financial management

Financial Management

INTRODUCTION

I feel very much delighted while submit this assignment for financial management. The most

important part of the assignment is forecasting project finance and analyzing the project

feasibility. Annual report calculation with comments are very important to this assignment

those are prepared myself properly other task also completed by referring books and internet.

Before calculating the project feasibility we have to consider some techniques of the

forecasting. Now a day’s some computer software have been used for calculate financial

thing. It is the most popular method in western countries. In our country still not started to

measure with the software because of technology but some construction companies have

started. Western countries have developed in technology. Forecasting and analyzing the

project is very significant for project and company.


Introduction for Pike Electric Corporation (my downloaded company).

Name: - TREX Company

Address: - 160 Exeter,

Dr. Winchester,

22603,

United States

Telephone: - 540-542-6300

Fax : - 540-542-8739

Web: - www.trexcompany.com

Trex Company is all decked out with plenty of places to go. The company makes wood-

alternative products, which are used to construct residential and commercial decks, rails,

fences, and trims. The Trex Wood-Polymer composite is made of waste wood fibers and

reclaimed plastic such as grocery bags and film. Its products resemble wood and have the

workability of wood, but require less long-term maintenance. Products are available in

traditional lumber sizes. The company sells mainly to professional installation contractors

and the do-it-yourself market through about 90 wholesale distribution centers, which in turn

sell to retailers, including The Home Depot and Lowe's across the US and Canada.

Name: - Fletcher Building Construction company

Address: - Fletcher Building Limited

810 Great South Road

Penrose 1061

Private Bag 92 114 Auckland 1142, New Zealand

Telephone: -+64 9 525 9000

http://www.trexcompany.com/


Company Description

Fletcher’s history began in 1909 with the construction of a timber weatherboard house in

Dunedin, New Zealand. Over the following 70 years, Fletcher grew into a respected

Australasian building products and construction company.

In 1981, the merger of Fletcher Holdings, Challenge Corporation and Tasman Pulp and Paper

created Fletcher Challenge, a multi-national corporation with construction, forestry, building,

and energy businesses.

During 2000 and 2001 Fletcher Challenge sold the Paper and Energy divisions, and

established separate companies focused on the remaining sectors. Fletcher Building was

formed to manage the businesses at the heart of the Fletcher tradition – the manufacture and

distribution of building products and construction materials, and the construction of

commercial, residential and infrastructure developments.

In March 2001, Fletcher Building listed on the NZX and ASX.


TASK:-1

Explain the principles of working capital management of Fletcher Building Construction

Company Ltd.

01. You may calculate the working capital of each year & cash conversion cycle in days.

Working Capital Management

At the starting point of the project, the working capital should be budgeted and it will be

companied with actual working capital, achieved a maintain at last day of the project

Positive working capital means that the company is able to pay off its short-term

liabilities. Negative working capital means that a company currently is unable to meet its

short-term liabilities with its current assets (cash, accounts receivable and inventory), Also

known as "net working capital".

If a company's current assets do not exceed its current liabilities, then it may run into trouble

paying back creditors in the short term. The worst-case scenario is bankruptcy. A declining

working capital ratio over a longer time period could also be a red flag that warrants further

analysis. For example, it could be that the company's sales volumes are decreasing and, as a

result, its accounts receivables number continues to get smaller and smaller.

Working capital also gives investors an idea of the company's underlying operational

efficiency. Money that is tied up in inventory or money that customers still owe to the

company cannot be used to pay off any of the company's obligations, so if a company is not

operating in the most efficient manner (slow collection), it will show up as an increase in the

working capital. This can be seen by comparing the working capital from one period to

another; slow collection may signal an underlying problem in the company's operations.

Working capital = Current assets – Current liabilities


Current Assets

It represents the operating liquidity is available to construction work. It is necessary to

purchase the current assets of a construction work and fund the payment of current liabilities.

Current assets are important to Construction Company because they are the assets that

are used to fund day-to-day operations and pay ongoing expenses. Firms may have fixed

assets which are long-term assets, plant, machinery and equipment, but they will also have

assets which can be realized (cashed-in) in the short-term. This is generally taken in

accounting terms to be less than a year. The current assets are therefore ones that can be

quickly realized and change frequently. There are several kinds of current assets in the

construction company such as

Closing stocks

Debtors

bank

Cash in hand

Current Liabilities

These are bills that are due to creditors and suppliers within a short period of time. Normally,

companies withdraw or cash current assets in order to pay their current liabilities.

