CPA I1.1 MANAGERIAL FINANCE Revision Guide

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CONTENTS

Title

Page

Study Techniques

3

Examination Techniques

5

Assessment Strategy

11

Learning Resources

12

Sample Questions and Solutions

13

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STUDY TECHNIQUE
What is the best way to manage my time?
•

Identify all available free time between now and the examinations.

•

Prepare a revision timetable with a list of “must do” activities.

•

Remember to take a break (approx 10 minutes) after periods of intense
study.

What areas should I revise?
•

Rank your competence from Low to Medium to High for each topic.

•

Allocate the least amount of time to topics ranked as high.

•

Allocate between 25% - 50% of time for medium competence.

•

Allocate up to 50% of time for low competence.

How do I prevent myself veering off-track?
•

Introduce variety to your revision schedule.

•

Change from one subject to another during the course of the day.

•

Stick to your revision timetable to avoid spending too much time on one topic.

Are study groups a good idea?
•

Yes, great learning happens in groups.

•

Organise a study group with 4 – 6 people.

•

Invite classmates of different strengths so that you can learn from one another.

•

Share your notes to identify any gaps.

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EXAMINATION TECHNIQUES
INTRODUCTION
Solving and dealing with problems is an essential part of learning, thinking and intelligence.
A career in accounting will require you to deal with many problems.
In order to prepare you for this important task, professional accounting bodies are placing
greater emphasis on problem solving as part of their examination process.
In exams, some problems we face are relatively straightforward, and you will be able to deal
with them directly and quickly. However, some issues are more complex and you will need to
work around the problem before you can either solve it or deal with it in some other way.
The purpose of this article is to help students to deal with problems in an exam setting. To
achieve this, the remaining parts of the article contain the following sections:
•

Preliminary issues

•

An approach to dealing with and solving problems

•

Conclusion.

Preliminaries
The first problem that you must deal with is your reaction to exam questions.
When presented with an exam paper, most students will quickly read through the questions
and then many will … PANIC!
Assuming that you have done a reasonable amount of work beforehand, you shouldn’t be
overly concerned about this reaction. It is both natural and essential. It is natural to panic in
stressful situations because that is how the brain is programmed.
Archaeologists have estimated that humans have inhabited earth for over 200,000 years. For
most of this time, we have been hunters, gatherers and protectors.
In order to survive on this planet we had to be good at spotting unusual items, because any
strange occurrence in our immediate vicinity probably meant the presence of danger. The
brain’s natural reaction to sensing any extraordinary item is to prepare the body for ‘fight or
flight’. Unfortunately, neither reaction is appropriate in an exam setting.
The good news is that if you have spotted something unusual in the exam question, you have
completed the first step in dealing with the problem: its identification. Students may wish to
use various relaxation techniques in order to control the effects of the brain’s extreme
reaction to the unforeseen items that will occur in all examination questions.

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However, you should also be reassured that once you have identified the unusual item, you
can now prepare yourself for dealing with this, and other problems, contained in the exam
paper.

A Suggested Approach for Solving and Dealing with Problems in Exams.
The main stages in the suggested approach are:
1. Identify the Problem
2. Define the Problem
3. Find and Implement a Solution
4. Review

1. Identify the Problem
As discussed in the previous section, there is a natural tendency to panic when faced with
unusual items. We suggest the following approach for the preliminary stage of solving and
dealing with problems in exams:
Scan through the exam question
You should expect to find problem areas and that your body will react to these items.
PANIC!!
Remember that this is both natural and essential.
Pause
Take deep breaths or whatever it takes to help your mind and body to calm down.
Try not to exhale too loudly – you will only distract other students!
Do something practical
Look at the question requirements.
Note the items that are essential and are worth the most marks.
Start your solution by neatly putting in the question number and labelling each part of your
answer in accordance with the stated requirements.
Actively reread the question
Underline (or highlight) important items that refer to the question requirements. Tick or
otherwise indicate the issues that you are familiar with. Put a circle around unusual items that
will require further consideration.

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2. Define the Problem
Having dealt with the preliminary issues outlined above, you have already made a good start
by identifying the problem areas. Before you attempt to solve the problem, you should make
sure that the problem is properly defined. This may take only a few seconds, but will be time
well spent. In order to make sure that the problem is properly defined you should refer back
to the question requirements. This is worth repeating: Every year, Examiner Reports note that
students fail to pass exams because they do not answer the question asked. Examiners have a
marking scheme and they can only award marks for solutions that deal with the issues as
stipulated in the question requirements. Anything else is a waste of time. After you have reread the question requirements ask yourself these questions in relation to the problem areas
that you have identified:
Is this item essential in order to answer the question?
Remember that occasionally, examiners will put ‘red herrings’ (irrelevant issues) into the
question in order to test your knowledge of a topic.
What’s it worth?
Figure out approximately how many marks the problem item is worth. This will help you to
allocate the appropriate amount of time to this issue.
Can I break it down into smaller parts?
In many cases, significant problems can be broken down into its component parts. Some parts
of the problem might be easy to solve.
Can I ignore this item (at least temporarily)?
Obviously, you don’t want to do this very often, but it can be a useful strategy for problems
that cannot be solved immediately.
Note that if you leave something out, you should leave space in the solution to put in the
answer at a later stage. There are a number of possible advantages to be gained from this
approach:
1) It will allow you to make progress and complete other parts of the question that you are
familiar with. This means that you will gain marks rather than fretting over something
that your mind is not ready to deal with yet.
2) As you are working on the tasks that you are familiar with, your mind will relax and you
may remember how to deal with the problem area.

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3) When you complete parts of the answer, it may become apparent how to fill in the
missing pieces of information. Many accounting questions are like jigsaw puzzles: when
you put in some of the parts that fit together, it is easier to see where the missing pieces
should go and what they look like.

3. Find and Implement a Solution
In many cases, after identifying and defining the problem, it will be easy to deal with the
issue and to move on to the next part of the question. However, for complex problems that
are worth significant marks, you will have to spend more time working on the issue in order
to deal with the problem. When this happens, you should follow these steps:
Map out the problem
Depending on your preferred learning style, you can do this in a variety of ways including
diagrams, tables, pictures, sentences, bullet points or any combination of methods. It is best
to do this in a working on a separate page (not on the exam paper) because some of this work
will earn marks. Neat and clearly referenced workings will illustrate to the examiner that you
have a systematic approach to answering the question.
Summarise what you know about the problem
Make sure that this is brief and that it relates to the question requirements. Put this
information into the working where you have mapped out the problem. Be succinct and
relevant. The information can be based on data contained in the question and your own
knowledge and experience. Don’t spend too long at this stage, but complete your workings as
neatly as possible because this will maximise the marks you will be awarded.
Consider alternative solutions
Review your workings and compare this information to the question requirements. Complete
as much of the solution as you can. Make sure it is in the format as stipulated in the question
requirements. Consider different ways of solving the problem and try to eliminate at least one
alternative.
Implement a solution
Go with your instinct and write in your solution. Leave extra space on the page for a change
of mind and/or supplementary information. Make sure the solution refers to your workings
that have been numbered.

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4. Review
After dealing with each problem and question, you should spend a short while reviewing your
solution. The temptation is to rush onto the next question, but a few moments spent in
reviewing your solution can help you to gain many marks. There are three questions to ask
yourself here:
Have I met the question requirements?
Yes, we have mentioned this already. Examiner Reports over the years advise that failure to
follow the instructions provided in the question requirements is a significant factor in causing
students to lose marks. For instance, easy marks can be gained by putting your answer in the
correct format. This could be in the form of a report or memo or whatever is asked in the
question. Likewise, look carefully at the time period requested. The standard accounting
period is 12 months, but occasionally examiners will specify a different accounting period.
Is my solution reasonable?
Look at the figures in your solution. How do they compare relative to the size of the figures
provided in the question?
For example, if Revenue were 750,000 and your Net Profit figure was more than 1 million,
then clearly this is worth checking.
If there were some extraordinary events it is possible for this to be correct, but more than
likely, you have misread a figure from your calculator. Likewise, the depreciation expense
should be a fraction of the value of the fixed assets.
What have I learned?
Very often in exams, different parts of the solution are interlinked. An answer from one of
your workings can frequently be used in another part of the solution. The method used to
figure out an answer may also be applicable to other parts of your solution.
Conclusion
In order to pass your exams you will have to solve many problems. The first problem to
overcome is your reaction to unusual items. You must expect problems to arise in exams and
be prepared to deal with them in a systematic manner. John Foster Dulles, a former US
Secretary of State noted that: The measure of success is not whether you have a tough
problem to deal with, but whether it is the same problem you had last year. We hope that, by
applying the principles outlined in this article, you will be successful in your examinations
and that you can move on to solve and deal with new problems.

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Stage: Intermediate Level
Subject Title: I1.1 Managerial Finance
Examination Duration: 3 Hours
Assessment Strategy
Examination Approach
Some questions may be entirely discursive, while others will be both discursive and
computational. Skills examined will include comprehension, detailed application, analysis,
evaluation, synthesis, and effective communication skills in relation to the production of
reports and memoranda for internal use. Managerial Finance is a core subject, and this is
reflected by the limited choice in both sections of the examination paper. Students are
expected to integrate and apply learning from this and other syllabi, as appropriate.
Examination Format
The assessment is by an unseen closed-book examination of 3 hours’ duration. The paper is
divided into two sections.
In Section A students are required to answer 3 questions, question 1 a compulsory 25 mark
question, question 2 a compulsory 20 mark question and question 3 a compulsory 15 mark
question.
Students have a choice of answering Part A or Part B of question 3.
In Section B students are required to answer 2 questions from 3. In summary, students are
required to answer a total of 5 questions out of 6.
Marks Allocation

Marks

Section A
Question 1
Question 2
Question 3
(Students have a choice,
Part A or B must be answered)
Section B
Question 4
Question 5
(Students have a choice,
Part A or B must be answered)

25
20

15

20

20
Total 100

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CPA Syllabus 2012

Learning Resources
Core Texts
Arnold / Corporate Financial Management
4th Edition/ Pearson 2008 / ISBN
9780273725220
Drury / Management & Cost Accounting 7th
ed / (Cengage) / 2007 / ISBN:
9781844805662 / ISBN 1844805662.
Manuals
I1.1 Managerial Finance manual – Institute of Certified Public Accountants of Rwanda
Useful Websites
(as of date of publication)
www.icparwanda.com
http://www.rra.gov.rw/
http://www.gfmag.com/
www.cfo.com -CFO.com
www.ifac.org/ - International Federation of
Accountants.
www.ft.com - Financial Times.
www.wsj.com - The Wall Street Journal
online.
www.investmentinternational.com Investment International.

