Managing Finanacial Principles And Techniques Of Forecasting Finance Essay - Free Essay Example

MB Enterprise is Private firm. It is manufacturing company who produce sleeper. It has 4 factories at different location. The production is based on quantity e.g. production in unit. they get job work on the basis of issue of tender every weekend . Part A Forecasting method What the means of forecasting? Forecasting means to forecast or predicts of something for future. E.g. we all are hearing the weather forecast on the radio or reading on newspaper, it shows the the weather will be like for the following few days. In business it defines as it predicts the level of income of spending and the level of income which the business will have during the following period of time. Cost forecast and revenue forecast It shows the various cost incurred by the organisation during the period of time its estimation of fixed cost variable cost and others by which incurred with the forecasting model Three kinds of expenses (cost) are incurred with a forecasting model: the cost of developing the model, the cost of accumulating and storing the data used in the model, and The expense involved in actually using the model. A comparison of the estimated costs for various models can be the deciding factor as to which model is ultimately chosen (Hughes 1999). A number of forecasting models require a fairly large amount of data if they are to be used effectively. For example, when multiple regression models are used, at least thirty to forty periods of past data may be needed. ARIMA models can require sixty to seventy periods of past data. In the volatile high-tech industry, firms might have less than two years of sales data available, a condition that restricts greatly the types of models that can be used. In the case of new, totally unique products, since no previous sales data exist, this eliminates time series and causal models as possible forecasting tools. The financial report: Months of year 2009 No. of Units produced (in  £) Cost of Production in pounds(  £) JAN 1500 150000 FEB 1800 180000 MAR 2500 200000 APR 2700 160000 MAY 2900 250000 JUN 3000 ? The forecasting can be calculated easily by using the formula Total cost: fixed cost +variable cost i.e. Y= a+ b x Whereas variable cost (B): cost per unit *no. of unit In this method I use high and low Method , it shows highest Highest unit produced = 3000 units Cost of production =  £ 139500 Lowest unit produced = 1400 units Cost of production =  £150,000 Different in units produced is 1400 units are 150,000. Reason for the High and low method it has highest and lowest point its simple to do and it is straight forward. Formula Variable cost per unit = [cost at high level of activity cost at low level of activity] / [unit at high level of activity units at low level of activity] Variable cost per unit = 250,000 150,000 / 3000 1400 = 100,000/1600 = 62.5 Variable cost per unit (b) =  £62.5 Fixed cost of production = a + (b * 1400) = a + (62.5 * 1400) = a + (87500) 150,000 = a + 87500 a = 150,000 87500 = 62500 Production of the month June, Y = a + bx Y = 62500 + (62.5* 1400) Y = 62500 + 87500 Y =  £150000 Revenue Forecast Below shown tabular column illustrates the companys last five months sales revenue. Using the high/low method Im going to calculate the sale for June month with a formula relating sales expressed in June month price levels using RPI. Months Revenue RPI values January 150000 0.1% February 170000 0.0% March 190000 -0.4% April 200000 -1.2% May 220000 1.1% June ? January 09 = 150,000 (150000*0.1/100) =  £149850. February 09 = 170,000 (170,000*0.0/100) =  £170,000. March 09 = 190,000 (190,000*(-0.4/100)) =  £190,760. April 09 = 200,000 (200,000*(-1.2/100)) =  £2024000. May 09 = 220,000 (220,000*(1.1/100)) =  £217580. Highest value attained in 5th month may =  £217580. Lowest value attained in 1st month January =  £149850 Difference in months = 5 Gradient (b) =  £67730/ 5 = 13546 Formula: Y = a + bx. Y =  £149850 + ( £13546 * 6) Y =  £149850 +81276 Y =  £231126 So the expected revenue for the month June is  £231126 The forecasting is a process usually followed by every organization in order to provide an idea for decision making and planning for the future business. The organization can get alert message by using these techniques about their future risk in their business. The cost forecasting is the process is based on assumption. It will explain the cost of labour, cost of buying materials and cost of production. so it is very advisable for all organization to practice the cost forecasting method. The revenue fore casting is a process used for calculating the organization expected revenue of sales. Forecasting Techniques There are various techniques of forecasting which can be use for the business such as Box-Jenkins model, Delphi model, exponential smoothing, moving averages, and Regression analysis and trend projection. Fir ms generally use forecasting techniques that their decision makers feel comfortable with, even though these techniques may not be the most effective ones. Many decision makers have neither the quantitative nor the computer background to understand and use the more complicated models such as adaptive filtering or ARIMA. They prefer making decisions based on techniques that make sense to them and are relatively easy to apply (Kress Snyder 1994).   