Introduction

The life blood of an organization is known as finance. If the blood circulation is not run properly than the whole body will disable and like this if financial activities is not run properly within an organization. It will not work properly. In this study the financial operations such as cash flow statement, income statement, ARR, IRR, PP, and NPV is described for the company Wild Frontier Builders Ltd. and Eye Watering Inc. As a travel agency how WFB can manage their financial activities is described in this case. On the other hand Eye Watering Inc. should follow what kind of financial tool s to maintain their business is also described.

1. A clear understanding of the difference between profitability and cash flow and how these are expressed in the company’s accounts.

Sales and profit are two different things for every company and most of them are important for the company. Sales is the prerequisite of profit. Sales ensure receive amount for the company whereas profit makes earning. Without strong cash flow a company hardly can achieve higher profit. Both of profitability and cash flow measures the cost and expenses of a company. As both of them bear almost same meaning but there have a significant difference between them. To know the difference it is at first should know what cash flow and profitability actually is.

Cash flow refers to cash flow forecast tracks and difference between inflow and outflow of the company. Cash are receive by the company if a sales is occur or company get previous payments from the debtors and cash are go to outside of the company if the company purchase or pay to the creditors.

Profitability refers to the ability to use the resources of the company to allocate revenues in the terms of expense. Profitability also shows the difference between earning of a company and their expenses.

Difference between cash flow and profitability

Cash flow keeps record of actual cash transaction whereas profitability keeps record of income and profit statement. Cash flow can be grown up by capital invested by the owner and cash from selling an asset on the other hand profitability can be affected by depreciation, asset sold at loss and by building up an inventory. Cash flow is a regular procedure for the company but profitability is periodic. Cash flow show the ability to maintain liquidity of a company but profitability shows the ability to earning profit by the company. Finally it can be finish by the sentence that profitability is a long term procedure and company do this after a certain period of time and cash flow is a regular procedure that company do regular in order to maintain liquidity (Arnold, 2005).

Ways of expressing profitability:

Profitability is generally measured by income statement. Income statement can be both single and multi-step. If the sources of a company cost are single then the statement will single step and if the sources are several then the statement will multi. One of the basic element of income statement is net profit which is generated from all of these sources. It also called bottom line of the company.

A sample of income statement of a company is given below:

Ways of expressing cash flow

Liquidity is the most important element of a company and as cash flow maintains this element so it’s also an important part of any company. Liquidity is represents how much cash are available in the hand of the company. Cash flow statement of a company includes three basic areas of a company such as operating activities, inventing activities and financing activities. To present the liquidity of a company cash flow can use in both direct and indirect method (Atrill, 2007).

A sample of cash flow statement is given below:

2. Application of the concept of working capital management to the company and how the current situation is a reflection of how the business in managed.

Working capital management concept represents the term “to manage the working capital” of a company. It is a strategy by which a company can monitor and utilize the working capital of their organization. It is the amount of capital that a company uses to operate daily activities including current assets and liabilities. So the working capital of a company calculated by finding the differences between current assets and current liabilities. As working capital ensures a company to finding out how much capital is available on their hand it is important to find out and maintain working capital properly (Brealey, 2006).

As working capital determine how smooth a company will run it will ensure that WFB is operating their financial resources more efficiently and more effectively. It also ensures the proper management of financial operation of the company. To monitor cash flow, short term asset and liabilities it requires three essential ratio analysis and they are working capital ratio, collection ratio, and inventory turnover ratio (Cagan, 2007).

Working Capital Ratio: By determining the financial health of the company it helps to manage the working capital to meet short term liabilities. It is calculated by:

Working Capital Ratio = Current Assets ÷ Current Liabilities

Collection Ratio: By determining average period of getting a payment by the company it helps to find out collection period of the company. The calculation formula for collection ratio is:

Collection Ratio = (Accounts Receivable ÷ Net Sales) × 365

Inventory Turnover Ratio: By determining the number of times the inventory is sold it helps to manage the working capital. The formula is:

Inventory Turnover Ratio = COGS ÷ Inventory

It is crucial to determining the efficiency for working capital management. The case is for Wild Frontier Builders Ltd. (WFB). It is seen that are now suffering for prospering managing and it is a great threat for them. The company is not on a suitable situation now. Neil Geezer, the manager of WFB has not monitoring the cash flows of the company properly. The company also facing the problem of working capital, because they do not appropriately manages their working and operational capitals. WFB has a bank overdraft for last nine months and also owed the property of Vulture estate and Weasel properties. Neil is also reluctant to press his customer about the current condition of the company. For these reasons WFB is now in a high inefficiency (Cinnamon, 2010).

3. Steps needed to be taken to improve the company’s working capital management

WFB is now in a critical stage and they should have overcome these stage. To overcome this stage should at first ensure effective working capital management. Their manager Neil should give a great concentration of their working capital management as well as liquidity management. They also should improve over financial health of the company and should use a proper procedure to overcome this condition (Cooke, 2003). Wild Frontier Builders Ltd can also follow this steps:

Steps needed to be taken by WFB:

WFB can change their short term debts into long term in order to get better benefit for the long run and manage their working capital efficiently.

WFB should reduce their debts collection periods because shorter the period more cash will available in the hand of the company to manage daily operations.

WFB should follow a effective inventory stocks technique. They should sell unnecessary holdings to get extra amount of cash.

To manage the working capital effectively WFB should reduce unnecessary expenses.

WFB should establish cash flow forecasting because it is the first step of working capital management. They should also utilize their working capital properly.

WFB should set up a contingency plan to deal with the UN foreseen incidents.

WFB should combine financial and operational activities in order to be innovative in their current business condition.

WFB should follow the above recommendation in order to overcome their current business situation and make their company more productive.

