Financial statement of different organizations:
Sole trader prepare profitability statement and balance sheet after ending the financial year. Although, it has not any legal obligations to prepare necessary financial statement. However, partnership prepares profit and loss account, P & L appropriation account, partner's capital account and balance sheet. It prepare all the necessary statements according to the partnership act. However, company is a legal body and legally obliged to prepare profitability statement, balance sheet, cash flow statement, statement of changes in equity and retained earnings. Furthermore, it is legally obliged to
(Beth Laurence, J.D Learn About Business Ownership Structures 2015)
Sole Proprietorship
Advantages
• All the profits belong to one person only that is owner of the businesses.
• Inexpensive in terms of financial cost.
• Owner has all the authority of power
• Easy to establish
Disadvantages
• Owner bears responsibility for all debts
• Unlimited liability
Partnership
• Lower expense of establishment
• General partner has a right to monitor all the activities of the company.
• Shared ideas of partners
• Secured investments are there by consent of all the partners.
• Less preferred business type as it may leads to conflicts as well in the business.
• Issue of personal disputes as perception of partners may differ.
• Partners depend on each other’s decisions.
Corporation
• It carries a higher level status.
• Limited liability
• Opportunity to extend the invested cash
• There are certain benefits such as tax allowances that require a certain rate of profits to apply
• It has costly setup fees as it includes huge investment for initiating business along with high legal fees.
• The cost is between $500-2,500 (Business and enterprise – Topics – GOV.UK, 2015.)
Nynfus Corporation was founded in Liverpool, UK, over 10 years ago and since its inception it has been at the forefront of laboratory diagnostics. It develops, manufactures and markets diagnostic instruments. Its biggest markets are the USA and Germany.
5 years ago a private equity fund bought almost all the shares of the company. A few managers and directors own several shares.
Throughout the world, the Nynfus brand name has been established to manufacture high quality and reliable instruments resulting in their products being sold and marketed in more than 100 countries. Today, there are more than 30,000 of their instruments in laboratory use and their customer base continues to grow stronger year after year.
At Nynfus, they do not only pride themselves in the quality of their products but also in the quality of their support through their comprehensive product training programs and their excellent technical support and customer service teams.
Their dedicated sales and marketing team can provide the customers with sales support material and with the advice on how to market the products best in all of the countries. The company also provides the electronic files of brochure artwork allowing their partners to produce their market-specific materials.
All issues related to placement of orders, product availability and deliveries should be addressed to the customer service group, who take great pride in providing excellent service to fulfill their partners' needs.
Following are the financial statements used by Nynfus for business analysis.
Chart 1: Own chart: Nynfus Corporation Financial Statement 2011-2012
Illustration 6: Income statement of sole trader
(Source: Healy. and Palepu, 2012)
Illustration 7: Income statement of partnership
(Source: Ormiston and Fraser, 2013)
Illustration 8: Balance sheet of the partnership
(Source: Humpherys and et.al, 2011)
Illustration 9: Income statement of the company
(Source: Tsalavoutas, André and Evans, 2012)
Illustration 10: Balance sheet of the company
(Spurce: Marques, 2010)
There is a slight difference in the financial statements of sole trader, partnership and companies. This difference is observed because there is difference in size of company operations. Hence, this is the reason due to which minor difference is observed in financial statements of sole trader, partnership and companies.
As per the due or expiry dates of payments and assets, the items of the financial statements have to be considered and an action plan has to be built up. In the list below the items for which the actions are planned are shown:
Expenditure and payment point of view: Overdue invoices received from the suppliers must be settled.
Investment point of you:
Role of auditor
Auditor play a very important role from company and its stakeholder’s point of view. Auditor by checking company accounts make sure to employer that his employees are not involving in Malpractice Company accounts. Moreover, stakeholders on the basis of certification of authentic accounts given by auditor also believe that company is not cheating them. Hence, this lead to trustworthy relationship between company and its stakeholders. Thus, it can be said that auditor play a very important role in the company.
Published VS internal financial information
Published financial information is an information that is published in the newspaper and other sources of information. Whereas, internal financial information refers to the facts and figures that are top secret and never published in any source of information.
