CPA I1.1 MANAGERIAL FINANCE Revision Guide

User Manual:

Open the PDF directly: View PDF .
Page Count: 60

CONTENTS
Present Value Table
Annuity Table
- Appendix 2 - Payback Period
- Corporation Tax Computations
  - Conclusion
  - Appendix 1

BLANK

Page 1

CONTENTS

Title

Page

Study Techniques

Examination Techniques

Assessment Strategy

Learning Resources

Sample Questions and Solutions

Page 2

BLANK

Page 3

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.

Page 4

BLANK

Page 5

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.

Page 6

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.

Page 7

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 re-

read 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.

Page 8

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.

Page 9

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.

Page 10

BLANK

Page 11

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 25

Question 2 20

Question 3

(Students have a choice,

Part A or B must be answered) 15

Section B

Question 4 20

Question 5

(Students have a choice,

Part A or B must be answered) 20

Total 100

Page 12

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 13

REVISION QUESTIONS AND

SOLUTIONS

Stage: Intermediate I1.1

Subject Title: Managerial Finance

Page 14

BLANK

Page 15

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?

of publicly owned services/utilities.

Page 16

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:

2008

2009

2010

2011

2012

Number Sold – (000’s)

100

Sales Prices (RWF’000 per

unit)

120

100

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.

would your decision be?

Page 17

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:

Year 1

Year 2

Year 3

Year 4

RWF ’000 RWF ’000 RWF

’000

RWF

’000

Labour costs

150

170

150

200

Additional materials used

170

Other expenses

110

140

Factory overhead

110

120

220

290

Loan interest

Depreciation

530

590

780

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.

Page 18

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 well-

established 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:

Page 19

• 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 RWF 12.00 per unit

Materials 2 kg per unit at RWF 2.40 per kg

Labour RWF 1.80 per unit

Direct expenses 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.

Page 20

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

Required Outlay

NPV

RWF

150,000

65,000

120,000

50,000

200,000

80,000

30,000

400,000

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

Page 21

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

these opportunities.

Page 22

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 = RWF 10

Direct Labour 1 hour @ RWF 8 per hour = RWF 8

Variable Overhead 1 hour @ RWF 2 per hour = RWF 2

Standard Marginal Cost per Doll = RWF 20

Budgeted Selling Price per Doll = RWF 30

Standard Contribution per Doll = 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.

Page 23

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]

Page 24

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.

above, outline the advantages and disadvantages of centralisation of the treasury

function.

Page 25

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

2011

Assets

Non Current Assets (at NBV)

Property & Plant (Showrooms)

300

530

Other Assets

Non Current Assets

340

560

Current Assets

Inventories

700

1,650

Trade Receivables

250

Cash & Cash Equivalents

400

Total Current Assets

1,180

1,900

Total Assets

1,520

2,460

Equity and Liabilities

Equity attributable to equity holders

Share capital

100

Other reserves (Retained Revenue Reserves)

260

880

360

980

Non Current Liabilities

Long term borrowings

400

100

Current Liabilities

Trade Payables

380

1,000

Short term borrowings

100

Current portion of long term borrowings

380

280

Total Current Liabilities

760

1,380

Total Liabilities

1,160

1,480

Total Equity and Liabilities

1,520

2,460

2010 2011

Revenue

3,600

6,400

Less: Cost of Sales

2,600

4,500

Gross Profit

1,000

1,900

Less: Expenses

780

1,280

Net Profit

220

620

Page 26

Requirement:

Prepare a briefing note for NMH Limited’s management on its working capital

management during 2011. Total: 15 Marks

Page 27

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 28

• 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

2,000,000

Plant & Equipment at Net Book Value

200,000

Current Assets

Trade Receivables

3,500,000

Cash and Cash Equivalents

Total Assets

5,700,000

Equity and Liabilities

RWF 10 Ordinary Shares

1,000,000

Accumulated profits

3,200,000

Current Liabilities

Trade payables

1,350,000

Corporation Tax

70,000

Short Term Borrowings/Overdraft

80,000

Total Equity and Liabilities

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 29

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)

