and expected conditions and performance of the firm. The most commonly used form of financial analysis is ratio analysis, which shows relative measures the performance and condition of the firm. The important ratios are profitability ratio, liquidity ratios, and
(a) Liquidity Ratio
Liquidity ratio shows the company's ability to pay back short-term obligations out of its total cash. under these ratios we will discuss different types of ratios are as follows
it express the company's ability to payout short-term creditors from its total current assets. The current ratio is result of dividing the total of current assets by the current liabilities.
Current Ratio = Current Assets/Current Liabilities
The higher value of current ratio is better for company that shows the more capability of the company to pay its obligations. This ratio is concerned with the financial position of the firm and we will find these items in the firm's balance sheet. The current assets belongs to the assets side of the balance sheet and the current liabilities are belongs to the liabilities side of the balance sheet. Firm's suppliers are normally concerned with these ratios to check that firm is in position to pay its short term obligations.
(b) Acid Test Ratio (Quick Ratio)
it express the company's ability to payout short-term creditors from its total most liquid assets(the assets quickly convertible into cash). The Acid test ratio (Quick Ratio) is result of dividing the total of current assets less current stock by the current liabilities.
Acid Test Ratio (Quick Ratio) = Current Assets - Stock / Current Liabilities
The acid test ratio is more conservative and liquidity measure because it excludes the stock from the current assets. Some time it is not possible for a firm to convert its stock in to cash very quickly. it gives a more clear picture of the firms liquidity. Its is more similar to the current ratio and
Profitability ratios express the use company's assets and keep control over expenses to make an adequate rate of return. Profitability ratios present measures the profit performance of firm that serves to evaluate the periodic financial success of a firm
1. Return on ordinary shareholders' funds: the return on shareholders funds (ROSF) ratios used by industry investors as to measure the profit for the period which is available to the owner's stake in a business. The ROSF ratio is therefore a measure of profitability. This measure of profitability is calculated as:
Return On Shareholders Funds= Profit for the year (net profit) - any preference dividend/ Ordinary share capital + Reserves *100
Investors & the industry are more interested in the RSOF because a high ROSF percentage indicates that a company is profitable and has more profit available for shareholders.
Profit: from income statement
Preference dividend: balance sheet/financial statement
Oridenery share capital: balance sheet/financial statement
Reserves: balance sheet/financial statement
2. return on capital employed
it is a measuring tool that measures the efficiency and profitability of capital investments undertake by a organization. A firm acquire capital assets such as vehicles, computer, etc to makes its business operations more capable, cut down on costs and realize greater profits and acquire more market share.
Return on Capital Employed ratio also shows whether the company is earning sufficient revenues and profits using its capital assets. It is expressed in a percentage form, and the higher the percentage is better.
Return on capital employed = Operating profit /
Share capital + Reserves + Non-current liabilities * 100
operating profit: operating profit can be obtained from the income statement
share capital: share capital can be obtain from the financial statement
Reserves: reserves can be obtained from financial statement
Non current liabilities: can be obtained from the financial statement
3. Operating profit margin
The operating profit margin provides important information to businessman about firm's profitability, mainly regarded to cost control. OPM show the total cash out flow after most of the expenses are met. A high operating profit margin shows that the company has good cost control and/or that the increase in sales is faster than costs, which is the most favourable situation for the company.
Operating profit margin = Operating profit / Sales revenue * 100
Operating profit: income statement
Sales revenue: income statement
4. Gross profit margin
The gross profit margin ratio described the profit a business makes on its cost of sales/cost of goods sold. It is a very simple idea and it tells us how much gross profit per pound of turnover our business is earning. Gross profit is the profit we earn before we take off any administration costs, selling costs and so on. So we should have a much higher gross profit margin than net profit margin.
Gross profit margin = gross profit / sales revenue * 100
gross profit: Income Statement
Sales revenue: from income statement
1. Average inventory turnover period
The Inventory turnover is a measure of the number of times inventory is sold or used in a particular time period such as a year. The equation for inventory turnover equals the cost of goods sold divided by the average inventory. Inventory turnover is also known as stock turnover.
