ACFI2208 Performance Measurement in Organizations

Section A

Plummer plc (Plummer) UK.

  1. Evaluation of the liquidity and Profitability position.

Profitability Ratios

Profitability rations uses balance sheet assets, revenue, company equity and operational costs to measure the ability of the company to generate income. They include the following;

  1. Gross Profit ratio

Gross profit ratio = gross profit / Revenue.

Figures in £000

Year 2019

Year 2018

Gross profit = 28,400

Revenue = 80,000

Gross profit = 35,600

Revenue = 98,000

Therefore,

Gross profit ratio = 28400/ 80000

= 0.36

Therefore,

Gross profit ratio = 35600/ 98000

= 0.36

This shows that the rate of generating the gross profit in the two years is the same.

  1. Operating profit ratio

Operating profit ratio = operating income/ revenue

Figures in £000

Year 2019

Year 2018

Operating income = 14,700

Revenue = 80,000

Gross profit = 18,250

Revenue = 98,000

Therefore,

Operating profit margin = 14700/ 80000

= 0.18

Therefore,

Operating profit margin = 18250/ 98000

= 0.19

The company was efficient in its activities in 2018 than in 2019.

  1. Return on Equity

ROE = Net income/ Shareholder equity

Figures in £000

Year 2019

Year 2018

Net income = 11,762

Shareholder equity = 81,960

Net income = 14,602

Shareholder equity = 90,100

Therefore,

ROE = 11762/ 81,960

= 0.14

Therefore,

ROE = 14602/ 90,100

= 0.16

The company was able to pay better returns to shareholders in 2018 than in 2019 by 0.02

  1. Return on Assets

ROA = Net income/ Total assets

Figures in £000

Year 2019

Year 2018

Net income = 11,762

Total assets = 127,080

Net income = 14,602

Total assets = 129,100

Therefore,

ROA = 11762/ 127,080

= 0.09

Therefore,

ROA = 14602/ 129,100

= 0.11

The company was more efficient in 2018 than 2019 as it was able to realise a better return on invested assets

Liquidity Ratios

They assess the ability to pay debts.

  1. Current Ratio

= current assets/ current liabilities

Figures in £000

Year 2019

Year 2018

Current assets = 29,630

Current liabilities = 25,520

Current assets = 27,650

Current liabilities = 18,600

Therefore,

CR = 29,630/ 25,520

= 1.16

Therefore,

CR = 27,650/ 18,600

= 1.49

The company is capable of paying short-term liabilities more efficiently in 2018 than in 2019 however its current position is good.

  1. Acid-test Ratio

= current assets-inventories/ current liabilities

Figures in £000

Year 2019

Year 2018

Current assets = 29,630

Inventories =8,700

Current liabilities = 25,520

Current assets = 27,650

Inventories =7,500

Current liabilities = 18,600

Therefore,

CR = 29,630-8700/ 25,520

= 0.82

Therefore,

CR = 27,650-7500/ 18,600

= 1.08

The company is a position to pay short-term debts without selling inventories however the position was better in 2018.

  1. Evaluating bankruptcy for Plummer Plc.

= 1.2(A) + 1.4(B) + 3.3(C) + 0.6(D) + 1.0(E)

 

2019

2018

A = WC/ Total Assets

= 4110/127,080

0.03

= 9050/129,100

0.07

B = Retained Earnings/ Total Assets

= 14,160/127,080

0.11

= 22,300/129,100

0.17

C = EBIT/ Total Assets

= 14,700/127,080

0.12

= 18,250/129,100

0.14

D = Market capitalization/ Total Liabilities

= 170,000/45,120

3.77

= 176,000/39,000

4.51

E = Sales/ Total Assets

= 80,000/127,080

0.63

= 98,000/129,100

0.76

Z-Score

1.2(0.03) + 1.4(0.11) + 3.3(0.12) + 0.6(3.77) + 1.0(0.63)

= 3.47

1.2(0.07) + 1.4(0.17) + 3.3(0.14) + 0.6(4.51) + 1.0(0.76)

= 4.17

Limitations of Altman Z-Score

  1. This formula does not take into account the deferred revenue
  2. The formula also depends on the credibility of the financial data provided by the company since it uses data directly from the company, (Altman, 2013).
  3. The formula shows a one financial year score where a company might have performed poorly of well due to some factors hence does not show the long-term situation, (Altman, 2013).
  1. International Dimension in Accounting

Reasons for different accounting practices.

  1. The type of capital market. The capital market authorities of different countries have different financial presentation requirements on presentation of financial reports. Hence, these makes a difference in the way figures will be valued.
  2. Type of legislative system. The type of law followed by different countries also differs. Some financial requirements and treatments are highlighted by law and enforced by the government which may result in difference in the accounting practices, (Delen, et al, 2013).
  3. The financial reporting system. From the universal IFRS, different counties have adopted their methods of financial reporting with bodies regulating them. Hence, the accounting practices will differ.
  4. Economic and Political system. Different economic zones have a similar way of approaching to financial matters. Political system in different countries have been linked with significant influence in financial operations. Therefore, different political systems is different regions or blocks will have different influence to the financial system, impacting differently on financial presentation hence accounting practices will differ, (Komala, and Nugroho, 2013).

