Arden University

Business Management

Introduction to Business Finance

Time Constrained Assessment

STU134866

Bruno Cignacco

3263

Table of Contents

Part 1 3

1A.Calculation of financial ratios3

1B. Interpretation of financial ratio results and operating leverage 3

1C. Advantages of automated bookkeeping systems 5

Part 2 6
2 A,B,C. Investment appraisal calculations for Software X and Y 6

2D. Investment recommendation 6

2E. Benefits of FinTech for the online retail sales expansion 7

Part 3 8

3A. Critical analysis of different budgeting approaches 8

3B. Problems of budgetary slack 9

3C. Sources of debt finance 9

References 10
 Part 1

1A. Calculation of financial ratios

(Sourc
e: Calculated by Author)

1B. Interpretation of financial ratio results and operating leverage

For ascertaining the profitability position of AAA Ltd., there are three profitability group of ratios
that have been opted for. The gross profit margin shows the profitability performance in managing the cost
of sales for any organisation each year. The metric has increased from 15.79% to 21.50%. This is because of
an increase in the total sales of the company from £190 M to £200 M as well as a decline in the cost of sales
from £160 M to £157 M. The net profit margin as a financial ratio looks to ascertain the ultimate
profitability position. This is done by looking at the net income in proportion to the sales generated which
shows the cost efficiency of an entity when managing the total expenses of the company (Kieso et al. 2019).
The results have increased from 2.11% to 7.00% because of an increase in sales as well as being cost
efficient for the most part throughout the financial period. Finally, the ROE shows the efficiency with which
a company can capitalize upon the total capital invested by the equity holders for generating profit. The
metric has increased from 5.63% to 17.95% because of an increase in the total net income of the company
due to additional capital seeded into the company.

The current ratio and the quick ratio have been selected for ascertaining the short-term liquidity
performance of the company. The current ratio shows the availability of current assets with the company
for meeting the total current liabilities during a span of one year (Weygandt et al. 2019). The metric has
improved from 0.87 times to 1.10 times. A similar trend can also be noticed for the quick ratio which only
considers those current assets that have the potential to be liquidated quickly for meeting the short-term
debts. The metric has improved from 0.48 times to 0.68 times. An improvement in the overall liquidity
performance is on account of the increase in the total current assets and a reduction of the total current
liabilities of the business.

When it comes to the long-term solvency aspect, AAA Ltd. reflects a marginal increase in their debt
to capital ratio from 1.20 times to 1.54 times. The metric can be interpreted as the total available reliance
upon debt capital in the capital structure for every pound of owner’s capital invested. A marginal increase in
this metric is because of increase in total liabilities from £85 M to £120 M during the year. The times
interest earned ratio helps to evaluate the total number of times a company can provide cover for their
interest expense obligations by relying upon their available operating profit. The metric has favourably
improved from 5.00 times to 11.00 times because of an increase in the operating profit of the company
from £10 M to £22 M.

Finally, from an operating efficiency standpoint, the company can be observed to have a decline in
their inventory turnover ratio from 5.54 times to 5.20 times because of an increase in the value of closing
stock. This raise concerns over the efficiency of stock management and forecasting of demand (O'Hare
2016). The debtor’s turnover ratio of the company can also be seen to have declined this year from 7.60
times to 6.90. This is because of an increase in the value of debtors this year when compared to the prior
period. This happens to raise concerns over how the company is managing their debtors for goods sold on
credit. Finally, the creditors turnover ratio can be witnessed to have marginally increased from 3.17 times to
3.25 times because of a decrease in the trade creditors figure. This validates a marginal improvement in
efficiency when it comes to making timely supplier payments.