1. The stages of the capital budgeting process and the main capital investment appraisal methods.

Capital budgeting or investment appraisal is the process of planning which indicates an organizations long term investment in new machinery, replacement of machinery, new plants, and new product worth the funding of cash through the use of capitalize structure. It’s evaluate and determines a company’s project whether it is worth investment of the capital. Generally a company budget a capital for the asset which will be used for long time. There are six major stages which can help a company to budget their capital investment (Oswald, 2002). They are described below:

Identifying Initial Investment Project refers to the identification of available initial opportunities for making an investment in a project. It is the 1^st step of capital budgeting process. Company generally use capital budgeting to enlarge the existing opportunities present in a project, or make investment in a new project. They try to identify the potentiality of the project.

Evaluating the Investment Project focuses on analyzing the investment opportunities and it is the second step of capital budgeting process. Company tries to find out potential benefits and shortcomings from the project in this stage. They use different capital budgeting tool to find out this potentiality such as Pay Back Period, NPV, and IRR and so on.

Selecting the investment project the third stage in capital budgeting process by which company determines the best one option by analyzing and evaluating existing other. They select the best one which can generate a higher return.

Implementation the fourth stage of the capital budgeting process and in this stage company implement the plan made for the project. The plan comes into reality in this stage and company tries to include a proper timeline to implement the plan accordingly.

Monitoring Performance is consider as the final stage of capital budgeting process and company takes necessary controls to implement the plan properly and they monitor the project after a period of time to find out whether any mistakes are happen.

Post Audit is consider sixth or an additional stage in capital budgeting process and company analyses the result of the outcomes from the capital budgeting decisions. This stage usually measures the effectiveness and efficiency of the project (Ricci, 2000).

Capital investment appraisal method

These are the techniques by which the company measures the worth of the capital investment decision. There are several capital investment appraisal and them ARR, PP, NPV and IRR are described below;

Accounting Rate of Return (ARR) determines the profitability of a company. It’s the 1^st step of capital appraisal method. When an investment made, how much it will return determine by the ARR.

Advantages it’s a simple and easy method to find out accounting rate of return for an investment and also identifies profitability factor for investment made.

Disadvantages it has a limitation and that are it cannot find out the time value of money.

Payback Period (PP) is required to cover the outlay of the investment from the cash flow

Advantages it’s a simple and easy method and provides good risky assessment factor for investment decisions.

Disadvantages It cannot consider the time value of money.

Net Present Value (NPV) represents the differences between the present value of cash inflow and outflow. It is the third step of capital appraisal method.

Advantages it is better predictor for deciding an investment whether it is profitable or not.

Disadvantages it is very sensitive in case of change in cash flows.

Internal Rate of Return (IRR) It is the fourth capital appraisal stage and indicates the discount rate which shows that NPV equals to zero. It is one of the great measure of supporting capital investment decision.

Advantages it very easy and simple method and consider time value of money.

Disadvantages: it is not consider economies of scale and highly depends on contingent project.

2. The potential application of these methods to the projects under consideration.

To get a clear and desired return from the investment, Eye Watering Inc. should properly understand the potential consideration of the methods to the project under consideration. They must consider the appropriate calculation and evaluation process of these methods:

Application of ARR

The formula stands for ARR is:

ARR = Average Accounting Profit ÷ Average Investment

As ARR is not consider the time value of money Eye Watering Inc. Needs to accept project whether the calculated ARR is higher than required ARR.

Application of Payback Period

The formula stands for PP is:

If cash flow of the project is not equal to required one then PP will calculated using this formula:

Eye Watering Inc. needs to accept lowest one by calculating two projects payback period. They can use any one of these formula.

Application of NPV

The formula stands for NPV is as follow:

If the cash flow is even

If the cash flow is odd

NPV is the one of the easiest measure of the investment decision. In this type of calculation time value is measured appropriately. Eye Watering Inc. should consider positive result of NPV for a single project. In the competing projects they should consider higher NPV. The negativity is not accepted for a single project.

Application of IRR

The calculation formula for IRR is as follow:

Eye Watering Inc. should accepted IRR if only it is higher or greater than the projected IRR estimated before and in the case for competing project Eye Watering Inc. should accept the IRR if only it is positive (Rigby, 2007).

3. Analysis of the most appropriate method for the decision making process in this case.

There are two consideration for Eye Watering Inc. in this case and they are call of assassins and Coalmining. These two are game projects and they have their own financial and future aspects. Call of assassins is always requires higher investment and takes time to start two to four years on the other hand Coalmining requires lower and takes time to start one to two years.

The project will be evaluated in this case that it can be begin with payback period and it will provide an assessment to do the task in a required time to give a backup to both of the projects. Another appraisal method called Accounting Rate of Return is not suitable in this case because it is only dictate the profitability of the project and it is not accept additional consideration to complete task.

Another appraisal method Internal Rate of Return is not also appropriate appraisal for these projects as it is conflicting results of the projects which is mutually exclusive in the nature. It make complex the project work. Therefore the best method which will suits the project and make the investment decision meaningful is Net Present Value. It is the most appropriate method because it is not effected by the lifetime issues. It has provide a better assessment of competing the project. It is better predictor for deciding an investment whether it is profitable or not. At last it can be said that NPV is the best appraisal tool for use by the Eye Watering Inc. (Ryan, 2007).

Conclusion

Conclusion of the study can be drawn by capital budgeting analysis of both of the company. At first we can say about the capital budget of Wild Frontier Builders Ltd. They are a travel agency and for this they should have enough cash available on their hand in order to run daily activities and face daily huge cost. They should have a short term payback period in order to make their asset quickly in term of liquidity. Eye Watering Inc. should set up a policy by which they can get their investment after a long period of time with a higher amount of return.