Financial Analysis And Capital Budgeting Techniques For HomeCreate Plc Essay.

Introduction and Background

The primary purpose of this report is to analyse and measure the company’s financial performance with the help of financial accounting ratios calculation. However, an understanding of various patterns of cost behaviour analysis & an analysis of cost-profit-volume has also been applied or implemented with respect to the business decisions. Moreover, an appropriate techniques of management accounting has also been applied in order to support the decisions. Lastly, a conclusion has been provided on the basis of overall discussion and analysis mentioned in the report.

Based on the case study background, HomeCreate Plc commenced as the family business endowing in selling and importing broad variety of furniture to the United Kingdom furniture retailers. Stewart Thomas started this business who already have worked as a manger. Though he wished to place a huge order with the production, but his advisor discarded the idea. However, he was persuaded that the furniture will be famous in the United Kingdom & it was a good chance to be missed. Therefore, he would wish board of directors (BOD) to reassess this investment opportunity.

Based on the capital budgeting techniques calculation that has been provided in the excel sheet, it can be recommended to company to invest in it as it is clear evident from the calculation of net present value where cost of capital is considered at the rate of 8%, payback period, and the accounting rate of return (Dance and Imade 2019). However, the value of NPV is positive which stands at 9629.90 which means that the project is desirable and attractive. Whereas, on the other hand, the payback period is also less which stands at 3.49 years and lastly the accounting rate of return is also high which stands at 13.75%. Hence, on the basis of above analysis, it is recommended to invest from the financial perspective. Additionally, decisions should not only be made on the basis of financial values as it is important for the company’s management to consider non-financial factors which is extremely crucial for the techniques of capital budgeting.

Furthermore, if the hurdle rate is around 12%, then it has been observed on the basis of investment appraisal technique that the value of net present value turns into negative that is -7933.78. Although the payback period is less and the accounting rate of return is high then also it will not be recommended to invest in it because the value of net present value is in negative.

Net Present Value refers to the value of all the future cash flows over the whole life of an investment. It is one of the most important capital budgeting tools which is utilized in analysing the projects and investments profitability (Baum, Crosby and Devaney 2021). However, if the value of NPV is in positive then it is considered that the projects investment is favourable and desirable. In order to compute NPV, one needs to anticipate further cash flows for every period and decide the precise discounting rate. Furthermore, one of the most important benefits of utilizing this technique is that it considers the concept of TVM (time value of money). It also enables the process of decision-making for the organizations and not only it assists in evaluating the projects but it also assists in recognizing whether a specific investment is loss making or profit making (Pawlak, Rapacewicz and Zarzecki 2020).

Capital Budgeting Techniques for Investment Appraisal

Accounting Rate of Return is also known as the average rate of return which assess the anticipated profitability from the capital investment. It indicates the profitability from projects investments utilizing simple approximates which assists in measuring the capital projects. Hence, this technique is computed by dividing the company’s net income from its investments. Utilizing ARR would allow the investors to determine the capital projects profitability and viability to be undertaken (Raki?evi? et al. 2016). It also assists investors in analysing the risk included in the investments & conclude if the projects investments would yield adequate earnings to meet the level of a risk. Whereas, one of the major ARR limitations is that it doesn’t distinguish among investments that produce various cash flows over a project’s life time.

Payback Period is another technique of investment appraisal which refers to the time needed to earn the amount that has been invested or capitalized in an asset. It is an easy way to measure the risk related with an intended project (Batkovskiy et al. 2017). However, a project investment with a lesser period is considered to be better, meanwhile the initial outlay of an investors is at danger for the shorter period. This technique is computed by dividing the investment amount with its annual cash flow. Fund managers and account managers make use of this payback period method for the purpose of determining whether to go with the investment or not. Lastly, one of the disadvantages of this method is that it does not considers the concept of time value of money (Ndanyenbah and Zakaria 2019).

Following the current success or achievement of the company, the representation of the new line aiming the high-end marketplace is considered. However, the design has been grown and is prepared for application or implementation. The company’s management must determine whether to manufacture fully in the new factory across their primary building or may be outsource the production to the supplier firm.

Based on the calculation, it has been observed that the operational leverage or gearing is high in the in-house as compared to outsourcing. Thus, the operational gearing stands at 8.44 and 1.80 in In-House and Outsourcing. Whereas, on the other hand, the total cost incurred stands at 547500 in In-House and 550000 in outsourcing. Hence, on the basis of above analysis, it can be recommended to HomeCreate Plc to choose.

Operational Gearing is also referred as an operational leverage which explains the relationships between the fixed costs and variable costs of the company. Operational gearing is significant and simple and frequently neglected.

Relevant cost refers to a term of managerial accounting that explains avoidable costs that is mainly incurred or sustained while making particular business decisions. Thus, the relevant costs concept is utilized to eliminate an unnecessary information that may complicate the process of decision-making.