It may be in the form of creditors or firms who have sold you goods which you have not yet

paid for, or it may be money borrowed from a financial institution loans or overdrafts. Those

liabilities are owed in the short-term. This is generally taken in accounting terms to be less

than a year. Short-term liabilities thus tend to be trade creditors and short-term borrowing

such as overdrafts.

There are several kinds of current liabilities in the construction company

Creditors

Accruals

Bank over draft


The amount of working capital

TREX Company

Year 2008 2009

Current assets

(-) current liabilities

Working capital

Sales/construction revenue

116,354

(51,269)

65,085

329,194

106,571

(45,926)

60,645

272,286

Comment

Since the company had decreased its sales up to $272,286 in the year 2009 it is better for

them to reduced working capital also to $ 60,645 as appropriately.

Fletcher Building Construction Company

year 2009 2010

Current assets

(-) current liabilities

Working capital

Sales/construction revenue

2,317,000

1,384,000

933,000

6,799,000

2,255,000

1,313,000

942,000

7,103,000

Comment

Since the company had decreased its sales up to $7,103,000 in the year 2010 working capital

also $942,000 as appropriately.


General comment

When we are compare the working capital concept Fletcher Building Construction Company

better than the Trex Company in the last year. Because Fletcher Building Construction

Company

is good in the 2010, they improved their working capital according to the increases the sales

revenue, in such case Trex Company in a good position in the previous year. They have

good sales revenue, but working capital performance is decrease in the 2009. That’s why

their working capital is decreases. So they should be increase the size of sales. If consider

these thinks they will be get the good working capital.

Cash conversion cycle

In management, most of the companies are calculating the cash conversion cycle because of

their effective cash management. The cash conversion cycle attempts to measure the amount

of time each net input dollar is tied up in the construction and interim bills process before it is

converted into cash through bills to client. Thus, the cash conversion cycle measures how

risky it would be to increase this investment with suppliers in the course of expanding

customer sales. However, shortening the cash conversion cycle creates its own risks.

Usually a company acquires inventory on credit, which results in accounts payable. A

company can also sell products on credit, which results in accounts receivable. Cash,

therefore, is not involved until the company pays the accounts payable and collects accounts

receivable. So the cash conversion cycle measures the time between outlay of cash and cash

recovery. This cycle is extremely important for retailers and similar businesses. This measure

illustrates how quickly a company can convert its products into cash through sales.


General comment

When we are comparing the inventory conversion period, Fletcher Building Construction

Company is better than the TREX Company. Therefore that company owners should be gets

the payments from the clients quickly. If that company used the purchase materials in the

long time, they spent more storage, security and other necessary expenses. So other expenses

also high, this is bad. TREXCompany decrease 18days of Inventory Conversion Period of

2008-2009. But Fletcher Building Construction Company decrease the 8 days Inventory

Conversion Period of 2009-2010. Therefore Fletcher Building Construction Company is

better than the TREX Company TREX Company with the Inventory Conversion Period

comparison.

In this moment both companies in a good performance for the Inventory Conversion Period.

2. Receivable Collection Period / Debtors collection period.

Which is the average length of time required to convert the firm’s receivable into cash that is

to collect the cash following a credit sale.

Equation for R.C.P

R .C .P= DebtorsCost of sales

x365

TREX Company

year 2008 2009

Debtors/receivable

Sales revenue

13,555

329,194

31,429

272,286


Receivable collection period 15days 42days

Comments

The clients had taken 42days to settle its bills. In the year 2009 the debtors collection period

had increased so that it will not be favourablely affect the working capital


year 2009 2010

Debtors/receivable

Sales revenue

Receivable collection period

1,114,000

6,799,000

60days

1,112,000

7,103,000

58days

Comment

The clients had taken 58days to settle its bills in the year of 2010 the debtors collection

period had decreased so that it will not be favourablely affect the working capital

General comment

When we are comparing the receivable period, it shall be high is better for the Fletcher

Building Construction Company If the company gets the money from the client in the

minimum period, they do the balance work and can invest the other business. So they will get

more benefits.

When we consider the TREX Company, is a bad performance for the receivable period.

Because this period is increasing the year 2008 to 2009 so it’s bad for this company. In such

case Fletcher Building Construction Company in a good position of this receivable period.


3. Creditors Payment Period (C.P.P)/ Payment period.

This is the average length of time between the purchases of materials and labors the payment

of cash for them.

