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Task 1

Overview of the Selected Organization

Tasty (Pvt) Ltd. is one of the largest distributors of a wide range of edible oil products
and food item in Sri Lanka; they distributed all kind of oils and food items to both
wholesale and retail markets. They have well known for their premium quality for
their entire product range. They cater to chain of Hotels/Restaurant, Bakery and chain
of supermarkets.

They import wide range of oil items and food range from reputed countries and purify
the oil and pack the food item in their own plant and distribute to all over Sri Lanka
under their premium brands.

1.1. Explain the importance of costs in the pricing strategy of an


In the essence of strategizing pricing decisions one of the key variables for any
organization is costing and the cost structure, this is even true for nonprofit making

In the context of this question we will just look at the expenses involved in running a
business and exclude capital costs from the analysis. Costs are a consideration or an
amount paid in exchange to obtain something for the organization.

As a start, cost helps an organization to understand what would be the pricing

strategy; this is true when it comes to cost-oriented methods of pricing such as cost
plus pricing, mark-up pricing, break even pricing, target return pricing and early cash
recovery pricing.

One of the critical factors in understanding costs when it comes to pricing strategy is
to understand the breakeven point for the organization. This is the point where the
organization neither makes a profit nor a loss from the product or service in offering.
Therefore, cost becomes a key variable to measure this.

Understanding the cost will help companies to set promotional prices or decide
discounts. For example, during certain seasons of the year such as Christmas many
companies offer products at discounted prices to encourage large scale purchasing.
Understanding cost will enable the company to determine the best discount price
without incurring a loss.

Understanding costs will enable the company to decide the % profit expected on the
costs, this would be known as cost plus pricing. In this case the profit the organization
would make has a direct link to the costs. This is why most organizations
continuously aim for cost reduction programs.

Changes to the cost structure of the organization would further help to determine
whether changes need to be made to the selling price. If the increase to cost is drastic
due to for example increase in fuel price, the end price may need to be increased.
However if the changes to the cost structure is minimal price may not be changed.

Understanding cost will also help the firm to know whether it is the cost leader in the
market or where in stands in relation to competition. If the firm wants to adopt
Porters cost leadership strategy it can focus on reducing cost, once this is achieved
the firm can later strategize its pricing decision i.e. either charge a lower price to sell
more units that competitors or maintain market pricing while having a better or
amplified margins.

The above analysis clearly depicts the fact that cost is a key component for
strategizing pricing

1.2. Evaluate the existing cost system and propose improvements to
the costing and pricing systems used by the organization

Existing Costing System

Since it is a traditional organization, it uses the absorption costing method to calculate

cost for iits product ranges.

Variable Costs Identification

1. Direct material cost

All costs related to purchase of oil and food items considered as direct cost

a. Oil and food purchase price

b. Taxes and port charges

c. Carriage inwards

2. Direct labor costs

All costs related to purifying oil and packing workers costs

a. Labor cost involved in refining the oil (Per hour cost)

b. Number of warehouse labors directly involved in packing the

product (Weekly wage)

3. Other production variable overheads

a. Packing materials

b. Pricing tags

c. Material for pasting label (batch cost)

d. Seal item

Production overhead identification, allocation and apportionment methods

All fixed production related overhead costs were identified as

fixed production overhead cost

a. Factory and store rent

b. Supervisors and stoker keeper and store assistant salary

c. Wages paid to the casual store workers

d. Electricity

All overhead costs are allocated to the identified cost center and apportioned to the
product based on the number of units produced during the period (unit based
absorption rate is used)

Current Pricing System

The company currently uses cost plus pricing method to price their product. The
company currently uses the below method to derive the selling price for their product


Improvements to the Costing System and Pricing System

According to our analysis in the total production cost, approximately 60% of the cost
recognized as fixed production cost. Therefore identification of fixed cost and
apportionment rate play a critical role in deciding the product price

1. Cost Centers

There is no clear division between food and oil costs center. All fixed costs are
allocated to single cost centers.


1. Clear allocation of fixed cost based on the utilization or resource consumption



2. Removal of non-production related cost from the fixed cost allocation,

example wage paid to the store assistant could be treated as administration
cost since the assistant directly deals with the head office activities

3. Use of common apportion rate will result the incorrect pricing for certain
product ranges. We recommend using specific overhead absorption rate to
product unit to derive at the selling price. For example specific rate for Food
range and a specific rate for oil range

4. Better fixed cost management should be introducing to the organization

because there is a possible manipulation in casual workers wage. The
organization should introduce strict internal control in paying an verifying the
wages paid to the casual workers since it constitutes 25% of fixed cost

5. Optimum utilization of skilled and semi-skilled labors will be another

improvement point where the organization could control the fixed cost

6. Current pricing model could be revised in order to be competitive in the


Product Cost
Distributors Margin
Total Product Cost
Target Proft
Selling Price


Previously target profit was derived before the distributors margin which would have
resulted incorrect price setting because distributors margin is a committed cost where
the company required paying the margin to the distributors. Considering distributors
margin as a cost will help the organization to rethink on their target profit before
setting the selling price

1.3. Evaluate on the potential for the use of Activity-Based Costing

Overview of Activity Based Costing (ABC)

ABC is a modern costing technique which identifies the activities in an organization

and assigns the cost of each activity.

Traditional Costing Method Activity Based Costing Method

(Figure 01: Turney, Peter B. B. Activity Based Costing. London: Kogan

Page123, 1996. Print.)

