The Essay On Investment Appraisal Techniques: Significance And Limitations. (70 Characters)

The Importance of Cash Flow Statement

A. Discussing the importance of the cash flow statement and its main activities with examples:

The cash flow statement is considered one of the significant measures that are used by investors and organizations to evaluate the current cash flow conditions of the company. The major importance of a cash flow statement is that it allows the organization and investors to evaluate the catch from operations, cash from investing and cash flow from financing activities of the company over the financial year (Purnus and Bodea 2016). The segregation of the overall cash flows directly allows the company to make adequate adjustments to their current operations to minimize the level of cash outflow and maximize cash inflow. The three major activities on the statement of cash flows report are:

• Cash flows from operations: The cash flow from operations directly requires relevant actions and measures that the organization conducts in their operations, which directly alters the cash flow conditions of the company and helps in detecting the cash inflows and outflows of the organization. The cash flow operations directly evaluate the changes in working capital conditions and add back the relevant depreciation that is deducted from the net income. Changes in the levels of cash flow from operations directly indicate the income and expenses that the organization incurs throughout its operations in the financial year (Arnold, Ellis and Krishnan 2018). The major examples of the cash flow from operations, which are evaluated in the section, are changes in working capital accounts such as debts, inventory, prepaid, accounts payable and other current assets and liability segments while adding back depreciation.
• Cash flows from investing: The second component of the cash flow statement is cash flows from investing which directly requires the relevant levels of selling and buying process that is conducted by the company on relevant assets. The investing operations directly indicate about the selling and expenses of capital expenditure of the company over the period of the financial year, which enables the management to understand whether the organization's overall cash is being deployed to purchase assets (Soboleva et al. 2018). This measure also allows the management to understand whether the cash influx in the overall organization is due to the selling of capital expenditure, which is essential for allowing the management to make informed decisions. Hence, the examples of cash flow investing directly include buying or selling capital expenditures, which can enable the management to understand the actual levels of cash flow of the organisation affected by capital assets.
• Cash flows from financing: Cash flow from financing activities at this is the third segment of the overall cash flow statement where the organization is able to identify the different levels of financing activities conducted over the period of time to support its cash requirements. Hence, the overall loans, cash dividends and financing activities that are conducted by the organization throughout the financial year are listed under the segment, which enables the management to understand different levels of measures that are being conducted to ensure the continuity of cash flow in the operations. Phone repayments, loan advancements, cash distribution, dividend payments and new loans are all listed in the financing segment of the cash flow statement (Atieh 2014).Hence, the cash flow from financing activities directly includes entries such as obtaining a loan or distributing cash dividends.

B. Discussing the main advantages and disadvantages of the Accounting Rate of Return and Payback period:

Investment appraisal techniques are one of the key measures that are used by organizations to evaluate the financial attributes of a particular project and help in choosing the adequate project from the pool of projects presented to the organization. The payback period and accounting rate of return are two different levels of measures that are used by the management to identify the overall financial attributes of the project (Rossi 2014). Hence utilizing both the measures has relevant advantages and disadvantages which are discussed as follows.

The major advantages of accounting rate of return calculations are its simplicity, the use of accounting data and accounting profitability that is determined by utilizing the method. Therefore, accounting rate of return calculations is relatively considered easy as it only utilises the present value of the future cash flows along with the initial investment. The combination of both the data directly allows the management to identify the overall rate of return of the project, which can then be evaluated based on the return generation capability of the project. Moreover, the overall calculations require accounting data and it is considered to evaluate the investment while detecting the true reflection of the company’s performance from the project (Dhanushkodi, Wilson and Sudhakar 2015). The accounting rate of return allows the management to evaluate the income and profitability stream of the project and identify the complete picture of the overall investment.