Ratio analysis is done to identify the position of the business for further decision making process. The following ratios are generally considered for analysis: profitability, solvency, liquidity and efficiency. The following two ratios reflect the profitability of the company:
Table 1: Ratio analysis of Tesco
2014
2015
Gross profit
4010
-2112
Sales
63557
62284
Gross profit ratio
6.31%
-3.39%
Net profit
974
-5741
Net profit ratio
1.53%
-9.22%
Operating income
2631
-5792
Operating profit ratio
4.14%
-9.30%
Current assets
15572
11958
Current liability
21399
19810
Current ratio
0.73
0.60
Net income
Outstanding shares
268
270
EPS
3.63
-21.26
Price
246
186
Earning
PE ratio
67.68
-8.74
Average account receivables
2357
2155
Debtor turnover ratio
26.97
28.90
Interpretation
Company’s comparison
Tesco
Sainsbury
1208
23775
5.08%
-166
-0.70%
641
2.70%
4421
6923
0.64
191
-0.87
264
-8.748
-303.759
452
52.60
Entire conclusion is that financial condition and performance of Tesco is very weak relative to Sainsbury.
Industry bench marking:
As per industry standards current ratio must be at least 1.5 but Tesco ratio is below one and this reflects that firm is not performing well in comparison to its competitors. On the other hand, profitability ratios of the firm must be nearby to 26% but actual gross profit of the firm is far from this standard and it can be said that firm is giving poor performance relative to industry. PE ratio of UK retail industry is 20 and name of company is very low. On other hand, firm profit is negative this reflects that firm shares are fairly valued and they are undervalued in terms of low PE ratio. Hence, it can be said that performance of the firm is not good if compared to industry standards and it need to do lot of work in order to improve performance.
Limitations of ratio analysis:
Ratio indicate historical performance while investors are more likely to predict future business performance. Thus, it cannot be used for determining potential business performance which is greatest limitation. Another, different organization follow different accounting policies, rules and regulations. In this case, comparison may not provide any meaningful conclusion and the objectives of comparative analysis may not be fulfill. Furthermore, companies that operates in different market also very much influenced by its market environment which is not considered by the ratios henceforth, it is also its limitation. In addition to it, interpretation of ratios is very difficult as it cannot be said that the identified ratio is good or bad.
There are numerous sources of business finance available for businesses: Large financial need ($500,000) might require the use of multiple sources, for example the combination of an amortisation loan and an overdraft. $360K amortisation loan could be taken for 18 months to be repaid in monthly instalment of $20K, along with an overdraft of $140K.Short term loans may also be requested. Although it involves some risk, but it is a cost-effective solution which gives immense time period to the person to make the payment.
Non-refundable loans can also be taken from EU tenders. Investors can be found and convinced to support the company, and this way their share capital can be increased.
Short term working capital:
Every business needs short term working capital to support its all the operational activities. It will be needed for day to day functions.
Importance of working capital for business continuity
Without having adequate amount of working capital, business cannot survive effectively in the market. Firms will not be able to operate and done its daily functioning without sufficient working capital. Each and every organization whether small or large scale need to purchase material, making payment of wages, rent, insurance, electricity, office expenses, marketing and others. Thus, they need adequate availability of funds for this purpose otherwise, it may face operational difficulties and cannot survive in the market.
Short-term financing
Long-term financing
Short-term financing involves a loan term that is typically less than one year.
Long-term financing is any debt obligation with a loan term that is greater than one year.
The distinction is important for accounting and tax purposes.
Businesses keep a close eye on the money they make and the bills they owe. Anything that is not paid immediately is financed. Financing is a type of credit or loan that allows a business to take possession of an asset in the present but not pay for it until sometime in the future. The financing obligation is carried in the company's accounting system as a liability, or an outstanding amount owed.
As per Shim, 2008, “The evaluation of assets and liabilities allows a person to determine the financial health of a company at any particular time. If a company has more assets than liabilities, it is in relatively good shape; however, if it has more liabilities than assets, it could be in trouble.”