The major hurdle to most of the sales forecasting software packages now available is that many of their potential users do not understand how and when these models should be used. Most surveys of businesspeople seeking information about the types of forecasting models being used discover that the most widely used models are usually those that are relatively simple to apply and understand. Many decision makers not only have to understand the forecasting process, they also have to be familiar with tools that can qualify and quantify markets. The basic measure of a forecasting models accuracy is the difference between its forecast of expected sales for a specific time period and the actual sales that occurred during that time period. The difference between these two values is referred to as an error (Riahi-Belkaoui 1998). Most forecasters have some typical time frame for which they are expected to make forecasts. For example, some forecasters may be responsible primarily for short-term forecasts whereas others generally make twelve-month forecasts. Some may even be asked to make relatively long-term forecaststhree to five years into the future (Knoop 2004) Financial information in making strategic investment decisions The financial information of the FDI would be used to decide on strategic investments. The FDI can help in analyzing the trends in a new market and it can identify the probable problems in the new market. Since there is a 51% FDI in single brand outlet in India it can be said that the invest ment project in the country would be a success. A high rate of foreign direct investment means that firms in India are experiencing good business and it attracts big investors. Analysis may predict the expected future cash flows of the project, analyse the risk associated with those cash flows, develop alternative cash flow forecasts, examine the sensitivity of the results to possible changes in the predicted cash flows, subject the cash flows to simulation and prepare alternative estimates of the projects net present value (Dayananda et al., 2002). While the basic concepts, principles and techniques of project evaluation are the same for different projects, their application to particular types of projects requires special knowledge and expertise. For example, asset expansion projects, asset replacement projects, forestry investments, property investments and international investments have their own special features and peculiarities. Financial appraisal will provide the estimated addition to the firms value in terms of the projects net present values. If the projects identified within the current strategic framework of the firm repeatedly produce negative NPVs in the analysis stage, these results send a message to the management to review its strategic plan (Luo 1999). Part B Identify the sources of fund There are several methods by which businesses may raise necessary finance. The method which they choose depends on how much they wish to borrow and how long they wish to borrow it for. The main resource required for all the organizations in this world is money. The money is available and it is provided to many organizations by bank with the proper rate of return called interest. The management should make a proper forecasting on their business before approaching for a loan. The emerging organizations should not believe completely on the bank loan as their main capital source because the possibility of risk is more in it. The organizations should consider the following if they seek for finance sourcing. Finance can be raised both internally (inside the business) or the externally (from sources Sources outside the business) Internal Sources of finance External Internal sources That money raised inside the business. There are below internal sources Owners own capital Retained profit Sales of fixed assets Sales of stocks Debt collection External sources That Money is raise from outside the business. There are the points Bank loan/overdraft Additional Partners Share issue Leasing Assets/ hire purchase Mortgage, Trade credit Government grants Appraisal methods India has a growing retail market lead by retailers such as Shoppers Stop and Gitanjali Gems. Retail companies believe that India is a good place of