Cash Budget, Budgeted Income Statement, and Capital Investment Appraisal with Builder Selection

BB Ltd's Finance Department

BB Ltd’s Finance Department has prepared the following cash budget and budgeted income statement for the first 3 months of the 2021/22 budget year, a period in which the company is expected to return to profit.

The following information is relevant to the cash budget:

1. Credit customers are allowed one month’s credit on sales;
2. Credit suppliers allow one-month credit on raw materials purchases;
3. Materials and production labour costs are included in the cost of sales in the budgeted income statement.

The following information from the budgeted Statement of Financial Position is also available.

The Production Department has come to me with an idea to increase automation in one of their main production processes – see the table below for the relevant information.  

If implemented, it will significantly impact the cost structure of one of their most popular lines of virtual reality headsets.  Current annual sales are steady around 12.000 units. 

Can you advise – and don’t forget to list any additional questions we should be asking them?

 Item 4 - Capital investment appraisal

BB Ltd is planning some new building to allow the re-organisation of certain production processes.  There are two building options using the same land within the current factory perimeter, Medium Build (MB) and Small Build (SB).  Big build was rejected at an earlier stage.  Both will bring a wide range of benefits but, as many are hard to estimate, the figures needed to be treated with even more caution than usual.  Not included in the calculations is that MB allows for future expansion in a way that SB does not.  10% of the initial cost is to be paid in year 3 as part of the retention process.  After year 5, indicated by the infinity symbol, ?,  the gains flow in perpetuity (i.e. every year and in principle forever,).

The perpetuity has been turned into a capital value by the application of the I/r factor.  The information below about the cash flows and capital investment appraisal measures has been collected so far.  ABCD applies a cost of capital of 6%.for such projects, this being irrelevant to the Accounting Rate of Return (ARR) which ABCD does not use.  As the BB managers are most familiar with ARR, you need to identify why ARR is inferior to other appraisal methods.

Item 5 – Selecting the Builder

The technical and marketing staff have got together to get us to two options, two companies we can go with.  That’s good, but what worries me is the risk that whoever we pick might either go bust or get into such trouble that they go slow or leave the job half-finished or to try to squeeze more money from us.  I recall building companies being more likely than average to get into financial trouble.

ABCD subscribes to FAME, a financial database.  Attached are documents for you to use:
1. FAME reports on Novus and Harper (Appendices to this brief)

2. Companies House links to their public details:
   - Harpers https://find-and-update.company-information.service.gov.uk/company/06892284 - Novus https://find-and-update.company-information.service.gov.uk/company/02403551 .

What I’d like you to do in 650 – 800 words are the following:

1. Report on and explain what accounting ratios we can use to inform ourselves as part of guarding ourselves against the failure of those with whom we choose to work. There is gearing, the current and the quick ratios, but what else?  I don’t think people can cope with more than 10 ratios – anything up to another half dozen on top of these 3 should be fine.  And again, brevity/economy is good!
   
   
2. Using all the ratios arising from Task 1 above, report on Novus and Harpers. Do they both pass the financial tests?  Please also comment on anything you find that needs to be drawn to the attention of senior management.

1. Analyse and interpret core financial statements for sole traders and limited companies, in line with prescribed international accounting standards. Focus will be put on the use of annual reports of international real-world public companies.
   
   
2. Evaluate appropriate management accounting techniques and use management accounting information to support business decision-making.
   
   
3. Understand apply and evaluate management accounting concepts and techniques in decision making.