N1086 IntroductiontoAccounting

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1 Discussion

Every business must know about the risks and rewards of their business because that
will help them to improve and do their best in order to achieve the objectives of
the business. If a business is generating enough profit, a sense of achievement, and
good customer feedback, these things are considered under business rewards. It gives
control of the business and a good expansion plan for the future. On the other
hand, if a business is facing losses, issues in sales or unexpected events that are
harmful to the business, these things lie under business risks and should be
overcome in order to achieve the objectives of the business.
If we look at the Meg Plc. financials, we will realise that it is performing well in
generating revenues as their actual sales are greater than budgeted sales. That is a
reward to this business. On the other hand, in their operating activities, they are
lacking somewhere as their actual operating expenses are greater as compared to
budget and this causes lower profit at the end and it is a risk to the business. With
that, Meg Plc. also has to repay the loan amount of £500 million, which is also a
risk to the business. If we look at the equity proportion of the business, that is
more than 50% of the total business worth. It indicates that Meg Plc. should focus
on buying loans instead of issuing shares as it will be a costly investment and will
share the ownership as well.
1.1 Budgetary control report

The budgetary control report provides the details of how a business is performing;
whether it is making losses or generating profits. It helps to compare the budgeted
amounts with actual spending. This budgetary control report indicates that Meg plc
did well in sales and maintaining operating expenses, but in cost of sales, the Meg
Plc. failed to manage within the budgeted amount. It indicates that a Meg Plc.
should work on their cost of sales portion in order to minimise the cost. Because
this cost of sales figure ruined the whole profit scenario.

1.2 Ratio Analysis

Ratio analysis is used to get an idea of a Meg Plc.'s liquidity, operation, and
profitability position. Ratio analysis is done on a Meg Plc.'s financial statements in
order to realise the exact financial position of the Meg Plc. in terms of liquidity,
operational efficiency, and profitability.
N1086 IntroductiontoAccounting

Profitability ratios
Normally there are 4 profitability ratios that are used to calculate the liquidity
position of the Meg Plc.. But here we will calculate two ratios in order to take the
quick review of the Meg Plc. liquidity position.

Current ratio = Current Assets / Current

liabilities Current ratio = 2560 / 2680 =
0.95

It is near 1 that is considered well. It means that a Meg Plc. can easily manage its short-
term obligations with its current assets. So, it shows the good liquidity position of the
Meg Plc..

Quick ratio = Current Assets – Inventory / Current

liabilities Quick ratio = 2560 - 1140 / 2680 = 0.53

Quick ratio indicates that how fast a Meg Plc. can pay its short term obligations. It
subtracts the inventory as it will take some time to convert into cash. So the quick
ratio value indicates that the Meg Plc. can pay 53% of their short term obligations
within no time.

Profitability ratios
Gross Profit Ratio is used to calculate the percentage of gross profit to
the sales. Gross profit ratio = Sales – CGS / Sales
Gross profit ratio = 10531 – 8371 / 10531= 20.51%

It indicates that gross profit of the Meg Plc. is equal to the 20.51% of the total
sales. Although it is good but it should be maximum in order to generate profit. It
indicates that 80% of the sales are used to cover the cost of sales. So Meg Plc.
should work on their CGS portion and try to minimise the CGS.

Net Profit Ratio is used to calculate the percentage of net profit to the sales.

Net profit ratio = Net profit / Sales

Gross profit ratio = 546 / 10531=
5.18%
N1086 IntroductiontoAccounting

It indicates that net profit of the Meg Plc. is equal to the 5.18% of the total sales.
Although it is good but it should be maximum. It indicates that 95% of the sales
are used to cover the cost of sales and other expenses. So Meg Plc. should work
on their CGS and Selling and admin portion and try to minimise it.

Operational efficiency ratios

The asset, inventory, and receivables turnover ratios are the most important of these
ratios. By calculating these ratios, we can easily conclude how efficiently a Meg
Plc. is performing its operational activities. Higher operational efficiency ratio figures
will indicate higher performance and vice versa.

1.3 Cash Budget for 2021

Cash budget is used to estimate available cash to the firm. On that basis Meg Plc.
decides that either this cash is enough to meet its operational activities or not. If
the available cash is not enough then Meg Plc. try to meet the limit of cash
through financing. In this case cash budget of the Meg Plc. is given in the
appendix and as Meg Plc. has to repay the loan amount of 500million so the
available cash is not enough to meet its requirement. That’s the reason Meg Plc.
has to refinance the cash in order to meet the requirement of cash.