Page 12

REVISION QUESTIONS AND
SOLUTIONS
Stage:
Subject Title:

Intermediate I1.1
Managerial Finance

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Revision questions
1. A You have been summoned to a meeting with your new managing director. He states
that as maximisation of the company’s share price depends upon the level of earnings
per share that is achieved, it is vital to improve profits next year. He gives you a list of
suggested ways to achieve this. The list includes:
(i)

Minimise capital investment to reduce depreciation charges.

(ii)

Increase wages and salaries by less than the level of inflation and sell the land
that is currently used as a staff sports field.

(iii) Reduce overdraft charges by delaying payments to creditors.
(iv) Delay expenditure on new equipment that would reduce pollution levels from the
company’s factory.
Requirement:
Prepare a memo to the managing director discussing the possible effects on relevant
stakeholders of the managing director’s suggestions and whether or not they are likely
to result in an increased share price.

B.

‘During the 2000’s the key objective of the executive directors of companies that are
listed on the Stock Exchange is to ensure that their respective companies survive so that
they may keep their jobs.’
Requirement:
Discuss the validity of this statement and explain what financial or other factors are
likely to influence executive directors’ objectives.

C.

Discuss whether or not the objectives of directors of a quoted company are likely to
conflict with those of the company’s shareholders.

D.

Discuss the importance and limitations of ESOP’s (Executive Share Option Plans) to
the achievement of goal congruence within an organisation

E.

(a)

‘Managers and owners of businesses may not have the same objectives.’
Explain this statement, illustrating your answer with examples of possible
conflicts of interest.

(b)

In what respects can it be argued, that companies need to exercise corporate
social responsibility?

(c)

Explain the meaning of the term ‘Value for Money’ in relation to the management
of publicly owned services/utilities.

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2.

Silicon Limited over the past 4 years has spent RWF 3,000 million on developing a
new silicon chip and is faced with three mutually exclusive choices:
(1)

It can manufacture the chip itself in which case the plant will cost RWF 5,000
million. This will be spent at the end of December 2007. Additional working
capital of RWF 2,100 million will be required when production commences at the
start of 2008. Sales and selling prices are expected to be as follows:
Number Sold – (000’s)
Sales Prices (RWF’000 per
unit)

2008
100
120

2009
100
120

2010
100
120

2011
80
100

2012
80
90

Silicon usually depreciates plant of this type over 5 years using the straight line
method and assumes a zero scrap value. Variable costs are expected to be RWF
65 per unit and attributable fixed costs, including depreciation, RWF 3,000
million per year.
(2)

Sell the know-how to a major international firm for a single payment of RWF
3,100 million, receivable at the end of December 2007.

(3)

Sell the know-how for a royalty of RWF 10,000 per unit. Anticipated sales of
chips would be as shown above.
If choices (2) or (3) are taken then the company will not manufacture the chips
itself. Silicon estimates that its weighted average cost of capital is 12%. You
should assume that sales revenue and costs occur at the end of the year in which
they arise. Ignore taxation.

Requirement:
(a)

Calculate the cash flows relevant to a decision whether or not to manufacture the
chips. You can ignore choices 2 and 3 for this part of the answer.

(b)

Calculate the net present value of each option.

(c)

What other factors should be taken into account before a decision is made? What
would your decision be?

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3.

The management team of Bryher Ltd is considering the purchase of equipment to
enable the corrosive waste produced by one of its existing manufacturing processes to
be converted into a marketable product. At present the corrosive waste is removed by a
firm and the contractual arrangements for the safe disposal of the waste will cost
Bryher RWF 100,000 per year for each of the next four years. Early termination of the
contract, which will be required if the waste is used for production, will cost RWF
60,000 immediately and this contract termination penalty will not be allowed as a tax
deductible expense.
The machinery will cost RWF 400,000, financed entirely by a fixed interest 10% loan.
At the end of year 4 the equipment will be sold for RWF 40,000; the dismantling,
cleaning and selling costs will amount to RWF 30,000.
Availability of the waste product would restrict sales of the marketable product, all
made on a cash basis, to RWF 450,000 for each of years 1 and 2 and to RWF 700,000
for each of years 3 and 4. The operating and other costs of the proposal are estimated
at:

Labour costs
Additional materials used
Other expenses
Factory overhead
Loan interest
Depreciation

Year 1
RWF ’000

Year 2
RWF ’000

150
60
80
110
40
90
530

170
80
90
120
40
90
590

Year 3
RWF
’000
150
170
110
220
40
90
780

Year 4
RWF
’000
200
170
140
290
40
90
930

All ‘Other expenses’ are caused by the proposed project and are paid in the years
shown. Similarly, ‘Labour costs’ are incremental cash costs except that part of the costs
for each of years 1 and 2 relate to persons currently employed by Bryher who are not
fully utilised in productive work. The transfer of these employees to the proposed
project is expected to reduce idle time payments by RWF 30,000 and RWF 20,000 for
each of years 1 and 2.
Purchases of additional materials are for cash. Storage of materials will utilise space
which would otherwise have been rented out for RWF 20,000 per year for years 2 and 3
only. Included in ‘Additional materials used’ are 1,000 units per year of material X at a
cost of RWF 15 per unit; this is the price which Bryher has contracted to pay for each
unit of the material. However, until the end of year 3, material X will be in short supply
and any available quantities could be used elsewhere in Bryher to earn a contribution
before tax of RWF 10 per unit in excess of cost. From year 4, material X will not be in
short supply. No stocks of material X are ever held at year-ends.
‘Factory overhead’ is an apportionment of general factory overheads which, as a result
of this venture, will increase in total only by RWF 60,000 per year for the additional
insurance premiums relating to the hazards of handling the corrosive material.
It may be assumed that all cash flows relating to Bryher’s activities which occur during,
but not at the start of a year, actually occur at the year-end.
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Bryher is subject to tax at a rate of 50% with a one-year delay. Capital expenditure is
eligible for 100% first year allowances and sales proceeds of assets are subject to tax.
Apart from the contract termination payment all operating expenses are tax deductible.
Bryher is a very profitable firm and can utilise all first year allowances in full at the
earliest opportunity.
Requirement:
Using 15% as the appropriate after-tax discount rate within a net present value
calculation, advise Bryher on the desirability of converting the corrosive waste into a
marketable product.
To what amount could the contract termination payment become before your advice
would change?

4.

Cong Ltd has asked for your assistance to review a capital investment proposal. The
proposal involves purchasing a three-year exclusive licence for the EAC to brew a wellestablished brand of Asian beer, called Cofisher.
Your review of the draft licence has noted that:
•

The licence allows you to brew 4,000,000 bottles per annum.

•

Cong Ltd’s intention is to brew 75% of the permitted volume in Kigali and enter
into a sub-licencing agreement with a brewery in Mombassa for the remaining
volume (this is allowable under the terms of the licence).

•

To purchase the licence for the three year period will cost Cong Ltd RWF
2,880,000.

Key elements of the business proposal put together by Cong Ltd’s staff are:
• Each bottle will wholesale for RWF 2 and will cost RWF 0.50 to distribute. The
brewing process taking place in Kigali will cost RWF 1 per bottle. Additional
factory overheads will be incurred on the project costing RWF 100,000 per
annum.
• Cong Ltd plans to spend RWF 500,000 immediately on an initial promotional drive.
Thereafter, in year 1 it will spend RWF 500,000 and in year 2 this will reduce by
RWF 100,000. It will not spend anything on promotion in the last year of the
licence.
• The Mombassa based brewer has agreed to pay Cong Ltd a royalty of RWF 0.30 per
bottle.
• The brewer will contribute a one off payment of RWF 60,000 in year 3 to Cong Ltd to
help defray the promotional cost.
Other Information:
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• Cong Ltd pays corporation tax at 15% one year in arrears. Licence payments are fully
deductible. Corporation tax will not be refunded, instead payments are calculated
on a cumulative liability/carry forward of tax losses basis.
• Cong Ltd’s financial director has stated that investments of this type are only accepted
if they achieve both a three-year payback and a minimum internal rate of return
(IRR) of 11%.
Requirement:
Prepare a report for the Board of Cong Ltd. which:
1.

Advises whether or not to accept the investment based on financial criteria alone.
(16 marks)

2.

Identifies four other qualitative factors which the management of Cong Ltd
should consider before reaching their final decision.
(8 marks)

Note:

Presentation
(1 mark)
[Total: 25 marks]

5.

ARED LIMITED
Ared Ltd manufactures a single product. It is preparing monthly budgets for the six months
from July to December. The following standard revenue and cost data are available:
Selling price
Materials
Labour
Direct expenses

RWF 12.00 per unit
2 kg per unit at RWF 2.40 per kg
RWF 1.80 per unit
RWF 1.20 per unit

Sales in June and July are forecast to be 10,000 units in each month. As a direct result of
marketing expenditure of RWF 95,000 in August, sales are expected to be 11,000 units in
August and to increase by 1,000 units in each month from September to December. Sales after
December are expected to remain at the December level.
25% of sales are paid for when they occur and 75% of sales are paid for in the month following
sale. Stocks of finished goods at the end of each month are required to be 20% of the expected
sales for the following month. Stocks of materials at the end of each month are required to be
50% of the materials required for the following month’s production.
Materials are paid for in the month following purchase. Labour and direct expenses are paid
for in the month in which they occur. Overheads for production, administration and
distribution will be RWF 34,000 per month, including depreciation of RWF 12,000 per month.

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These overheads are payable in the month in which they occur. Ared Ltd has a RWF 750,000
bank loan at 8% per annum on which it pays interest twice per year, in March and September.
The cash balance at the end of June is expected to be RWF 50,000.
Requirement:
(a)

Prepare the following budgets for Ared Ltd on a month by month basis for the six month
period from July to December:
(i)

Production budget (units);

(ii)

Cash budget.

6.

