Using techniques to obtain financial information for decision making

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Case Study:

Moorfields Eye Hospital NHS Foundation Trust London is one of the largest centres for ophthalmic treatment, teaching and research in the world. Annual Reports and Accounts, Annual Plan, and other publications containing relevant financial and non-financial information about this healthcare organisation can be accessed by clicking the following link http://www.moorfields.nhs.uk/Publicationsandresources/Corporatepublications/Annualreports

Assume you have been hired (by the management of this organisation) as external consultant to provide financial advisory services to the management. Please research the Reports and use the financial and ancillary information contained therein to answer the following questions. You may like to make use of any other sources of information as well if required.

This task involves using techniques to obtain financial information for decision making. Answer the following

Select appropriate forecasting methods to enable cost and revenue forecasts to be constructed for Moorfields Eye Hospital for the year 2012-2013, adjusting for expected movements in prices.

Forecasting can be broadly considered as a method or a technique for estimating many future aspects of a business or other operation. Planning for the future is a critical aspect of managing any organization, and small business enterprises are no exception. Indeed, their typically modest capital resources make such planning particularly important. In fact, the long-term success of both small and large organizations is closely tied to how well the management of the organization is able to foresee its future and to develop appropriate strategies to deal with likely future scenarios. Intuition, good judgment, and an awareness of how well the industry and national economy is doing may give the manager of a business firm a sense of future market and economic trends. Nevertheless, it is not easy to convert a feeling about the future into a precise and useful number, such as next year's sales volume or the raw material cost per unit of output. Forecasting methods can help estimate many such future aspects of a business operation. All forecasting methods can be divided into two broad categories: qualitative and quantitative. Many forecasting techniques use past or historical data in the form of time series.

Linear regression models could be used in a variety of business situations, like forecasting the cost and revenue of Moorfields Eye Hospital for the year 2012-2013. First we have to determine relationships between these variables, cost and revenue, which are intuitively related. Once a relationship is established between the two, we can then predict the future. The most common analysis that could be used is the regression analysis. Regression analysis involves gathering sufficient data to determine the relationship between the variables. The goal of regression is to produce an equation of a line that "best" depicts this relationship. Regression tries to "fit" a line between the plotted data points so that the "squared differences between the points and the line are the least."

Other forecasting techniques which could be used in the case of Moorfields Eye Hospital, are the time series techniques which forecast outcomes based on changes in a relationship over time. Time series analysis considers time by plotting data as it occurs. The technique then attempts to "decompose" the fluctuations within the data into three parts:

The Underlying Trend - up, down, flat ( a long-term measure)

The Cycles - hourly, daily, weekly, monthly (a short-term pattern)

Unexplained Movements - unusual or irregular movements caused by unique events and quirks of nature.

Regression and moving averages are used to determine the trend and cycles. However, for Moorfields Eye Hospital, we will use Trend Percentages. Trend percentages are a form of horizontal analysis. Trends show the direction a business is heading. We will use trending to create a forecast of the income and expenditure accounts for the years 2012 - 2013.

Moorfields Eye Hospital

Income and expenditure account forecast 2012-2013

2013 2012 2011 2010 2009 2008

Income from activities 179, 913 151, 398 127, 403 107, 211 90,219 75,920

Other operating income 29, 597 27, 553 25, 651 23, 880 22,231 20,696

Total income 209, 510 178, 951 153, 054 131, 091 112,450 96,616

Operating expenses (218, 898) (184, 193) (154, 990) (130, 417) (109,740) (92,341)

Appraise the sources of funds available to Moorfields Eye Hospital.

Moorfields Eye Hospital uses a wide range of sources of funds to help finance their operating activities. Not all of them are in cash; some take the form of assets that the business uses. These can be used to improve cash flow in both the long and short term.

The sources of funds available to Moorfields Eye Hospital are the following, which help it improve and manage its cash flow:

The profits that they make from operations. Based on their notes to financial statements (3.2 - Income by source), more than half of this income come from primary care trusts. The others are from the Department of Health, Non-NHS, NHS trust and NHS foundation trusts.

2009 2008

RETAINED SURPLUS FOR THE YEAR 640 2,235

Rate of return on income (2008) = Net income 2, 235 / Income from activities 75, 920 = 2.94%

Rate of return on income (2009) = Net income 640 / Income from activities 90, 219 = .7%

Companies strive for a high rate of return, the more revenues that provide income to the business and the less of sales that are absorbed by expenses. Moorfields Eyes Hospital's rate of return on income has decreased by 2.24% from 2008 to 2009.

At the end of the trading year a business will work out its profit. All of this profit can be taken by the owners, (this would be a dividend in limited company), or alternatively some or all of it could be reinvested in the company, to help the business grow and therefore make even more profit in the future. Retained profit is shown as reserves on a Balance Sheet, but can take the form of any business asset, so it may not be cash, or money in bank. Normally when preparing a cash flow any Retained Profit will be allowed for and shown in opening balance, if it is held as cash.

