The aim of this assignment is to apply relevant forecasting techniques to obtain information for decision making purposes by using the available sources of funds. To support this I am going to examine and apply the financial appraisal techniques used to evaluate potential investment decisions. In the third part of this assignment I will calculate and interpret financials ratios for Morrisons supermarket using its financial statements.
Forecasting in finance is a technique used to estimate the future financing requirement of an organization. It can be also called as a process of estimation in unknown situations. Forecasting helps firms to measure how much funds they want to run the business, which will be based on past data of previous years. Firms can finance from either internal or external sources. Internal sources means cash flow generated by company's normal operating activities and external sources mean the capital provided by external parties. They are mainly investors and banks.
There are so many forecasting methods used in business namely, quantitative method, qualitative method, the High Low method, time series analysis, scatter graph, and regression analysis.
The High -Low method
High-Low method is used to calculate the variable cost per unit using the highest and the lowest costs. This is very simple and easy to apply the advantage is that it does not need large amount of data.
Time Series Analysis
Firms do a set of observations at equal time intervals like annually, quarterly, monthly and weekly etc. There are four components of this.
Here, the two variables that are considered to be related on some way can be represented on a form of a graph. A scatter graph can be used to make an estimate of fixed and variable cost by drawing a "line of best fit" through the points which represent all of the points plotted. Line of best fit is a cost equation of the form
Y= a + bx, where a= fixed cost and b= variable cost per unit.
In this assignment I am going to produce a scatter graph
Investment appraisal is a managerial tool used by a financial manager to choose investments with satisfactory cash flows and cash returns.. Businesses want to make adequate financial returns from their assets and investors want t to make financial return from their investment. To do this a sound procedure to evaluate, compare and select project is needed.
Techniques of Investment Appraisal
An important part of the investment appraisal is to ensure that the businesses use the appropriate methods of evaluation. There are for mainly used by businesses. They are
1. Accounting Rate of Return (ARR)
ARR is an accounting technique used to determine the profitability that an investment will generate and express as a percentage of the average investment made over the life of a project. The strengths of the ARR are
But there are some limitations on this method.
The number of years needed to recover the initial investment is called payback period. This method is more likely a liquidity measurement rather than profitability because it concentrates on cash flows and not accounting measures. If the payback period is in an acceptable length of time to the firm, the project will be selected. If there are two or more projects, the projects with less payback periods are accepted. However the selected projects should meet the target payback period which should be set in advance.
3. Internal Rate of Return
This is mainly used in capital budgeting and is a profitability measurement. IRR is a discount rate that makes the present value of cash flows equal to the initial investment. It is a discount rate that makes the NPV equal to zero.
4. Net Present Value (NPV)
NPV is the present value of net cash inflows less its initial investment outlay. If the NPV of a project's future cash flow is greater than the initial cost, the project is worth undertaking and it is less than the initial cost, then the project should be rejected because the investors will lose their money if the project is accepted. The NPV unlike the average rate of return and the payback period recognises the time value of money. NPV method is considered as the most modern technique of capital budgeting.
I am going to calculate the average rate of return and the net present value in regard to the second task of this assignment.
Performance measurement is a tool used by organisations to measure the quality of their activities and services. It appraises the organisational performances and how they are managed to deliver for customer and other stakeholders. It measures the productivity and the efficiency of the organisation.
There are many tools and techniques used to measure the performance of an organisation. Over the past decades performance measurement of an organisation was solely based on its accounting data. But things have changed over the recent years and no-financial measurements were introduced. These non financial measurements include balanced scorecard, leadership effectiveness, process efficiency, performance prism, self assessment techniques and swot analysis. The financial performance measurements include ratio analysis, activity based costing, economic profit, and economic value added.
Accounting ratios can be used to evaluate how financial positions change year to year basis and in a single firm and also to compare to compare between two firms. These two firms can be differed from size. Ratios are useful for managers inside the firm and investors and creditors outside the firm who want to predict future financial positions in the firm. Ratio analysis is used in measuring whether a firm
Generally the ratios are calculated using the historic data gathered from the financial statements. There are many accounting ratios, but following are the most commonly used ratios.
For the purpose of the task3 of this assignment I use the consolidated income statement and the balance sheet of WM Morrison supermarket. Based on appendix1 I am going to calculate the following ratios.
This ratio measures the profitability of an organisation. It shows how the firm's management of its liquidity, assets and debt has affected normal operating activities. The profitability ratios commonly used to examine
Return on capital employed is a commonly used measurement for comparing the performance between businesses and for assessing whether a business generates enough returns to pay for its cost of capital. There is slightly increased 0.24% in 2009 comparing 2008 means that Morrison's in 2009 improved in maximal utilizing the resources used in generating profit.
Liquidity ratios give an indication of how well the firm can meet its current obligations. It measures the ability to convert assets into cash quickly in a firm. Too much liquidity or too little liquidity is known as a bad sign. Too little liquidity means that the firm will have problems paying its current obligations in the future, and too much liquidity suggests the firm is not investing its funds wisely.
Limitations of ratios
Financial statement analysis provides useful information about a firm's financial position, but there are limitations that must be considered when interpreting the information.