Capital Rationing

(a)

Distinguish between ‘hard’ and ‘soft’ capital rationing, explaining why a company may
deliberately choose to restrict its capital expenditure.
(b)

Filtrex Ltd is a medium-sized, all equity-financed, unquoted company which specialises
in the development and production of water- and air-filtering devices to reduce the
emission of effluents. Its small but ingenious R & D team has recently made a
technological breakthrough which has revealed a number of attractive investment
opportunities. It has applied for patents to protect its rights in all these areas. However,
it lacks the financial resources required to exploit all of these projects whose required
outlays and post-tax NPVs are listed in the table below. Filtrex’s managers consider that
delaying any of these projects would seriously undermine their profitability, as
competitors bring forward their own new developments. All projects are thought to have
a similar degree of risk.
Project
A
B
C
D
E

Required Outlay
RWF
150,000
120,000
200,000
80,000
400,000

NPV
RWF
65,000
50,000
80,000
30,000
120,000

The NPVs have been calculated using as a discount rate the 18% post-tax rate of return
which Filtrex requires for risky R & D ventures. The maximum amount available for this
type of investment is RWF 400,000, corresponding to Filtrex’s present cash balances,
built up over several years’ profitable trading. Projects A and C are mutually exclusive
and no project can be subdivided. Any unused capital will either remain invested in
short-term deposits or used to purchase marketable securities, both of which offer a
return well below 18% post-tax.
Requirement:
(i)

Advise Filtrex Ltd, using suitable supporting calculations, which combination of
projects should be undertaken in the best interests of shareholders, and

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(ii)

(c)

Suggest what further information might be obtained to assist a fuller analysis.

Explain how, apart from delaying projects, Filtrex Ltd could manage to exploit more of
these opportunities.

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7.

FROG LIMITED

A client company Frog Limited has recently launched a new product, a porcelain doll.
It is now 4th February 2008, a few days after Frog Limited’s first month of production
and sale of the doll. Frog Limited operates a standard marginal costing system.
The standard cost card for the porcelain doll is as follows:
Standard Cost Card – Porcelain Doll
Direct Materials 2 Kg @ RWF 5 per Kg
Direct Labour 1 hour @ RWF 8 per hour
Variable Overhead 1 hour @ RWF 2 per hour
Standard Marginal Cost per Doll
Budgeted Selling Price per Doll
Standard Contribution per Doll

=
=
=
=
=
=

RWF 10
RWF 8
RWF 2
RWF 20
RWF 30
RWF 10

Frog Limited budgeted to produce and sell 10,000 dolls during January 2008. There
was no opening or closing stocks of raw materials or finished goods.
The actual results for the month ended 31st January 2008 were as follows:
12,000 Dolls were produced and sold for a total of
RWF 336,000
22,000 Kgs of raw material were purchased and used costing RWF 132,000
13,000 labour hours were worked costing RWF 7 per hour
Variable overheads incurred totalled
RWF 26,000
A discussion with staff has indicated the following issues arose during January 2008
relating to the production of the dolls:
• As a result of market shortages, Frog Limited’s buyers had to buy a more expensive
grade of material than that incorporated into the standard cost
• Management had to employ semi-skilled workers during the month due to an inability
to attract skilled workers for the RWF 8 hourly rate of pay offered
• A penetration price of RWF 28 was adopted for January 2008 to help achieve a
successful market entrance
Management have asked you to present a report on the performance of the doll for the
month ended 31st January 2008.

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Requirement:
Prepare a month-end briefing note for the management of Frog Limited which:
• Presents an operating statement that reconciles the budgeted contribution for January
2008 to the actual profit
(14 Marks)
• Comments on the January 2008 performance and identifies the likely cause of the
variances reported and recommend actions management may take to address the
causes of the variances and improve performance in January 2008
(6 Marks)
[Total: 20 Marks]

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8.

(a)

Explain, with the use of a numerical example, the meaning of the term ‘cash
operating cycle’ and its significance in relation to working capital management.

(b)

Dodgimotors Ltd owns a total of ten franchises, in a variety of locations, for the
sale and servicing of used cars. Dodgimotors operate different systems for
banking of sales receipts, depending on the type of sale. Receipts from car sales
are banked once a week on mondays, and receipts from car servicing work are
banked twice a week on wednesdays and fridays. No banking facilities are
available at the weekend i.e. Saturdays or Sundays. The sales mix (as a
percentage of total revenue) is as follows:
•

62.5% second hand vehicles;

•

37.5% servicing.

Total sales for all business areas amounted to RWF 10 billion in the recent year.
Dodgimotors pays interest at a rate of 8·5% per annum on an average overdraft of
RWF 65 m, and the company’s finance director has suggested that the company
could significantly reduce the interest charge if all sales receipts were banked on
the day of sale. All the garages are open every day except Sunday. Assume that
the daily sales value (for both areas of business) is spread evenly across the week.

Requirement:
Calculate the value of the annual interest which could be saved if all ten franchises
adopted the finance director’s suggestion of daily banking.
(c)

Using the example of a car dealership such as Dodgimotors, as given in (b)
above, outline the advantages and disadvantages of centralisation of the treasury
function.

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9.

Please find attached extracts from the Income and Expenditure and Balance Sheets of
NMH Limited for the last two years. NMH Limited is a motor dealership. Motor
manufacturers normally allow sixty days credit. The company has been aggressive in
the strategic pursuit of growth over the last year.
Balance Sheet as at 31st December 2010 and 2011
2010
Assets
Non Current Assets (at NBV)
Property & Plant (Showrooms)
Other Assets
Non Current Assets
Current Assets
Inventories
Trade Receivables
Cash & Cash Equivalents
Total Current Assets
Total Assets

2011

300
40

530
30
340

560

700
80
400

1,650
250
0
1,180
1,520

Equity and Liabilities
Equity attributable to equity holders
Share capital
Other reserves (Retained Revenue Reserves)
Non Current Liabilities
Long term borrowings
Current Liabilities
Trade Payables
Short term borrowings
Current portion of long term borrowings
Total Current Liabilities
Total Liabilities
Total Equity and Liabilities

2010
Revenue
Less: Cost of Sales
Gross Profit
Less: Expenses
Net Profit

3,600
2,600
1,000
780
220

Page 25

1,900
2,460

100
260
360

100
880
980

400

100

380
0
380
760
1,160
1,520

1,000
100
280
1,380
1,480
2,460

2011

6,400
4,500
1,900
1,280
620

Requirement:
Prepare a briefing note for NMH Limited’s management on its working capital
management during 2011.
Total: 15 Marks

Page 26

10.

It is the 1st September 2007, your client CLG Limited’s Financial Director, Sylvia
Laudenberg has just been informed that the finance manager of CLG Limited’s
Gikondo factory has gone on long-term sick leave. She is immediately concerned that
the first draft budgets for the year ended 31st December 2008 for the Gikondo factory
are due for submission by month end (30th September 2007). The Gikondo factory
manufactures just one product, a wooden horse.
Sylvia has asked you to travel to Gikondo with the urgent brief of submitting a
quarterly cash budget for the year ended 31st December 2008. You have spent the last
two days at the Gikondo factory. During this time you have inspected the budget
working files and had discussions with key staff. You have discerned the following
information relevant to the preparation of the requisite budgets.
Review of Budgeting Working File
•
The variable cost per unit is estimated at RWF 10
•

Budgeted quarterly fixed production costs for the year 2008 are RWF 2,575,000.
This includes annual depreciation on plant and machinery of RWF 100,000.

Discussions with Sales Manager
The sales demand projected for each quarter of 2008 are as follows:
Projected Sales Demand
Quarter Demand (units)
1
40,000
2
52,000
3
48,000
4
54,000
•

The price per horse has been set at RWF 120 for the first six months of the year,
increasing by RWF 30 per unit for the remainder of the year 2008.

•

Sales in both quarter 3 and 4 of 2007 are forecast at 35,000 horses per quarter at a
sales price of RWF 100 each

Discussions with Production Manager
•
Horses are manufactured on a JIT (just in time) basis
•

Each horse requires two units of component Zee costing RWF 8 per component.

•

Materials are purchased on a JIT basis

•

Two hours of direct labour are required for the production of each unit of finished
product. Labour currently costs RWF 10 per hour and is subject to a pay award of
20% effective from 1st October 2008.

Discussions with the Factory Bookkeeper
•
All sales are on credit. Debtors take three months to settle their accounts.
•

Materials are paid for six months after the date of purchase

Page 27

•

Wages and all overheads (fixed and variable) are paid in the quarter in which they
are incurred

•

On 1st January 2008 a motor vehicle will be purchased at a cost of RWF 50,000.
It will be paid for in full in September 2008.

•

Corporation Tax owing on 31st December 2007 must be paid in July 2008.

The Forecast Balance Sheet as at 31st December 2007 is as follows:
CLG Ltd – Gikondo Plant – Projected Balance Sheet as at 31st December 2007
RWF
Assets
Non Current Assets
Land & Buildings
Plant & Equipment at Net Book Value
Current Assets
Trade Receivables
Cash and Cash Equivalents
Total Assets
Equity and Liabilities
RWF 10 Ordinary Shares
Accumulated profits
Current Liabilities
Trade payables
Corporation Tax
Short Term Borrowings/Overdraft
Total Equity and Liabilities

2,000,000
200,000
3,500,000
0
5,700,000
1,000,000
3,200,000
1,350,000
70,000
80,000
5,700,000

Note:
The trade payable figures can be broken down as follows:
Quarter 3 purchases = RWF 650,000
Quarter 4 purchases = RWF 700,000
Requirement:
Prepare a quarterly cash flow forecast for year ended 31st December 2008
(19 Marks)
Presentation Mark (1 Mark)

Total: 20 Marks

Page 28

Present Value Table
Present value of 1 i.e. (1 + r)-n
Where r = discount rate
n = number of periods until payment
Discount rates (r)
Periods
(n) 1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