• Cost Behaviour: On the basis of cost behaviour, costs are mainly classified as either variable, fixed or mixed.
• Cost Allocation: On the basis of cost allocation, costs are mainly classified as either labour costs, expenses, and material costs.
• Decision Making Purposes: On the basis of decision-making purposes, costs are mainly classified as either standard costs, estimated costs, differential costs, pre-determined costs, product costs, shut-down costs, capitalized costs, absolute costs, explicit costs, discretionary costs, and implicit costs.

HomeCreate Plc was not a direct achievement and throughout the initial few years it would survive. Hence, when the store of department starts to place a huge order for furniture’s then only a breakthrough occurred. The new CEO was appointed and he did not function for the company before & lacks knowledge of the business environment of UK. Whereas, when the competitive pressure was increasing in a retail furniture industry then CEO took over the whole business. Once he was being altered of the complexities faced by its clients then he commissioned the company of marketing consultants in order to analyse the trends and to imply how HomeCreate must position itself in the customer base. Unfortunately, further growth was constrained by the finances shortages and the company has an overdraft service.

Net Present Value (NPV)

The financial performance of the company is being analysed or examined for the financial years 2018, 2019, and 2020 with the help of different types of financial ratios.

Based on the financial ratio computation, it has been observed that the company’s net profit margin has decreased significantly to 3.52% in 2020 from 5.77% in 2018, implying that the company has make less profits from its available net sales and is very inefficient in terms of generating net income (Gundall, Huber and Schotten 2021). Whereas, on the other hand, the operating profit margin has also reduced to 4.41% in the current year as compared prior financial years which indicates that the company’s financial risk has increased and less amount of operating profit has been created.

On the basis of financial calculations, it can be seen that the current ratio of the company for 2018, 2019, and 2020 is calculated at 3.08 times, 2.79 times, and 2.47 times. Hence, it implies that although the company is having enough liquid assets or cash to cover all of its debts obligations but it is not using its assets precisely. Hence, this misuse may present its individual issues to the group’s financial well-being. The quick ratio decreased to 1.16 times which means that the company is not dependent on its assets with respect to clearing its debts.

The overall operational efficiency position of the company has deteriorated in the current year as it is clear evident from the calculation of inventory turnover ratio and receivables turnover ratio (Kampf, Majer?ák and Švagr 2016). However, there was no significant change in the inventory turnover ratio but in the case of receivables turnover, the metric has reduced significantly to 7.57 times in 2020 from 8.18 times (2019) and 9.25 times (2018), indicating that the credit collection process of the company is not efficient and is observing more delinquent clients in the current year as compared to previous years.

On the basis of calculation, the company’s debt ratio pertaining to 2018, 2019, and 2020 stands at 0.10 times, 0.16 times, and 0.21 times, suggesting that there is marginal increment in the financial leverage and risk as the company’s dependency on debt has increased in comparison to total assets. While on the other hand, the debt-to-equity ratio has also increased to 0.26 times in 2020, implying that the stock or company are in higher financial risk with the shareholders (Kengatharan and Clamenthu 2017).

On analysing the company’s EPS, it has been observed that the metric has reduced marginally to $0.40 in 2020 as compared to prior years which means that the investors are not ready to pay more because they would believe that the company has lesser profits comparative to the share price (Kourtis, Kourtis and Curtis 2019). Lastly, the company’s ROE has also reduced to 6.60% in 2020 which means that the company has not utilized its equity efficiently in terms of producing net earnings.

Conclusion

On the basis of above discussion and analysis, it can be concluded that investment appraisal technique, financial ratio analysis, and break-even analysis have been utilized to interpret or analyse the financial performance and financial position of the company (Zarzecki and Pawlak 2020).   However, this technique not only assists in determining the creditworthiness, capability, and profitability but it also helps in providing a depth look with respect to how it functions or operates internally.

References

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Dance, M. and Imade, S., 2019. Financial ratio analysis in predicting financial conditions distress in indonesia stock exchange. Russian Journal of Agricultural and Socio-Economic Sciences, 86(2).

Gundall, M., Huber, C. and Schotten, H.D., 2021, September. Computation offloading at field level: Motivation and break-even point calculation. In 2021 26th IEEE International Conference on Emerging Technologies and Factory Automation (ETFA) (pp. 01-08). IEEE.

Kampf, R., Majer?ák, P. and Švagr, P., 2016. Application of break-even point analysis. NAŠE MORE: znanstveni ?asopis za more i pomorstvo, 63(3 Special Issue), pp.126-128.

Kengatharan, L. and Clamenthu, D.P., 2017. Use of capital investment appraisal practices and effectiveness of investment decisions: a study on listed manufacturing companies in Sri Lanka. University of Jaffna.

Kourtis, E., Kourtis, G. and Curtis, P., 2019. An integrated financial ratio analysis as a navigation compass through the fraudulent reporting conundrum: a case study.

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Pawlak, M., Rapacewicz, A. and Zarzecki, D., 2020. Investment appraisal practice in the biggest companies in Poland.

Raki?evi?, A., Miloševi?, P., Petrovi?, B. and Radojevi?, D.G., 2016. DuPont financial ratio analysis using logical aggregation. In Soft computing applications (pp. 727-739). Springer, Cham.

Zarzecki, D. and Pawlak, M., 2020. Investment appraisal practice in the European Union countries.