Basic steps in forming ABC

1. Form the cost pool

2. Identify the cost pool

3. Allocate the resource costs to activity

4. Identify the cost drivers

5. Calculate the cost

Use of Activity Based Costing

Due to product diversity and stiff competition in the market the organization could
consider of using the activity based costing as the alternative costing system to
calculate the product cost and to derive at the product pricing. Further since most of
the activities are similar in food and oil processes, the organization can introduce
ABC system for its product costing. We have identified the following similar
activities are happening in both the processes

1. Purchase material

2. Schedule production

3. Inspection

4. Material handling

5. Customer order

6. Packaging

7. Machine set up

After identifying the activities the organization could assign the cost to activities.
Further we have identified the cost drivers which results the overhead costs

Activities Cost Drivers

1. Purchase material No of purchase requisitions
2. Schedule production No of production set-up
3. Inspection No of inspection
4. Material handling No of material requisition
5. Customer order No of customer order
6. Packaging No of batch produced
7. Machine set up No of production set-up

The organization can use the activity based costing either in batch level or unit level
to get the appropriate results.

ABC costing will help the organization to have proper control over the overhead costs
and organization could have a clear idea which activity contributes to the most part of
production overhead cost. Through that it can manage the overhead cost. The
organization can maximize the profit or reduce the price and provide stiff competition
to its competitor though effective management of overhead cost

1.4. Design a costing system for use within the organization based on
identified opportunities

Considering the nature of competition and the number of competitors in the market
the possible option that the organization could win the market share is through
competitive pricing strategy. The company should offer premium quality oil and food
rangers through a competitive prices where other competitors could not be able to
offer in the market. Therefore market study is necessary in order to derive at the
competitive pricing strategy.

Target Costing System

1. The company need to decided on the market price for its product as the
first step

2. It should deduct expected profit and distributors margin for the set
market price

3. The target cost will be derived for the product.

4. All non-value adding activities should be removed from the process to

achieve the target cost

5. All non-value adding feature in the product needs to be removed to

achieve the target cost

Set the target selling price

Reduce the target proft

n Reduce the distributors
Target Cost


1.5. Recommend processes that could manage cost reduction in an


Cost reduction considered as methodical or systematic approach to reduce the cost of

a unit without reducing the quality or without impacting the product intended usage.

In the cost reduction approach the organization assumes that current cost is too high
and there is an opportunity to bring down the cost at an acceptable level through
eliminating wastage or through introducing efficiency in the production process.

Most of the organization adopts various approaches to reduce and control the cost

1. Review the current cost and process and identify

a. Which process incur most of the cost
b. Identify the non-value adding process
2. Identification of areas where most of the wastage or rework in the production
3. Identification of process where efficiency could be introduce to reduce the cost
4. Identification of possible area of capital investment to improve the
productivity which in return reduce the cost per unit
5. Improve production planning and change of factory layout to reduce the
material movement and wastage
6. Introduction of standard costing by setting the realistic standard and reviewing
the performance in each period
7. Introduction of Kaizen costing by setting cost reduction target for each period
and monitoring the achievement of those goals

8. Negotiating long term contractual obligation with the suppliers to get the
material at a fixed rate
9. Introduction of Economic Order Quantity(EOQ) method or Just In Time (JIT)
method in inventory holding
10. Efficient cost control management to reduce the cost

When the organization decided to reduce the cost without impacting the quality and
intended usage of the product, the organization must be committed continuously to
keep the cost at the lowest level and must be committed to invest capital to achieve
the desired results

1.6. Select budgetary targets for the organization and evaluate

budgetary monitoring process of the organization

Budgetary Targets

1. Estimated Sales Revenue

Achieving the budgeted sales target is the key requirement for any
organization in order to generate the target profit for the forecasted accounting
period. If the organization continuously fails to achieve the sales target the
organization will be ceased to exist. Therefore every company periodically
reviews their estimated sales and takes appropriate actions to achieve the

2. Estimated Production or Purchase

It is important to produce the estimated production or purchase in order to

achieve the estimated sales revenue. If the organization does not have the
technical or financial capability to produce or purchase the estimated units the
organization will face the limitation to meet the customer demand

3. Estimated Cash Inflow and Cash Outflow

The organization required sufficient cash balance to run the day-to-day
operation. The organization requires cash to settle its current operating

liability. If the does not generate the enough cash through its business it faces
difficulties in meeting the current obligation

4. Estimated Cost
Any organization required to control their cost below the estimated cost in
order to increase the profit to the organization. Effective review of actual cost
with planned always help the organization to understand the effectiveness of
the cost control system

Budgetary Monitoring Processes

Key processes to manage and monitor the budget effectiveness

1. The organization in focus lacks the consistent and continuous budget monitoring
and reporting process. The company must introduce a strong reporting process
against the internal budget on a consistent and continuous basis to access
whether the set targets are achieved
2. The targets are out-dated and it was not evaluated and revised periodically. The
management should be considering to review all the internal targets though
coordinated process where targets are achievable and the respective managers
accepted the target and all the employees in the organization knows about the
3. Predicting to manage deviation between budget estimates and actual results in
order to identify immediately, and respond to, changes in the external
environment or internal activities;
4. Reviewing and improving internal budget processes by monitoring the accuracy
and timeliness of budget processes to identify areas for improvement.

Task 2
2.1 Financial Statement Analysis
The following report analyses the financial position and performance of Ballard (Pvt)
Ltd which would assess the financial viability of the organization.