Average inventories turnover period = Average inventories held / Cost of sales * 365 days
2. Average settlement period for trade receivable
This ratio is helpful in analyzing the collectable of accounts receivable, or how fast a business can increase its cash supply. Although businesses establish credit terms, their customers do not always observe them. In analyzing a business, you must know the credit terms it offers before determining the quality of its receivables.
Calculation of 10 important ratios Marks and Spencer
1. Current Ratio = Current Assets / Current Liabilities
= 0.8041 Times
2. Quick Ratio = Current Assets - Inventories / Current Liabilities
= 1520.2 -613.2 /1890.5
= 0.4797 Times
3. Gross Profit = Gross profit / Revenue
= 37.94 %
4. Operating Profit Margin = Operating Profit / Revenue*100
= 9.934 %
5. Net Profit Margin = Profit before Tax / Revenue
= 702.7 / 9536.6*100
= 7.37 %
6. Total Asset Turnover = Total Sale / Total Assets
= 1.33 times
7. Return on Equity = Net Income / Equity*100
8. Dividend Cover = Profit attributable to Shareholder / Dividend Payable
= 2.22 times
9. Receivable Days = Debtors / Revenue x 365
= 10.77 days
10- Payable Days = Payables / Cost of Sales x 365
= 71.16 days
LO 1.3 Conducting Comparative Analysis of Financial data:
Following are the key financial ratios calculated for Marks and Spencer with details of how it evaluated the performance of Company for 2010 and 2009.
The Profitability ratios rise in 2010 in terms of gross profit and operating profit but it decline in terms of net profit as calculated above shows this decline may be because of loss economies of scales or may be marketing and selling cost increase or change in the sale price.
the liquidity of Marks and Spencer has increased in 2010 as shows in the above table(Liquid and Current Ratio) which shows improvement in cash management & justify good cash availability for future investment.
LO1.4 Reviewing and questioning financial data
Financial data is managed by the internal and external auditors and the duties of both is to validate financial data and find out the problems and errors out of the financial data and provide the true figure is the responsibility of internal auditor. Internal auditor works as watch dog in an organization and implement the internal process of audit and check the whole documents and verify it by his/her team and send them to the related departments for the posting and requisition.
The external auditor is another watch dog who audits the accounts at the year end of a financial period and produces a report which is mentioned in every financial report of every registered firm. External auditors check the whole financial accounts and match them with the available sporting documents.
LO 2.1 Identifying how a budget can be produced taking into account financial constraint and achievement of targets, legal requirements and accounting conventions:
Budget is a monetary plan viewing income and expenditure for a next fiscal year. It really helpful for management to recognize how much money you required covering your costs, it helps you cop over your expenditure, keep an eye on your revenues and manage the money. It is not possible to make 100% accurate budget because it based on assumption and past experiences. Some situation may remain same and some of them may change during the year ahead but make sure the that the figures are as accurate as possible. A good budget is mainly based on Primary Steps, Forecasting sales, Forecasting costs, Preparing budget, Actual income, Actual expenditure, Budget analysis
Furcating sale is the first and foremost part of the budgeting and considered essential tool to manage a business of any size. It is a month-by-month forecast of the level of sales you expect to achieve. Mark and Spenser draw up its sales budget once a year. A good constructed sales plan is one which is combined with precise sales forecasting, which allowed to management to develop the business more efficiently rather than to waist their time to respond for developments in sales and marketing.
Sales forecasting can be managed as follow
To use sales history
To assess expected sales resources
To use separate forecast - for different products or geographical areas
Considering seasonal patterns in the business and industry
1st Step: Determine the Flow of Information
A company gather the data essential to compile a budget.
2nd Step: Deciding objectives to Measure
This depends on how your business is organized, or how it wants to be organized. For instance:
3rd Step: Gathering Historic Data
The data can be obtained from different sources like the company's financial statements its balance sheet, income statement, and cash flow statement, other source would be the financial ratios.
Following are some important information to preparing a budget.
Collecting Sales Information
When it comes to gather historic sales data, the company must know its past performance based with the help of Product lines, Regions, Customers,
Collecting Expense Information
When it comes to gather historic expense data, the company ought to know its past performance based on with the help of direct costs, fixed costs and Variable costs.
4th Step: Making Projections
The forth step in the budgeting process is to project its performance for the next year.for this purpose we can use different types of techniques for budgeting.
Following are some most important budgeting techniques which are more widely use for forecasting and budgeting.