Nynfus Corporation
31.12.2012
31.12.2011
in USD
YTD Actual
Cash
12,441
9,984
Accounts receivable
2,224,236
1,570,623
Inventories
1,990,920
955,153
Raw material
1,486,910
642,965
WIP
365,850
210,521
Finished goods
138,160
101,667
Prepaid expenses
223,111
29,781
Other current assets
15,224
23,395
Current Assets
4,465,932
2,588,936
PP&E
559,402
388,269
Net fixed assets
Goodwill
1,464,156
1,792,493
Other intangibles
50,998
52,700
Financial Investments
1,913,636
Other Non-current assets
13,207
Total assets
8,467,330
6,749,242
Accounts payable
1,664,722
1,312,328
Provisions
10,686
37,285
Accrued Expenses
376,655
279,346
Accrued Taxes
-22,541
-58,374
Other interest
-
Other Current Liabilities
617,830
62,745
Current liabilities
2,647,352
1,633,330
Revolving Credit
1,890,168
Senior Term Debt
7,881
Capital leases
24,349
41,772
Other short term Loan
864,868
883,964
Total debt
2,779,384
2,823,785
Share Capital
153,000
Capital Reserves
1,244
Retained Earnings
2,137,883
2,126,339
Actual P/L
748,467
11,544
Total S/H equity
3,040,594
2,292,127
Total liabilities & equity
8,467,331
Total revenue
12,477,522
10,024,417
Share (pieces) 100$ per share
1,530
EPS 1
489
8
Net debt 2
2,755,036
2,782,013
Working Capital 3
1,818,579
955,606
Debt equity - liabilities and debt 4
0.66
Debt equity - S/H equity 5
0.36
0.34
Assets turnover 6
1.47
1.49
Banks and private investors are the main financial sources. All services have a set of conditions. This is contracted between the different sources of finance (such as banks, private investors, credit unions) as lender and the borrower.
Cost of finance: Retained earning involves opportunity cost to the business. It is the loss of income which can be generated through investing this profits for any alternative purpose. However, on the amount of loans, company has to pay timely interest which is its cost. On contrary, on issued share capital, firms have to make dividend payments to their shareholders. Thus, dividend is the cost of share capital. Along with this, it also diversify business control to the shareholders.
Impact of finance sources on the financial statements
Retained profits used to funding business will be shows under the statement of changing in equity and retained earnings. However, working capital can be improved by negotiating creditors and getting earlier from the debtors. Thus, the amount of debtors will be shows under the current assets head of balance sheet. However, the amount of creditors will be shows under the current liabilities head of balance sheet. Another, the amount of borrowed funds will be shows as long-term liabilities and improve cash balance in assets side. However, the interest payments will be shows under profit and loss account and deducted from cash balance. On contrary, share capital will be shows under the capital assets in liability side and enhance cash balance of the company. However, dividend payments will be shows as expenses in profitability statement and also will be subtracted from cash balance.
Substance over from risk: Firm has to manage their cash flows so that they will be able to discharge their financial obligations effectively. Financial risk is the risk associated with collection of funds. For instance, high borrowings will impose high interest obligations and vice versa. Moreover, rising in interest rates and foreign exchange rates will bring high financial risk to the company.
In the contract, it will be stated how much interest needs to be paid on the principle amount that is taken as loan and the deadlines after which penalties will apply. The interest rate may differ between various financial sources.
Financial Sources
Legal aspects
Financial aspects
Chance for bankruptcy
Dilution of control
Retained profit
Amount reserved for further investment
No financial implications
Nil
Dilution remains same as the part of company
Working capital
Amount belonging to operations of firm
NA
Share capital
Dividend has to be paid to legal shareholders of the firm
Generation of huge funds from public
Partial ownership of shareholders
Loan
Interest and principle to be paid for the loan amount
Timely payment of interest has to be done.
If interest and principle amount not paid
Collateral security taken by bank
Table 2: Implication of sources of finance
From the above table, it is observed that there are diverse aspects of consideration for various financial sources. There are certain costs that are associated with direct or indirect source. Every type of finance has some legal implication that has been presented.
External and internal sources: External finance sources are generated from outside while internal finance sources can be generated from the inside the organization. For instance, retained profits and working capital are internal sources whereas loan and share capital are external finance sources.
External sources of finance
Equity: - This is one of the most commonly used source of finance. In order to raise the capital through this source company is required to follow a legal procedure which is laid down by the regulatory authority. This source can be used by the organisation who are capable of listing in primary market.
This source is adjustable in nature. Company can issue shares as per there requirement.
Disadvantage
Power of the existing shareholders dilutes when new shareholders arrive.
Venture capital: - In order to avail this source company is not required to be listed on the primary market. This can be said as the variable of the equity.
Main advantage of venture capital is that it help the private firms to easily invest in the client company and in return they are able to get the shareholding in the client company.
One of the major disadvantage of this source is that control of the existing shareholders reduces due to the entry of new shareholders.
Debentures: - It is the acceptance of debt in written taken by the company from the general people. In lieu of which company is liable to pay the fixed rate of interest to the public from who they have raised the capital. In addition to this they are also required to repay the principle amount after the completion of a specific time period. On the other hand if company does not repay to them on time than in that case debenture holder has the right to the sue the firm.
While availing this facility power of the existing shareholders does not dilute. In addition to this rate of interest paid is less as compared to the dividend paid to the equity shareholders.