From borrowings and loans of creditors.

Amounts falling due within one year: 2009 2008

Current instalments due on loans 800 800

Interest payable 45 48

Payments received on account - 477

NHS creditors 1,501 4,606

Tax and social security costs 2,085 1,892

Obligations under finance leases and HP contracts 42 39

Capital creditors 832 1,120

Other creditors 7,558 5,815

Accruals 233 120

Deferred income 2,686 2,460

Sub total 15,782 17,377

Amounts falling due after more than one year:

Long-term loans 10,842 11,642

Obligations under finance leases and HP contracts 98 141

Other 657 113

Sub total 11,597 11,896

TOTAL 27,379 29,273

NHS creditors include:

Outstanding pension contributions 5 5

From Loans:

Amounts falling due: 2009 2008

In one year or less 800 800

Between one and two years 800 800

Between two and five years 2,401 2,401

Over five years 7,641 8,441

TOTAL 11,642 12,442

Debt ratio (2008) = Total liabilities 29, 273 / Total assets 99, 844 = 29.32%

Debt ratio (2009) = Total liabilities 27, 379 / Total assets 95, 159 = 28.77%

This ratio indicates the percentage of assets financed by debt or the proportion of the company's assets financed with debt. The higher the debt ratio, the higher the strain of paying interest each year and the principal amount at maturity. The lower the ratio, the lower the business' future obligations.

From equity funding. Shareholders are also owners of the company and they invest money in the hope of capital growth, (that is the business makes profits, grows, makes more profits, so as the business becomes bigger their investment will be worth), and dividend (the shareholders share of the companies profits).

After having appraised the sources of funds ( in 1.2 ), prepare a proposal for obtaining/sourcing funds for establishing a new Moorfields Eye Hospital in Accra, Ghana in line with Moorfields Eye Hospital Dubai.

New Moorfields Eye Hospital in Accra, Ghana

Budget Proposal

Sourcing of Funds

Required capital expenditures

Fixed assets - intangible 250

Fixed assets - tangible 50, 000

Required working capital 3, 000

Total Project Budget 53, 250

Projected sources:

Earned income 9at 3% (1st year) 1, 598

Grants 5, 000

Equity from stockholders 22, 573

Loans and borrowings at 30% of required capital 15, 975

Total funds 53, 250

(Word count :900 words)

Question 2: In this task you are expected to apply financial appraisal techniques used to evaluate potential investment decisions.

2.1 Use investment appraisal methods to analyse two competing investment projects: establishing Moorfields Eye Hospital in Accra, Ghana and commissioning/contracting additional in-patient intensive ophthalmic care facility in Moorfields Eye Hospital London.

When analyzing two competing investment projects for Moorfields Eye Hospital, like whether to establish Moorfields Eye Hospital in Accra, Ghana or commission/contract additional in-patient intensive ophthalmic care facility in Moorfields Eye Hospital London, it must be able to determine whether the proposed investment is likely to be worthwhile - this is where investment appraisal techniques come in.

Investment appraisal techniques fall into those which are cash flow based and those which are profit based.

Cash flow based methods include the following:

Net present value (equal annual cash flows) = Present value of annuity of £ 1 x annual net cash inflow or outflow

Net present value (unequal annual cash flows) = Compute the present value of each year's net

cash inflow or outflow (present value of annuity of £ 1 x net cash inflow or outflow) and add up yearly present values

Internal rate of return (equal annual cash inflows) = Annuity PV factor = Investment / expected annual net cash inflow

Internal rate of return (unequal annual cash inflows) = Trial and error, spreadsheet software, or calculator

Payback period (equal annual cash inflows) = Amount invested / Expected annual net cash inflow

Payback period (unequal annual cash inflows) = accumulated cash inflows until cash is recovered

Discounted payback period

Profitability index = Present value of net cash inflows /Initial cash outlay

Profit based methods include the following:

Accounting rate of return = Average annual operating income from asset / average amount invested in asset = Average annual net cash inflow from asset - annual depreciation on asset / (Amount invested in asset + Residual value) / 2

Net profit targets

2.2 Justify the selection of a project (out of two competing projects mentioned in 2.1) using investment appraisal techniques.

Establishing Moorfields Eye Hospital in Accra, Ghana, a long-term investment is more worthwhile than commissioning/contracting additional in-patient intensive ophthalmic care facility in Moorfields Eye Hospital London if:

Payback period is shorter than asset's useful life

Expected accounting rate of return on asset exceeds required accounting rate of return.

When using discounted cash flow methods: if net present value (NPV) is positive and internal rate of return (IRR) exceeds required rate of return.