1
2
3
4
5

0·990
0·980
0·971
0·961
0·951

0·980
0·961
0·942
0·924
0·906

0·971
0·943
0·915
0·888
0·863

0·962
0·925
0·889
0·855
0·822

0·952
0·907
0·864
0·823
0·784

0·943
0·890
0·840
0·792
0·747

0·935
0·873
0·816
0·763
0·713

0·926
0·857
0·794
0·735
0·681

0·917
0·842
0·772
0·708
0·650

0·909
0·826
0·751
0·683
0·621

1
2
3
4
5

6
7
8
9
10

0·942
0·933
0·923
0·914
0·905

0·888
0·871
0·853
0·837
0·820

0·837
0·813
0·789
0·766
0·744

0·790
0·760
0·731
0·703
0·676

0·746
0·711
0·677
0·645
0·614

0·705
0·665
0·627
0·592
0·558

0·666
0·623
0·582
0·544
0·508

0·630
0·583
0·540
0·500
0·463

0·596
0·547
0·502
0·460
0·422

0·564
0·513
0·467
0·424
0·386

6
7
8
9
10

11
12
13
14
15

0·896
0·887
0·879
0·870
0·861

0·804
0·788
0·773
0·758
0·743

0·722
0·701
0·681
0·661
0·642

0·650
0·625
0·601
0·577
0·555

0·585
0·557
0·530
0·505
0·481

0·527
0·497
0·469
0·442
0·417

0·475
0·444
0·415
0·388
0·362

0·429
0·397
0·368
0·340
0·315

0·388
0·356
0·326
0·299
0·275

0·350
0·319
0·290
0·263
0·239

11
12
13
14
15

(n)

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

1
2
3
4
5

0·901
0·812
0·731
0·659
0·593

0·893
0·797
0·712
0·636
0·567

0·885
0·783
0·693
0·613
0·543

0·877
0·769
0·675
0·592
0·519

0·870
0·756
0·658
0·572
0·497

0·862
0·743
0·641
0·552
0·476

0·855
0·731
0·624
0·534
0·456

0·847
0·718
0·609
0·516
0·437

0·840
0·706
0·593
0·499
0·419

0·833
0·694
0·579
0·482
0·402

1
2
3
4
5

6
7
8
9
10

0·535
0·482
0·434
0·391
0·352

0·507
0·452
0·404
0·361
0·322

0·480
0·425
0·376
0·333
0·295

0·456
0·400
0·351
0·308
0·270

0·432
0·376
0·327
0·284
0·247

0·410
0·354
0·305
0·263
0·227

0·390
0·333
0·285
0·243
0·208

0·370
0·314
0·266
0·225
0·191

0·352
0·296
0·249
0·209
0·176

0·335
0·279
0·233
0·194
0·162

6
7
8
9
10

11
12
13
14
15

0·317
0·286
0·258
0·232
0·209

0·287
0·257
0·229
0·205
0·183

0·261
0·231
0·204
0·181
0·160

0·237
0·208
0·182
0·160
0·140

0·215
0·187
0·163
0·141
0·123

0·195
0·168
0·145
0·125
0·108

0·178
0·152
0·130
0·111
0·095

0·162
0·137
0·116
0·099
0·084

0·148
0·124
0·104
0·088
0·074

0·135
0·112
0·093
0·078
0·065

11
12
13
14
15

Page 29

Annuity Table

Present value of an annuity of 1 i.e.

1 – (1 + r)–n
r

Where r = discount rate
n = number of periods until payment
Discount rates (r)
Periods
(n) 1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

1
2
3
4
5

0·990
1·970
2·941
3·902
4·853

0·980
1·942
2·884
3·808
4·713

0·971
1·913
2·829
3·717
4·580

0·962
1·886
2·775
3·630
4·452

0·952
1·859
2·723
3·546
4·329

0·943
1·833
2·673
3·465
4·212

0·935
1·808
2·624
3·387
4·100

0·926
1·783
2·577
3·312
3·993

0·917
1·759
2·531
3·240
3·890

0·909
1·736
2·487
3·170
3·791

1
2
3
4
5

6
7
8
9
10

5·795
6·728
7·652
8·566
9·471

5·601
6·472
7·325
8·162
8·983

5·417
6·230
7·020
7·786
8·530

5·242
6·002
6·733
7·435
8·111

5·076
5·786
6·463
7·108
7·722

4·917
5·582
6·210
6·802
7·360

4·767
5·389
5·971
6·515
7·024

4·623
5·206
5·747
6·247
6·710

4·486
5·033
5·535
5·995
6·418

4·355
4·868
5·335
5·759
6·145

6
7
8
9
10

11
12
13
14
15

10·37
11·26
12·13
13·00
13·87

9·787
10·58
11·35
12·11
12·85

9·253
9·954
10·63
11·30
11·94

8·760
9·385
9·986
10·56
11·12

8·306
8·863
9·394
9·899
10·38

7·887
8·384
8·853
9·295
9·712

7·499
7·943
8·358
8·745
9·108

7·139
7·536
7·904
8·244
8·559

6·805
7·161
7·487
7·786
8·061

6·495
6·814
7·103
7·367
7·606

11
12
13
14
15

(n)

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

1
2
3
4
5

0·901
1·713
2·444
3·102
3·696

0·893
1·690
2·402
3·037
3·605

0·885
1·668
2·361
2·974
3·517

0·877
1·647
2·322
2·914
3·433

0·870
1·626
2·283
2·855
3·352

0·862
1·605
2·246
2·798
3·274

0·855
1·585
2·210
2·743
3·199

0·847
1·566
2·174
2·690
3·127

0·840
1·547
2·140
2·639
3·058

0·833
1·528
2·106
2·589
2·991

1
2
3
4
5

6
7
8
9
10

4·231
4·712
5·146
5·537
5·889

4·111
4·564
4·968
5·328
5·650

3·998
4·423
4·799
5·132
5·426

3·889
4·288
4·639
4·946
5·216

3·784
4·160
4·487
4·772
5·019

3·685
4·039
4·344
4·607
4·833

3·589
3·922
4·207
4·451
4·659

3·498
3·812
4·078
4·303
4·494

3·410
3·706
3·954
4·163
4·339

3·326
3·605
3·837
4·031
4·192

6
7
8
9
10

11
12
13
14
15

6·207
6·492
6·750
6·982
7·191

5·938
6·194
6·424
6·628
6·811

5·687
5·918
6·122
6·302
6·462

5·453
5·660
5·842
6·002
6·142

5·234
5·421
5·583
5·724
5·847

5·029
5·197
5·342
5·468
5·575

4·836
4·988
5·118
5·229
5·324

4·656
4·793
4·910
5·008
5·092

4·486
4·611
4·715
4·802
4·876

4·327
4·439
4·533
4·611
4·675

11
12
13
14
15

Page 30

Suggested answers
1. A

Memo
Whilst I agree that it is important to ensure that our share price is maximised, share
price maximisation is dependent upon maximising the present value of future cash
flows, not on maximising earnings per share (EPS) or profits. There is, of course, a
correlation between EPS, profit and share price, but, as long as the stock market is
efficient, short-term accounting measures are not the most important influence on share
price. If the stock market is not efficient then short-term accounting measures might
influence the company’s share price. In an efficient market, in order to maximise share
price the company should concentrate on undertaking capital investments with a
positive net present value. Some of your suggestions might upset stakeholders and
result in a reduction in share price. For example:
(i)

Minimising capital investment to produce a short-term increase in accounting
profit takes a short-term perspective and could mean ignoring excellent
investment projects which would increase the value of the organisation.
Shareholder wealth could be reduced as a result of such actions and employee
remuneration could be lower than would be achievable with further investment.

(ii)

Increasing wages and salaries by less than inflation could increase profits, but the
detrimental effect on workforce morale might produce the opposite effect because
of reduced efficiency. Conflict with trade unions could occur and some
employees might seek employment elsewhere.
Disposal of the sports field could produce a very hostile response from staff.

(iii) There might be some scope for delaying payment to creditors but if this delay is
significant, relations with creditors might be harmed and the company might face
more stringent credit terms from suppliers when new orders are placed.
Additionally, such a move could result in a lower credit rating and possibly higher
costs of finance.
(iv) The company might have some flexibility to delay expenditure on pollution
control equipment but we must ensure that we can still meet all government
standards for pollution. There might be significant social costs. Delay might
harm our reputation in the local community and with environmental pressure
groups. The effect of adverse publicity could outweigh any savings from
delaying expenditure.
I hope that this indicates some of the potential problems. I would be happy to discuss
alternative ways of increasing the company’s share price.

B.

Many countries experienced an economic recession during part of the 1990s and 20082011, with high levels of corporate failure. Executive directors will normally strive to
ensure that their company survives and that they keep their jobs, but this should not be
their prime objective. In most listed companies the executive directors only own a
small minority of the company’s shares. Directors, as agents of the owners of the
companies (primarily non-director shareholders - NDS), should act in the best interest
Page 31

of such shareholders. There may be conflicts of objectives between NDS and directors.
NDS will normally seek to maximise their wealth, often subject to satisfying secondary
objectives such as environmental standards and social provision. Executive directors
may have many objectives, including keeping their jobs, maximising salaries or ‘perks,’
maximising prestige, pensions or compensation agreements should they lose their
positions.
Directors’ objectives are influenced and constrained by many factors including:
(i)

The provisions in the Memorandum and Articles of Association and any
additional legal restrictions agreed between shareholders and directors.

(ii)

Restrictive covenants imposed by providers of debt.

(iii) Stock Exchange regulations.
(iv) Restrictions on directors’ loans and other financial transactions with the company.
(v)

Internal & external auditors; audit committees chaired by non-executive directors.

(vi) Limited term appointments of directors.
Ensuring corporate survival may satisfy the majority of shareholders of companies that
are in financial distress, but for profitable going concerns it might mean that relatively
safe decisions are taken, which although maintaining corporate survival, do not
maximise expected net present value or shareholder wealth. Remuneration schemes
may be devised that reward directors according to corporate performance, especially
share price linked performance. This is an attempt to ensure that goals consistent with
the maximisation of shareholders’ wealth exist between directors and NDS. If directors
are going personally to benefit from good share price performance, e.g. through share
option schemes, they are likely to be motivated to take decisions that will maximise
share price. There have, however, been criticisms that many recent share option
schemes have been too generous to directors.
If the market is efficient, or almost efficient, the decisions of directors, including
investment decisions will be known to the market and share prices will move according
to how market analysts and NDS regard the decisions. A decision that is sub-optimal,
and is not using the company’s resources in the most efficient way is likely to result in a
fall in share price. This may increase the probability of a takeover. The fear of takeover
is believed to be an incentive for managers to try and take the decisions that maximise
shareholder wealth.

