DE3J 35: Preparing Financial Forecasts

Part A
Introduction
I am the advisor of the Tricol plc, I would like to make a flexed budget as well as give
some opinions to evaluate this project for the management.

Flexed budget

Tricol plc Flexed budget for the

product ‘Zupper’ for June
originals Flexible Actual Variance
2000 1600 1600 F/A
￡ ￡ ￡ ￡
Direct Material 80,000 64,000 61,600 2,400 (F)
Direct Labour 36,000 28,800 35,200 6,400 (A)
Variable
Production
Overheads 4,000 3,200 3,200 0
Depreciation 1,500 1,500 1,500 0
Rents & Rates 2,500 2,500 2,500 0
Administration
Overheads 2,000 2,000 2,200 200 (A)
Insurance 2,200 2,200 2,400 200 (A)
Total 128,200 104,200 108,600 4,400 (A)

Calculation
1. Direct material total variance:
(Standard units of actual production*standard price)- (actual quantity*actual price)
4kg*￡10 per kg*1,600 -￡61,600=￡2,400 (F) (3.75%)

2. Direct material usage variance:

Standard price*(standard units of actual production-actual quantity)
￡10 per kg*(4kg*1600-5,600kg)=￡5,000 (F) (12.5%)

3. Direct material price:

Actual quantity*(standard price-actual price)
5600kg*(￡10 per kg-￡61,600/5600)=￡5,600(A) (8.75%)

4. Direct labour total variance:

(standard hours of actual production*standard rate ph)- (actual hours*actual rate ph)
￡2 per unit*1,600*￡9 per hour-￡35,200 =￡6,400(A) (22.2%)

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DE3J 35: Preparing Financial Forecasts

5. Direct labour rate variance:

Actual hours*(standard rate ph- actual rate ph)
3,520 hrs*(￡9 per hour-￡35,200/3,520 hrs)=3,520(A) (12.22%)

6. Direct labour efficiency variance:

standard rate ph*(standard hours of actual production- actual hours)
￡9 per hour*(￡2 per unit*1600-3,520 hrs)=2,880(A) (10%)

7. Total overhead variance:

Total standard overhead for actual production-total actual overheads
(￡3200+￡1,500+￡2,000+￡2,500+￡2,200)-(￡3200+￡1,500+￡2,500+￡2,200+
￡2,400)
=￡11,400+￡1,180
=￡400(A) (3.51%)

Variance analysis
 Direct material total variance:
a) It was a favourable variance. Because the actual price is less than the
standard price and the actual quantity of materials (1600) used is different
from the standard quantity (2,000).

 Direct material usage variance:

a) It was a favourable variance. Because the company has recently upgraded the
production machinery used for this product, it improved the production
efficiency.
b) And they changed suppliers to use higher-grade materials too.
c) Also, the company has concluded a high-than-expected wage settlement for
productive operative which encouraged the morale of workforce.

 Direct material price:

a) It was an adversed variance and the actual price increased to￡11 per kg. Due
to the improvement of production machinery used for this product, it made
higher quality materials. But it would increase the cost price.
b) And the company has recently switched suppliers and is now using higher-
grade materials. Although the quality improved, it might loss the previous
discounts for the company.
c) It would also increase the cost of labour for the specification changes of the
new production machinery

 Direct labour total variance:

a) It was an unfavourable variance. The actual rate increased but it was not
efficient management should pay more attention on it.

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DE3J 35: Preparing Financial Forecasts

 Direct labour rate variance:

a) It was an adversed variance. The actual rate increased maybe for the
overtime working but it was not as expected. Thus, this was the main
negative effect that should concern more.
b) The company recently upgraded the production machinery and it might result
in the shortage of skilled labour.

 Direct labour efficiency variance

a) It was an adversed variance as the actual hours increased. There might be
lower grade workforce in the new machinery
b) And labours might need time to accommodate or be trained.

 Total overhead variance:

a) It was an unfavourable variance. For the company upgraded the production
machinery, there might be more insurance should be covered. Thus, the
insurance overhead increased.
b) And they changed new suppliers so that they needed some cost on training or
installing. Therefore, the administration overheads increased.

Recommendations
a) All of the rate of significance should be concerned and analyzed by the
management.
b) Some future investigations should be made on the increased price and low labour
efficiency which are the most significance to be considered. It is beneficial in the
long run to find accurate reasons and look for solutions

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DE3J 35: Preparing Financial Forecasts

Part B
Introduction
I am an advisor of the company and I would like to evaluate the financial viability of
the investment proposal to the management and give some recommendations to
improve the project.

Application
I will use two investment appraisal techniques to evaluate the project.

a. pay back period

Year Yearly net cash flow￡ Cumulative cash flow ￡

0 -1,000,000 -1,000,000
1 160,000 -840,000
2 160,000 -680,000
3 320,000 -360,000
4 320,000 -40,000

5(the first 1.5 months) 40,000 Nil

5(the rest 10.5 months) 280,000 280,000

net cash benefit 280,000 280,000
Payback will take exactly 4 years and 1.5 months.

b. NPV
Annual cash Present value Present
Year flow factors at 10% value
￡ ￡ ￡
0 -1,000,000 1 -1,000,000
1 160,000 0.909 145,440
2 160,000 0.826 132,160

3 320,000 0.751 240,320

4 320,000 0.683 218,560
5 320,000 0.621 198,720

Net present -64,800

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DE3J 35: Preparing Financial Forecasts

value

Assumptions
Assumptions can be summarised as below:
a) All the cost is happened at year 0.
b) All the cost and revenues for every year are all net cash flows
c) 10% of market rate of return is expected rate of return.
d) The cash flows in each year are evenly spread among 12 months of the year.
e) There is no inflation, no taxation to be considered.
f) Uncertainty does not exist.
g) Unlimited funds can be raised at a competitive rate.

Appraisal and recommendation

According to the calculation of payback period, the project is acceptable for the
payback period is shorter than expected investment payback period, and the
profitability and safety is comply with the company. However, there are some intrinsic
limitations. Firstly, it ignores time value of money. Then, it ignores cash flows after
initial outflow has been met. Additionally, it ignores the fact that benefits from
different projects may accrue at an uneven rate, etc. Therefore, management should
consider some more sophisticated and accurate ways to appraise.

From the result of the calculation of NPV, I found we cannot accept it because it was
negative. In the view of present value, it means the loss of cash and it was not break
even. And in the analysis of expected rate of return, the real rate of rate is lower than
expected rate of return. However, the calculation is unilateral. It only considered the
revenue over the next five years, and the project life is commonly longer than five
years. It may be different when considering the long-term project which may be
turned to be positive. Because the cash flows may increase continually, and the NPV
was not very high in terms of the whole company. Thus, it was not acceptable and the
management should take some other factors into account.

Other factors to be considered

To make more accurate and comprehensive decisions, what the management should
consider is listed as follows:
a) We can predict cash flow in the long run and make it in the NPV for more
comprehensive decision.
b) We should think some more external factors such as political and technical
factors, we can do some market research and do some SWOT and PEST analysis.
c) The management can consider redistribution of labour for better performance,
and labour’s morale and working efficiency will impact on the cash flow of
company, so we should not ignore it.
d) The management has to consider if we have enough funds to invest this project,
otherwise, some other financing ways may decrease the expected rate of return.

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