Activity Based Budgeting (ABB)
5th Step: Determining Break-Even Point
Fifth and final step is to determine "Break-even point" it is a technical than the other steps. Before to calculate Break Even Some terms should be well understood like contribution margin. Break-even point comes by many ways depending on the needs like Break Even by Sales, Break Even by Units.
Budget forecasting is necessary to manage the performance of every department from every aspect to provide a right guideline for department. These budgets could be:-
The marketing department can tell how many units of products can be sold provided specific quality and price is maintained:
The quantity of production depends upon the number of units to be sold and upon the number of units in the ending and opening inventories
The materials budget shows the quantity and cost of purchasing material for planned production and inventories.
Shows budget for all types of labour. Here we are taking budget for Direct Labour as an example
The marketing department can forecast about the unit sold, production department can predict about the total production, required material and total labour.
LO 2.2 Analysing the budget outcomes against organizational objectives and identifying alternatives:
The main objective of budgeting is to give a base to measure the actual performance it works only if the measurable action will be taken as a result. There is five main reason of the difference between the actual costs very from the budgeted costs.
A standard cost is the preset cost of manufacturing for even a single unit or a number of product units during a definite period in the immediate future. It is the predetermined cost of a product under current and/or under anticipated operating conditions.
Setting Standard Costs
Setting quantity and price standards are necessary to joint expertise of all workers who is responsible over input prices and over effectual use of inputs. Previous records of procurement prices and usage for production can be used to setting standards. These standards are devised to encourage well-organized future operations, not a repetition of past inefficient operations.
Ideal versus practical standard
Setting direct materials standards
Setting direct labour standards
Setting variable manufacturing overhead standards
Standard cost card
Standards and budgets
Direct Material Variance
The difference between actual purchase price and standard purchase price is known as 'Direct materials price variance'. Direct materials price variance could be calculated at the time of purchase of direct materials or at the time when the direct material is used
This is a difference between the quantity of materials used in production and the quantity that should have been used according to the standard that has been set. Although the direct material quantity variance concern with the physical usage of materials, but it is generally shows in pounds terms to help gauge its importance.
Direct Labour Variances
Direct Labour variance in terms of price variance is a difference between the price which is calculated and the price which is actually paid by the production department. This variance measures any deviation from standard in the average hourly rate paid to direct labour workers.
The quantity variance for direct labour is a difference between the in the standard calculated hours of labours and slandered hours of labours.
The variable overhead spending variance compares actual spending on variable overhead to the amount of spending that would be expected, given the actual direct labor-hours for the period. The variable overhead efficiency variance is computed as follows when the variable overhead rate is expressed in terms of direct labor-hours:
Variable overhead efficiency variance = (Actual direct labor-hours - Standard direct labor-hours allowed) ´ Variable overhead rate
Reasons of variance
Incorrect budget assumption
Change in the cost of the individual items
Change in the number of items bought
Above are some most common reasons of variance and the most important task is to moving the gap close between actual and budgeted, for this we need to be make sure that where the actually difference or error is. it is in the budget or in the actual performance. While calculating variance we should keep two important rules in our mind. The first one is to calculate variance for the convenience of the decision maker not for the reporter, and the second one is the budget must be flexed for the volume change to calculate a sensible variance
LO 3.1 identifying criteria by which proposals are judged:
To select a proposal from many is difficult task so management has to devise some criteria to select the potential one from them. The criteria should be parallel with strategic objectives of the organization. Management can judge a proposal on the bases of profitability analysis, increased production through which the company becomes the market leader. But the best is one which provides more cash flow. We can use use different techniques and tools to evaluate a proposal. Like internal rate of return, pay back method, net present value and breakeven analysis. These techniques are totally depends on the bases of company's mission and vision and strategic objectives.
LO 3.2 Analyzing the viability of a proposal for expenditure:
It is a technique normally used by management accountants and production management. The bases of this method are categorising production costs between two "variable cost" and "fixed cost". e.g.