The following table (Table I) provides insights into the organizations key
performance and position measures and it will be further analyzed for better
understanding to the stakeholders.
Ratio 2004 2003
Current Ratio = Current 34,370/13,270 27,680/6,090
Assets / Current Liabilities = 2.59 = 4.55
(34,370 - (27,680 -
Quick Ratio = Quick Assets /
17,260) /13,270 7,950) /6,090 =
Current Liabilities
Liquidity = 1.29 3.24
Ratio Debtors Turnover Period (In 17,110/148,000* 10,500/137,780*
Days) = Debtors / Sales*365 365 = 42 Days 365 = 28 Days
Creditors Turnover Period 8,450/103,600*3 6,090/95,550*36
(In Days) = Creditors / 65 5
COS*365 = 28 Days = 23 Days

Gross Profit Margin = Gross 44,400/148,000 42,230/137,780

Profitabilit Profit / Net Sales*100 = 30% = 30.65%
y Ratio
Net Profit Margin = Net Profit 13,160/148,000 12,120/137,780
/ Net Sales*100 = 8.89% = 8.80%

Assets Turnover = Total Sales / 148,000/50,710 137,780/43,290

Total Assets = 2.92 = 3.18
Return on Capital Employed
(ROCE) = 13,160/37,440 12,120/37,200
Earnings Before Interest & Tax = 0.35 = 0.33
(EBIT) / Capital Employed

Solvency 3,830/(3,830 +
Gearing = Debt / (Debt + 0/37,440
or Gearing 33,370) =
Equity) *100 = 0%
Ratio 10.30%
Table I Ratio Analysis

The current ratio has been reduced from 4.55 to 2.59 compared to the last year. The
significant reduction could be mainly due to settlement of bank loan before its

maturity period as the organization had to cease the agreement on sale or return
basis with the previous supplier and due to comprehensive training programs which
requires more finance. As a result, the net cash generated shows a negative figure
compared to 2013, leads to increase in bank overdraft and impacts the working capital
of the organization. Further acid test/quick ratio also shows a declining trend over the
years by more than 150% which shows the change in supply process has an adverse
impact on the liquidity of Ballard (Pvt) Ltd. The above ratios could be further
analyzed with the industry related information to access the risk position of the

The above changes in liquidity appears to have been coupled with longer credit
periods being provided to the customers compared to the credit period received from
creditors and larger volume of inventory being held over the period.

Even though the liquidity position has been declining, the performance of the
organization is almost constant compared to the last year. Gross profit margin has
been slightly reduced by 0.65% however the net profit margin is showing an increase
of 0.09%. The reduction to the gross profit margin could be mainly due to increase in
cost of sales by 8.42% even though the sales figures showing an increase of 7.42%
compared to prior year (Refer Table II). Purchasing agreement with the new supplier
to purchase low energy consumption mobile phones increased the purchasing cost as
the organization does not have the bargaining power due to considerable financial
problems faced over the years. Further as it operates in a technology driven industry,
the cost of sales shows an increasing trend over the past 7 years compared to sales
improvement due to ever changing market conditions (Refer Table III).

Comprehensive training programs to gain competitive advantage could be a major

reason for hike in operating expenses by 3.75% which restricted the organization to
generate more profit than the previous year (Refer Table II).

% increase in Turnover =
Percentage (148,000 - 137,780) / 137,780
(Sales in 2014 - Sales in
Change in Sales *100 = 7.42%
2013) / Sales in 2013 * 100

% increase in Cost of Sales
Percentage (103,600 - 95,550) / 95,550
Change in Cost of *100
(COS in 2014 - COS in
Sales = 8.42%
2013) / COS in 2013 * 100
% increase in Operating
Percentage (31,240 - 30,110) / 30,110
Expenses =
Change in *100
(OE in 2014 - OE in 2013) /
Expenses = 3.75%
OE in 2013 * 100
Percentage % increase in Dividends =
Change in (Dividends in 2014 - (12,850 - 8,360) / 8,360 *100
Dividend Dividend in 2013) / Dividend = 53.71%
Distribution in 2013 * 100
Table II Percentage Change in Figures

Year Sales (Rs '000) % Change in Sales COS (Rs '000) % Change in COS
2014 148,000 7.42% 103,600 8.42%
2013 137,780 (1.83%) 95,550 (2.00%)
2012 140,350 7.35% 97,504 7.89%
2011 130,745 (0.04%) 90,370 5.74%
2010 130,800 4.14% 85,467 5.89%
2009 125,600 4.35% 80,710 5.93%
2008 120,360 N/A 76,190 N/A
Table III Percentage Change in Sales & COS

Despite a constant performance in profit generation, the efficiency has been getting
reduced in terms of assets turnover. Assets turnover ratio has gone down from 3.18 to
2.92 over the two periods in concern, which shows the effectiveness of using the
assets of the business is deteriorating in generating the overall turnover. This is mainly
due to the organization is moving from selling high quality mobile phone brands to
low energy consumption mobile phones. It would expect couple of years to grab the
new market opportunities and effectively utilize the assets. However the impact has
been slightly negated to an extent by ROCE which has improved from 0.33 to 0.35.

The organization is facing a decreased level of gearing from 10% to zero due to early
settlement of bank loan as an effect of change in supplier process. Even though the

organization is not operated with outside fund, the short term liability; bank overdraft
has been introduced newly which could impact negatively the business performance
as the organization has to settle within a shorter period of time as compared to the
bank loan which had a longer repayment term.

