Free Case Study About Calculations

Published: 2021-06-21 23:42:44
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The production director of Wilmslow Ltd wants to schedule production for quarter 3 (the twelve weeks ending 17 September) and asks you to use the revised information to prepare the following:
- The revised production budget for Alphas and Betas;
Closing stock is 5 days and 10 days of sales for Q4, for alpha and beta respectively, which is 20% more than the new estimated demand, so the Q4 estimated demand is 120% of 2000 and 2400 respectively
2400/12=200 units (12 weeks because each week is 5 days)..For Alpha
For beta;
2880/6=480 units (divide by 6 since 10 days is two weeks)
- Materials purchase budget in Kilograms
Total production budget is 1700 units which requires 13,600 kilograms of material, =1700*8=13600 kg for Alpha.
For Beta, production is set at 2280 units hence 2280*12= 27360 kg of materials.
The total is 40960 kg of materials.
At end of Q3, material should be sufficient for 20 days production in Q4,
Production in Q4 will be 20% more than new estimated Q3, hence.
(120%*2000*8)+ (120%*2400*12) = 53760 (in 60 days)
In 20 days, 53760/60*20= 17920
Opening balance at the start of Q3 was 12,000 kg
Therefore, Materials to be purchased;
= 40960+17920-12000
46,880 kilograms.
- Statement of cost of material purchases;
A kg of material is £10
Therefore, 46,880 kg of materials cost £ (46,880*10) =£468,800
- Labour budget in hours,
Labour required is 3 hours for Alpha and 6 hours for Beta.
Budgeted production is 1700 Alphas and 2280 Betas,
(1700*3)+ (2280*6) = 18,780 hours
- Cost of labour
The labour will cost the firm £126,000 in the third quarter.
=50 * 210*12= £ 126,000
The employees will not work overtime.
Question 1 Task 2
Budgetary controls have been likened to a system of thermostatic control. Critically evaluate the statement in the context of how Wilmslow Limited could use budgetary control?
Thermostats are used to control the amount temperature to a certain point, usually a predetermined point. Thermostat control aims at ensuring that the desired temperatures are not exceeded and energy is not wasted.
Budgetary controls, on the other hand, are policies related to requirements of a projects as to resources such as man power, time and money. As a result, continuous comparisons are done between actuals and budgeted results to ascertain the real requirements of the policy with a view to revising the objective of the policy or re-distribute the resources, even to the tune of increasing the required resources.
For a thermostat to be set to control temperatures, the desired amount of heat has to be determined. For a budgetary control, the first step involves establishing the scope of the project or activity and drawing informed and detailed cost estimates for every event in the project. It is worth noting that, in a budget control, time is a very important factor. This means that it has to be quantified and estimated to grasp the real program or project scope. This is because consideration regarding time are essential in laying out the budget target periods and review points.
Thermostat controls have sensors which detect the temperatures so as to initiate the process of control. Budgetary controls, have set limits which should attract attention when reached or exceeded prompting a re-evaluation of the whole budgetary process. Mostly, accountants are taxed with the work of comparing the real costs with the budgeted cost and start the control process, repeatedly.
Thermostat and budgetary controls are likened. This likening, as regards Wilmslow, can be captured in the objectives of both thermostat and budgetary controls as discussed below;
Thermostat control is used to plan the use of energy. Budgetary controls are used by management to plan the future by in identifying individual, departmental and operational objectives and setting action plans. For Wilmslow, budgetary control can be used to determine the future levels of production by carefully estimating the rate of change in demand and planning beforehand for future demand increase. This entails sourcing for enough raw materials, adequate labour force and efficiency to increase production.
Cost of resources
A budgetary control can be used to determine the cost of resources. For Wilmslow, for example, a budget can be used to determine the scarce resources and source them in good time to avoid last minute disappointments and changes in prices of the resources which may not be translated in the price, immediately. A thermostat control, on the other hand, re-determines the cost of power used.
Wilmslow can use the budget to communicate the objectives of the company in a certain quarter. For example, the change in estimated demand and production can be a sign of changes in policy to the employees. In pursuit of the reasoning behind the increased targets, the employees can learn that a new sales plan approach has been introduced.
A budget establishes the expectations of the company from the employees and motivates them to work towards the targets. A machine operator knows that he needs to work more efficiently to produce more units than the previous quarter with the same machine.
A budgetary control is a continuous comparison between budgeted results and actual results. If an employee, a manager a department performs to the planned standards, then the management can view that as a very reliable basis to promote, award or appraise employees in any other way to keep them focused and motivated to achieving the company goals and objectives.
Question 1 Task 3
- Identifying and discussing two limitations of the use of linear regression;
Sensitivity to outliers;
Outliers can be defined as extreme data situations. For example, Wilmslow competitor might be going through challenges like breakdown of a key manufacturing machine or a staff go-slow. This will push the estimated demand up for a single quarter which may not be sustainable.
That single occurrence can result to overly estimated future prospects.
If the competitor returns to full operation, some loyal customers will stop buying Wilmslow products leading to a big variance between budgeted sales and actual sales.
If the company had employed more work force to meet the increased demand, it will be faced by imminent downsizing which can affect the goodwill of the company.
Assumes linear relationships between dependent and independent variables
This assumption that data relates perfectly can be misleading.
Sales forecasting by linear regression may not show some behavioral changes in the target population. This can be an event like consumption getting affected by the population structure such that a certain product is only popular with the youth. The demand falls as people grow older.
In such a case the curve will be steep in the beginning and slant as the population ages.
The linear regression will not capture the real forecast therefore leading to less than forecasted sales.
- Other ways of forecasting
Moving average
This method is used to estimate future value or figures by studying the patterns prior to the period. It is preferred because it is better than random estimates since it has a backing from past data.