The best capital budgeting methods are the discounted cash-flow methods (net present value and internal rate of return) because they incorporate both profitability and the time value of money.

2.3 Recommend a selected investment project based on a post-audit appraisal.

I would recommend commissioning or contracting additional in-patient intensive ophthalmic care facility in Moorfields Eye Hospital London. Although both investment projects are part of the company's long-term plan, and by using capital budgeting techniques we could analyze long-term investment decisions, the option of commissioning additional in-patient will not require huge additional fixed assets investment. However, if the company will establish Moorfields Eye Hospital in Accra, Ghana, it will need to source out additional funds of 53, 250, and most of this will be used to acquire fixed assets to be used in the Ghana Hospital operations.

2.4 Select relevant financial information for use in the process of making strategic decisions on investment.

The relevant financial information for use in the process of making strategic decisions on investment has two distinguishing characteristics: it is expected future data and it differs among alternatives.

Relevant information is used by managers to develop and implement strategies. A strategy is a set of business goals and the tactics to achieve them. The main financial goals in business are to earn profits and to build a strong financial position.

The cost of establishing Moorfields Eye Hospital in Accra, Ghana, the cost involved in contracting additional in-patient intensive ophthalmic care facility in Moorfields Eye Hospital London, finance costs in case the company will need to loan for the said investments, interest payments, cash inflows expected from each projected, the rate of return, and the revenues and expenses to be gained and incurred, depreciations and residual values.

(Word Count :1200 words)

Question 3: In this task you are expected to interpret financial statements of Moorfields Eye Hospital for planning and decision making

3.1 Analyse financial statements to assess the financial viability of Moorfields Eye Hospital.

The analysis of financial statements of Moorfields Eye Hospital applies some specific techniques to the data contained in its annual report. In addition to the financial statements, annual reports usually contain:

1. Notes to the financial statements, including a summary of the accounting methods used

2. Management's discussion and analysis of the financial results

3. The auditor's report

4. Comparative financial data for 5-10 years

The tools and techniques Moorfields Eye Hospital could use in evaluating financial statement information can be divided into three broad categories:

1. horizontal analysis

2. vertical analysis

3. ratio analysis

Horizontal analysis for Moorfields Eye Hospital

Increase (Decrease)

2009 2008 Amount Percent

Income 90,219 75,920 14, 299 19.00%

Other operating income 22,231 20,696 1, 535 .74%

Total income 112,450 96,616 15, 834 16.39%

Operating expenses (109,740) (92,341) 17, 399 18.84%

SURPLUS BEFORE INTEREST 2,710 4,275 (1, 565) (36.60%)

Although income, other operating income and total income has increased for Moorfields Eye Hospital by 19%, .74% and 16.39% respectively, surplus or excess before interest decreased by 36.60% because of the increase in operating expenses by 18.84%. This means that Moorfields Eye Hospital should have a careful cost analysis, and determine ways and means to improve and be more efficient in its operations, so as to avoid wastes and excess expenses. Some major operating expenses which it could target to decrease include staff costs, supplies and expenses - clinical, premises, services from other NHS trusts, fixed asset impairment, and others.

The horizontal analysis highlights changes in an item over time. Vertical analysis, on the other hand, reveals the relationship of each statement item to a specified base, which is the 100% figure. Every item on the financial statement is then reported as a percentage of that base.

Horizontal analysis for Moorfields Eye Hospital

2009 2008

Amount Percent Amount Percent

Income 90,219 100.00% 75,920 100.00%

Other operating income 22,231 24.64% 20,696 27.26%

Total income 112,450 124.64% 96,616 127.26%

Operating expenses (109,740) 121.64% (92,341) 121.63%

SURPLUS BEFORE INTEREST 2,710 3.00% 4,275 6.22%

The surplus before interest of Moorfields Eye Hospital decreased mainly because its other operating income decreased as a percentage of total income.

Financial ratios:

As to whether the company can meet its short-term and long-term obligations:

Debt ratio (2008) = Total liabilities 29, 273 / Total assets 99, 844 = 29.32%

Debt ratio (2009) = Total liabilities 27, 379 / Total assets 95, 159 = 28.77%

As to whether the company is profitable or not:

Rate of return on income (2008) = Net income 2, 235 / Income from activities 75, 920 = 2.94%

Rate of return on income (2009) = Net income 640 / Income from activities 90, 219 = .7%

3.2 Carry out a performance audit of Moorfields Eye Hospital with reference to internal and external factors.

Since the company employs the services of Deloitte LLP as external auditor and for other services, we are assured that its internal control system is effective. Internal control is the organizational plan and all the related measures that an entity adopts to:

1. Safeguard the assets the business uses in its operations.

2. Encourage adherence to company policies.

3. Promote operational efficiency (obtain the best outcome at the lower cost), and

4. Ensure accurate and reliable accounting records

"The trust and Deloitte have safeguards in place to avoid the possibility that the external

auditors' objectivity and independence could be compromised. The audit committee reviews the

annual report from the external auditors on the actions they take to comply with professional and

regulatory requirements and best practice designed to ensure their independence from the trust.