Further dividend distribution to the shareholders is showing a 54% increase over the
period which will further impact the financial position of the entity. Overall cash flow
position also moved down as finance raised over the period from share issuance has
been drastically reduced which in turn affects the businesss investing opportunity and
to grab future market openings.

As a conclusion Ballard (Pvt) Ltd is facing a sinking liquidity position with
considerable amount of short term finance being brought in, in the form of trade
creditors and bank overdraft. Further finance is tied up in the hands of debtors and
stock which leads to cash generated in the business to far negative side. The above
mentioned actions indicate that the entity will face an issue of over trading in the near
future if the issue prevails. On the other side, even though Ballard has experienced
considerable financial difficulties from its inception, it has managed to maintain
consistency in terms of overall profitability. However efficient use of assets to
generate turnover shows an alarming situation where it is observed a decreasing trend
in assets turnover and sales growth over the past years indicates an inconsistent

Control of long term outsiders fund on organization at its minimal level however
management of short term finance needs to be further looked into as it impact the cash
flow position of the organization. All the above mentioned concerns need to be taken
care at earliest with proper resource utilization to avoid the business being faced with
further financial crisis.

2.2 Recommendations

As Ballard (Pvt) Ltd is operating in an industry where the environment is ever
changing and demanding for new innovative products and services, the following
recommendations are put across to overcome the issues faced in the recent past:
Implementation of a proper pricing strategy which will lead to a positive
impact on the new product range introduced by the organization; low energy
consumption mobile phones. The proper pricing technique would create a
good image on customers mind and subsequently increase the turnover from
the new product range. The perception of quality is also depends on the
pricing and marketing strategy which the organization is going to adapt.
Premium pricing or skimming can be good options to market the product to a
niche market
Currently the business is maintaining a consistent profitability level over the
two years as compared to the liquidity position which is being deteriorating.
Therefore the organization should take action to maintain a proper balance
between the two variables in running the business successfully. The following
grid shows how important to manage profitability and liquidity and
consequences if one of it is not managed properly:

Low High
Die Slowly Thrive
Profitabilit h
Low Die Quickly Survive
Figure 2 (Bagchi, Bhaskar. "A Long-Run And Short-Run Cointegration
Model Explaining Relationship Between Liquidity Management And
Proftability". IJBEX 8.2 (2015): 123. Web.
According to the above figure, it is evidenced that organization is in Die
Slowly position and it could move to Die Quickly quadrant if a proper
balance is not maintained in the future. Ultimately it has to move into Thrive
where both liquidity and profitability are given equal importance
Proper balance between short term and long term financing techniques needs
to be further looked for better gearing position. Short term finance need to be
utilized for short term investments such as investing on stocks, providing
credit to the customers training and development to empower skills of the

employees etc. Whereas long term finance has to be better employed on long
term investments such as investment on fixed assets, business expansion
programs, investment in long term securities so on and so worth. The role of a
skilled finance manager is crucial in achieving the above objective
Supply chain management also needs to be looked into carefully as the
organization has started up operations with a new supplier. Product, cash and
information flows should be handled with due care to succeed in the new
market. The step taken on comprehensive training programs to the employees
will further benefit and creates a skillful staff for challenging business
In order to make strategic decisions to improve the business further, the
following details are requested from the management of Ballard (Pvt) Ltd:
o Relevant industry information which would enable comparison with
o Information on competitor actions over the time period in concern
o Changes in economic conditions enabling a conclusion to be reached
has to whether the changes in Ballard (Pvt) Ltd have been caused due
to an economic variation
o Information on the product categories marketed by the organization
and the individual profitability of such product ranges
o Technology related information and possible predictions
o Details on any restrictions faced by the entity on borrowing and share

2.3 Forecasting
Time series analysis has been used in predicting the Cost of Sales and Revenue of
Ballard (Pvt) Ltd for the upcoming years. Trend analysis is used to be prcised and a
trend line is formulated as given in the below to forecast the stated figures.
Trend Line: y = a + bx
y = Sales or Cost of Sales a and b = constant variables x = time period (years)
Year t/x Sales (Rs '000) (y) xy x2

2008 1 120,360 120,360 1
2009 2 125,600 251,200 4
2010 3 130,800 392,400 9
2011 4 130,745 522,980 16
2012 5 140,350 701,750 25
2013 6 137,780 826,680 36
2014 7 148,000 49
28 933,635 140

t/x COS (Rs '000) (y) xy x2
2008 1 76,190 76,190 1
2009 2 80,710 161,420 4
2010 3 85,467 256,401 9
2011 4 90,370 361,480 16
2012 5 97,504 487,520 25
2013 6 95,550 573,300 36
2014 7 103,600 725,200 49
28 629,391 140

Equation Sales COS

b = (7*3,851,370 - 28*933,635) b = (7*2,641,511 - 28*629,391)
b = (nxy - xy)
(7*140 - 282) / (7*140 - 282)
(nx2 - (x)2)
= 4,172.5 = 4,426.68
a = (933,635/7 - (4,172.5*28/7) a = (629,391/7 - (4,426.68*28/7)
a =y' - bx'
= 116,686.43 = 72,206.28

y = a + bx y = 116,686.43 + 4,172.5x y = 72,206.28 + 4,426.68x

Table IV Formulation of Trend Line

y = 116,686.43 + 4,172.5*8 y = 72,206.28 + 4,426.68*8

2015 (t=8)
= 150,066.43 = 107,619.72
y = 116,686.43 + 4,172.5*9 y = 72,206.28 + 4,426.68*9
2016 (t=9)
= 154,238.93 = 112,046.40
Table V Forecasted Values (Rs '000):

According to the above calculations the summary of forecasted values for the next
two years are given below:
Forecasted Sales (Rs '000) Forecasted COS (Rs '000)
2015 150,066.43 107,619.72
2016 154,238.93 112,046.40

Other factors related to time series analysis (i.e., seasonal, cyclical and random
variations) are not considered in the above calculation as relevant and required details
are not provided.