Equation for C.P.P

C.P.P = CreditorsCredit sales

x 365

TREX Company

year 2008 2009

Account payable

Cost of sale/ revenue

Creditors payment period

15,427

240,170

24days

16,514

191,339

32days

Comments

In the year 2009 the contractor/ company had taken 32days to settle their accounts to

creditors. Since the year 2009 the company had increased the creditor’s period up to 32days it

will be favorably affect to the working capital.


year 2009 2010

Account payable

Cost of sale/ revenue

1,116,000

5,141,000

996,000

5,442,000


Creditors payment period 80days 67days

Comments

In the year 2010 the contractor/ company had taken 67days to settle their accounts to

creditors. Since the year 2010 the company had decreased the creditor’s period up to 67days

it will be favorably affect to the working capital

General comment

When we are comparing the receivable period, it shall be high is better for the Fletcher

Building Construction Company. Therefore they get more advantages for these long credits

period. But TREX Company is not in finance good position. Because they have shot credits

period so when we are comparing of credits period Fletcher Building Construction Company

is better than the TREX Company according to the Credits period calculation.

TREX Company

year 2008 2009

Inventory conversion period

Debtors collection period


Cash Conversion Cycle

105days

15days

(24days)

96days

87days

42days

(32days)

97days

Comments

The increased in the C.C.C up 97days in the year 2009 shows high length of C.C.C so that it

is not better for working capital



year 2009 2010

Inventory conversion period

Debtors collection period


Cash Conversion Cycle

78days

60days

(80days)

58days

70days

58days

(67days)

61days

Comment

The increased in the C.C.C up 61 days in the year 2010 high length of C.C.C so that it is not

better for working capital

General comment

When we are comparing the cash conversion cycle, TREX Company’s C.C.C is high level.

So this is bad performance for Company. Fletcher Building Construction Company has

C.C.C shall be low is good for company. Therefore Fletcher Building Construction Company

is better for the TREX Company according to the C.C.C.

Relaxed working capital policy

It is one in which relatively large amount of cash & inventories are carried, sales are

stimulated by the use of credit policy that provides liberal finance to client & corresponding

high level of receivables. & where a company does not take advantage of credit provide by

material suppliers. Relatively large amounts of cash and marketable securities and inventories

are carried and sales are stimulated by a liberal credit policy that results in a high level of

receivables.


Restricted working capital policies

The holding of cash, inventories & receivables are minimized. & accruals & payable are

minimized. Under the restricted policy, working capital is turned over more frequently, so

each dollar / pound / Qatari riyal of working capital is forced to work hard. Holdings of cash

and marketable securities and inventories are minimized.

Short term working capital policies

Most businesses experience seasonal cyclical fluctuation. For example, construction

companies have peak in spring & summer, relatively peak around Christmas, & the

manufactures who supplies both construction companies & retailers follow similar pattern.

Similarly, virtually all businesses must built net operating working capital (NOWC) when the

company is strong, but they then sell all inventories & reduce the receivables when the

economy slack-off, still NOWC, rarely drop to zero-companies have some permanent capital

NOWC, which is the NOWC on hand at the low pint of the cycle.

Then, as sales as sales increase during, the upswing, NOWC must be increased & the

additional NOWC as define as the temporary NOWC. The manner in which the permanent &

temporary NOWC are financed is called the firm’s short term financing policies.

1) Maturity matching or self-liquidating approach

This strategy minimizes the risk that the firm will be unable pay off its maturing obligations.

A financing policy that matches asset and liability maturities

This would be considered a moderate current asset financing policy

Policy

Permanent current assets + Fixed assets = Equity + Long term liability

Temporary current assets = Current liability


2) Aggressive Approach

A policy in which all of the fixed assets of a firm are financed with long-term capital, but

some of the firm’s permanent current assets are financed with short-term non-spontaneous

sources of finances.

Policy

Part of the permanent current assets + Fixed assets = Equity + Long term liability

Temporary current assets + Part of the permanent current assets = Current liability

3) Conservative Approach

A policy in which all of the fixed assets, all of the permanent current assets, and some of the

temporary current assets of a firm are financed with long-term capital.

Policy

Part of the permanent current assets + Fixed assets = Equity + Long term liability

Temporary current assets + Part of the permanent current assets = Current liability +

Long term liability

Task 02

Prepare a Cash flow forecast & cash flow Statement.

Note: You may use the following techniques before marking the final conclusion for Fletcher


Building for past two years.

Accounting rate of Return.

Payback.

Net Present Value.

Intemal Rate of Return.