investment due to the countrys middle class population and various attractions for Retail giants that want to enter a new market. Investment projects in India will be successful due to the strong activity in the retail market and the assistance given by Indias government. Firms in India obtain their funds from three main sources-commercial banks, non-bank financial institutions (NBFIs) and the capital market. The reforms have had a profound impact on the relative importance of the various sources of funds tapped by firms to finance their investments. Financial sector reforms made it possible for firms to respond to changes in the cost of funds from various sources. Modelling investment at the firm level necessitates a different approach than that used at the industry level. This is because investment activity is lumpy at the firm level, proceeding with discrete jumps, rather than the smoothness in investment behaviour that one tends to observe at the industry or macro level (Tolentino 2000). The modern theories of investment relax the assumption of perfect capital markets and allow for information asymmetries and incentive problems. Consider a situation where information costs are high; that is, a situation where the quality and possibly the amount of information about profitable investment opportunities are different between firm insiders and outsiders. The empirical literature for developed countries that has studied the presence of fin ance constraints on investment have used a variety of firms attributes to demarcate firms into high and low information cost categories. Among the different variables, perhaps the most widely used is the size of the firm, with the hypothesis that smaller firms are more likely to face finance constraints than the larger, more mature firms. The argument here is that larger firms can offer a larger amount of collateral to the lender, thus, providing less incentive on the part of the borrower to default on the loan (Ganesh-Kumar, Vaidya Sen 2003). Small firms rely more on bank credit than large firms and in periods of tight credit, small borrowers are often denied loans in favour of large borrowers. It can be argued that a characteristic of the firm more revealing to the suppliers of funds in the Indian context is the firms outward orientation (Beenhakker 1996). In an economy that had allowed high degrees of firm-level x-inefficiency to exist in the past, attributes of the firm s uch as profitability, age and size may not be good indicators of its potential to grow in the future. Here, the clearest signal to the suppliers of funds of the firms quality may perhaps be how successful the firm has been in competing in international markets (Narula 1996). Proposal for Funds MB Enterprise should use the post audit appraisal to determine if the selected investment project decisions would be helpful to the firms growth and would be helpful for the success of the firm in the industry. MB Enterprise can use the post audit appraisal to analyze the financial standing of the firm. It can use such appraisal to understand how the firm improved after the investment project was initiated. Moreover MB Enterprise should make use of the post audit appraisal to know the trends in the finances and how it will affect the firm.   The future trends will help in forecasting the next steps that the firm must take. To improve the financial assets of the firm there shoul d be a focus on attracting more clients and giving them the best quality product they desire. Proposal for obtaining the above said funds. From, Manshi Patel To, Bank manager (HSBC) Croydon London. Date: 15/4/2010 Subject: Degrading a request for bank loan. Respected sir, I am writing this letter to get loan from your bank for my businesses which have the cost forecasted of  £150,000 and our organizations forecasted revenue is  £2,31,126 We have the 50% amount for owner and we requesting the rest 50% amount from you and the 10% interest rate can be easily payable for our organization because we have enough revenue from our company. So please grant us the loan amount. Thanking you, Yours Sincerely, ManshiPatel. Conclusion It is expected that MB Enterprise will continue its upward trend wherein it will acquire more market shares. Since the movement from May to Jun is an upward movement then it is expected that it will continue unless the environment forces a downward or unchanging movement. To improve the financial assets of Firm there should be a focus on attracting more clients and giving them the best quality product. An organization like MB Enterprise needs to have a positive portfolio so that it will achieve its financial and business goals.  References Beenhakker, HL 1996,  Investment decision making in the private and public sectors,  Quorum Books, Westport, CT.   