The following qualitative factors could affect the prediction made above on the
As the business is highly depends on technology, the variation in the
technological developments could affect the sales and cost of sales both
positively and adverse
According to the concept on BCG matrix the entitys product is still
considered as Problem Child and if the current situation remains same, it
could reduce the sales and in turn increase the cost of sales as opposed the
above prediction. However moving the product either towards Cash Cow
or Star would turn the results into positive drastically
As the new product is into early growth stage in the product life cycle the
figures could be expected to improve further if it grows year on year. This
can be further validated with the availability of industry facts

Task 3
3.1 Sources of Finance
The lack of cash is one of the biggest problems faced in taking decisions. Without
cash, an organization/individual would not be able to achieve the ultimate objective as
expected. With many possible uses of finance wages, advertising, development,
payment of interest on loans, expansion projects etc. Paul Kayman can consider

various sources of finance to fund the expansion project. Each source has its own
merits and drawbacks and different sources will be more suitable in different
The funding options for the two proposed projects are discussed in detail below.

Personal Savings
This is the most common and very first source of finance where use of own money as
capital which is being in the form of savings to invest on the said project. For an
instance a person can use the money earned from his employment for a certain period
of time, profit sharing from other investments or retirement benefit funds. This source
of finance is considered to be the cheapest financing method as it does not have to be
repaid and no interest is payable for the same. However there is a limit to the amount
which a person can invest on.

Borrowings from External Parties

The required fund to invest on the project can be gathered through borrowings from
external parties. This could be in the form of friends, relatives or partners who are
willing to lend money for us. This will be in the form debt capital which needs to be
repaid with interest and within a certain period of time. The trust among individuals is
much critical in this form of financing.

On the other side, borrowing can be obtained through commercial banks as well. Paul
can consider two forms of finance which bank offers, overdraft and loans. If a
business or an individual is approved to spend extra money than it is available in the
bank account, it is said to be bank overdraft. This is a short term source of finance
which needs to be repaid in a fairly short period of time with interest. This is useful to
fund short term finance requirements, hence considering this option will not be a
feasible option for Paul.
A bank loan is a long term source of finance and will often be for much larger sum of
money. As overdraft a bank loan also needs to be repaid with interest but it has fairly a
longer period of settlement. A loan is one of the ideal funding techniques for a growth
opportunity. Loans are often used to purchase fixed assets such as property, plant and
equipment. The main advantages of bank loans are repayments are spread over a

period of time which is good for cash flow and budgeting. Availability of loan is fast,
if the borrower has all the suitable documentations; any bank can process the
application within a very shorter period of time even within an hour.

Having said that bank loan can be expensive if the interest charged is at a higher rate.
Further to obtain a bank loan an individual would be requested to mortgage personal
assets as security. Failure to pay the repayment on time could lead to losing own

The leasing process allows gaining assets without the need to pay a large lump sum
upfront. It is arranged through a finance company. Leasing facility is something
similar to renting an asset. It involves making set repayments and it provides the
chance to make use of capital without ownership.
As other sources leasing also has its own advantages and disadvantages. The leasing
facility offers fixed rate financing which means payment can be made at the same rate
throughout the period. Typically it is much easier to get lease financing than loans
from commercial lenders. Further it offers possible tax benefits depending on how the
lease is structured. On the negative side, it can be expensive and generally leases may
not be ended before the original term is completed. Therefore this can pose a major
financial problem for the owners of assets if they are facing a downturn. Further
although we are not the owners until the lease term completes, still responsible for
maintain the asset as specified by the terms of the lease. Failure to do so can prove

Sale of Assets
This is a form of finance by selling currently owned assets such as property, fixtures
& fittings, machinery, vehicles, share certificates etc. It is often used as a short term
source of finance, however could provide much longer term finance to invest on a
residential project like this if the assets being sold are very valuable such as land or
buildings. If Paul wants to use its own assets, he may consider sale and lease-back
where he may sell his assets and then rent or hire it back from the party who now

owns the assets. It may give the impression paying more money in the long run but it
provides sufficient cash for the current funding requirement.

3.2 Investment Appraisal

Various investment appraisal techniques are used to evaluate the performance of the
two proposed plans; investing on housing or apartment project.

Discounted Payback Period (DPP)

This involves calculating the length of time which is required for a stream of cash
proceeds from an investment to recover the original cash outlay required by the same
investment. The calculated period is compared with the pre-defined Acceptable
Period and decision is taken if the condition is met. Time value of money is
incorporated into the basis payback calculation to arrive at discounted payback.
It is the simplest technique to calculate and to understand. The method can be used in
screening stage in eliminating obviously inappropriate projects prior to more detailed
evaluation. Further it can be used when there is a capital rationing to identify the
projects which generates higher cash inflow quickly. However it ignores timing of
cash flows within the payback period where cash flow after the payback period is not
considered. In addition to that tends to favor short term projects over longer term

