Business Analysis and Interpretation for Landscaping Business

Question: Discuss about theBusiness Analysis and Interpretation for Landscaping Business. Answer: The monthly cash budget for the Landscaping Business for the three months ended 30 September 2016 is presented below: Particulars July August September Beginning cash balance $26,500 -$74,000 $61,800 Add: Budgeted cash Receipts Fees $1,40,000 $1,60,000 $2,00,000 Proceeds from sale of surplus non-current assets $1,00,000 Total cash available for use $1,66,500 $1,86,000 $2,61,800 Less: Cash disbursements Salaries and wages $70,000 $70,000 $70,000 Supplies $8,500 $9,200 $12,000 New Equipment $1,20,000 Purchase of plants $42,000 $45,000 $61,000 Total disbursements $2,40,500 $1,24,200 $1,43,000 Budgeted ending cash balance -$74,000 $61,800 $1,18,800 In case the business decides to lease the new equipment instead of buying it, the cash changed cash budget is presented below: Particulars July August September Beginning cash balance $26,500 $36,000 $1,61,800 Add: Budgeted cash Receipts Fees $1,40,000 $1,60,000 $2,00,000 Proceeds from sale of surplus non-current assets $1,00,000 Total cash available for use $1,66,500 $2,96,000 $3,61,800 Less: Cash disbursements Salaries and wages $70,000 $70,000 $70,000 Supplies $8,500 $9,200 $12,000 New Equipment $10,000 $10,000 $10,000 Purchase of plants $42,000 $45,000 $61,000 Total disbursements $1,30,500 $1,34,200 $1,53,000 Budgeted ending cash balance $36,000 $1,61,800 $2,08,800 From the above we see that if the company leases the new equipment, the ending cash balance is positive for all the three months whereas in the initial arrangement, when the company had bought the equipment and paid for it in the month of July, the ending cash balance of July was negative as cash payments were more than the cash receipts. It is very important for any business to maintain a positive cash balance at any given point in time because cash is required on a day to day basis to run the business operations smoothly. If the cash balance is negative, the company will have to borrow money from the bank and this borrowing will attract interest which is a finance cost to the company(Ross, Hillier, Westerfield, Jordan, 2012). Moreover as a result of leasing, the cost of the equipment will be evenly divided throughout the year. Hence, it is better to lease the new equipment in order to maintain a positive cash balance for all the three months. Question 2 Break even points in units = fixed costs / contribution margin Fixed costs = $402,800 Contribution margin = selling price per unit variable cost per unit Particulars 1 year old tree 2 year old tree 3 year old tree Total Selling price $20 $28 $45 $93 Variable cost per unit $12 $18 $27 $57 Contribution margin per unit $8 $10 $18 $36 Therefore, total break- even point in units = $402,800 / $36 = 11,189 units For per product break-even units, the total break-even units are divided between the products on the basis of the percentage of product sale in total sales. 1 year old tree 2 year old tree 3 year old tree Total Selling mix 125000 75000 50000 $2,50,000 Percentage share 0.5 0.3 0.2 1 Per product break-even point: 1 year old tree 2 year old tree 3 year old tree Total Percentage share 0.5 0.3 0.2 1 Break even units 5,594 3,357 2,238 11,189 b) The profit before tax for Landscaping business is presented below: 1 year old tree 2 year old tree 3 year old tree Total Selling price $20 $28 $45 Variable cost per unit $12 $18 $27 Contribution margin $8 $10 $18 Selling mix 1,25,000 75,000 50,000 250,000 Contribution margin $10,00,000 $7,50,000 $9,00,000 $26,50,000 Fixed costs $4,02,800 Profit before tax $22,47,200 In order to increase its profitability, the company is looking at increasing the sales of 3 year old trees while reducing the sale of 1 year old trees, resulting in an increase in fixed costs. The new profit before tax for the above change is calculated below: New sales mix 1 year old tree 2 year old tree 3 year old tree Total Sales mix 40% 30% 30% 100% Selling units 100,000 75,000 75,000 250,000 The profit before tax for the new initiate is given below: 1 year old tree 2 year old tree 3 year old tree Total Selling price $20 $28 $45 Variable cost per unit $12 $18 $27 Contribution margin $8 $10 $18 Selling mix 100,000 75,000 75,000 250,000 Contribution margin $10,00,000 $7,50,000 $9,00,000 $26,50,000 Fixed costs $4,52,800 Profit before tax $24,47,200 Looking at the above analysis, we do not recommend that the Landscaping business should go ahead with changing the sales mix by increasing the sales of 3 year old trees and reducing the sale of 1 year old trees as the profit margin has remained almost the same. The before tax profit margin for initial sales mix was 32.8% whereas the new sales mix has a profit margin of 32.7%. So we see there is no change in the profit margin. Though the total profits have increased by $200,000 but even the fixed costs have increased by $50,000. Thus the resulting increase in profits does not justify the increased fixed costs and hence the business should stick to the old sales mix. Currently the company is relying on two capital budgeting techniques ARR and IRR to decide between purchasing one of the two pieces of equipment. ARR is the accounting profit of the investment whereas IRR is the rate at which the NPV of the project is 0. Both ARR and IRR do not use discount rate of the investment in its calculations. However, it is very important to discount the future cash flows to present to incorporate the effect of inflation into the investment analysis. Generally companies use cost of capital as their discount rate if the risk of investment is similar to the existing business risks. Discount rate is required in calculation of NPV which is the most useful technique in capital budgeting analysis. Only if NPV of an investment is positive, other measures like ARR and IRR can be considered (Houston Brigham, 2016). No, the owner cannot rely solely on ARR and IRR to decide on the purchase of new equipment. Net present value (NPV) is the most effective capital budgeting technique used when deciding on a project. In order for an investment to be acceptable, the NPV of the project should be positive which means the cash inflows should be more than cash outflows. A positive NPV means the project is profitable. If the NPV of the project is negative with other capital budgeting techniques like ARR and IRR exceed the minimum required rate, still the project will be unacceptable because the NPV is negative. So in order to make a decision with regards to the investment in equipment, calculation of NPV is extremely important and the NPV should be positive. ARR does not consider the time value of money as the cash flows are not discounted, also ARR does not consider the cash flows and terminal value. If all the calculated returns exceed the entitys minimum rate, then we would recommend equipment B as it has a higher IRR. The investments are mutually exclusive, and even though both are acceptable as per the capital budgeting techniques, however since only has to be selected, we will consider IRR for making an investment decision. IRR is a better risk measuring technique as it considers the time value of money and all the cash flows are taken into consideration (Luckett, 1984) . For mutually exclusive projects, it is advisable to use IRR and project with a higher IRR is selected. Equipment B has a higher IRR at 18% as compared to Equipment A which has an IRR of 16%. Bibliography Houston, J., Brigham, E. (2016). Fundamentals of Financial Management. Australia: Cengage Learning US. Luckett, P. (1984). ARR vs. IRR: A REVIEW AND AN ANALYSIS. Journal of Business Finance and Accounting. Ross, S., Hillier, D., Westerfield, R., Jordan, B. (2012). Cash Management. McGraw Hill.