The operating leverage is a metric that shows how sensitive is the operating profit of an entity
relative to the increase or decrease in the total sales generated. The operating leverage of AAA Ltd is 22.8
times which is very high. This means that the company have very high fixed costs as opposed to their
variable costs. Hence, it will take considerable time to breakeven as the company will have to sell more
units of product offerings to be profit making. The related calculation of the same has been presented as
follows:
 (Sourc
e: Calculated by Author)

1C. Advantages of automated bookkeeping systems

AAA Ltd. makes use of traditional bookkeeping systems as mentioned in the case study. This has
resulted in the company to generate inaccurate financial reports having material errors and cannot be relied
upon for decision making purpose. Hence, the company should upgrade their bookkeeping systems to deal
with these concerns. There are a wide variety of software systems available in the market that can be
customized, and tailor made to meet specific entity requirements for their bookkeeping and financial
reporting process. Some of the prominent solutions which the market has to offer include Sage, NetSuite,
Zoho, FreshBooks etc.

An investment in automated bookkeeping systems have a plethora of advantages for AAA Ltd. One
of the most important advantages of the same is with respect to time savings. These software systems help
the accounting department to get rid of any manual entries. This allows for transaction recording,
generating financial reports and invoices swiftly in comparison to the outdated bookkeeping systems. Such
software solutions can also help the management with better data insights that helps to improve
productivity which arise because of effective decision making. There are very minimal chances of errors to
creep in which increases the reliability of financial reports to make informed decisions. The data stored in
these systems are not just accessible by logging in with valid credentials on different devices but are also
very secure because of backups, encryption and protection from malicious risks. Another important benefit
of automated systems is the use of relevant key performance indicators for measuring the financial and
non-financial aspects of performance which can help to identify any cause of concerns and put in place
effective remedies to prevent such concerns in future (Collier 2015). Finally, financial reporting discipline is
highly regulated, and a good accounting software ensures the company to be compliant with accounting
regulations.
 Part 2

2 A, B, C. Investment appraisal calculations for Software X and Y

(Source: Calculated by Author)

2D. Investment recommendation

The investment appraisal calculations shown above can be relied upon to determine which of the
two software choices the company should acquire to proceed with online sales expansion. There are in total
three different methods for gauging the viability of the investment.

The first method is the accounting rate of return using the average method. The method can be
interpreted as the total net profit from an accounting standpoint which is expected to be earned relative to
the average outlays invested in the investment (Atrill and McLaney 2021). When comparing the results for
both the software, it can be observed that Software X is having a much higher ARR at 25% when compared
to 18% which Software Y generates. Hence, considering a profitability standpoint, a potential acquisition of
Software X is much lucrative when compared to Y.

The second method to be calculated in the payback period. This method looks to compute the total
expected turnaround time of an investment. It is the measure of the total time taken within which a
company should recover the total initial costs of the investment prospect. It is mostly used in cases where
the company is prudent from a liquidity standpoint and is looking to recover cash flows at the earliest
(Weetman 2019). From the calculated results it is obvious that Software X is much more lucrative since its
payback period of 2.50 years is lower than 2.94 years of Software Y.

Finally, the most superior investment appraisal method based on which most investment decisions
are undertaken is the net present value. It is consistent with the fundamental wealth maximisation
objective of financial management. The metric quantifies in absolute terms the total value expressed in
cash flows which a potential investment will generate over the long term. It is the excess of cash inflows
compounded to their present value over the compounded cash outflows (Zutter and Smart 2019). The NPV
in the case of Software X is positive at £2,125. However, the NPV in the case of Software Y is negative at -
£233. As a result, Software X is more favourable in terms of the NPV.

To conclude, the company must consider investing in Software X because of all the three results
turning out favourable when compared to Software Y. However, the management at AAA Ltd. should also
take to their confidence the favourability of qualitative factors that are also very important when
undertaking investment decisions. This is because non-financial factors have the potential to alter the future
financial results of any entity. These may include examples such as political factors, regulatory landscape,
supplier relations, customer demand, environmental sustainability etc.

2E. Benefits of FinTech for the online retail sales expansion

Irrespective of the sales segment of the business, online or offline, any business is highly reliant
upon online banking. However, when it comes to traditional banks who provides the businesses with online
banking services, there are several costs associated. These include the likes of bank fees, maintenance
limits, transaction limits etc. However, with the arrival of financial technologies, digital payments have
helped several e-commerce businesses to not face any such concerns. Online payments can help the
businesses to improve their cash flow position. FinTech operations have also allowed financial institutions to
provide loans at 0% rate of interest at the time of checkout while buying products in bulk. Hence, this has
led to exponentially helping e-commerce businesses which have an online sales business model.