Debt burden of the company increases.
Retained profit:- It is the part of profit that is kept by the company as a reserve. No cost is incurred by the company at the time of using this source.
Main advantage of this source is that company is not at all required to bear any cost while availing this source. They can use this source as and when required.
There is no disadvantage of the using this source.
A company could choose from various sources of finance depending on the amount of capital required and the purpose fro need. Sources of finance can be divided into three categories, namely traditional sources, ownership capital and non-ownership capital (Four Basic Types of Financial Ratios Used to Measure a Company's Performance, 2015). Firms can take long term asset backed loan which is secured for banks. By keeping asset with banks firm can easily get a loan from the bank. In case of short term loan also some of the banks took a security of asset. Firm can approach to those banks who are giving a loan without taking any asset. Hence by following this strategy or recommendation by pledging less assets firm can raise good amount of funds.
Internal sources could be a company’s assets, factoring or invoice discounting, personal savings and profits that have not been reinvested or distributed among shareholders. Working capital is a short term source of finance and is the money used for a company’s day-to-day activities, including salaries, rent, payments for raw materials and electricity bills. Hence, traditional source of finance must be used to meet working capital requirements of the firms.
Ownership capital is the capital owned by the shareholders of a company. A company can raise substantial funds through an IPO (Initial Public Offering). These funds are usually used for large expenses, such as new product development, expansion into a new market and setting up a new plant. The various types of shares are:
Companies that are already listed on a stock exchange can opt for a rights issue, which seeks additional investment from existing shareholders. They could also opt for deferred ordinary shares, wherein the issuing company is not required to pay dividends until a specified date or before the profits reach a certain level.
Unquoted companies (those not listed on stock exchanges) can also issue and trade their shares in over-the-counter (OTC) markets.
III. Non-Ownership Capital
Non-ownership capital includes funds raised from lenders, such as banks and creditors. Companies typically borrow a fixed amount from a bank, at a predetermined interest rate and with a fixed repayment schedule. Certain bank accounts offer overdraft facilities. This is used by companies to meet their short-term fund requirements, as they usually come at a very high interest rate.
Factoring
Factoring enables a company to raise funds using its outstanding invoices. The company typically receives about 85% of the value of the invoice from the factor. Remaining amount remains with the bank that is providing factoring services to the firm. There are different factoring schemes and companies can opt any scheme as per their convenience. This method is more appropriate for overcoming short-term cash-flow issues (Statement, 2009).
Hire purchase
Hire purchase allows a company to use an asset without immediately paying the complete purchasing price. After paying installments when value of same in aggregate become equal to the asset value then it is assume to be purchased by the firm Trade credit enables a company to obtain products and services from another firm and pay the bill later.
Venture Capital
Firms in the early stages of development can opt for venture capital. This option gives the financing company some ownership as well as influence over the management of the enterprise.
Under this there is a venture capital firm that makes an investment in the company. In return they get shareholding in the firm in which they make an investment. Venture capital firm also get a share in the profit earned by the client firm. Moreover, they have right to participate in the board meetings to take day to day business decisions.
Duration
Depending on the date of maturity, sources of finance can be grouped into various types (Maynard, 2013). They are as follows:
Sources of funds
Application
Advantage
Long terms sources
Share capital or equity share
Issue of shares to public for raising funds
Able to raise huge amount through public
Have to pay dividend out of the profits
Preference shares
Raising amount through selected people who are given preference
1. Absence of voting rights
2. Fixed return to shareholders
1. High rates of dividend
2. Tax disadvantages are there
Retained earnings
Part of revenue that is kept as reserve
No dividend to be paid that increases cost
Reduces capital of the firm
Debentures/Bonds of different types
Creditors of the firm carrying fixed rate of interest
Interest over debenture is tax deductible that saves income tax of firm
Compulsory payment of interest after a fixed period that is burden for the company
Loans from financial institutions
Amount borrowed from financial institution against collateral security
Easy to apply and quick grant of loan
Interest has to be paid that increases expenses of the firm.
Loans from commercial banks
Loan obtained from banks against financial security
Easy to obtain funds for managing financial tasks
Getting loan is more expensive than traditional banks.