Wilmslow can use either simple moving average or weighted moving average. Weighted moving average is used when it is believed that latest volumes or figures will influence future ones more than earlier figures. So one will assign an arbitrary figure to the forecast model so as to capture a more accurate estimate for future prospects.
It is considered as a reliable smoothening approach. However, effects of seasonality, business cycles and random events can increase the forecast error.
Exponential smoothening
Another method of forecasting is the exponential smoothening. Primarily, this model ignores all fluctuations irrelevant to the purpose at hand.
These fluctuations are kept out by introducing exponential or an adjusting technique where the previous season’s forecast is compared to that period’s actual occurrence. A downward or upward adjustment is then done to achieve a more accurate forecast.
Question 2
- Cash budget
Calculations are done as per instructions.
For example, cash paid for raw materials for the second month is the total materials used for production in the first month. Note that, in the first month, raw materials were used to produce goods to be sold in the second month, and the case is the same in the subsequent months.
The £15,000 worth of raw materials opening balance was used to produce sales to fill the deficit for month 1. The deficit was £30,000 worth of finished goods, requiring raw materials costing £15,000.
Mark up to cost of production is 60%. Formula used;
160%=Sales (before discounts) * 100%
Production cost
Since the sales are given, calculations are done to solve for production cost.
Total fixed overhead per year is £208,000. Rent and rates are paid in month 1, hence;
(208,000-25000)/12= £15,250 sales and administration expense.
- Debtor, stock and creditor balance, end of fourth period;
Discount on sales
(25/100*100,000)*10%= £2500, Credit sales= 75/100*100,000= 75,000
Debtors= 75000-2500= £72,500
Stock = 100/160*104,000 =£65000
Creditors= = £348, 450
The company has high debts compared to the assets and returns.
(c). How to control liquid levels
- Funding from external sources. The company can source funds from external sources to settle some of the creditors especially those of capital nature. However, this type of financing should be carefully done to avoid cases where the company is unable to meet debt responsibilities.
- Smoothening cash collections and payments. The company can discuss with creditors, especially buyers, to have a better payment agreements to boost cash levels.
- Finding a perfect balance between liquidity and profitability. This ensures that the right amount of cash is at disposal to ensure smooth running of the business.
- Ensuring ethic working capital management. The finance manager should ensure that the practice of strict cash handling is ingrained, both by employees in charge of disbursement and collection.
- Holding liquidity in different forms. Extra cash can be held in forms like financial instruments which are easily convertible to cash like treasury bills and committed facilities (by banks)
Question 3
- Discount rate and two ways it can be achieved.
Discount rate is an adjustment of future cash flows to present value by taking into consideration the time value of money, risk and uncertainty as well as other factors specific to the project. The word ‘discount’ is used to capture the fact that cash in the future has less value than the same amount today.
Simply put, discount rate is used to find out company’s or project’s value today by evaluating its projected cash flows in the future. This stems from the argument that investors value an investment by what they will receive from it in future.
Two approaches can be used to determine the rate to be used; the CAPM and WACC.
- CAPM (Capital Asset Pricing Model); this approach to determining the discount rate is hinged on the need for investors to earn additional return for taking an additional risk in a given investment.
Re= Rf + Beta (Rm - Rf), Re is return on investment, Rf is risk free rate and Rm is the expected Market return. (Rm-Rf) represents the risk premium or simply the additional return on the investment or project compared to returns on risk free investments like treasury bonds. It is the motivating reason for an investor to put money in a project.
Beta measures the relationship between the company’s shares and the general market movements. A negative Beta shows that the share is moving opposite ways to the market, a Beta of one shows the share is moving in line with the market.
- WACC (Weighted average cost of capital)
As the name suggests, WACC determines the company’s cost of capital by proportionally weighing the different sources of capital, from debt, equity, bonds, preferred equity and convertible shares. The average of all these costs is called WACC and is commonly used as the discount rate.
WACC= E/V*Re+D/V*Rd*(1-Tc) where E is equity value, D is debt value and V is equity value plus Debt value. Re and Rd are cost of equity and cost of debt respectively while Tc is corporate tax.
- Net Present value, why it is technically superior to payback and ARR
Payback period is a project appraisal approach which seeks to determine the length of time to be taken to recoup the invested capital. If one invests £3,000 in a project which gives a return of £100 yearly, then the payback period is three years.
On the other hand, accounting rate of return is average returns as a percentage of the initial investment. It gives an idea of how profitable is the investment compared to the capital tied to it in the start.
NPV (Net Present Value), is the resultant value after deducting the present value of cash outflows from the present value of cash inflows. NPV approach takes into consideration the interest rates, time value of money and inflation.
NPV, also, compares the investment with other available opportunities to invest. If, for example, the investment has a discounted return of 8%, one can compare it with bank fixed terms of 9% and opt to invest in the bank because the returns are better.
When a company is faced with a choice between two projects, NPV can be used to determine the better project in returns by discounting the future cash flows and deducting the outflows to know the net worth of each project.
In some cases NPV can be used to measure absolute profitability of a single project. Before a company starts a project, computations on the future cash flows can be done to determine their present value. If it happens that the NPV is negative, the project should be rejected.
Compared to the payback period, NPV gives a more accurate length of time for the business to recoup the initial capital. Definitely, NPV calculations will indicate a longer period than the payback computation because the future cash flows are discounted to reflect inflation, interest rates other specific factors affecting the project. Note that the payback period using NPV is achieved when NPV= 0. It is also worth noting that payback period approach does not consider cash flows after the payback period.
Moreover, ARR (accounting rate of return) only takes the average of the returns in absolute terms. This approach relies on profits only, but not actual cash flows. Profit calculations can be wrong especially in calculating depreciation. This leads to wrong returns.
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