The major limitation of the accounting rate of return calculations is the ignorance of cash flows' time value of money and considered an arbitrary cut off value. The accounting rate of return does not utilize the cash flow conditions of the company as it only focuses on profitability where two investment evaluations are ignored which can be fatal for the organization in the long run. Furthermore, the accounting rate of return ignores the time value of money, which is the key component of the overall investment appraisal techniques. Hence, the utilizing time value of money is essential, as it helps in detecting the financial attributes of the project by comparing the present value of future cash flows with the initial investment (Tesfaye et al. 2018). Lastly, the accounting rate of return is considered an arbitrary cut off method, which companies used to create a yardstick to restrict the projects that do not provide returns higher than the minimum accounting rate of return requirements of the organization.

Investment Appraisal Techniques

The major advantages of the payback period are that it is simple to use and which solution provides a reference for liquidity and is useful in case of uncertainty by the organization. The payback period method is considered the simplest measure and easy to understand method as it allows the management to detect the minimum period at which the overall investment would return to the organization. It provides a quick solution where no in-depth analysis of the time value of money cash flow conditions is needed to determine the minimum payback period of the project when compared with other projects presented to the organization. Furthermore, with the help of a payback period the organization is able to identify projects that require the lowest level of the time period to return the initial capital. Thus, with the preference for liquidity companies can select projects that would get back the investment quickly, which can be reinvested in other investment projects (Baum, Crosby and Devaney 2021). Moreover, the presence of uncertainty in the other calculations such as Net present value, internal rate of return and accounting rate of return would lead to the consideration of the payback period results. Therefore, the company can reduce uncertainty with the results, while allowing the management to select projects that have the lowest level of the time period to return the invested capital.

There are major limitations of the payback period method, which are ignoring the time value of money, not following all the cash flow of the project, having unrealistic measures and ignoring profitability. From the overall analysis, it is detected that payback periods' have a relevant limitation, as they ignore the time value of money, which is derived by utilising future cash flows that are discounted with the adequate cost of capital to determine the present value of the future income (Kengatharan and Nurullah 2018). In addition, the payback period of the company does not accommodate all the cash flows of the project, where it stops when the initial investment is recovered. Moreover, the payback period is considered unrealistic, as it ignores profits and only focuses on the recovery of the initial investment made by the company on the project.

After the overall analysis of both the payback period and accounting rate of return, it is detected that using the accounting rate of return would be preferable, as the ARR method provides the organisation with data regarding the returns that the project would generate over the period of time. However, the payback period only indicates about the years in which the initial investment would be returned to the organisation. Therefore, with the use of an accounting rate of return the company could select projects with a certain cut off rate to generate returns higher than the discounting rate.

C. Discussing the budget definition and explaining the importance of preparing budgets:

The budget is considered an overall spending plan, which is used by the company to map the income and expenses needed in the next financial year. Moreover, companies that use budget are able to to determine the relevant estimates needed for completing the spending in the coming year (Yagudina, Serpik and Ugrekhelidze 2015).

Advantages and Disadvantages of Accounting Rate of Return

The major advantage of a budget is that it allows the organisation to coordinate activities across departments, improve communication with employees, translate strategic plans into action, improve resources allocation and maximise benefit from operations. The above-listed measure mainly ensure that the performance of the organisation is directly linked with the budget, where budget allows the management to minimise the wastage of essential resource, while maxmiumsing the income for the financial year (Throsby 2016). Thus, the organisation with the help of budget is able to allocate the resources to each departments, while ensureing that minimium expenses are incurred for completing the opperationsal process over the financial year.

There is certain limitation of the budget is inaccurate or unreasonable assumptions, as it might nullify the benefit of the budget, while making it unrealistic. The preparation mechanism involved in the applied mechanics of the budget needs to be analysed, as any unrealistic measures could provide inappropriate results for the organisation. In addition, budgets can cause perceptions of unfairness and create competition for resources within the operations of the organisation, which can be demotivating for the workforce. Hence, it could be understood that the overall performance of the organisation is not linked with the budget, when it is not prepared in accordance with the realistic data feed (Ayodele 2019). In addition, the limitations negatively affect the performance of the company and hamper future operations of the organisation.