Asset securitization
Creates portfolio of assets and issue them as interest bearing security
It provides high credit ratings and low borrowing cost
Very complex structure to be created and followed
Venture capital funding
Fund is raised through investment of other firms that is profitable to investor and issuer
Creates advantageous industrial connections that are beneficial for future
The accounting and legal cost makes the securing deal to be a difficult process
Medium-term sources
Raising amount through selected people who are given preference by board
Fixed return to shareholders
High rates of dividend
Debentures/bonds
Public deposits for duration of three years
Amount invested by public for 3 years and interest will be paid
Easy source of fund with very less legal formalities
There are legal restrictions over limits of raising funds
Commercial banks
Financial institutions
State financial corporations
Fund is raised through government approved loans where lender are not intended to make profits
They are secured as board of managers are appointed by government
They are difficult to manage and control
Lease financing / hire purchase financing
Using the asset by paying installments that is owned when total cost of asset is paid
Limited outflow of cash, hence company can manage funds easily for installments
Ownership is not transferred till all the installments are paid
External commercial borrowings
Commercial loans taken from non-resident lenders
Fluctuating interest rate in global market that may give benefit to loan taking firm
The fluctuating interest rates include huge risks of changing market conditions that may prove negative as well
Euro-issues
It is the type of foreign currency bank loan
It gives companies a wider access to international market.
It may face foreign exchange risk if total foreign debts are not matched against foreign currency asset
Foreign currency bonds
Allowing non-resident people to invest in the company by issue of bonds
The changing interest rates may provide advantage to issuing company
It gets easily affected by inflation in the market.
Short term sources
Trade credit
Credit is given to the buyers while purchases
It enhances sales of the firm
No cash is obtained on immediate basis
Interest over Fixed deposits for a period of 1 year or less
Earnings can be kept deposited in financial institution for getting interest
Non-taxable up to a certain limit
Opportunity cost of other investment can be borne
Advances received from customers
Amount is received from people for the purchase of goods in advance
No interest is paid to the customers
Liability of the firm increases for particular time period
Various short-term provision
They are provisions made out of current profits to meet tax obligations
It is cheap source of finance without any cost
Excess provisions may be created that leads to misuse of funds
Table 3: Sources of funds
Cash flow forecast: It can be forecasted through estimating potential cash revenues and expenditures. Revenues has been identified through anticipating future sales while spendings have been determined through estimating electricity charges, wages, require investment and loan repayment.
The revenue and the Cost of Goods Sold will be postponed one month based on the 30 days payment term. The different types of expenses that will be included in the formation of budget includes:
Budgetary control system: Budget is an effective tool which can be used by the corporation as control mechanism. Through using this tools, management can monitor business payments on a continuous basis. They can control business spending so that actual spending will not cross the budgeted expenses. Thus, it can maximize revenues and control spending.
Budget formation: It can be constructed through determining potential future revenues and spending. Thereafter, net cash flow in terms of surplus or deficit can be determined through identifying the difference between cash revenues and payments. However, closing balance can be determined through adding opening cash balance to the net cash flow. Under the zero base budgeting, it can be prepared through identifying future operational activities. However, incremental budgeting method will increase all the previous cash incomes and payments without considering its importance for future period.
July
August
September
October
November
Opening balance
5000
11000
16000
15700
10000
8000
9000
15000
19000
25000
21000
24700
Expenses
Electricity bills
1000
1300
Wages
3000
4000
Investment on truck
Loan repayment
Total expenses
14000
5300
Closing balance
14700
Analysis:
Because of the financial position profits and losses are not that strong, the timing on loan payback is not good. The company can deal with it, but my suggestion is the company should request more instalments from the bank. This has to be discussed with the Bank.
They have credit to purchase a truck. But this is mainly credit, which needs to be paid back in November. So leasing the truck would be more appropriate.
If they have other unplanned expenses or CAPEX income in January (December invoice 92Ł) then there will not be enough money for the operation of the company.
Based on the forecast, the upcoming year seems to be very weak for the company which will also affect the cash flow.
As I mentioned the CAPEX (lease) and postponing, the instalment will be a strategically smart decision. The actual picture shows how they could handle those expenses without any other sources of funds, but considering that the profit and loss is just a forecast, and if they are not able to keep it then it will destroy the cash flows as well.
Because the depreciation isn’t part of the cash flows until the incomes are higher than costs reduced by the depreciation, the operations are financed.
On top of that they will have other expenses as CAPEX, loan, repayment, credit, and they won't be able to cover those if the company continues its weakening activities.
Managing cash flows: On the basis of above budget, it can be seen that sales shows a fluctuating trend as it got improved or decreased over the period. Thus, it can be suggested that firm has to increase its cash inflow through higher sales. It has to construct policies for growth in sales. However, for cost reduction, business has to control its electricity and wages payments through saving energy and hiring staff at lower wages rate. It will lead to reduce cash outflows so that company can enhance its positive cash flow and ending cash balance. This in turn, organizations can operate successfully in the market.