The discounted payback periods for the given projects are calculated as below:
Cash Flows ($ Discounted Cash
PV of Discounted Cash
Yea '000) Flows ($ '000)
$1 @ Flows ($ '000)
Housi Apartme 10% Housin Apartmen Apartme
ng nt g t nt
0 (8,000) 1.000 (4,500) (8,000) 0 0
1 2,500 2,000 0.909 2,272.5 1818.0 2,272.5 1,818.0
2 2,500 2,000 0.826 2,065.0 1652.0 4,337.5 3,470.0

3 1,400 3,500 0.751 1,051.4 2628.5 6,098.5
4 1,400 3,500 0.683 956.2 2390.5
5 1,000 3,500 0.621 621.0 2173.5
6 1,000 3,500 0.564 564.0 1974.0

162.5 1,901.5
2 10
2 Years 3 Years
&2 & 10
Months Months
Table I Discounted Payback Period

Net Present Value (NPV)

Net present value is the present value difference between net cash inflows and net
cash outflows of a selected project or an investment. Shareholder wealth is maximized
by accepting projects that offers a positive NPV.
It provides the investors with a simple decision rule of accepting a project with
positive NPV. It is relatively a simple method to calculate and unlike the payback
technique, it takes into account cash flows throughout the lifetime of the project.
Superior to the IRR approach because it does not suffer the problem of multiple rates
of return due to irregular cash flows. On the other hand it may be difficult for a non-
finance person to under the concept. Determination of the correct discount rate also
can be a difficult task.

The Net Present Values for the given projects are calculated as below:
Cash Flows ($ '000) PV of $1 @ Present Value ($ '000)
Housing Apartment 10% Housing Apartment
0 -4,500 -8,000 1.000 -4,500 -8,000
1 2,500 2,000 0.909 2,272.5 1,818.0
2 2,500 2,000 0.826 2,065.0 1,652.0
3 1,400 3,500 0.751 1,051.4 2,628.5

4 1,400 3,500 0.683 956.2 2,390.5
5 1,000 3,500 0.621 621.0 2,173.5
6 1,000 3,500 0.564 564.0 1,974.0
NPV 3,030.1 4,636.5

Table II Net Present Value

Internal Rate of Return (IRR):

Internal Rate of Return represents the true rate of return earned on an investment over
the course of its economic life. It equates the value of cash returns with cash invested.
It requires a trial-and-error method for solution.
It is relatively an easier technique to understand by non-finance managers. It avoids
the identification of a discount rate which is complicated for many years ahead with
inflation and uncertainty. As other methods this has its drawbacks too. Relative size of
the investment is ignored in this method. When discount rates are expected to differ
over the life of the project, it cannot be incorporated unlike in NPV. Further projects
with non-conventional cash flows or when comparing with between mutually
exclusive projects this method could lead to multiple or no IRR.

The Internal Rate of Return for the given projects is calculated as below:
PV of
Present Value ($ Present Value ($
Cash Flows ($ '000) PV of $1 @
Yea '000) '000)
$1 @ 40%
Housin Apartme 10% Housin Apartmen Housin
g nt g t g
0 -4,500 -8,000 1.000 -4,500 -8,000 1.000 -4,500 -8,000
1 2,500 2,000 0.909 2,272.5 1,818.0 0.714 1,785.0 1,428.0
2 2,500 2,000 0.826 2,065.0 1,652.0 0.510 1,275.0 1,020.0

3 1,400 3,500 0.751 1,051.4 2,628.5 0.364 509.6 1,274.0
4 1,400 3,500 0.683 956.2 2,390.5 0.260 364.0 910.0
5 1,000 3,500 0.621 621.0 2,173.5 0.186 186.0 651.0
6 1,000 3,500 0.564 564.0 1,974.0 0.133 133.0 465.5
3,030.1 4,636.5 -247.4 -2,251.5
1 2

IRR = r1 + (NPV1/
(NPV1 - NPV2)) *
(r2 - r1)
Housin Apartmen
g t
37.74% 30.19%
Table III Internal Rate of Return

3.3 Investment Decision

Based on the above analysis and calculations the following conclusions can be
derived. According to the discounted payback technique a project which has a shorter
payback period needs to be selected. Consequently housing project can be chosen for
investment as it meets Pauls discounted payback target of 3.5 years. The initial
investment can be recovered within a shorter period of time of 2 years and 2 months
compared to the apartment project which takes longer period. However as mentioned
above, cash flow after the payback period is not considered in this method. Apartment
project appears to flow more cash inflow in the later part of the cycle which could be
more beneficial when compared to housing project.

Both housing and apartment project are generating a positive NPV, hence elected to
be chosen. However the project which generates a higher NPV should be selected as
the projects are mutually exclusive. Therefore apartment project needs to be selected
as it provides a higher NPV and in the meantime meets Pauls NPV criteria of $2.8m.

Based on the IRR method, the project with a highest IRR would be recommended for
investment as it is more profitable. According to that, housing project seems a better
option for Paul to invest on as it generates a higher IRR of 37.74% and meets his
initial target of 20%.

When two mutually exclusive investments are compared, one of the NPV or IRR
methods could be used to select the best investment option. As the decisions with two
methods are contradicting to each other, a proper conclusion needs to be arrived at.
Between the methods NPV is technically superior to IRR as it is an absolute measure,
whereas IRR is a relative measure. Without calculating two NPVs at two different
rates, IRR would not be possible.