With the arrival of fintech solutions, it has also allowed businesses to move beyond their markets
for penetrating global markets since these technologies eliminate intermediaries for payment processing. As
a result, e-commerce businesses have started to thrive worldwide. Furthermore, these solutions have also
led to an increase in transparency levels in payment transactions. This is because, both the business and
customer will have to link their bank accounts to a fintech platform which makes purchase and sales easy.
FinTech has allowed for an execution of automated customer service with the help of chatbots who can
customize the communication process to understand the behaviour profiles and preferences of customers.
Fintech has also resulted in an increase in the demand for blockchain technology which helps companies to
maintain a database for keeping track of transactions. These relatively newer technologies can help
businesses to exercise control over the supply chain network while at the same time to increase the
efficiency levels in managing inventory and the overall working capital functions. These solutions also help
step up the mitigation measures to prevent entities from any risks which are concerned with data security
issues and the risk of cyberattacks.

Fintech applications also capitalize upon the capabilities of machine learning, automation, and big
data for not only storing data but also analysing them in bulk quantities to provide strategic insights which
can help the management to make better product and pricing related decisions (DeMarzo, Berk and Harford
2015). These applications are also very helpful for businesses to facilitate management of risk. Finally, one
of the main benefits of these technologies is in their cost effectiveness as with the help of automation and
fewer personnel requirements, a company is able to lower their overhead expenses. This in turn can help
with better profit margins. In a nutshell, there are several benefits of FinTech which AAA Ltd. may gain if
they were to use them as a part of their online sales expansion.

Part 3

3A. Critical analysis of different budgeting approaches

The management at AAA Ltd. presently makes use of the incremental approach of budgeting. This
approach makes use of financial information from previous year budgets and results. On identifying trends,
the business will make use of them and apply these trends to prepare all subsequent budgets. The
approach of budgeting has several advantages and disadvantages. The main advantage of the incremental
approach of budgeting is with its simplicity. The steps involved in calculating is very simple with only a
minimal need for assumptions which is a time saving process for the management. Since the method is very
easy to implement there are very fewer costs associated with implementation. Since incremental changes
are made at each period, this also reduces any concerns over internal rivalries amongst the departmental
managers. However, the approach also has several limitations. One of the crucial demerits of the same is
the high possibility of a budget slack in the prepared budget. Furthermore, since the approach is very
conservative in nature, it is not willing to assume major risks (Drury 2018). This can also limit and discourage
the company from innovating. Also, cost control from this approach of budgeting is questionable.

There are several other alternative approaches to budgeting which the company may opt for. This
assignment looks to discuss two such approaches. The first approach is referred to as a rolling forecast
approach. This approach is best suitable for the modern economy which is fast paced and volatile in nature.
It assumes a dynamic approach in budgeting since it allows for monitoring the changes in the external
business environment very frequently to adjust the budget figures for reflecting the present situation. These
forecasts can help entities to gain access to a lot of long-term data which can help to engage in long term
decision making and an optimal resource allocation (Eldenburg et al. 2020). Since an organisation can
anticipate any risks well in advance, this approach can help a lot with better risk management. An entity
may attain visible improvements in cash flow due to this approach along with sound decision making. There
are however several different issues as well with this budgeting approach. One of the more important cons
of this approach is that it requires a lot of time and resources. It is also very hard to implement because of
the frequent changes in data making it more tough. Finally, the approach also limits the practicality of
undertaking comparative analysis.

Another alternative approach of budgeting which AAA Ltd. can consider is the use of zero-based
budgeting. It is very different from the fundamentals of incremental budgeting. This is because the
approach does not depend upon application of trends to historical data but instead chooses to hold
departmental managers accountable for each line item by starting from zero. Theoretically, if implemented
well, this approach has the potential of attaining a visible difference when it comes to cost control. The
main advantage of this approach is to ensure that the budget line items are consistent with present trends
instead of outdated trends. The approach is aggressive when cutting down on costs which can help improve
margins. It can also help businesses to identify activities which lead to wastage or are counterproductive in
nature. However, there are several demerits of the same as well. The process is very time consuming in
nature. Further, the approach also has the potential of causing internal rivalries if the allocated budget
amongst different departments tend to vary. Finally, it can also be very aggressive when cutting down on
costs which may affect the quality of products and service (Blocher et al. 2019).