Based on the criteria of Net Present Value, the NPV2 is better due to the smaller loss.
Profitability Index is also better, only the half of the investments is recoverable. Both projects are negative.
Personally I would keep it in the Bank, even without interest. The figures are the following:
NPV of Project I
NPV of Project II
Cost reduction after 3 years
-49.7
-24.9
Immediate outlay
£200
£100
Loss
-£133
-£44
Since the NPV in both cases are negative; this case, the IRR will be negative as well as per the basic economic context.
Based on the sample provided: advantages, disadvantages of each source
Reduce the inventory amount, speed up the stock rotation, decrease the days of rotation. So our money will not stick in the ITO.
2012 rotation speed in days 58.24 days
In 2013 with 10-% business growth with the ITO 33-% decreases these days can reduce by 35.26 days this will create a lot of free cash. Control the customer debt. Select the future strategic partners. Maybe this will decrease our income but this is still better position. We don't need to redact the final net income.
Financial statements help the business to identify their financial status that demonstrate its working. It is required to be assessed so that appropriate decisions regarding further business practices can be taken by stakeholders of the entity. The budgeted income statements for six months of Green Limited which is a wholesaler are as follows:
Item
Jul
£’000
Aug
Sept
Oct
Nov
Dec
Sales Revenue
114
118
124
104
96
92
Cost of goods sold
(64)
(66)
(70)
(59)
(54)
(52)
Salaries and wages
(20)
Electricity
(6)
(8)
(10)
(12)
Depreciation
Other overheads
(4)
(100)
(102)
(108)
(99)
(96)
(94)
Profit/loss for the month
14
16
5
0
(2)
From the above presented figures, the following results are obtained:
Investment appraisal is the technique that is performed to identify the best project which should be selected by the company out of the list of various projects. It is performed by determining Net Present Value of the project. Moreover, it identifies the payback period and Average Rate of Return. It is performed to observe the feasibility of the project alternative regarding the selection of better choice for greater profitability.
Hanley Manufacturing Limited has two potential projects. They can only invest in one project. The following information is available on the projects.
Project 1
Project 2
Cost (immediate outlay)
200
100
Expected annual operating profit (loss):
Year 1
58
36
Year 2
Year 3
4
Estimated residual value of machinery
7
12
The business has an estimated cost of capital of 10% and uses the straight line method of depreciation for non-current assets. The business has sufficient funding to meet capital expenditure requirements for either project.
Project 1)
Net Present Value = -200 + (58/1.1 - 2/1.12 + 4*1.13 + 7*1.13) = -141
Profitability Index = (200 - 141)/200 = 0.297
Project 2)
Net Present Value = -100 + (36/1.1 - 4/1.12 + 8/1.13 + 12/1.13) = -56
Profitability Index = (100 - 56)/100 = 0.444
Observing the figures that have been derived, it is found that both projects are not a good investment, because the NPV (net present value) showed negative results. Simultaneously, it is found that the PI (Profitability indexes) are less than 1 as well. This clearly demonstrates that it is difficult to get the money back from this investment, because the PI<1 and the NPV<0.
NPV P1 (cushion) = - 200+200/1.13 = -49.7
NPV P2 (cushion) = - 100 + 100/1.13 = -24.9
If I do not invest, I will have more money…
If I must choose one of these versions of investments, the second will be my choice.
I will have to deposit less money and observe less loss than the first project.
Because the NPVIRR (internal rate of return) will be negative as well, this is an economic axiom.
Control:
The Internal Rate of Return that has been obtained from both the projects:
Internal Rate of Return
(58-2+4+7)/200-1 =
-0.67
(36-4+8+12)/100-1 =
-0.48
This shows that the investments will not be able to generate profit as expected by the firm because as per the principle, if IRR<0, the investment will make a loss for the business.
Books & journals
Bohušová, H. and Svoboda, P., 2014. Comparability of financial statements prepared according to IFRS and IFRS for SMEs in the field of intangible assets. Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis. 58(6). pp.67-78.
Charles, S.L., Glover, S.M. and Sharp, N.Y., 2010. The association between financial reporting risk and audit fees before and after the historic events surrounding SOX. Auditing: A Journal of Practice & Theory. 29(1). pp.15-39.
Healy, P. and Palepu, K., 2012. Business Analysis Valuation: Using Financial Statements. Cengage Learning.
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