Birchard, B Epstein, MJ 2000,  counting what counts: Turning corporate accountability to competitive advantage, Perseus Books, Cambridge, MA.   Carlson, RH 2001,  Ownership and value creation: Strategic corporate governance in the new economy, John Wiley Sons, New York.   Case, J, Kremer, c Rizzuto, R 2000,  Managing by the numbers: A commonsense guide to understanding and using your companys financials, Perseus Books, Cambridge, MA.   Christy, P Katsaros, J 2005,  getting it right the first time: How innovative companies anticipate demand, Praeger, Westport, CT.   Comiskey, EE Mulford, CW 2000,  Guide to financial reporting and analysis, John Wiley Sons, New York.   Dayananda, D, Harrison, S, Herbohn, J, Irons, R Rowland, P 2002,  Financial apprai sal of investment projects, Cambridge University Press, Cambridge, England.   Ganesh-Kumar, A, Vaidya, RR Sen, K 2003, International competitiveness, investment and finance: A case study of India, Routledge, New York.   Hughes, BB 1999,  International futures: Choices in the face of uncertainty, Westview Press, Boulder, CO.   Kanji, GK 2002,  Measuring business excellence, Routledge, London.   Knoop, TA 2004,  Recessions and depressions: Understanding business cycles, Praeger, Westport, CT.   Kress, GJ Snyder, J 1994,  Forecasting and market analysis techniques: A practical approach, Quorum Books, Westport, CT. Luo, Y 1999,  Entry and cooperative strategies in international business expansion, Quorum Books, Westport, CT.   Milgate, MA 2004,  Transforming corporate performance: Measuring and managing the drivers of business success, Praeger, Westport, CT.   Morgan , A 1999,  eating the big fish: How challenger brands can compete against brand leaders, John Wiley Sons, New York.   Narula, R 1996,  Multinational investment and economic structure: Globalization and competitiveness, Routledge, New York.   Nilson, TH 2003  Customize the brand: Make it more desirable and profitable, Wiley, Chichester, England.   Riahi-Belkaoui, A 1998,  Financial analysis and the predictability of important economic events, Quorum Books, Westport, CT.   Schaefer, HG 1993,  Economic trend analysis for executives and investors, Quorum Books, Westport, CT.   Tolentino, P 2000,  Multinational corporations: Emergence and evolution, Routledge, London. Task -2 Introduction A) Define 2 competing investment projects and explain the current appraisal methods and make justification on this competing investment projects Which is the profitable or not? B) Draw on the financial information and post audit appraisal and make recommendation on it Objective of the task Report appraisal on different two investment projects Define the appraisal methods Net Present Value Internal Rate of Return Payback Accounting rate of Return Defining 2 competing investment projects Post audit appraisal Recommendation on the basis of Post audit Appraisal Conclusion References Report appraisal on different two investment projects From: Manshi Patel Crown paper Ltd Croydon To: Managing Director (Crown Paper Ltd) Croydon London Sub: Appraisal and comparison and post audit appraisal on the selected investment project Date: 15.4.2010 Respected Sir, I am concluding here, the investment appraisal methods and comparison of two investment projects and post audit appraisal on the projects Define the Investment Appraisal Methods It refer to the series of techniques designed for the getting the answer of the question -should we go ahead with a proposed investment? Is the project give us expected return? These techniques are use for the comparison for the cost of investment project with the expected return in the future. It includes the four techniques such as Net Present Value, Internal rate of return Accounting Rate of return Pay back Method Net Present Value It is the method of evaluating project that recognizes the money received immediately is preferable to money received at some future date. This approach finds the present value of expected net cash flows of an investment, discounted at cost of capital and subtract from it the initial cash outlay of the project. If the present value is positive the project will be accepted and if it is negative the project should be rejected. Internal rate of return: It is defined as annual% return achieved by a project at which the sum of the discounted cash inflows over the life of the project is equal to the discounted cash outflows The rate of discount where NPV= 0 Whereas the NPV is the sum of the money, IRR is the expected yield in terms of % Identify two investment projects 1st investment project Calculation of NPV and IRR on the basis of below information A project would involved a capital initial outlay  £80000, rate of discount would be 10%, cash inflow would be  £ 16000 per year For 5 Years Month /year Cash inflow (  £ ) Dis. rate Outflow 0 (80000) 