3B. Problems of budgetary slack

It can be best explained as an intentional misstatement of the budget wherein the sales estimate
are understated and the expenses are overstated which in turn helps the management to better manipulate
the numbers to attain the budget. This practice can help the department managers to earn more incentives
and bonuses since their performance bonus may be tied to achieving the budget. There are several
concerns because of the slack introduced. It can interfere with the actual performance of the organisation
as employees are more focused upon achieving the budget which is intentionally low to maximise their
bonuses. Further, if a slack is existing from multiple years in a company’s budget, this can compromise the
performance of the company relative to the peers. It will tend to hinder the profitability aspect of the entity
while also resulting in a loss of market share and customer base (Eldenburg et al. 2016).

3C. Sources of debt finance

If the company proceeds with the planned investment, they will require finances and hence it is
pivotal for the management to properly design a good financing strategy. Debt financing is one of the most
important sources of capital, given that the interest expense is cheaper when compared to dividend
payments in the case of equity capital. Furthermore, the interest expense also allows for tax deduction
which results in cheaper financing for an entity. There are several sources of debt for a company to choose
from. Some of these sources are discussed in this paper.

AAA Ltd. can opt for traditional bank loans from any banking institution. These loans for the most
part are secured as the company will have to provide some guarantee. These are provided for a fixed period
and requires repayment as per the credit terms. Depending upon the time frame, these loans may classify
as short term, intermediate, and long term. Another prominent source of debt finance is the use of trade
credit wherein the company is offered credit by suppliers for delayed payments. Hence, cash flows may
instead be used to invest in any prospects. Instalment purchases are another type of debt which the
company can choose to avail wherein assets may be acquired under a mortgage arrangement requiring
instalment payments which are decided in advance. The company can also choose to issue their own bonds
for securing debt finance in exchange of interest rates which are higher than the fixed deposit rates offered
by banks.
 References

Atrill, P. and McLaney, E., 2021. Accounting and Finance for Non-specialists. Pearson Higher Ed.

Blocher, E.J., Stout, D.E., Juras, P.E. and Smith, S., 2019. Cost Management (A Strategic Emphasis) 8e.
McGraw-Hill Education.

Collier, P.M., 2015. Accounting for managers: Interpreting accounting information for decision making. John
Wiley & Sons.

DeMarzo, P., Berk, J. and Harford, J., 2015. Fundamentals of Corporate Finance, PDFebook. Pearson Higher
Ed.

Drury, C., 2018. Cost and management accounting. Belmont, CA, USA: Cengage Learning.

Eldenburg, L.G., Brooks, A., Oliver, J., Vesty, G., Dormer, R., Murthy, V. and Pawsey, N., 2020. Management
accounting. John Wiley & Sons.

Eldenburg, L.G., Chen, L.H., Wolcott, S.K. and Cook, G., 2016. Cost Management: Measuring, Monitoring,
and Motivating Performance, Binder Ready Version. John Wiley & Sons.

Kieso, D.E., Weygandt, J.J., Warfield, T.D., Wiecek, I.M. and McConomy, B.J., 2019. Intermediate Accounting,
Volume 2. John Wiley & Sons.

O'Hare, J., 2016. Analysing financial statements for non-specialists. Taylor & Francis.

Weetman, P., 2019. Financial and management accounting. Pearson UK.

Weygandt, J.J., Kieso, D.E., Kimmel, P.D., Trenholm, B., Warren, V. and Novak, L., 2019. Accounting
Principles, Volume 2. John Wiley & Sons.

Zutter, C.J. and Smart, S.B., 2019. Principles of Managerial Finance: Brief. Harlow, UK: Pearson.