A. Preparing an Income Statement and a Balance Sheet:

Income Statement
Particulars	Value
Sales revenue	150,000
Cost of goods sold	35,000
Bills expense	25,500
Salaries expenses	39,500
Profit	50,000

Balance Sheet
Particulars	Value	Value
Closing inventory	40,000
Prepayments	87,000
Cash on Hand	37,500
Debtors	22,000
Current assets		186,500
Machines	30,000
Properties	45,000
Non-current assets		75,000
Total assets		261,500
Accruals	44,000
Creditors	55,000
Liabilities		99,000
Net assets		162,500
Share Capital		112,500
Retained profit		50,000
Equity		162,500

Profitability	Value
Net profit margin	33.33%
Gross margin	76.67%
Return on assets	19.12%
Liquidity	Value
Quick ratio	1.48
Current ratio	1.88
Absolute liquidity ratio	0.38
Efficiency	Value
Creditors days ratio	574
Fixed asset turnover	2.00
Debtors days ratio	54

The above table provides information on the overall financial position of the organization, which is evaluated by three different financial ratio segments. The profitability ratio segment directly comprises net profit margin, gross profit margin and return of the organization, which helps in detecting the financial position of the company and the administrative expenses that are incurred for generating the relevant returns from investment. From the overall analysis, it is detected that the gross margin is 76.67%, where more than 75% of the revenues are being generated from the manufacturing process, while less than 25% is used for the cost of goods sold, which can be further reduced to maximize returns in the long run. However, a drastic decline in the overall net profit margin is seen in comparison to the gross profit margin (Kanapickiene and Grundiene 2015). This drastic decline represents the administrative expenses, the interest cost and other operating expenses that the company incurred to ensure the relevant completion of the production process. The net profit margin of the company is higher than 30%, which directly indicates that the overall revenues of the company are expensed on operating conditions of the company, which needs to be administered to many miles of the relevant cash outflows of the organization. Moreover, the return on assets of the company is 19.12%, which is appropriate and indicates that the company is utilizing efficiently all the relevant resources to support its sales.

Further information is presented regarding the liquidity ratio and official series of the organization. The liquidity ratio indicates that the quick ratio of the company is 1.48 whereas the current ratio is 1.88 and the absolute liquidity ratio is 0.38. This information directly indicates the performance of the organization is moral and appropriate as it is able to support its short term obligations through a quick ratio whereas with the absolute liquidity ratio the company is not able to support the short term obligation. Moreover, the efficiency ratio indicates that a creditor ratio is at 574 days whereas the debtors’ ratio is at 54 days, which in the case of the organization has a higher level of creditors and lower levels of debtor days, which increases the working capital conditions of the company while the fixed turnover ratio is at 2. Hence, the overall financial performance of TAN plc is adequate, where the company is able to generate profits from the operations while having lowered risk from insolvency and adequate working capital management.

The shareholders of TAN Plc need to compare the industry average for some of the ratios with the organisation, where the net profit ratio is 20%, the current ratio is 120%, debtors’ days 110 days and creditors' days 130 days. Moreover, the data of further analyses financial ratios, which can enable the potential shareholders of the organization to compare the financial ratios of net profit, current ratio, debtors days and creditors days with the industry average of the organization. From the overall analysis, it is detected that the financial performance of TAN Plc regarding the net profit margin is relatively high, as it is more than the industry average. Further analysis indicates that using the industry average the shareholders can detect that the current ratio of the company is higher than the industry, which states about the liquidity position of the company (Faello 2015). The organisation is maintaining adequate levels of current assets to support its short term obligations. In addition, further analysis indicates that the debtor’s day’s ratio of TAN Plc is mainly at the level of 54 days, which is lower than the industry average of 110 days that indicates that the debtor management of the company is adequate, whereas lower days are required to convert credit into cash from debtors. Additionally, the creditor’s days are 130 days in the industry average, while the copy has 540 days, which is higher than the industry. Hence, the overall financial ratios when compared with the industry average indicate that the performance of the company is high, where the investors should be invested in the company and the new potential investor should buy shares of the company.