C.

The main objective of shareholders is often assumed to be to seek the maximisation of
their wealth, subject to taking an acceptable amount of risk. In practice shareholders
may have multiple objectives which include social and environmental issues.
The objectives of directors do not automatically correspond with those of the
shareholders. Directors may seek to maximise their own income and/or wealth, which
could be at the expense of shareholders, to increase work related benefits such as cars
and pension schemes, to increase power and prestige, or to generate job security. The

Page 32

amount of risk that directors are prepared to take may significantly differ from the
desired risk of shareholders, especially those shareholders who own a diverse portfolio.
To some extent the actions of directors should correspond to the objectives of
shareholders who, at least in theory, have the right to replace directors if they are not
satisfied with the directors’ performance. In practice, unless major shareholders act in
unison the removal of directors may not be easy. Directors may, however, be
influenced by market forces to take actions that result in a high quality performance of
the company. If they do not, and if the market in which they operate is at least
reasonably efficient, the share price of the company will fall and the company will be
more exposed to takeover bids, which could result in the directors losing their positions.
If the market is not efficient, poor or self-motivated decision-making by directors may
not feed quickly and accurately into changes in market price.
Shareholders may try to encourage the objectives of directors to correspond to their
own through a variety of incentive schemes, such as performance related remuneration,
or share option schemes. The idea is that the directors will benefit from the same
positive corporate performance as the shareholders and, thus, have the incentive to take
decisions which lead to the best possible performance.

D.

Goal congruence refers to the situation where the goals of different groups coincide. In
many companies there are potential conflicts of objectives between the owners of the
company, the shareholders, and their agents, the managers of the company. Other
interest groups such as creditors, the government, employees and the local community
might also have conflicting objectives to the company’s shareholders. One way by
which managers, and sometimes employees in general, might be motivated to take
decisions/engage in actions which are consistent with the goals of the shareholders is
through ESOPs. ESOPs, however, will not assist in encouraging goal congruence
between other interest groups and the shareholders and managers.
ESOPs allow managers to purchase a company’s shares at a fixed price during a
specified period of time in the future, usually a period of years. They are aimed at
encouraging managers to take decisions which will result in high NPV projects, which
will lead to an increase in share price and shareholder wealth. The managers are
believed to seek high NPV investments as they, as shareholders, will participate in the
benefits as share prices increase.
There is, however, little evidence of a positive correlation between share option
schemes and the creation of extra share value. There is no guarantee that ESOPs will
achieve goal congruence. Share options will only be part of the total remuneration
package and may not be the major influence on managerial decisions. If share prices
fall managers do not have to purchase the shares and the value of the option to buy
shares becomes worthless or very small. This means that managers face less risk than
shareholders as they have an option which may be exercised if things go well but may
be ignored if things go badly. Shareholders have to face both circumstances.
Managers may be rewarded when share prices increase due to factors that have nothing
to do with their managerial skills. Additionally, ESOP schemes often base reward in
Page 33

part upon earnings per share, an accounting ratio which, at least in the short term, is
subject to manipulation by managers to their advantage.
Although ESOPs may assist in the achievement of goal congruence they are by no
means a perfect solution.

E.

(a)

It may be argued that managers and owners of a business may not have the same
interests because of the divorce between ownership and control. In many
organisations, the shareholders will have very little influence over the day to day
operations and management of a business. Managers will be aware of the need to
seek to maximise the wealth of their shareholders, but at the same time they may
be equally concerned to serve their own needs/interests. For example,
shareholders may be highly risk averse, looking only for one reasonable and
steady income from their investment. By contrast, a manager may by nature be
more of a risk taker, because he considers that his career may progress faster if he
is successful in the risks taken. In such a scenario, if the manager follows his
instincts in selecting business opportunities, then the shareholders’ objectives are
not being met. The reverse situation may be equally true, whereby shareholders
believe that management are excessively cautious in their selection of business
opportunities, but management are wary of taking risks as they wish to avoid any
large scale losses which might threaten their personal position. In both instances
there is a gulf between the objectives of the managers and owners.
Another example of where objectives might conflict is in the case of mergers and
take-overs. If a company has been reporting poor results, and becomes the victim
of a take-over bid, the shareholders are likely to be pleased as they will look to an
increase in the value of their investment. In contrast, the managers of the victim
company may well be very unhappy, as they sense the risk of redundancy.
Williamson suggested that many of the aims of managers actually work in direct
conflict with those of owners because managers look for perquisites and selfaggrandisement which add to company costs. Shareholders may be happy if
managers drove Honda Civic as the company cars. The managers may well seek
to have Mercedes instead! Similarly, having a large office and many staff to
supervise is good for a manager’s self-esteem, but they may not be essential to
the efficient running of the business: owners may be better off without them.
One key area where owner-manager objectives may conflict is in terms of the
time horizon used to judge success. Owners, especially institutions such as
pension funds, look to the long-term in setting their objectives, whereas a
manager may need to have short-term successes in order to further his/her career
prospects.

(b)

Corporate social responsibility can be defined in a number of ways, but the term
refers, in general, to the ways in which a privately owned company needs to be
aware of and respect the needs of the wider community. The responsibility to
shareholders is reasonably clearly defined and monitored by the financial markets
and company reporting systems. Corporate responsibilities to customers,
employees, and the community at large are less likely to be well defined. A
Page 34

company may be regarded as having responsibilities to its customers in terms of
providing them with a quality product, at an appropriate price, which is supplied
in a timely and efficient manner. The duty to the general public involves a
responsibility not to endanger the public in any way, to respect the environment,
and to support the local community where possible. Social responsibility also
extends to creditors, who should expect to be paid accurately and promptly.
National and local governments are also affected by the activities of businesses
and hence come under the remit of areas of social responsibility. Companies have
a duty to pay their taxes as due, and comply with national and local laws e.g.
planning/health and safety regulations. Lastly companies have a responsibility to
take care of their employees, ensuring a safe working environment and paying
fair wages.
In conclusion it is no longer sufficient for a company to think that it need only
serve the interests of its shareholders. It is now regarded as good practice to look
to the needs of the broader stakeholder group and so take on a wider social
responsibility.
(c)

At its simplest, ‘Value for Money’ (VFM) means getting the best possible service
for the least possible cost. Public services are funded by the taxpayers and in
seeking value for money, the needs of the taxpayer are being served, insofar as
resources are being used in the best manner to provide essential services.
It is important to note that VFM does not mean lowest cost per se: it assesses cost
in relation to the service provided. Three aspects of VFM are of relevance:
efficiency, economy and effectiveness. Efficiency relates to the level of output
generated by a given input. Reducing the input/output ratio is an indication of
increased efficiency. Economy measures the cost of obtaining the required quality
of inputs needed to produce the service. The aim is to acquire the necessary
inputs at the lowest possible cost. Effectiveness measures the extent to which the
service meets its declared objectives. For example, a refuse collection service is
only effective if it meets its target of, say, weekly collections from domestic
premises. The service is economic if it is able to minimise the cost per weekly
collection and not suffer from wasted resources. The service is increasing its
efficiency if it is able to raise the number of collections per vehicle per week for
no change in cost.

Page 35

2.

Silicon Ltd

(a)
End of Year
No. sold 000’s
Sales price RWF’000 per
unit
Variable price RWF’000 per
unit
Contribution RWF’000 per
unit

2007

RWF
m
Total contribution
Less fixed costs
Plant
Working capital
Net cash flow

(5,000)
(2,100)
(7,100)

2008
100

2009
100

2010
100

2001
80

2002
80

120

120

120

100

90

65

65

65

65

65

55

55

55

35

25

RWF
m
5,500
(2,000)

RWF
m
5,500
(2,000)

RWF
m
5,500
(2,000)

RWF
m
2,800
(2,000)

RWF
m
2,000
(2,000)

3,500

3,500

3,500

800

2,100
2,100

3,500
0.89
3,115

3,500
0.80
2,800

3,500
0.71
2,485

800
0.64
512

2,100
0.57
1,197

10
100
1,000
0.89
890

10
100
1,000
0.80
800

10
100
1,000
0.71
710

10
80
800
0.64
512

10
80
800
0.57
456

(b)
Net cash flow
Discount factor
Present value

(7,100)
1.00
(7,100)

Net Present Value - RWF m

3,009

Single Payment
Net Present Value - RWF m

3,100

Royalty
Royalty – RWF’000 per unit
No. sold 000’s
Total Royalty - RWF m
Discount factor
Present value - RWF m
Net Present Value – RWF m

(c)

3,368

There are a number of other factors which should be considered before a choice
between the three alternatives is made. Firstly the company should consider its overall
strategy. Has it a policy to license its know-how rather than to use it in its own
production? Secondly, it should consider carefully the impact of any decision to sell its
know-how on the employment prospects within the firm and on the morale of its
employees. Thirdly it should assess any other financial factors which have not been
included in the analysis. For example no allowance has been made in the question for
taxation or inflation.
From a purely financial viewpoint the royalty option has the highest net present value
of just over RWF 3,300 million. However it is more risky that the down-payment
whose net present value is RWF 3,100 million. The manufacture option with virtually
the same net present value of just over RWF 3,000 m does not look particularly
Page 36

attractive in view of its risks. Probably the best option would be for Silicon to try to
negotiate a minimum royalty payment. If this is not possible, the down-payment option
appears to be marginally the most attractive choice.