10%

0·990

0·980

0·971

0·962

0·952

0·943

0·935

0·926

0·917

0·909

0·980

0·961

0·943

0·925

0·907

0·890

0·873

0·857

0·842

0·826

0·971

0·942

0·915

0·889

0·864

0·840

0·816

0·794

0·772

0·751

0·961

0·924

0·888

0·855

0·823

0·792

0·763

0·735

0·708

0·683

0·951

0·906

0·863

0·822

0·784

0·747

0·713

0·681

0·650

0·621

0·942

0·888

0·837

0·790

0·746

0·705

0·666

0·630

0·596

0·564

0·933

0·871

0·813

0·760

0·711

0·665

0·623

0·583

0·547

0·513

0·923

0·853

0·789

0·731

0·677

0·627

0·582

0·540

0·502

0·467

0·914

0·837

0·766

0·703

0·645

0·592

0·544

0·500

0·460

0·424

0·905

0·820

0·744

0·676

0·614

0·558

0·508

0·463

0·422

0·386

0·896

0·804

0·722

0·650

0·585

0·527

0·475

0·429

0·388

0·350

0·887

0·788

0·701

0·625

0·557

0·497

0·444

0·397

0·356

0·319

0·879

0·773

0·681

0·601

0·530

0·469

0·415

0·368

0·326

0·290

0·870

0·758

0·661

0·577

0·505

0·442

0·388

0·340

0·299

0·263

0·861

0·743

0·642

0·555

0·481

0·417

0·362

0·315

0·275

0·239

(n)

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

0·901

0·893

0·885

0·877

0·870

0·862

0·855

0·847

0·840

0·833

0·812

0·797

0·783

0·769

0·756

0·743

0·731

0·718

0·706

0·694

0·731

0·712

0·693

0·675

0·658

0·641

0·624

0·609

0·593

0·579

0·659

0·636

0·613

0·592

0·572

0·552

0·534

0·516

0·499

0·482

0·593

0·567

0·543

0·519

0·497

0·476

0·456

0·437

0·419

0·402

0·535

0·507

0·480

0·456

0·432

0·410

0·390

0·370

0·352

0·335

0·482

0·452

0·425

0·400

0·376

0·354

0·333

0·314

0·296

0·279

0·434

0·404

0·376

0·351

0·327

0·305

0·285

0·266

0·249

0·233

0·391

0·361

0·333

0·308

0·284

0·263

0·243

0·225

0·209

0·194

0·352

0·322

0·295

0·270

0·247

0·227

0·208

0·191

0·176

0·162

0·317

0·287

0·261

0·237

0·215

0·195

0·178

0·162

0·148

0·135

0·286

0·257

0·231

0·208

0·187

0·168

0·152

0·137

0·124

0·112

0·258

0·229

0·204

0·182

0·163

0·145

0·130

0·116

0·104

0·093

0·232

0·205

0·181

0·160

0·141

0·125

0·111

0·099

0·088

0·078

0·209

0·183

0·160

0·140

0·123

0·108

0·095

0·084

0·074

0·065

Page 30

Annuity Table

Present value of an annuity of 1 i.e.

1 – (1 + r)–n

Where r = discount rate

n = number of periods until payment

Discount rates (r)

Periods

(n)

10%

0·990

0·980

0·971

0·962

0·952

0·943

0·935

0·926

0·917

0·909

1·970

1·942

1·913

1·886

1·859

1·833

1·808

1·783

1·759

1·736

2·941

2·884

2·829

2·775

2·723

2·673

2·624

2·577

2·531

2·487

3·902

3·808

3·717

3·630

3·546

3·465

3·387

3·312

3·240

3·170

4·853

4·713

4·580

4·452

4·329

4·212

4·100

3·993

3·890

3·791

5·795

5·601

5·417

5·242

5·076

4·917

4·767

4·623

4·486

4·355

6·728

6·472

6·230

6·002

5·786

5·582

5·389

5·206

5·033

4·868

7·652

7·325

7·020

6·733

6·463

6·210

5·971

5·747

5·535

5·335

8·566

8·162

7·786

7·435

7·108

6·802

6·515

6·247

5·995

5·759

9·471

8·983

8·530

8·111

7·722

7·360

7·024

6·710

6·418

6·145

10·37

9·787

9·253

8·760

8·306

7·887

7·499

7·139

6·805

6·495

11·26

10·58

9·954

9·385

8·863

8·384

7·943

7·536

7·161

6·814

12·13

11·35

10·63

9·986

9·394

8·853

8·358

7·904

7·487

7·103

13·00

12·11

11·30

10·56

9·899

9·295

8·745

8·244

7·786

7·367

13·87

12·85

11·94

11·12

10·38

9·712

9·108

8·559

8·061

7·606

(n)