1.000 (80000) 1-5 16000 3.791 60656 NPV 19344(positive) Discount rate 1/1.10 Its best and good return after the 5th years of project rather than 7th year in case of NPV To indentify the IRR, I need to choose that discount rate by which NPV become zero Internal rate of return (IRR) enables decision maker to find out the rate of return at which NPV Become Zero. 2nd project Initial Cash outlay would  £ 40000 Discount rate 10% and cash inflow  £ 11000 for 5 year Year Cash inflow( £) Discount rate (%) Cash outflow 0 (40000) 1.000 (40000) 1-5 11000 3.791 41791 NPV (1791) In this project NPV is negative so its not profitable or suitable project Comparison of Project 1 and 2 It is advisable project 1 is better for future its shows net Present value after 5 years and if NPV is Positive so project 1 is accepted. And project 2 should be rejected. Post audit appraisal Post audit means to comparison of the actual income yielded by the projected at the time of project appraisal. Concerned with performance and plan. Relating to material,labour,overheads and sales. Variance analysis(Material,labour,overhead) Assets comparision (current assets and fixed asstes) Report is provided to management for decision making in the control of performance, or in the re-appraisal of plans, or in the improvement of planning the future. The appraisal should cover the implementation of the project from authorization to commissioning and its technical and commercial performance after commissioning. The information provided is also used by management as feedback, which helps the implementation and control of future projects On the above two project I explain the Net present value of the project I explain how many income invested in both project and how much expected value of the both project Recommendation on the basis of the Post Audit Appraisal In the comparison of both projects 1 is accepted because of the Net Present Value is Positive and project 2 had the negative NPV so it should rejected. Every cost reduced projects actual net present values will exceed their expected NPV by a fraction. New projects will often fall shot on by large amount of NPV. Adding or expanding projects will often fall short of their expected values. Conclusion And thus as I conclude the organization should choose the NPV which shows the positive result even it is an long or short term project and suggested ideas would benefit our organization which is based in the post-audit appraisal. Reference: Mcmenamin, J 1999, financial Management: An Introduction, Routledge, London Hitt, C Weil, R 2003, Financial Accounting: An Introduction to Concepts, Methods and uses, 8th Edition, Harcourt Brace and Company, F1. Task -3 Income statement AA BB 20ÃÆ'Æ’- 5 20ÃÆ'Æ’-4 20ÃÆ'Æ’-5 20ÃÆ'Æ’-4 Turn over 31 30 20 35 Staff cost 3 2 5 6 General expense 2 2 10 10 Depreciation 12 9 3 6 Interest 5 5 1 1 (22) (18) (19) (23) Profit 9 12 1 12 Summary balance sheet Non-current assets 165 132 22 22 Current assets 5 6 13 12 Total assets 170 140 35 34 Current liabilities (3) (6) (4) (4) Debentures (47) (47) Net assets 120 87 31 30 Shareholder equity 120 87 31 30 Report of corporate financial performance From, Manshi Patel Crown paper Ltd Croydon To, Managing director (CC Holdings), South London, England. Subject: Corporate financial performance Date: 15th April 2010 Respected sir, Here I am going to use different financial ratios and the comparative financial performance of AA and BB. ROCE (Return on Capital Employed) ROCE = Profit ÃÆ'Æ’- 100  ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­Ãƒâ€šÃ‚ ­ Capital involved (Capital Involved = Share holder equity) Interest and debentures are to be included. AA BB Year 20X5 (9+5) ÃÆ'Æ’- 100/ 120 + 47 = 8.4% Year 20X4 (12+5) ÃÆ'Æ’- 100/ 87 + 47 = 12.7% Year 20X5 (1ÃÆ'Æ’-100)/31 = 3.2% Year 20X4 (12 ÃÆ'Æ’- 100)/30 = 40% This calculation shows the net profit which the owner has received on the capital invested The efficiency and profitability of the companys capital investment is identified by using the ROCE. By using the ROCE analyses the company capability of utilizing the capital to generate revenue. It should be higher than the borrowing amount because it affects the shareholders earning. Here we found that that BB subsidiary has achieved a very high return on capital involved but AA subsidiarys percentage is less than expected. Profit margin Profit margin = Operating profit ÃÆ'Æ’- 100 Turnover Interest is to be included. AA BB Year 2005 (9+5) ÃÆ'Æ’- 100/31 = 25% Year 2004 (12+5) ÃÆ'Æ’- 100/30 =56.7% Year 2005 (1ÃÆ'Æ’-100)/20 = 5% Year 2004 (12+100) 35 =34.3% Profit margin is a suitable tool for identifying the companies trading process. In this process low profit margin indicates a low margin of safety, higher risk that a decline in sales will clear the profit and results in net loss In