Page 37

3 Bryher Ltd

Sales

Year 1
RWF
’000
450

Year 2
RWF
’000
450

Year 3
RWF
’000
700

Year 4
RWF
’000
700

120
60
10
80
60
330
120
60

150
80
10
90
60
20
410
40
20

150
170
10
110
60
20
520
180
90

200
170
140
60
570
130
65

Labour costs (note 1)
Materials used
Loss on material X (note 2)
Other expenses
Insurance
Loss of rent
Profit
Corporation Tax @ 50%

Notes:
(1) Labour costs are reduced by RWF 30,000 and RWF 20,000 in each of years 1 and
2. These amounts will be paid by Bryher whether or not the project is undertaken
and are therefore not incremental costs of the project.
(2)

1,000 units @ RWF 10 per unit.
Incremental Cash Flows

Cost of machinery and tax
Net salvage value and tax
Incremental operating profits
Tax
Contract termination
Contract payments saved
Tax on contract payments
Net cash flows

Year 0
Year 1
Year 2
Year 3
Year 4
Year 5

Year 0
RWF
’000
(400)

Year 1
RWF
’000
200
120

Year 2
RWF
’000

Year 3
RWF
’000

Year 4
RWF
’000

40
(60)

180
(20)

10
130
(90)

100
(50)
30

100
(50)
210

100
(50)
100

Year 5
RWF
’000
(5)
(65)

(50)
(120)

(60)
100
(460)

420

Cash Flows
RWF ’000

D.F. @ 15%

(460)
420
30
210
100
(120)

1.000
0.870
0.756
0.658
0.572
0.497

Page 38

PV
RWF
’000
(460.00)
365.40
22.68
138.18
57.20
(59.64)
63.82

The net present value is RWF 63,820 and the project is worthwhile. Therefore, Bryher
should convert the corrosive waste into a marketable product.
The contract termination payment could increase by RWF 63,820 i.e. to RWF 123,820,
before the above advice would change.

Page 39

4.

Report
To:

Board of Directors, Cong Ltd

From:

A.N. Other, Financial Consultant

Date:

1st September 2005

Subject:

Financial Review of Licence Proposal

Introduction
This report sets out the results of the financial evaluation and identifies the wider issues to
consider prior to making the decision whether or not to purchase the licence for Cofisher beer.

Approach
The report uses information obtained from the draft licence agreement and information
provided by your business analysts.
Given that the proposal is for three years the financial evaluation must consider the
time value of money. To take into account the time value of money I have used a
mathematical technique called discounting. This involves discounting all future cash
flows back to their present value.
Financial Analysis
Please see attached Appendix 1 and 2, which set out the detailed calculations. The
results can be summarised as follows:
• Payback Period = 2.5 Years
• Internal Rate of Return = 10.3%
Recommendation
Based solely on the above financial criteria the proposal should be rejected as it does
not achieve the required internal rate of return of 11%. Please note that the project
meets the criterion to payback within three years.
Other Considerations
Before arriving at a final decision the following qualitative factors should be
considered:
• Has Cong Ltd an option to extend the licence after the three years?
• What competitor beers are on/likely to reach the market over the three years period of
the licence?
• Have we the necessary skills/abilities to brew the beer to the quality levels expected?
• How will Rwandan customers’ tastes and preferences impact on the likely demand for
the beer?

Page 40

• What is the intention of the Asian company in relation to serving the Rwandan market
after the three year period e.g. will it be sold to a competitor, do they intend to
brew themselves?
• How will the beer impact on our present products?
• What laws are we to use to enforce the licence - Rwandan or Indian?
• How reliable is the quality of the Mombassa brewer?
Conclusion
On strict financial criteria the proposal must be rejected. However, there may be more
commercial reasons to accept the proposal.
Appendix 1 – Internal Rate of Return

Licence Purchase
Net contribution Kigali
Royalty Mombassa brewer
Fixed Factory Costs
Promotional Spend
Contribution Mombassa brewer
Tax Payable
Net Annual Cash Flow

0
RWF ’000
-2,880

-500

1
RWF ’000

2
RWF ’000

3
RWF ’000

1,500
300
-100
-500

1,500
300
-100
-400

1,500
300
-100

4
RWF ’000

-3,380

1,200

1,300

60
0
1,760

Discount Factor 10%
Present Value
Net Present Value +16

1.0
-3,380

.9090
1,091

.8260
1,074

.7510
1,322

.6830
-90

Discount Factor 12%
Present Value
Net Present Value -103

1.0
-3,380

.8930
1,072

.7970
1,036

.7120
1,253

.6360
-84

-132
-132

IRR = 10% + 16/(16+103) x (12%-10%) = 10.27%

Appendix 2 - Payback Period
Cumulative Cash Flow

0
-3,380

1
-2,180

2
-880

3
880

Payback Period is 2.5 years. i.e. (2 years + (880/1760 x 12 months)
Note 1:
Cash contribution per bottle (RWF 2-RWF 1-RWF 0.5) = RWF 0.50 x 3m bottles =
RWF 1,500,000 p.a.
Note 2:

Royalty from Mombassa = RWF 0.3 per bottle x 1m bottles = RWF 300,000 p.a.

Page 41

4
748

Corporation Tax Computations
0
Net Cash Flow (above)
Cumulative Taxable Profits
Taxable profits
Taxation @ 15%

1

-3,380
-3,380
0

Page 42

1,200
-2,180
0

2
1,300
-880
0

3
1,760
880
880
0

4

132

5.

ARED LIMITED

Ared Ltd: Production budget for 6 months to end of December
Jun
July
Aug
e
Units
Sales
10,00
11,000
0,00
0
0
Units
Stock increase
200
200
Units
Production
10,20
11,200
0
Receipts
Cash sales
Credit sales

RWF'000
RWF’000

Total receipts

RWF’000

Payments
Materials
Labour
Direct expenses
Fixed overheads
Advertising
Interest

RWF'000
RWF'000
RWF'000
RWF'000
RWF'000
RWF'000

Net Cash flow
Opening balance
Closing Balance

Sept

Oct

Nov

Dec

12,000

13,000

14,000

15,000

200
12,200

200
13,200

200
14,200

0
15,000

3,300
9,000

3,600
9,900

3,900
10,800

4,200
11,700

4,500
12,600

12,300

13,500

14,700

15,900

17,100

4,848
1,836
1,224
2,200

5,136
2,016
1,344
2,200
9,500

5,616
2,196
1,464
2,200

6,096
2,376
1,584
2,200

6,576
2,556
1,704
2,200

7,008
2,700
1,800
2,200

10,10
8
1,892
5,000
6,892

20,196

3,000
14,476

12,256

13,036

13,708

-7,896
6,892
-1,004

-976
-1,004
-1,980

2,444
-1,980
464

2,864
464
3,328

3,392
3,328
6,720

July
10,00
0
12

Aug
11,000

Sept
12,000

Oct
13,000

Nov
14,000

Dec
15,000

12
13,200

12
14,400

12
15,600

12
16,800

12
18,000

13,200

14,400

15,600

16,800

18,000

3,300
9,900

3,600
10,800

3,900
11,700

4,200
12,600

4,500
13,500

3,000
9,000
12,00
0

RWF'000
RWF'000
RWF'000

Workings

June
Sales (units) 1
10,00
12

Sales price (RWF )
Sales revenue
RWF'
000

12,00

12,00
0

12,00
0
3,000
9,000

12,00
0
3,000
9,000

Calculation of sales receipts

Sales revenue
Cash sales (25%)
Credit sales (75%)

RWF'000
RWF'000

Page 43

Calculation of
Purchases
June
Production

units

10,00
0
Kg

Materials for
production

20,00
0

July
10,20
0

Aug
11,200

Sept
12,200

Oct
13,200

Nov
14,200

Dec
15,000

20,40
0

22,400

24,400

26,400

28,400

30,000

5,376

5,856

6,336

6,816

7,200

2,688

2,928

3,168

3,408

3,600

2,928

3,168

3,408

3,600

5,616

6,096

6,576

7,008

Oct

Nov

Dec

RWF'000

4,800
Half delivered in
month
Closing stock

RWF'000

2,448
2,400

RWF'000

2,448
Total purchases in
month

RWF'000

2,688
5,136

4,848

Payable in
Labour costs

4,896

July
RWF
Kg

Materials

2.00

Aug

Sept

180.0
0
2.00

180.00

180.00

180.00

180.00

180.00

2.00

2.00

2.00

2.00

2.00

Cost per Kg

RWF'000

2.40

2.40

2.40

2.40

2.40

2.40

Direct expenses
per unit

RWF'000

0.12

0.12

0.12

0.12

0.12

0.12

2,200

2,200

2,200

2,200

2,200

2,200

cash fixed o/heads RWF’000 3,400 less
Dep’n of RWF’000 1,200 non cash item

Page 44

6.

(a)

Hard capital rationing applies when a firm is restricted from undertaking all
apparently worthwhile investment opportunities by external factors over which it
has no control. These may include government monetary restrictions and the
general economic climate, e.g. a depressed stock market precluding a rights issue
of ordinary shares.
Soft capital rationing applies when a company decides itself to limit the amount
of capital expenditure which it is prepared to authorise. The capital budget
becomes a control variable which the company may relax if it chooses. Segments
of divisionalised companies often have their capital budgets imposed by the main
board of directors.
A company may purposely curtail its capital expenditure for a number of reasons:
It may consider that it has insufficient management expertise to exploit all
available opportunities without jeopardising the success of new and on-going
operations.
It may be deliberate policy to restrict the capital budget to concentrate
management attention on generating the very best and most carefully analysed
proposals. Self-imposed capital rationing may be an exercise in quality control.
•
•
•
•

(b)

(i)

Many companies adopt the policy of restraining capital expenditure to the
amounts which can be generated by internal resources (in reality, cash flow).
Reluctance to use the external capital markets may be due to:
a risk-averse attitude to financial gearing, possibly because of the operating
characteristics of the industry, e.g. high operating gearing in a cyclical
industry.
a reluctance to issue equity in the form of a rights issue, for fear of diluting
earnings, or
in the case of an unlisted company, reluctance to seek a quotation owing to
the time and expense involved and the dilution of ownership.
Assuming Filtrex wishes to maximise the wealth of its shareholders, it will
seek the set of investment projects with the highest combined NPVs.
As a first approximation it may examine the projects ranked according to
their estimated NPVs and select those with the highest NPVs, consistent
with the budget limitation. However, this would confine the programme to
project E alone, which apart from losing any benefits of diversification, is a
solution which can be improved upon because it overlooks the relationship
between the NPV itself and the amount of capital required to yield the
estimated NPV. Under capital rationing, it is often considered desirable to
examine the productivity of each RWF of scarce capital invested in the
various projects. This information is given by the profitability index (PI).
The ranking of the five projects according to their PIs is:
A