Accordingly the apartment project can be selected by Paul as it generates a higher

NPV. Further it is generating an IRR which is closer to the initial IRR target set by
him. Additionally as the apartment project generates more absolute cash inflows as
opposed to the housing project it can be chosen for deal.
Despite the correct method is being used to decide the best project, the following non-
financial factors can influence the choice of the investment especially due to unstable
economic condition in South East Asia:
The availability of required capital
The need for borrowing
Uncertainty of estimated cash flow
Non-financial benefits of the investment
Whether the investment causes any negative impact amongst stakeholders
(customers, employees, suppliers etc.)

4.1 Explain the Process of Creation of a Master Budget


A Master budget consists of a set of operating budgets and a set of financial budgets
that detail an organizations financial and planned operational plans for a specific
accounting period, generally a year. It is a comprehensive plan of all aspects of a
firms future business and production operations. Master budget comprises of many
separate budgets and it summarizes the planned activities of all subunits of an
origination. These budgets include:

1. Operating Budgets
a. Sales Budget
b. Purchases Budget
c. Production Budget
i. Direct Material Purchase Budget
ii. Direct Labor Budget
iii. Production Overhead budget
d. Cost of Goods manufactured Budget
e. Cost of Goods Sold Budget
f. Selling and Administrative Expense Budget

2. Financial Budgets
a. Budgeted Income Loss Statement
b. Cash Budget
c. Capital Budget
d. Budgeted Balance Sheet

The process of preparing master budget is similar in all three types of organizations
(Manufacturing, Retail and Service). The process differs mainly in the kinds of
operating budget each type of organization prepares due to the operational variations.

Manufacturing Master Budget Preparation Process

(Self built)

Retail Master Budget Preparation Process

(Self built)

Service Master Budget Preparation Process

(Self built)

Master Budget Preparation Process (General)

Sales budget is prepared at the beginning of the process. Once sales budget is being
developed other budgets are prepared based on the estimated sales budget. These
other budgets will help manage the organization's resources so that profits can be
generated on sales

Steps in preparing Master Budget

1. Collection of basic data

2. Preparation of operational

3. Preparation of fnancial

Operational Budgets

It is a set of budgets that are used in planing the daily operations of an organization.
The following techinques are used in preparing the operational budget

a. Cost behaviour analysis

b. Cost-volume-profit analysis
c. A target profit or target costing methods

1. Sales Budget

It is a detailed plan, expressed in both units and monetary value that identifies
the product (or service) sales expected in an accounting period.

This is the very first budget prepared in the preparation of master budget

Total Budgeted Sales = Estimated Selling Price per Unit X Estimated Selling

2. Production Budget or Purchase Budget

It is a detailed plan showing the number of units a company must produce or

purchase to meet budgeted sales and inventory levels

Total Production Units = Estimated Sales Units + Estimated Ending

Finished Goods at Inventory Opening Finished Goods at Inventory

3. Direct Material Purchase Budget

It is a detailed plan that identifies the quantity of purchases required to meet
budgeted production and inventory needs and the costs associated with those

Total Direct Material to be Purchased = Required Directed Material for

Estimated Production + Estimated Ending Direct Material at Inventory
Opening Direct Material at Inventory

4. Direct Labor Budget

It is a detailed plan that estimates the direct labor hours needed in an

accounting period and the associated costs

Total Budget Direct Labor = Estimated Direct Labor Hours X Estimated

Direct Labor Cost per Hour

5. Production Overhead Budget

It is a detailed plan of anticipated production overhead costs, other than direct

materials and direct labor costs that must be incurred to meet
budgeted production needs

6. Selling and Administrative Expense Budget

It is a detailed plan of operating expenses, other than those related to

production, that are needed to support sales and overall operations in an
accounting period

Financial Budgets

It is a projection of financial results for an accounting period

1. Budgeted Income Loss Statement

It projects an organizations net income or loss in an accounting period based

on revenues and expenses estimated for that period

2. Capital Expenditure Budget

It is a detailed plan reflecting the estimated amount and timing of capital
outlays for non-Current assets in an accounting period

3. Cash Budget

It is a projection of the cash an organization will receive and the cash it will
pay out in an accounting period

4. Budget Balance Sheet

It projects an organizations financial position at the end of an accounting


Master Budget Preparation Overview

Figure: 03 (,. N.p., 2016. Web. 15 Jan. 2016.)

4.2 Compare the actual income and expenditure and analyze

performances of the above organization in comparison to their
budget and suggest appropriate recommendations to improve

Executive Summery

Delilah Co recorded a loss of ($1200) in relation to the budgeted profit of $1000 for
the month end June 2015. The reported loss for the month would have been incurred
due to management inefficiencies in the controllable factors or due to any other
uncontrollable factors (inflation, taxation, and change in political and economic
condition). These will be analyzed in detail

Sales Volume Variance and Price Variance

Sales Price Variance

We do not observe a significant increase in the sales price (Estimated Sales Price per
unit was $20, but actual selling price was $20.63.) The increase in the sales price
could be ignored assuming the increase was due to inflation factor.

Sales Volume Variance

The estimated sales volume was 1000 units but actual sales unit was 800 units as a
result there was a 200 adverse sales unit variance reported for the month in focus.
This would have been incurred due to

1. Not focusing on external factors when preparing the sales budget

a. Local economic climate
b. The state of industrys economy
c. Nature of the competition

2. Not focusing on internal factors when preparing the sales budget

a. Number of units sold in prior period and trend analysis
b. Organizations credit policy
c. Organizations manufacturing capacity
d. Any new product company plans to introduce to the market
e. The stage of life cycle of the product

These factors need to be evaluated further to understand the appropriate reasons for
the adverse volume variance.