Suppose following sale and cost figures are available about a manufacturing unit
Sale price per unit
Variable cost per unit
Total fixed costs
Breakeven Point = Fixed Cost/ Contribution margin per unit
Contribution margin = Sale price per unit - variable cost per unit
Contribution margin = £50-£30 = £20
the sale volume can be determined to compare fixed and total variable cost with sales revenue, break-even is particular point where there company facing no profit no loss or the point where the total volume of sales is equal to the total cost(total variable + total fixed cost) of the project
Payback period method
Payback period in business and economics refers to the period of time required for the return on an investment to "repay" the sum of the original investment.
Formula is as follow
Payback period = Investment required / Net annual cash inflow
The payback period method is an abstractly straightforward and easy to calculate. It is also a critically imperfect method of evaluating investments.
The payback period takes long time to recover the initial investment. For instance if the initial investment is £85000 on a particular project and the annual profit is first year £25,000, second year £17,000, third year £19,300, fourth year £17,700 and fifth year 17,000 out of them it means the investment will take 4.35 year to recover. Many companies take interest in that contract which recover investment in shorter period and they use the criterion will have a maximum acceptable e.g.
The payback period has a number of serious flaws:
No value to cash flows is attached after the end of the payback period.
no adjustments for risk is made.
it is not like NPV and not directly related to wealth maximisation.
time value of money is ignored in this method.
The "cut off" period is arbitrary.
Net Present Value
a net present vale is a value of stream for future cash flow, it might be positive or negative. The value of each cash flow needs to be adjusted for risk and the time value of money.
all types of cash flows are included in NPV including initial cash flows like purchasing of asset.
in NPV we need discount rate to adjust the and time value , it is applied as under
NPV = CF0 + CF1/(1+r) + CF2/(1+r)2 + CF3/(1+r)3 ...
CF 1 = cash flow the investor receives in the first year
CF2 = cash flow the investor receives in the second year etc.
r = discount rate.
The series is normally end in a terminal value; at this point it is a rough estimate of the value. It is normally for this to be satisfactorily far in the future to have only a slight affect on the NPV, so rough estimates acceptable, which usually based on a valuation ratio.
Any periods could be used other than a year, but the discount rate needs to be adjusted. e.g. we start from an annual discount rate then to adjust to another period we would use,
I is interest rate
r is annual discount rate
X for a period , where x is a fraction (e.g., six months = 0.5):
i + 1 = (r + 1)x
the discount change over time so we consider r1 is the rate for first year, r2 is the rate for second year and so on. We would have to resort to a more basic form of the calculation:
NPV = CF0 + CF1/(1+r1) + CF2/((1+r1) Ã-(1+r2)) + CF3/((1+r1) Ã-(1+r2) Ã-(1+r3)) ...
This would be bit difficult to calculate by hand but is quite easy to apply in a spreadsheet.
Weaknesses of NPV
The calculation of discount rate is very sensitive in NPV: a small change in the discount rates can create a big change in the NPV. As the estimation of the right discount rate is uncertain, this makes NPV numbers very uncertain.
it relies on the uncertain predictable future cash flows. The complexity problem this is obviously depends on how uncertain the forecasts are. The best way to solve the problem is to calculate a range of NPV numbers by different discount rates and forecasts.
LO 3.3 Identifying the strengths and weaknesses and giving feedback on the proposal
An investment's payback period in years is equal to the net investment amount divided by the average annual cash flow from the investment.
Easy to calculate
Provides some indication of risk by separating long-term projects from short-term projects.
it does not determine profitability
it does not account for the time value of money
After reaching the break-even period it ignores financial performance
Net present value
a net present vale is a value of stream for future cash flow, it might be positive or negative. The value of each cash flow needs to be adjusted for risk and the time value of money.
Allows consideration of such things as rate of interest, cost of capital and investment opportunity costs
suitable for long-term projects
it doesn't compare absolute levels of investment
NPV focus at cash flows and ignore profits and losses the way accounting systems do
Highly sensitive to the discount percentage, and that can be tricky to determine
LO 3.4 Evaluating the impact of the proposal on the strategic objectives of the organisation:
Marks and Spencer is to provide superior technical representation and to add valuable a focused group of leading edge Corporation by offering synergistic, valuable and high innovative solutions for our customer, design procurements and manufacturing needs with continues improvement of our quality, service and productivity to a competitive advantages.
The selected proposal has a great impact on the strategic objectives of the organisation. if management choose a wrong one means a proposal which gives a less cash flow and low productivity them it become hurdle in the way of organization to achieve its strategic objectives.