65/150

=

0.43
Page 45

B
C
D
E

50/120
80/200
30/80
120/400

=
=
=
=

0.42
0.40
0.37
0.30

Moving down the ranking, Filtrex would select projects A and B, but then,
due to indivisibility and the fact that projects A and C are mutually
exclusive, it would have to depart from the rankings and move down to D.
The remaining project E is too demanding of capital.
The selected programme of ABD would require an outlay of RWF 350,000
and generate an NPV of RWF 145,000. RWF 50,000 of scarce capital
would remain unspent and, according to the stated policy, would be
invested in short-term assets. Although of low risk, these offer a return less
than the 18% required by shareholders. Consequently it might be
preferable to return this unspent capital to shareholders in the form of a
dividend or share repurchase, if shareholders are able to invest for higher
returns in alternative activities. Liaison with major shareholders may be
required to determine their preferences.
It is possible to improve on both of the previous selections by trial and error
in an attempt to utilise the whole of the capital budget. The optimal
selection is BCD which offers a joint NPV of RWF 160,000. However,
even this result is suspect as it relies on evaluating the projects at the rate of
return required in the absence of rationing, in this case 18% post-tax. This
neglects the impact of capital rationing on the cost of capital - if apparently
worthwhile projects are rejected, there is an opportunity cost in the form of
the returns otherwise obtainable on the rejected projects. Projects should be
evaluated at the discount rate reflecting the rate of return on the best of the
rejected projects. Unfortunately, until the evaluation and selection is made,
this remains an unknown! It would be helpful to find the IRR for each
project.
(ii)

In addition to IRRs, other useful information might include:
Whether the rationing is likely to apply over the long-term, in which case,
projects can be postponed, and the impact of postponement on profitability.
If projects can be postponed, it may be desirable for Filtrex to select
projects in the base period offering a rapid return flow of cash in order to
provide funds to enable investment in postponed projects in the next time
period. In other words, it would be helpful to examine the cash flow
profiles of these projects and hence their rates of payback.
The degrees of risk: It is unlikely that all projects have a similar degree of
risk in practice, especially for the types of new product development
planned by Filtrex. A capital-constrained company may use its limited
access to finance to justify rejecting a high-risk activity, especially if it is
reliant on subsequent cash flows to finance postponed projects.

Page 46

What is the likelihood of obtaining marginal supplies of finance and on
what terms?
There are two basic ways in which a company in Filtrex’s position might
still manage to exploit more projects. It can involve other parties in the
project, or it can seek outside capital.
Sharing projects:
To the extent that some part of the project(s) still require further
development, e.g. design and market research, some of this work can be
subcontracted to specialist agencies who may be able to perform the work
at lower cost, or even to take payment out of the project cash flows.
The production and/or sale of the products can be licensed or franchised to
another party, with Filtrex arranging to receive a royalty or a percentage of
sales. This is particularly appropriate for overseas activities.
A joint venture could be mounted with a competitor, although for
commercial reasons it is often safer to arrange such alliances with
companies outside the industry, or with overseas companies wishing to
penetrate the local market.
The patent rights to one or more products could be sold and the purchaser
allowed to develop the projects.
Raising external finance:
Some marginal finance could be squeezed out of more intensive use of
working capital, although this could be counterproductive e.g. reducing
credit periods for customers may lose sales.
Some equipment could be leased.
If Filtrex has assets of sufficient quality, it may be possible to raise a
mortgage or issue debentures secured on these.
Alternatively, good-quality property assets could be sold to a financial
institution and their continued use secured via a leaseback arrangement.
Filtrex might approach official sources of aid such as a regional
development agency, if relevant, or perhaps the foreign investment bank.
Filtrex might approach a venture capitalist which specialises in extending
development capital to small to medium-sized firms. However, they may
require an equity stake and possibly insist on placing an appointee on the
board to monitor their interests.

Page 47

Filtrex may decide to seek a Stock Exchange quotation. However, this
would be time-consuming and costly, and involve releasing equity to a
wider body of shareholders.

Page 48

7.

FROG LIMITED

To: Board of Directors, Frog Limited
From: A. Hobbs, Accountant
Subject: Porcelain Doll – Performance Review for Month Ended January 2008
Date: 8th February 2008
Introduction
The purpose of this note is to brief management on the financial performance of the
porcelain doll for the month ended January 2008.
Performance Review – Porcelain Doll – January 2008
Overview
During January 2008 Frog Limited earned RWF 13,000 less contribution than budgeted
from producing and selling the porcelain doll. Full details of performance are provided
in the following operating statement which reconciles the budgeted contribution for the
month to the actual contribution achieved for the month.
Frog Limited - Operating Statement Month Ended January 2008
Variances

Details
Budgeted Contribution
Variances
Sales Price
Sales Volume
Direct Materials Price
Direct Materials Usage
Direct Labour Rate
Direct Labour Efficiency
Variable Overhead Expenditure
Variable Overhead Efficiency
Sub Totals
Net Variance
Actual Contribution

Note
1

Favourable

2
3
4
5
6
7
8
9

Adverse

Total
100,000

-24,000
20,000
-22,000
10,000
13,000
0
43,000

-8,000
0
-2,000
-56,000
-13,000

10

87,000

Commentary on Performance
Volume Increases - RWF 20,000 additional contribution
12,000 dolls were sold, a 2,000 increase on the budgeted sales. As a direct result Frog
Ltd. earned RWF 20,000 additional contribution above that budgeted. A major
contributory factor in achieving the sales volume increase is likely to be that we sold
each doll at RWF 2 less than budgeted.
Labour Rate Savings - RWF 13,000 saving
Page 49

We actually paid RWF 7 per labour hour. This was RWF 1 lower than the budgeted
hourly rate. The total saving as a result was RWF 13,000 favourable. This is likely to be
as a result of employing semi-skilled staff.
Efficient Direct Materials Usage - RWF 10,000 saving
An average of 1.83kg (22,000kg/12,000 dolls) of direct material was used to produce
each doll. This compares favourably with the standard expected input of 2kg per doll.
The resulted in a saving of 2,000 kgs/RWF 10,000. It is likely that this variance is a
direct result of buying a higher grade material.
Adverse Performance
Inefficient Labour Efficiency - RWF 8,000 overspend.
Our direct labour was inefficient. We worked 1,000 more hours than expected,
resulting in a labour efficiency overspend of RWF 8,000. This is likely to be as a result
of employing semi-skilled staff. As a direct result of this inefficiency additional
variable overhead costs were incurred, resulting in an additional overspend of RWF
2,000.
Direct Materials Price - RWF 22,000 overspend.
The average cost per kg. of direct material purchased was RWF 6. This represents a
RWF 1 increase on the budgeted cost of RWF 5. The impact of this cost increase was
an overspend of RWF 22,000. The likely reason is that a higher grade of material was
used with a consequent higher cost. This was due to unavoidable reasons as there was a
market shortage of the material planned to be used in the standard cost.
Sales Price - RWF 24,000 adverse
Each doll was sold at RWF 28. This is RWF 2 less per doll than budgeted. This
deliberate price reduction was required in order to achieve market penetration for the
new product. As a direct result we under-recovered RWF 24,000 in income for the
month. This price reduction is likely to have been a major contributory factor in the
ability to sell 2,000 more dolls than budgeted for the month.
Recommended Actions
• Management should send a memo to all sales staff recognising their effort during the
month in achieving 2,000 extra unit sales.
• Management must attempt to employ skilled labour in future months to reduce the
efficiency overspends.
• Management should revert to the original standard material.
Conclusion
January 2008 has been a month in which actual contribution fell short of budgeted
contribution. The main cause of this improvement has been the increased unit sales.
However, there are a number of cost and efficiency overspends which management
must address urgently in order to correct performance over the coming months.

Page 50

Frog Limited : Supporting Notes
Note 1) Budgeted Contribution
Budgeted Unit Sales * Standard Contribution Per Unit
10000 * 10 = 100000
Note 2) Sales Price Variance
(Actual Unit Price - Budgeted Unit Price ) * Actual Units Sold
(28 - 30) * 12000 = -24000 Adverse
Note 3) Sales Volume Variance
(Actual Units Sold - Budgeted Unit Sales ) * Standard Profit Per Unit
(12000-10000) * 10 = 20000 Favourable
Note 4) Direct Materials Price Variance
(Standard Unit Cost - Actual Unit Cost ) * Actual Units Purchased
(5 - 6) * 22000 = -22000 Adverse
Note 5) Direct Materials Usage Variance
(Standard Unit Usage (for the actual level of production)- Actual Units Used) *
Standard Cost Per Unit
(24000 - 22000) * 5 = 10000 Favourable
Note 6) Direct Labour Rate Variance
(Standard Hourly Rate - Actual Rate Per Hour ) * Actual Hours Worked
(8 - 7) * 13000 = 13000 Favourable
Note 7) Direct Labour Efficiency Variance
(Standard Hours (for the actual level of production)- Actual Hours Worked) * Standard
Rate Per Hour
(12000 - 13000) * 8 = -8000 Adverse
Note 8) Variable Overhead Expenditure Variance
(Standard Hourly Cost - Actual Cost Per Hour ) * Actual Hours Worked
(2 - 2) * 13000 = 0
Note 9) Variable Overhead Efficiency Variance
(Standard Hours (for the actual level of production)- Actual Hours Worked) * Standard
Cost Per Hour
(12000 - 13000) * 2 = -2000 Adverse
Note 10) Actual Contribution
Actual Sales Revenues
Less: Actual Costs Incurred
Direct Materials
132,000
Direct Labour
91,000
Variable Overheads
26,000
Total Costs
Actual Contribution
Page 51

336,000

249,000
87,000

8.