The audit committee also reviews the statutory audit, tax and other services provided by Deloitte, and compliance with the trust's policy, which prescribes in detail the types of services which the external auditors can and cannot provide:

External audit services

Other audit services - work which regulators require the auditors to undertake, such as on behalf of the Care Quality Commission

Tax services - all significant tax consulting work is put out to tender, except where the auditors are best placed to do this, such as in relation to value added tax

Internal audit - the external auditors may not perform internal audit assignments

General consulting - the external auditors may not tender for such engagements

All engagements with the external auditors over a specified amount require the advance

approval of the chair of the audit committee. The policy is regularly reviewed and, where necessary,

amended in the light of internal developments, external requirements and best practice.

So far as the directors are aware, there is no relevant audit information of which the auditors are unaware and the directors have taken all of the steps that they ought to have taken as directors in order to make them aware of any relevant audit information and to establish that the auditors are aware of that information." Moorfields Eye Hospital INHS Foundation Trust annual audit report and accounts 2008 - 2009.

To guarantee the accuracy of their accounting records, Moorfields Eye Hospital undergo periodic audits. An audit is an examination of the company's financial and accounting system. Since the company is employing one of most reputable audit forms, we are assured of its internal and external efficiency and effectivity. Internal examinations are done to ensure that employees are following company policies and that operations are running effectively and external audits are done to determine whether the company's financial statements are prepared in accordance with the generally accepted accounting principles, and the company's adherence to government laws and regulations.

3.3 Assess how to improve the quality of financial information about Moorfields Eye Hospital.

Although the financial information presented by Moorfields Eye Hospital is substantial enough. It should still seek to improve the quality of financial information. This statement noted that if there is a substantial gap between the quality of financial information available and the reasonable expectations of the users of this information. It should also identify the closing of that gap as a major priority issue for all actors in the international financial marketplace - buyers, sellers, investors, lenders, borrowers, regulators, finance ministries and central banks. Improvement of quality financial information calls for:

"… the changes necessary at national and international level so that all general-purpose financial information may be prepared according to a single worldwide framework using common measurement criteria and requiring fair and comprehensive disclosure. The framework must provide users with a transparent representation of the underlying economics of transactions and must be applied rigorously and consistently."

The potential benefits of a worldwide framework for financial reporting are significant:

1. Greater comparability and comprehension of financial information for investors,

especially those engaging in cross-border transactions,

2. Increased availability of capital and lower costs,

3. More efficient allocation of resources, and

4. Higher economic growth.

However, the financial information of Moorfields Eye Hospital is considerable enough.

3.4 Suggest a strategic portfolio for Moorfields Eye Hospital based on the interpretation of financial and ancillary information.

I would suggest a customer value innovation management. Financial projections alone may not provide a meaningful assessment of a company's potential market success. And especially with the hospital business. It should seek to provide the greatest value to each of its patient and not simply focus on acquiring fixed assets for its operations. Paradoxically, by putting aside financial data and giving more weight to customer value data when making product portfolio decisions, Moorfields Eye Hospital can in fact improve financial performance by identifying products with the potential to delight clients. Customer value, defined as the customer's perception of how well a solution meets their needs, is the only proven course to drive profit: The greater the value of the solution to the customer, the more likely the customer will buy it -- and pay a premium price for it. And, unlike many financial projections (and contrary to the beliefs of many executives), customer value is based on something real, which you can accurately measure to yield trustworthy results.

This approach uses techniques that uncover customer value so corporate managers can base portfolio decisions on factual, objective data about what customers will value. Far more encompassing than the traditional portfolio management goals of allocating resources and choosing among proposed product ideas, the VIP approach to portfolio management leads to a product portfolio that:

1. Delights customers by delivering total solutions to customer problems

2. Aligns new products with the strategic goals of the company

3. Optimizes investment intensity to ensure the right amount of investment at the right time and in the right places depending on a product's role in the portfolio

The prevailing focus of portfolio management must expand to encompass more than just development resource allocation. Resource allocation -- figuring out what R&D should do over the next year, how much money it needs, and how many people it requires -- may have been a worthy overarching focus in a simpler business environment. But today, products are complex, competition is tough and multifaceted, differentiation is the mantra of success, and long cycle times cripple even the best products. The question becomes how to create economic value in the face of these challenges. The answer is to take a broader view of resource allocation, to make sure that senior management views portfolio management as a strategic, not tactical tool, and to tie portfolio management explicitly to customer value.

(Word Count :1200 words)

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