A. Prepare a cash budget for AMF Ltd:

Advantages and Disadvantages of Payback Period

	October	November	December	January	February	March	Total
Cash Receipt
Planned sales	0	12,000	12,000	12,000	12,000	16,000	64,000
Total cash receipt	0	12,000	12,000	12,000	12,000	16,000
Cash payments
Cash payments for purchases in the month	5,000	9,000	9,000	9,000	9,000	9,000	50,000
Payment of Bills	1,000	1,000	1,000	1,000	1,000	1,000	6,000
Payment of Rent	4,000	4,000	4,000	2,000	2,000	2,000	18,000
Payment for purchase equipment			3,000	3,000			6,000
Total expenses	10,000	14,000	17,000	15,000	12,000	12,000	80,000
Net (Total cash receipt-Total cash payment)	-10,000	-2,000	-5,000	-3,000	0	4,000
Opening cash balance	10,000	0	-2,000	-7,000	-10,000	-10,000
Closing balance (Opening balance + Net)	0	-2,000	-7,000	-10,000	-10,000	-6,000

The overall analysis of the cash budget directly helps in identifying the cash inflow and outflow of the company over the period of 6 months. From the analysis of the cash budget, it is detected that the organization needs to properly manage their cash to maximize the level of the available closing balance in future. Therefore, it is detected the company’s unorthodox expenses on the equipment and other expenses has mainly forced the cash flow to be negative from November. Hence, active management of the cash flow is needed to maximize the level of benefits, while reducing the problems that might occur from low cash balances. The organization has adequate levels of credit requirements where the purchases would be paid after 2 months of the overall initiation date. Moreover, the other bills and rent need to be incurred on the current basis, which is essential for the continuation of the operations. Therefore, the organization needs to address the relevant changes in its purchases and sales income, which would directly alter the cash balance of the organization (Gunay and Fatih 2020). Firstly, the overall sales income needs to be distributed in a 2 months period where 75% of the sales would be in cash and 25% would be in credit, which can be paid in the following month. This would help the organization to get higher cash inflow from operations while conducting the relevant expenses. Further changes in the purchases of the organisation need to be conducted, where payments are made in two parts, which would allow the company to get relevant discounts and minimise the cash outflow of the organisation. Henceforth, the changes in the levels of purchases and sales income would directly allow the management to control the cash balance and reduce the probability of negative cash balance, which occurred from November.

References:

Akinbogun, S.P., Binuyo, O.P. and Akinbogun, O.T., 2017. A Comparison of Monte Carlo Simulation and Discounted Cash Flow Investment Appraisal Techniques Using an Office Building in Akure, Nigeria. Nigerian Journal of Environmental Sciences and Technology (NIJEST) Vol, 1(2), pp.299-308.

Almarri, K. and Blackwell, P., 2014. Improving risk sharing and investment appraisal for PPP procurement success in large green projects. Procedia-Social and Behavioral Sciences, 119, pp.847-856.

Arnold, A.G., Ellis, R.B. and Krishnan, V.S., 2018. Toward effective use of the statement of cash flows. Journal of Business and Behavioral Sciences, 30(2), pp.46-62.

Atieh, S.H., 2014. Liquidity analysis using cash flow ratios as compared to traditional ratios in the pharmaceutical sector in Jordan. International journal of Financial research, 5(3), pp.146-158.

Ayodele, T.O., 2019. Factors influencing the adoption of real option analysis in RED appraisal: an emergent market perspective. International Journal of Construction Management, pp.1-11.

Baum, A.E., Crosby, N. and Devaney, S., 2021. Property investment appraisal. John Wiley & Sons.