Section B: Performance Measurement and Project Appraisal

Question 1 (a) Division Performance Measurement

  1. ROI

ROI = (Net Income / Cost of Investment)*100

Net Income = £3.8m

Cost of Investment = £20m

ROI = (3.8 / 20)*100

= 19%

  1. RI

RI = (Controllable Margin - Required Return) * Average Operating Assets

Controllable Margin = £3.2m, (3.8-0.6)

Required Return = 0.05, (5%)

Average Operating Assets = £20m

RI = (3.2 – 0.05) * 20

RI = £63 million

  • Discussion on whether RI should be introduced

Return on investment measures the investment return of the department which will measured as income earned in operations by the divided against the department total assets. The department return is 19% which means that it is able to generate £0.19 in every £1 invested in it.

According to the Residual Income, a representation of the excess income in the department over its opportunity cost was valued at £63 million.

Valuing the department however using ROI creates a room for the department head not to invest in projects that will reduce the department’s compound ROI however the projects might be having a return than the required minimum return, (Al-Matari, et al, 2014). Therefore, RI will be useful to allocate the investment resources in the department and hence calculate manager bonuses depending to the extent of positivity of the realized RI margin.

  1. Importance of non-financial performance measurement
  2. Non-Financial measures helps in understanding the strengths and weaknesses of a business. They help the business understand certain aspects that are not captured in financial statement such as wait times that a customers will wait before they are served, (Sohrabi, 2017). For example, Zeta can use a feedback survey KPI as a non-financial measurement to measure its rate of satisfying the customers.
  3. Non-financial measures are also useful in understanding and evaluating the performance of the business. However this can be indicated by financial measures, tracing it back to the resultant variable requires non-financial measures, (Dobrovic, et al, 2018). For example, Zeta can use employee turnover rate survey to understand the reasons for a high budget allocation in the human resource section.
  4. Non-financial Key performance Indicators are always useful in helping the employees in formulating steps to achieve the strategic the company. They are indicates to employees on what should be done, (Komala, and Nugroho, 2013). For example, Zeta can use overdue project percentage rates to show projects that are behind schedule improving employees’ efficiency.

Question 1(b) Project Appraisal

  1. Calculation of the Two projects IRR, Payback Period and NPV.

Year

A

B

A

B

Cash flows

Cash flows

Present Value factor

PV of Cash flows

PV of Cash flows

£m

£m

10%

£m

£m

0

-130

-13

1

-130

-13

1

90

3

0.9091

81.819

2.7273

2

40

10

0.8264

33.056

8.264

3

40

13

0.7513

30.052

9.7669

NPV

IRR

Payback Period

14.927

7.7582

18%

33%

Year 2

Year 2

  1. Discussions on the best project to take.

From the above calculation, the NPV for Project A and B is £14.927m and £7.7582 respectively. Project A has therefore a hire NPV than project B. NPV method has the advantage of considering the time value of money, hence helping the management in planning. Its disadvantage is that it does consider other costs that are associated with a project and it is not useful to compare different types of projects, (Žižlavský, 2014).

The IRR of project A and B is 18% and 33% respectively. Project B has therefore a higher IRR than project A. the advantage of this method of appraisal is that it show the rate at which the investment will be generating annual returns. IRR has however the disadvantage of not showing the returns on actual pounds but percentages which may lead to poor decisions, (Götze, et al, 2008).

The Payback Period for the investment in project A and B is 2years in both cases. The projects are therefore expected to payback the initial cost of investment at year 2. The method has an advantage of finding projects that can return initial costs early enough and generate profits, (Johansson, and Kriström, 2015). However, the method has a disadvantage of not considering the time value of money and the cash flows after the payback period.

Therefore, considering Payback Period constant, the company should invest in project A since it has a far way large NPV B by almost double.

References.

Al-Matari, E. M., Al-Swidi, A. K., & Fadzil, F. H. B. (2014). The measurements of firm performance's dimensions. Asian Journal of Finance & Accounting, 6(1), 24.

Altman, E. I. (2013). Predicting financial distress of companies: revisiting the Z-score and ZETA® models. In Handbook of research methods and applications in empirical finance. Edward Elgar Publishing.

Delen, D., Kuzey, C., & Uyar, A. (2013). Measuring firm performance using financial ratios: A decision tree approach. Expert Systems with Applications, 40(10), 3970-3983.

Dobrovic, J., Lambovska, M., Gallo, P., & Timkova, V. (2018). Non-financial indicators and their importance in small and medium-sized enterprises. Journal of Competitiveness, 10(2), 41.

Götze, U., Northcott, D., & Schuster, P. (2008). Investment appraisal. Methods and Models, Berlin, Heidelberg 2008.

Johansson, P. O., & Kriström, B. (2015). Cost-benefit analysis for project appraisal. Cambridge University Press.

Komala, L. A. P., & Nugroho, P. I. (2013). The Effects of Profitability Ratio, Liquidity, and Debt towards Investment Return. Journal of Business and Economics, 4(11), 1176-1186.

Sohrabi, M. (2017). The Relationship between Non-Financial Innovative Management Accounting Tools and Risk and Return of Iranian Stock Market Listed Companies. Dutch Journal of Finance and Management, 1(2), 40.

Žižlavský, O. (2014). Net present value approach: method for economic assessment of innovation projects. Procedia-Social and Behavioral Sciences, 156, 506-512.


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