Direct Material Variance

The analysis shows that there is an increase in material price from $8.00 to $9.13. As
a result there was an adverse direct material price variance of ($900) reported for the
month in focus.

Reasons for adverse direct material price variances

1. Sudden increase in the market price of the material

2. Loss of regular supplier
3. Loss of purchase discount due to small order size
4. Increase of bargaining of the supplier

5. Inefficient buying by the procurement staff

6. Purchase of higher quality material

Direct Labor Variance

It was recorded a favorable direct labor variance of $300 (budgeted - $4 per unit and
actual was $3.63 per unit)

Reasons for favorable direct labor variance

1. Employed un-skilled or semi-skilled labors to do the production (This will

impact the quality and the quantity of the product)
2. Change in the pay system of wage Example from per hour payment to no of
units produced payment (piecemeal system) or vise verse
3. Decrease in overall wage due to high supply in the labor market
4. Inappropriate high setting of standard labor rate

Since the unit change of direct labor variance is insignificant, we do not believe that
the first reason would have impacted the favorable variance since it has an adverse
impact in quality. The reasons for favorable variance need to be investigated further in
order to revise the standard costing

Variable Production Overhead Variance

An adverse variable production overhead variance of ($500) suggests that the

company incurred a higher cost than the estimated cost

Potential Reasons for an adverse variance

1. A wage increase in indirect labors due to minimum wage policy introduce by
the government
2. The decrease in the level of activity was not fully offset by a decrease in
overheads (example, electricity consumption or maintenance cost)
3. Inefficient cost control system (non-optimization of production cost when
producing smaller batches)
4. Planning errors


Variable production overheads cost by nature includes costs that cannot be directly
traceable to a specific unit of output unlike direct material and direct labor which may
vary in proportion to the output. Variable overheads do vary but with the change in
another variable. Therefore it would be hard to determine the factor which influences
the variable overhead expense.

Fixed Overhead Expenditure Variance

An Adverse fixed overhead expenditure variance of ($400) indicates that higher fixed
cost were incurred during the period than the estimated fixed cost in the budget

Potential reason for adverse fixed cost expenditure variance

1. Expense of a business undertaken during the period was not considered

2. Sudden increase in rent or other fixed charges
3. Inefficient fixed overheads management

4. Planning error

Suggestions and Recommendation

1. Organization seems to be struggling in achieving the budgeted sales volume in

order to reach the required profit. Therefore organization need to change their
marketing policy which help them to reach the required profit
a. Expending the market for the current product
b. Changing the pricing strategy which helps them to compete in the
c. Introducing a new product along with the current product
d. Introducing value added service to the customer along with the product
e. Reach out the customer and find their needs
f. Run customer reward program where customer is motivated to buy the
g. Improve the quality of the product, since quality plays a vital role in
selling the product
h. Provide reasons to your dealers why they sold sell it
i. Improve advertising and market promotion
j. Give free sample to the customer and make them buy the product
k. Diversification of product range

2. Perform breakeven analysis and sensitivity analysis during budgetary

preparation stages.
a. Current breakeven point (no profit or no loss point) is 834 units of
sales and the company must target to sell 833 or more to gain the profit
b. Sales volume and direct material price seem to be sensitive in reaching
the target profit therefore the organization should pay more attention
on the variance of those two items
c. According to the current budgeted level the margin of safety of 167
units is seems to be adequate (Budgeted sales unit 1000 minus
breakeven point 833 units, but it is very sensitive element to reach the

target profit. Therefore the organization should periodically monitor
the sales unit

3. Planned budget Vs. Revised budget

a. Recommend to revise the budget to calculate the correct variance
b. If the standard cost card is out of date, the analysis will not support the
company to make the correct decision
c. Eliminate the planning errors and uncontrollable cost factors from the
standard cost card
d. To include the inflation impact and other impact to the standard cost

4. Reduce the direct material cost is another key sensitive element in reaching
target profit
a. Substitute lower material where possible without impacting the quality
b. Reduce the waste
c. Eliminate unnecessary product feature
d. Find out leverage suppliers (have alternative suppliers who could
supply you the similar product to lower price
e. Introduce EOQ (Economic Order Quantity) or JIT (Just In Time)
inventory ordering system
f. Offer quick payment for lower cost supplier
g. Negotiate long term supply agreement for a fixed price

5. Fixed cost must be controlled since it has a direct impact to the breakeven
a. Appropriate allocation and reapportionment of fixed cost which are
related to the product
b. Eliminated non-value adding fixed cost
c. Get warehouse facility from the supplier or dealer through introducing
JIT inventory system to reduce the ware house cost
d. Use computer based system rather than human based activity which
will increase the fixed cost


Overall the organization could improve the profitability through changing some of its
approaches to marketing and pricing policy.

Variance and Other Supporting Calculation

Revised Budget Results Variance
Sales and Production
(Units) 800 800

Sales 16000 16,500 500 F

Variable cost
Direct material 6,400 7,300 (900) A
Direct labor 3,200 2,900 300 F
Variable overhead 1,600 2,100 (500) A
Contribution 4800 4,200
Fixed cost 5000 5,400 (400) A
Profit -200 -1,200

Sales Volume Variance = Budgeted sales volume Actual sales volume

1000 - 800
200 Adverse
Contribution/per unit

Selling Price 20
Direct material 8
Direct labor 4
Variable overhead 2

Contribution 6

Total Budgeted Fixed

Break Even Point Cost
Contribution per Unit

= 833

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