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

0·901

0·893

0·885

0·877

0·870

0·862

0·855

0·847

0·840

0·833

1·713

1·690

1·668

1·647

1·626

1·605

1·585

1·566

1·547

1·528

2·444

2·402

2·361

2·322

2·283

2·246

2·210

2·174

2·140

2·106

3·102

3·037

2·974

2·914

2·855

2·798

2·743

2·690

2·639

2·589

3·696

3·605

3·517

3·433

3·352

3·274

3·199

3·127

3·058

2·991

4·231

4·111

3·998

3·889

3·784

3·685

3·589

3·498

3·410

3·326

4·712

4·564

4·423

4·288

4·160

4·039

3·922

3·812

3·706

3·605

5·146

4·968

4·799

4·639

4·487

4·344

4·207

4·078

3·954

3·837

5·537

5·328

5·132

4·946

4·772

4·607

4·451

4·303

4·163

4·031

5·889

5·650

5·426

5·216

5·019

4·833

4·659

4·494

4·339

4·192

6·207

5·938

5·687

5·453

5·234

5·029

4·836

4·656

4·486

4·327

6·492

6·194

5·918

5·660

5·421

5·197

4·988

4·793

4·611

4·439

6·750

6·424

6·122

5·842

5·583

5·342

5·118

4·910

4·715

4·533

6·982

6·628

6·302

6·002

5·724

5·468

5·229

5·008

4·802

4·611

7·191

6·811

6·462

6·142

5·847

5·575

5·324

5·092

4·876

4·675

Page 31

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 2008-

2011, 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 32

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 33

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 34

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 self-

aggrandisement 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 35

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.

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 36

2. Silicon Ltd

(a)

End of Year

2007

2008

2009

2010

2001

2002

No. sold 000’s

100

Sales price RWF’000 per

unit

120 120 120 100 90

Variable price RWF’000 per

unit

65 65 65 65 65

Contribution RWF’000 per

unit

55 55 55 35 25

RWF

Total contribution

5,500

2,800

2,000

Less fixed costs

(2,000)

Plant

(5,000)

Working capital

(2,100)

2,100

Net cash flow

(7,100)

3,500

800

2,100

(b)

Net cash flow

(7,100)

3,500

800

2,100

Discount factor

1.00

0.89

0.80

0.71

0.64

0.57

Present value

(7,100)

3,115

2,800

2,485

512

1,197

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

100

Total Royalty - RWF m

1,000

800

Discount factor

0.89

0.80

0.71

0.64

0.57

Present value - RWF m

890

800

710

512

456

Net Present Value – RWF m

3,368

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 37

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 38

3 Bryher Ltd

Year 1

Year 2

Year 3

Year 4

RWF

’000

RWF

’000

RWF

’000

RWF

’000

Sales

450

700

Labour costs (note 1)

120

150

200

Materials used

170

Loss on material X (note 2)

Other expenses

110

140

Insurance

Loss of rent

330

410

520

570

Profit

120

180

130

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

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

RWF

’000

RWF

’000

RWF

’000

RWF

’000

RWF

’000

RWF

’000

Cost of machinery and tax

(400)

200

Net salvage value and tax

(5)

Incremental operating profits

120

180

130

Tax

(60)

(20)

(90)

(65)

Contract termination

(60)

Contract payments saved

100

Tax on contract payments

(50)

Net cash flows

(460)

420

210

100

(120)

Cash Flows

D.F. @ 15%

RWF ’000

RWF

’000

Year 0

(460)

1.000

(460.00)

Year 1

420

0.870

365.40

Year 2

0.756

22.68

Year 3

210

0.658

138.18

Year 4

100

0.572

57.20

Year 5

(120)

0.497

(59.64)