Cash flow Forecast

The Cash Flow Forecast is the most important aspect of any company. A firm needs to plan

its cash flow carefully, and this should be in the form of a cash flow forecast. This will set

out all incoming cash from any form and when it is coming in, and all outgoing cash and

when it is going. The Construction companies may have alternative or optional projects to be

invested as follows

Stating new project as a main contractor

Act as a sub contractor to a main contractor

Incurring cost for to develop new products

Finance are a limiting factor to any of the construction company, it will be evaluated the

project’s feasibility by using investment appraisal techniques.

Investment Appraisal Techniques

Investment Appraisal Techniques means of assessing whether an investment project is

worthwhile or not. Investment project could be the purchase of an important materials for a

construction company, a new piece of equipment in a manufacturing plant, a whole, etc. these

techniques are Used in both public and private sector.

Accounting rate of return

This is one accounting method and it is used for comparison. It is an internal method for selecting

the projects. It can also be used to measure the performance of projects and subsidiaries within an

organization. ARR is based on numbers that include non-cash items. The accounting rate of return


is conceptually similar to payback period. The accounting rate of return is a very simple rate of

return: average profit/average investment as a percentage.

Payback period

The Payback Period is perhaps the simplest method of looking at one or more investment projects or

ideas. The Payback Period method focuses on recovering the cost of investments. The Payback Period

represents the amount of time that it takes for a capital budgeting project to recover its initial cost. It

always was cash flows to the calculation of payback period.

Net Present Value (NPV)

The present value states that an investment should be adopted only if the present value of the

cash flow it generates in the future exceeds its cost, that is, if it has a positive net present

value Net present value is the net benefit that accrues to firm from adopting the investment.

Internal Rate of Return (IRR)

An internal rate of return is the rate we expect to earn on an investment project. The Internal

rate of return is that rate which discounts a project’s cash flow to a net present value of zero.

The internal rate of return method requires that if a particular investment is either to be

accepted or rejected. It should be accepted if its internal rate of return exceeds the cost of

capital. The rationale is that if an investment earns more than the cost of funds used to

finance, it should be adopted.

There are two methods available for calculation of the IRR;

Formula method of IRR

Graphical method of IRR

Decision Rule/ Criteria

IRR > COC Accept

IRR < COC Reject


Prepare cash flow forecast and cash flow statement

1) Accounting Rate of Return(ARR)

TREX Company

Year Net profit + Depreciation = Net cash flow

2008 (Yr – 01) 7,534 + 25,876 = 33,410

2009 (Yr – 02) 16,444 + 24,485 = 40,929

2010 (Yr – 03) 17,550 + 25,245 = 42,795

2011 (Yr – 04) 19,450 + 26,600 = 46050

2012 (Yr- 05) 20,542 + 27,412 = 47954

Note: Last three years figures were assumed.

ARR = Avg. Net profits x 100

Initial outlay

= 16,304 x 100

137,828

= 11.82 %

Comment:

In the TREX Company, when investment is $100, average net profit is $11.82. Company’s

percentage of ARR is positive. So, this company earns good profit. As a result this is good for

the company’s future.

Fletcher Building Construction Ltd

Year Net profit + Depreciation = Net cash flow

2009 (Year -1) $ (46,000) + $ 129,000 = $ 83,000


2010 (Year -2) $ 272,000 + $ 198,000 = $ 470,000

2011 (Year -3) $ 320,000 + $ 330,000 = $ 650,000

2012 (Year -4) $ 270,000 + $ 470,000 = $ 740,000

2013 (Year -5) $ 415,000 + $ 240,000 = $ 655,000

Note: Last three years figures were assumed.

ARR = Avg. Net profits x 100

Initial outlay

= 2,462,000 x 100

2,984,000

= 8.25%

Comment:

In the Fletcher Building Construction Ltd, when investment is $100, average net profit is

$8.25. Company’s percentage of ARR is positive. So, this company earns good profit. As a

result this is good for the company’s future.

General Comment:

Once we compare between TREX and Fletcher, TREX ARR is greater than Fletcher. When

TREX invests $100, it can earn net profit of $11.88, at the same time Fletcher invest $100

and earned net profit of $8.25. Form these analyzing we can decide TREX financial position

is better than Fletcher.

2) Payback period

TREX company

Year Net cash flow Cumulative cash flow


0 (256,459) (256,459)

2008 40,350 216,109

2009 50,120 165,989

2010 70,450 95,539

2011 75,400 20,139

2012 80,480 60341

Payback period time is more than 5years.

Comment:

In TREX, they return their investment after 5 years from their date of investment.