Dhanushkodi, S., Wilson, V. and Sudhakar, K., 2015. Life cycle cost of solar biomass hybrid dryer systems for cashew drying of nuts in India. Rigas Tehniskas Universitates Zinatniskie Raksti, 15, p.22.

Easton, P.D., McAnally, M.L., Sommers, G.A. and Zhang, X.J., 2018. Financial statement analysis & valuation. Boston, MA: Cambridge Business Publishers.

Ezeokoli, N.B., Adebisi, O.S. and Olukolajo, M.A., 2014. The practice of investment viability appraisal in Akure, Nigeria. Ethiopian Journal of Environmental Studies and Management, 7(5), pp.581-587.

Faello, J., 2015. Understanding the limitations of financial ratios. Academy of accounting and financial studies journal, 19(3), p.75.

Faleiros, D.R., Álvares, J., Almeida, A.M., De Araújo, V.E., Andrade, E.I.G., Godman, B.B., Acurcio, F.A. and Guerra Junior, A.A., 2016. Budget impact analysis of medicines: updated systematic review and implications. Expert review of pharmacoeconomics & outcomes research, 16(2), pp.257-266.

Günay, F. and Fatih, E.C.E.R., 2020. Cash flow based financial performance of Borsa ?stanbul tourism companies by Entropy-MAIRCA integrated model. Journal of multidisciplinary academic tourism, 5(1), pp.29-37.

Harris, P., 2016. A case study of the cash flow statement: US GAAP conversion to IFRS. Journal of Business Case Studies (JBCS), 12(1), pp.1-6.

Kanapickien?, R. and Grundien?, Ž., 2015. The model of fraud detection in financial statements by means of financial ratios. Procedia-Social and Behavioral Sciences, 213, pp.321-327.

Kengatharan, L. and Nurullah, M., 2018. Capital investment appraisal practices in the emerging market economy of Sri Lanka. Asian Journal of Business and Accounting, 11(2), pp.121-150.

Leelahavarong, P., 2014. Budget impact analysis. Journal of the Medical Association of Thailand= Chotmaihet Thangphaet, 97, pp.S65-71.

Purnus, A. and Bodea, C.N., 2016. Multi-criteria cash flow analysis in construction projects. Procedia engineering, 164, pp.98-105.

Rossi, M., 2014. Capital budgeting in Europe: confronting theory with practice. International Journal of Managerial and Financial Accounting, 6(4), pp.341-356.

Simoens, S., Jacobs, I., Popovian, R., Isakov, L. and Shane, L.G., 2017. Assessing the value of biosimilars: a review of the role of budget impact analysis. Pharmacoeconomics, 35(10), pp.1047-1062.

Soboleva, Y.P., Matveev, V.V., Ilminskaya, S.A., Efimenko, I.S., Rezvyakova, I.V. and Mazur, L.V., 2018. Monitoring of businesses operations with cash flow analysis. International Journal of Civil Engineering and Technology, 9(11), p.2034.

Sullivan, S.D., Mauskopf, J.A., Augustovski, F., Caro, J.J., Lee, K.M., Minchin, M., Orlewska, E., Penna, P., Barrios, J.M.R. and Shau, W.Y., 2014. Budget impact analysis—principles of good practice: report of the ISPOR 2012 Budget Impact Analysis Good Practice II Task Force. Value in health, 17(1), pp.5-14.

Tesfaye, T., Johakimu, J.K., Chavan, R.B., Sithole, B. and Ramjugernath, D., 2018. Valorisation of mango seed via extraction of starch: preliminary techno-economic analysis. Clean Technologies and Environmental Policy, 20(1), pp.81-94.

Throsby, D., 2016. Investment in urban heritage conservation in developing countries: Concepts, methods and data. City, Culture and Society, 7(2), pp.81-86.

Yagudina, R.I., Serpik, V.G. and Ugrekhelidze, D.T., 2015. Methodological basis for budget impact analysis. Pharmacoeconomics: theory and practice, 3(4), pp.9-12.