63.82

Page 39

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 40

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 41

• 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

RWF ’000

Licence Purchase

-2,880

Net contribution Kigali

1,500

Royalty Mombassa brewer

300

Fixed Factory Costs

-100

Promotional Spend

-500

-400

Contribution Mombassa brewer

Tax Payable

-132

Net Annual Cash Flow

-3,380

1,200

1,300

1,760

-132

Discount Factor 10%

1.0

.9090

.8260

.7510

.6830

Present Value

-3,380

1,091

1,074

1,322

-90

Net Present Value +16

Discount Factor 12%

1.0

.8930

.7970

.7120

.6360

Present Value

-3,380

1,072

1,036

1,253

-84

Net Present Value -103

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

Appendix 2 - Payback Period

Cumulative Cash Flow

-3,380

-2,180

-880

880

748

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 42

Corporation Tax Computations

Net Cash Flow (above)

-3,380

1,200

1,300

1,760

Cumulative Taxable Profits

-3,380

-2,180

-880

880

Taxable profits

880

Taxation @ 15%

132

Page 43

5. ARED LIMITED

Ared Ltd: Production budget for 6 months to end of December

Jun

July

Aug

Sept

Oct

Nov

Dec

Sales

Units

0,00

10,00

11,000

12,000

13,000

14,000

15,000

Stock increase

Units

200

Production

Units

10,20

11,200

12,200

13,200

14,200

15,000

Receipts

Cash sales

RWF'000

3,000

3,300

3,600

3,900

4,200

4,500

Credit sales

RWF’000

9,000

9,900

10,800

11,700

12,600

Total receipts

RWF’000

12,00

12,300

13,500

14,700

15,900

17,100

Payments

Materials

RWF'000

4,848

5,136

5,616

6,096

6,576

7,008

Labour

RWF'000

1,836

2,016

2,196

2,376

2,556

2,700

Direct expenses

RWF'000

1,224

1,344

1,464

1,584

1,704

1,800

Fixed overheads

RWF'000

2,200

Advertising

RWF'000

9,500

Interest

RWF'000

3,000

10,10

20,196

14,476

12,256

13,036

13,708

Net Cash flow

RWF'000

1,892

-7,896

-976

2,444

2,864

3,392

Opening balance

RWF'000

5,000

6,892

-1,004

-1,980

464

3,328

Closing Balance

RWF'000

6,892

-1,004

-1,980

464

3,328

6,720

Workings

June

July

Aug

Sept

Oct

Nov

Dec

Sales (units) 1

10,00

11,000

12,000

13,000

14,000

15,000

Sales price (RWF )

Sales revenue

RWF'

000

12,00

13,200

14,400

15,600

16,800

18,000

Calculation of sales receipts

Sales revenue

12,00

13,200

14,400

15,600

16,800

18,000

Cash sales (25%)

RWF'000

3,000

3,300

3,600

3,900

4,200

4,500

Credit sales (75%)

RWF'000

9,000

9,900

10,800

11,700

12,600

13,500

Page 44

Calculation of

Purchases

June

July

Aug

Sept

Oct

Nov

Dec

Production

units

10,00

10,20

11,200

12,200

13,200

14,200

15,000

Materials for

production

20,00

20,40

22,400

24,400

26,400

28,400

30,000

RWF'000

4,800

4,896

5,376

5,856

6,336

6,816

7,200

Half delivered in

month

RWF'000

2,400

2,448

2,688

2,928

3,168

3,408

3,600

Closing stock

RWF'000

2,448

2,688

2,928

3,168

3,408

3,600

Total purchases in

month

RWF'000

4,848

5,136

5,616

6,096

6,576

7,008

Payable in

July

Aug

Sept

Oct

Nov

Dec

Labour costs

RWF

180.0

180.00

Materials

2.00

Cost per Kg

RWF'000

2.40

Direct expenses

per unit

RWF'000

0.12

cash fixed o/heads RWF’000 3,400 less

Dep’n of RWF’000 1,200 non cash item

2,200

Page 45

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.

• 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.