(a)

The working capital cycle (or cash operating cycle) is the length of time
between when a business makes payments to its suppliers for raw materials and
goods entering into stock, and when the business receives payment for those
resources from its customers. The number of days in the cycle is equal to:
Debtor days + Stock days (Finished goods + WIP + raw materials) – Creditor
days
For example, if analysis of company financial statements revealed the following
statistics:
Days
45
20
25
15
50

Debtors
Raw material stocks
Work in progress
Finished goods
Creditor days
Working capital cycle = 45 + 20 + 25 + 15 – 50 = 55 days

The number of days in the cycle represents the length of time for which the
business requires funding for working capital if it is to continue trading. As the
length of the cycle increases, therefore, the amount of working capital required by
the business also increases.
Working capital may be funded from either long-term or short-term sources of
finance, but as a general rule it is argued that ‘permanent’ working capital should
be paid for by long-term sources and ‘temporary’ working capital by short-term
sources. Debentures are an example of a long-term source of funds, and an
overdraft facility is an example of a short-term source. The significance of the
cycle for working capital management lies in the fact that if a company can
reduce the length of the cycle, it can lower its funding needs, and this can in turn
increase the potential ROCE. The length of the operating cycle can be reduced in
a number of ways, which vary from the very simple to the sophisticated. The use
of tight credit controls, Just in Time stock management and debt factoring are
various examples of ways in which the cycle can be reduced.
(b)

Dodgimotors
Annual sales RWF 10 billion, split as follows:
Second hand vehicles (62.5%) RWF 6.25 billion
Servicing (37.5%) RWF 3.75 billion
Second Hand Vehicle Sales
Weekly value RWF 6·25bn/52 = RWF 120.2m
Daily value RWF 120.2m / 6 (working days) = RWF 20.032m
Page 52

The cost of not banking receipts can be calculated daily, with the maximum delay
equalling 6 days, for sales made on Tuesday but not banked until the following
Monday. The total days delay in any one week is thus equal to:
Sales
Monday
Tuesday
Wednesday
Thursday
Friday
Saturday
Total

Delay
Nil
6 days
5 days
4 days
3 days
Nil
18
days

Weekly cost of delay = 18 x RWF 20.032m x 8.5%/365 = RWF 83,970
Annual cost of the delay = RWF 83,970 x 52 = RWF 4.366m
Vehicle Servicing
Weekly sales value RWF 3.75b/52 = RWF 72.115m
Daily sales value RWF 72.115m /6 = RWF 12,.019m
Total days banking delay:
Sales
Monday
Tuesday
Wednesday
Thursday
Friday
Saturday
Total

Delay
2 days
1 day
Nil
1 day
Nil
2 days
6 days

Weekly cost of delay = 6 x RWF 12.019m x 8.5%/365 = RWF 16,794
Annual cost of delay = 52 x RWF 16,794 = RWF 873,288
Total cost of delays in banking both sets of receipts
= RWF 4.366m + RWF 0. 874m = RWF 5.240m
Note: The calculation assumes that Dodgimotors Ltd is operating on an overdraft
on every working day of the year. In practice, it is likely that the level of
overdraft will vary throughout the year, and when the account is in credit, the
company will gain no interest saving benefit from the faster banking of receipts.
(c)

Management of the banking side of a business’ operations is just one of the
functions of the treasury department. Treasury is also responsible for the raising
of short and long-term finance, the control of cash and investment of cash
surpluses, foreign currency risk management, management of capital investment
and organisation of insurance for company assets. When treasury activities are
Page 53

centralised, these activities become the sole responsibility of the central unit, and
local divisions of a business simply hold cash for day to day transactions, and do
not get involved in raising finance, hedging foreign exchange risk etc.
The primary advantage to be gained from centralisation of treasury is the
increased control that it offers. For a company such as Dodgimotors, the need is
to maximise overall corporate profit. This means, for example, that if one
dealership is currently running a cash surplus, the treasury function can then use
that money to fund any of the dealerships which may be running a cash deficit.
In this way the need to look for external funding is reduced or eliminated.
Consequently, it is argued, a centralised treasury can save a company money via
reduced borrowing requirements and lower bank charges. Lower banking costs
may also be available via the use of the central department to negotiate finance
when required. If, for example, a dealer wished to acquire and develop a new
retail site then if the organisation was decentralised, the funding terms would be
negotiated between the individual dealership and the local bank. If all funding
requirements are dealt with via the central treasury, it is likely that the terms
available will be preferable because the overall account will be larger, and the
company regarded as a more ‘important’ bank customer. A secondary benefit of
centralisation is the elimination of the need for each element within a group
company to employ staff with treasury skills. This reduces duplication, and
should work to raise the overall standard of treasury provision as the skills and
experience of the centre’s staff are likely to be greater than those of staff working
in the smaller individual divisions. For some businesses which buy/sell in foreign
markets, the role of central treasury in managing the process of hedging foreign
exchange risk can be very important. Dodgimotors is unlikely to require such
hedging, but if they were then a central department can offer the advantage of
expertise that is often scarce at a local level.
The main disadvantage of centralisation of treasury activities is that it can lead to
slower decision making, and the potential loss of local market advantage as a
result. If a local manager wishes to obtain funds to buy assets e.g. second hand
car stock, he may have to put a business case to head office to obtain the funds.
In the time taken to process the application, the buying opportunity may
disappear, and with it the opportunity to increase profit. At the same time, many
writers would argue that the independence of local management is important to
good performance, because responsibility serves to motivate staff. Giving
responsibility to the centre can simply demotivate, whilst at the same time
eradicating the detailed understanding of local conditions.
There is no clear cut answer as to whether centralised or decentralised treasury
functions are preferable. The choice is ultimately dependent upon the specific
needs of the individual company.

9.

Briefing Note

Page 54

To:
From:
Date:
Subject:

Management NMH Limited
C Willis, Accountant
16th May 2006
Working Capital Management

Introduction
This report analyses the working capital management of NMH Limited. It is based on
an analysis of the two most recent annual audited accounts, for the years ended 31st
December 2010 and 2011 respectively. Please find at Appendix 1 a summary of the
key indicators calculated and used for the purposes of this briefing.
Findings
Sales increased by 78% over the two years. Intrinsic profitability measured by the GP%
has increased 1.9%. Likewise ultimate profitability has increased significantly by
3.6%. This growth is to be welcomed. However, the increased investment in
inventories of RWF 950k, with average inventory days increasing by 36 days to 134
days, and non-current assets of RWF 220k is placing a strain on the company’s
liquidity. This is because this investment is being primarily financed from expensive
short-term sources, whilst, during the year we also repaid RWF 300k of our long term
loan. As a direct result of this the short term cash holdings changed from a surplus of
RWF 400K to an borrowing of RWF 100K.
Liquidity is an increasing concern for the company with current asset ratio cover
reducing from 1.55:1 to 1.38:1. Likewise, quick ratio cover has also fallen from 0.63:1
to 18:1.
Whilst we have used increases in creditors of RWF 620k to help fund the investment in
inventories, we have increased our average payment days by 28 days to 81 days. This
means we are extending credit beyond the industry norm of 60 days. If left unchecked
this could damage our credit rating and lead to foregoing settlement discounts.
The debtors collection period has increased from 8 days to 14 days. Whilst extending
credit may help win more sales, this trend needs to be managed more carefully in order
to avoid the risk of bad debts and to provide much needed cash-flow.
Conclusion
The investment in growth allied to deteriorating working capital management is
threatening the short term liquidity and survival of the company. The term structure of
the company’s finances needs to be addressed immediately.
Appendix 1
Key Financial Indicators for Years Ended 31st December 2010 and 2011
Indicator Formulae

2010

2011

Gross Profit % GP/Sales x 100
Net Profit % NP/Sales x 100
Sales Growth (Current - Prior) / Prior x 100

27.8%
6.1%

29.7%
9.7%
77.8%

Page 55

Current Ratio Current Assets : Current Liabilities
Quick Ratio Current Assets-Stock : Current Liabilities
Collection Days (Debtors/Sales x 365)
Creditors Days Creditors/Cost of Sales x 365
Inventory Days (Stock/Cost of Sales x 365)

Page 56

1.55
0.63
8
53
98

1.38
0.18
14
81
134

10.

CLG Ltd – Gikondo Plant – Projected Cash Budget
for the year ended 31st December 2008
Details
Receipts from Debtors
Payments
To raw material suppliers
Direct wages
Variable overheads
Fixed overheads – cash
Corporation tax
Purchase of motor vehicles
Net in Month Cash Movement
Opening cash balance
Closing cash balance

Quarter 1
Quarter 2
Quarter 3
Quarter 4
3,500,000
4,800,000
6,240,000
7,200,000
-650,000
-800,000
-400,000
-2,475,000

-700,000
-1,040,000
-520,000
-2,475,000

-825,000
-80,000
-905,000

65,000
-905,000
-840,000

-640,000
-960,000
-480,000
-2,475,000
-70,000
-50,000
1,565,000
-840,000
725,000

-832,000
-1,296,000
-540,000
-2,475,000

2,057,000
725,000
2,782,000

CLG Ltd – Gikondo Plant – Projected Cash Budget (Note 1) – Sales Receipts
Details
C/F Debtors from 31/12/08
Previous Quarter Sales Units
Unit price
Sales receipts

Quarter 1
Quarter 2
Quarter 3
Quarter 4
3,500,000
40,000
52,000
48,000
120
120
150
3,500,000
4,800,000
6,240,000
7,200,000

CLG Ltd – Gikondo Plant – Projected Cash Budget (Note 2) – Payments to Creditors
Details
Quarter 1
Quarter 2
Quarter 3
Quarter 4
C/F Creditors quarter 3 of y/e
650,000
31/12/07
C/F Creditors quarter 4 of y/e
700,000
31/12/08
Q1 Purchases 2008 @ 80,000 units
640,000
@ RWF 8 /unit
Q2 Purchases 2008 @ 104,000
832,000
units @ RWF 8 /unit
Creditor payments
650,000
700,000
640,000
832,000

CLG Ltd – Gikondo Plant – Projected Cash Budget (Note 3) – Wages Payments
Details
Quarterly Production
Direct labour hours per unit
Total direct labour hours
Wage cost per hour
Total wage payment

Quarter 1
Quarter 2
Quarter 3
Quarter 4
40,000
52,000
48,000
54,000
2
2
2
2
80,000
104,000
96,000
108,000
10
10
10
12
800,000
1,040,000
960,000
1,296,000

Page 57

CLG Ltd – Gikondo Plant – Projected Cash Budget (Note 4) – Variable Overhead
Payments
Details
Quarterly production
Variable overhead per unit
Total variable overhead payment

Quarter 1
Quarter 2
Quarter 3
Quarter 4
40,000
52,000
48,000
54,000
10
10
10
10
400,000
520,000
480,000
540,000

CLG Ltd – Gikondo Plant – Projected Cash Budget (Note 5) – Fixed Overhead Payments
Details
Total monthly overhead
Less:
Non-Cash
(depreciation)
Total wage payment

Quarter 1
Quarter 2
Quarter 3
Quarter 4
2,575,000
2,575,000
2,575,000
2,575,000
Item
-100,000
-100,000
-100,000
-100,000
2,475,000

Page 58

2,475,000

2,475,000

2,475,000



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