the case of the BB subsidiary. The profit margin will indicate the company on telling its pricing and its cost control. Asset utilization Asset utilization = Net Sales Total Assets (Nate Sales = Turnover) AA BB Year 2005: 31/167 = 0.18 Year 2004: 30/1 34=0.22 Year 2005: 20/31 = 0.6 Year 2004: 35/30 = 1.2 On increasing the asset utilization it allows minimizing the investment cost and saves huge amount ever year. Liquidity Liquidity (acid test) = Current Asset Stocks Current Liabilities AA BB Year 2005: 5/3 = 1.7 Year 2004: 6/6 =1 Year 2005: 13/4 = 3.25 Year 2004: 12/4 = 3 Risk (gearing) Risk (gearing) = Loan Capital Capital Employed (Loan capital = Debenture; Capital employed = Shareholder equity) AA BB Year 2005: 47/120 = 0.4 Year 2005: 0/31 = 0 Year 2004: 47/87 = 0.9 Year 2004: 0/31 = 0 Gearing is concerned with the relationship between the long term liability that a business has and its capital employed. The idea is that this relation ought to be in balance, with the share holders funds being significantly larger than the long term liabilities. Growth (turnover, profit, and capital involved) Companies AA BB Turnover 31-30/30 = 0.03 20-35/35 = -0.4 Profit 9-12/12 = -0.25 1-12/1 = 11 Capital employed 120-57/87 = 0.72 31-30/30 = 0.03 Financial ratios By using the ratio analysis, the organizations profit ratio is analysed, we can tell if it has enough money to pay its bills and we can even tell whether its shareholders should be happy. Ratio analyses are also used to analyze the organizations year by year performance. It can compare our business with other competitors. Financial ratio is calculated by very few information from the companys financial statement. In other words, the gross margin is the gross profit from operations divided by the total sales or revenue of the company, expressed in percentage term. Financial ratio can give a financial analyst an excellent structure of a companys situation and the trends that are developing. A ratio gains utility by comparison to other data and standards. Taking our example, a gross profit margin for a company of 25% is meaningless by itself. If we know that this companys competitors have profit margins of 10%, we know that it is more profitable than its industry peers which are quite favorable. If we also know that the historical trend is upwards, for example has been increasing steadily for the last few years, this would also be a favorable sign that management is implementing effective business policies and strategies. Credit analysts, those interpreting the financial ratios from the prospects of a lender, focus on the downside risk since they gain none of the upside from an improvement in operations. They pay great attention to liquidity and leverage ratios to ascertain a companys financial risk. Equity analyses look more to the operational and profitability ratios, to determine the future profits that will accrue to the shareholder. Conclusion Historical data (Roce, profit/rev, trend) AA is an organization which runs on the monopoly principle and it is in regulatory body and it runs under local authority. By having desired contract the companys profitability can be easily assumed. And they cannot increase their rate of investment as the revenue cannot automatically be generated. BB is completely different from AAs organization they have several issues like labor, cost of running the organization and they have to handle the continuity of their previous services. On the other side we cannot compare both the organization AA and BB because the cost expenses are completely different (method of calculation and depreciation). Benchmarking: is the process to compare other business in the same sector. Here we are going to make external benchmarking it means to compare through the trade association and the industry itself, external also includes comparing through activity. Activities like learn from someone, who is very good in some other business, try to imitate the best from the performer, and looking at the management itself. As a conclusion, above information shows BB managers lacks efficiency on making financial decisions as the calculation does show the considerable results while appraising companys performance. AA subsidiary is almost the public sector company; the company operates on the long term fixed contract. Even AA is not performing up to the expectation. It is reliable on having the contract.BB is losing revenue, because it has got competitive market. Above maid analyses was made by having only the two years (2004, 2005) finance datas and I cant tell if the previous years more or on the contrary less successful and productive. So I cant provide an accurate objective analysis of both subsidiaries AA and BB. But by doing the given 2 years financial calculation, BB subsidiaries are losing their business.