Fletcher Building Construction Limited

Year Net cash flow Cumulative cash flow

0 (2,984,000) (2,984,000)

2009 83,000 (2,901,000)

2010 470,000 (2,431,000)

2011 650,000 (1,781,000)

2012 740,000 (1,041,000)

2013 655,000 (386,000)

Payback period is more than 5 year

Comment:

In Fletcher Building Construction Limited, they return their investment after 5 years from

their date of investment.

General comment:


Once we compare with TREX and Fletcher, both companies return their investment within

5years, therefore they have to wait long period to return their investment. Therefore both

companies’ situations are bad.

3) Net Present Value (NPV)

Note: Cost of capital is assumed as 6 %.

D.C.F = 1/ (1 + r) n

r =Cost of capital

n =nth year

DCF at 6%

Years 0 1 2 3 4 5

DCF 1

(1+0.6 )0

= 1.0

1

(1+0.6 )1

= 0.94

1

(1+0.6 )2

= 0.89

1

(1+0.6 )3

= 0.84

1

(1+0.6 )4

= 0.79

1

(1+0.6 )5

= 0.75

TREX

Year Net cash flow D.C.F at 6% Discounted cash flow

0 (256,459) 1 (256,459)

2008 40,350 0.94 37929

2009 50,120 0.89 44607

2010 70,450 0.84 59178

2011 75,400 0.79 59566

2012 80,480 0.75 60360

NPV= 253842.60

Comment:

In this company, NPV is in positive figure. Therefore company project is well.

Fletcher Building Construction Limited

Year Net Cash flow D.C.F at 6% Discounted Cash flow


0 $ (2,984,000) 1 (2,984,000)

2009 $ 83,000 0.94 78020

2010 $ 470,000 0.89 418300

2011 $ 650,000 0.84 546000

2012 $ 740,000 0.79 584600

2013 $ 655,000 0.75 491250

NPV = (866430)

Comment:

In this company, NPV is in Negative figure. Therefore company project is not feasible.

General comment:

Once we compare TREX and Fletcher, TREX companies NPV are in positive figure. But

Fletcher Company NPV is negative. So TREX Company is good.

4) Internal Rate of Return (IRR)

Note: Assumed cost of capital is 14 %

TREX

Year Net cash flow D.C.F at 14% Discounted cash

flow

0 (256,459) 1 (256,459)

2008 40,350 0.88 35,508

2009 50,120 0.77 38,592.40

2010 70,450 0.68 47,906

2011 75,400 0.59 44,486

2012 80,480 0.52 41,849.60

NPV = 48,117

Cost of capital

6% 14%

253,842.60 48,117


IRR = r1 + [NPVr2 x (r2 - r1)]

NPVr1- NPVr2

= 6% + [48,117 x (14-6)]

205725.6

= 6+ [384936]

205725.6

= 6 + 1.87 = 7.87%

Comment: TREX Inc‘s IRR is grate than cost of capital. Therefore company project is good

feasible.

IRR < COC

7.87% < 6% accept

Fletcher Building Construction Ltd

Year Net Cash flow D.C.F at 14% Discounted Cash flow

0 (2,984,000) 1 (2,984,000)

2009 83,000 0.88 73040

2010 470,000 0.77 361900

2011 650,000 0.68 442000

2012 740,000 0.59 436600

2013 655,000 0.52 340600

NPV = (1329860)

Cost of capital

6% 14%


- 866430 -1,329860

IRR = r1 + NPVr1 x (r1 - r2)

NPVr1 - NPVr2

= 6% + - 866430 x (14% - 6%)

- 866430– (-1329860)

= 6% - 14.95%

= -8.95%

Comment:

In Fletcher Inc company’s IRR is less than cost of capital. Therefore company project is not a

feasible.

IRR < Cost of capital

-8.95% < 6% rejected

General comment:

Once we compare TREX Inc and Fletcher Ltd, TREX company IRR than is grate than cost of

capital. But Fletcher Company’s IRR is less than cost of capital. Therefore TREX Inc’s

project is more feasible than the Fletcher Ltd.

Summary:

Analytical Techniques TREX Fletcher Comment

ARR 11.82 % 8.25 % TREX Inc net profit is better than Fletcher

Ltd when they invest $100.

Payback period 05years 05 Years Both companies have to wait for a long time

to return their investment.


NPV 253842.60 -8664300 TREX companies projects are feasible

IRR 7.87% (-8.95) % TREX Inc is better than the Fletcher Ltd.

When compare both companies TREX company is best.