(b) (i) 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 46

B 50/120 = 0.42

C 80/200 = 0.40

D 30/80 = 0.37

E 120/400 = 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 47

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 48

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 49

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 Note Favourable Adverse Total

Budgeted Contribution 1 100,000

Variances

Sales Price 2 -24,000

Sales Volume 3 20,000

Direct Materials Price 4 -22,000

Direct Materials Usage 5 10,000

Direct Labour Rate 6 13,000

Direct Labour Efficiency 7 -8,000

Variable Overhead Expenditure 8 0 0

Variable Overhead Efficiency 9 -2,000

Sub Totals 43,000 -56,000

Net Variance -13,000

Actual Contribution 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 50

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 51

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 336,000

Less: Actual Costs Incurred

Direct Materials 132,000

Direct Labour 91,000

Variable Overheads 26,000

Total Costs 249,000

Actual Contribution 87,000

Page 52

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

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 53

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

Delay

Monday

Nil

Tuesday

6 days

Wednesday

5 days

Thursday

4 days

Friday

3 days

Saturday

Nil

Total

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

Delay

Monday

2 days

Tuesday

1 day

Wednesday

Nil

Thursday

1 day

Friday

Nil

Saturday

2 days

Total

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.

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 54

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 55

To: Management NMH Limited

From: C Willis, Accountant

Date: 16th May 2006

Subject: 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

27.8%

29.7%

Net Profit % NP/Sales x 100

6.1%

9.7%

Sales Growth (Current - Prior) / Prior x 100

77.8%

Page 56

Current Ratio Current Assets : Current Liabilities

1.55

1.38

Quick Ratio Current Assets-Stock : Current Liabilities

0.63

0.18

Collection Days (Debtors/Sales x 365)

Creditors Days Creditors/Cost of Sales x 365

Inventory Days (Stock/Cost of Sales x 365)

134

Page 57

10. CLG Ltd – Gikondo Plant – Projected Cash Budget

for the year ended 31st December 2008

Details

Quarter 1

Quarter 2

Quarter 3

Quarter 4

Receipts from Debtors

3,500,000

4,800,000

6,240,000

7,200,000

Payments

To raw material suppliers

-650,000

-700,000

-640,000

-832,000

Direct wages

-800,000

-1,040,000

-960,000

-1,296,000

Variable overheads

-400,000

-520,000

-480,000

-540,000

Fixed overheads – cash

-2,475,000

Corporation tax

-70,000

Purchase of motor vehicles

-50,000

Net in Month Cash Movement

-825,000

65,000

1,565,000

2,057,000

Opening cash balance

-80,000

-905,000

-840,000

725,000

Closing cash balance

-905,000

-840,000

725,000

2,782,000

CLG Ltd – Gikondo Plant – Projected Cash Budget (Note 1) – Sales Receipts

Details

Quarter 1

Quarter 2

Quarter 3

Quarter 4

C/F Debtors from 31/12/08

3,500,000

Previous Quarter Sales Units

40,000

52,000

48,000

Unit price

120

150

Sales receipts

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

31/12/07

650,000

C/F Creditors quarter 4 of y/e

31/12/08

700,000

Q1 Purchases 2008 @ 80,000 units

@ RWF 8 /unit

640,000

Q2 Purchases 2008 @ 104,000

units @ RWF 8 /unit

832,000

Creditor payments

650,000

700,000

640,000

832,000

CLG Ltd – Gikondo Plant – Projected Cash Budget (Note 3) – Wages Payments

Details

Quarter 1

Quarter 2

Quarter 3

Quarter 4

Quarterly Production

40,000

52,000

48,000

54,000

Direct labour hours per unit

Total direct labour hours

80,000

104,000

96,000

108,000

Wage cost per hour

Total wage payment

800,000

1,040,000

960,000

1,296,000

Page 58

CLG Ltd – Gikondo Plant – Projected Cash Budget (Note 4) – Variable Overhead

Payments

Details

Quarter 1

Quarter 2

Quarter 3

Quarter 4

Quarterly production

40,000

52,000

48,000

54,000

Variable overhead per unit

Total variable overhead payment

400,000

520,000

480,000

540,000

CLG Ltd – Gikondo Plant – Projected Cash Budget (Note 5) – Fixed Overhead Payments

Details

Quarter 1

Quarter 2

Quarter 3

Quarter 4

Total monthly overhead

2,575,000

Less: Non-Cash Item

(depreciation)

-100,000

Total wage payment

2,475,000

CPA I1.1 MANAGERIAL FINANCE Revision Guide

Navigation menu

Versions of this User Manual:

Views

Navigation