1.4 Refinancing

Refinancing is borrowing more loans in order to pay off the existing loan amount. It
is used to replace the current debt obligations with another. It occurs when a Meg
Plc. has to borrow a loan against an existing loan. In this case, because the Meg
Plc. is having difficulty meeting its obligation to repay a 500 million loan, That
Meg Plc. has to take another loan in order to meet its obligations. So it has to
move towards refinancing. Cash position of the Meg Plc. is given in the cash
budget of the Meg Plc..

2 Summary of Recommendations

After analysing the case of the Meg Plc.'s financial statements, I will recommend
that the Meg Plc. work on CGS figures and try to keep them to a minimum as
much as possible. As in the budgetary control report, it is clearly identified that the
Meg Plc. is failing to maintain its CGS figures at the budgeted amount. It will be
a good reward for the business as it will result in an increase in profits. With that,
I would also suggest the Meg Plc. go for a borrowing loan
N1086 IntroductiontoAccounting
N1086 IntroductiontoAccounting

instead of issuing shares in order to generate cash. Issuance of shares will be costly,
and ownership will also be shared. On the other hand, if a Meg Plc. borrows a
loan from the bank, it will be less costly as tax is deducted after the payment of
interest. The Meg Plc.'s equity position also indicates that the Meg Plc. can borrow
money as their debt to equity ratio is less than 1. It means that the Meg Plc.'s
equity is much higher than its loan.

3 References

DeFranco, A. L., & Schmidgall, R. S. (2017). Cash Budgets, Controls, and

Management in Clubs. The Journal of Hospitality Financial Management, 25(2), 112-
122.
Evans, J. R., & Mathur, A. (2014). Retailing and the period leading up to the
Great Recession: a model and a 25-year financial ratio analysis of US retailing.
The International Review of Retail, Distribution and Consumer Research, 24(1), 30-
58. https://www.cliffsnotes.com/study-guides/accounting/accounting-principles-
ii/budgets/cash-budget
https://www.accountingtools.com/articles/discounted-cash- flow.html#:~:text=Discounted
%20cash%20flow%20(DCF)%20is,an%20entity's%20cost%2
0 of%20capital. https://www.investopedia.com/terms/r/ratioanalysis.asp#:~:text=What
%20Is%20Ratio
% 20Analysis%3F,cornerstone%20of%20fundamental%20equity%20analysis.

Appendix

Cash
Budget
Beginning Cash 146
Cash Inflows
Cash Sales 10501
Account Receivable Collected 0
Asset Sales 40
Total Cash Available 10687
Cash Out flows
Operating expense -1529
Purchases -8426
Purchase of Asset -300
Dividends Payment -130
N1086 IntroductiontoAccounting

Tax -60
Total Outflows -10445
N1086 IntroductiontoAccounting

Financing
Borrowing
Principal repayment -40
Interest -32
Net Borrowing cost -72
Net Cash 170

Required:
Using discounted cashflow techniques, calculate how long would take the private
equity Meg Plc. to recover its investment?

Assume that:

● Their cost of capital is 10% per year

● After 2023, cash receipts increase at 5% a year and cash payments increase
at 4% a year

Answer
2023 = (500m)
2024 = 80m
2025 = 80m
2026 = 80m

Increase in cash receipts – Increase in cash payments

5% - 4% = 1%

500 – 80 (1-(1+0.10)N /0.10)

0.375 = (1+0.10)N

Log 0.375 = Log (1.10)N

N = Log 0.375 / Log

1.10

N = 10.29 years

SECTION B
Answer ONE QUESTION
only

Answer
N1086 IntroductiontoAccounting

Depreciation is the process of allocation, not valuation. In this process, we allocate

the cost of fixing assets over their useful life. We do not revalue our assets during
the depreciation process; instead, we simply allocate some costs to tangible long-
term assets based on their useful life. It is related to measuring the expected benefits
from the asset over a period. Process of depreciation is used to allocate expense in
order to fulfil the matching principle. The cost allocation enables the organization to
purchase a new long-term asset at the end of its useful life. The depreciation
process is used to allocate the cost of an asset based on benefits that are derived
from these assets over time; it is not used to measure the value of assets. There
are four types of depreciation process (Straight Line Depreciation Method,
Diminishing Balance Method, Sum of Years' Digits Method, and Double Declining
Balance Method) that are normally used to allocate the cost to the tangible fixed
assets over their expected derived benefits.