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Finance in The Hospitality Industry

Mont Rose College of Management and Sciences

Code: R/601/1789

Task 1:

1.1 Reviewing sources of finance available for the business and service industry

1.2 Evaluation on the contribution made by various methods of income generation in the large chains of restaurant

Task 2:

2.1 Discussion on the elements of cost, gross profit percentage and selling prices of products and services

2.2 Evaluation on the methods of controlling stock as well as cash in business and service environment

Task 3:

3.3 Discussion on the purpose and process of budgetary control as well as an outline on the budgetary control cycle

3.4 Reviewing the variances analysis of Yuri’s budget along with reasons behind the variances

Task 4:

3.1 Assessment on sources and structure of trail balance

3.2 Evaluation on the business accounts, adjustments and notes

4.1 Calculation and analysis of financial ratio in order to offer consistent interpretation of historic performances

4.2 Recommendation on appropriate future management strategies

Task 5:

5.1 Categorization of cost under fixed, variable and semi-variable

5.2 Calculations for contribution per products and explanation on the cost/ profit/ volume relationship

5.3 Justification for the acceptance of the proposal based on short-term management decisions


Answer

Introduction

Finance and accounting have their own language topped with various techniques and statements that can easily bewilder non-accounting individuals (Drury, 2012). The current study covers both the financial as well as accounting aspect with the help of various case studies and tasks. The study provides a review on the sources of finance and the cost elements associated with products and services. In addition to this, an evaluation on the method of controlling cash and stock, business accounts adjustments and notes have been provided in the study. Moreover, the study also provides calculations for the financial ratios while making recommendations to the companies for appropriate future management actions.

Task 1:

1.1 Reviewing sources of finance available for the business and service industry (AC 1.1, M1, M2, M3, D2, D3)

As mentioned by McLaney and Atrill (2012), the finance play a vital role in the growth and development of an organization as it ensures that the value of money is exalted. The sources of finance are of two types internal and external. The eight sources of finance for purchasing a machinery costing GBP 50000 are as under:

Internal sources:

Retained earnings

Considering the words of Wood and Sangster (2011), retained earnings are regarded as one of the most common and most fruitful sources of finance for any business. This type of financing enables businesses to use their own retained profits for boosting its operations. In the present case, the retained earnings can be used for funding the maximum portion of the machinery cost for the sole trader. In addition to this, Epstein (2012) added that the cost implication for retained earnings are nil therefore, makes them most appropriate sources of finance.

Sale of non-performing assets:

The sole trader may also opt for selling the non-performing assets. This would lead to increase in the cash and cash equivalents that would be used for funding the new machinery. Like other internal sources of finance, the sales of non-performing assets have no implications on cost. 

Credit control

The sole trader may also opt for controlling his credit options as it would ensure lower discount allowed while on the other hand, also ensure more frequent and timely cash generation. This in turn would be used for funding the new machinery. 

External Sources:

Bank credits

As in the words of Cecchini et al. (2010), bank credits are one of the most common external sources of finance for a sole trader business. This type of sources of finance involves payment of interest at a specified rate for a definite period of time. In this context, Doumpos et al. (2012) added that the breach of control in this type of sources of finance leads to legal implication affecting the market reputation of the business.

Bank overdrafts

The sole trader may also opt for bank overdraft that would enable short term funding for the new machinery. As stated by Castro and Rebeca (2013), bank overdraft are generally taken on short-term basis while attracts higher interest rates as compared to bank loans. This high interest payment is one of the major shortcomings for this type of financing source. 

Mortgage

The sole trader may also opt for mortgage wherein, the sole trader can keep certain property as guarantee to the seller of machinery and use the machinery for income generation. The payments are made at agreed terms of contracts between the creditor and debtor, which the cost implications are similar to those in case of bank loans. 

Private investors

The sole trader may also opt for funding the new machinery by acquiring funds from friends and family members. This is one of the most common sources of finance for the sole traders. Generally these type of funding do not involve interest payments moreover, the principle repayments time are also easily adjusted. 

Hire Purchase

In the current case of sole trader, the funding of the capital assets may also be done by hire purchase method. In this type of financing, the payments for the assets are made in instalments and the ownership of the assets is transferred once the final instalments are made. However, the breach of control just like bank loans leads to legal implication affecting the market reputation of the business. On the contrary, the cost implications for this type of funding are generally lower when compared to bank loans. 

1.2 Evaluation on the contribution made by various methods of income generation in the large chains of restaurant (AC 1.2, M1, M2, M3, D2, D3)

The various methods for income generation in large chain of restaurant are as under:

Increment in sales: the most fruitful and most efficient means for increase income for a large chain of restaurant is by increasing sales. This increase in sales would enable increment in profits at all the level. However, the increment in sales also results in increased cost for the restaurant. However, effective and efficient management of the cash and cost strategies would enable high return for the large restaurant chain with increased sales. 

Sales of non-performing assets: In the words of Carraher and Van Auken (2013), the sales of non-performing assets would lead to increase in cash and cash equivalents for the large restaurant chain. This increased cash and cash equivalents can be injected into the operation of the restaurant chain for further income generation. 

Letting and sub-letting: This method of income generation involves renting out of the spare premises of a large restaurant chain to other businesses. This renting of spare properties would enable the restaurant chain to generate income while acting as a support of the core business activities. 

Commission based business activities: Under this method of income generation, the large restaurant chain may opt for commission-based businesses wherein, the restaurant chain may advertise the business and products of other companies. In the words of Zanievicz et al. (2013), the commission-based business excludes the activities of the competitors. 

Task 2:

2.1 Discussion on the elements of cost, gross profit percentage and selling prices of products and services (AC 2.1, M1, M2, M3, D2, D3)

Cost refers to a certain amount of cash that is invested for acquiring revenue both in short run as well as in long run. In the present case of Marks & Spenser, cost would mainly involve payments for the material, employees and overheads. In the words of Warren, K. (2015), cost can be under the following heads:

  • Type - direct and indirect
  • Behaviour - fixed, semi-variable and variable
Elements of costs
Examples
Direct cost
Staffing cost, Food wastage cost and carrier bags
Indirect cost
Telephone expenses, stationery cost and electricity   expenses
Fixed cost
Payment of rents for assets
Semi-variable cost
Electricity expenses, telephone expenses
Variable cost
Wages to staffs


In addition to this, Wagenhofer (2015) stated that the cost elements also involve overhead payments, which are classified as under:

Types of overhead for Marks & Spenser
Examples
Manufacturing overhead 
Depreciation of assets and insurance payments
Selling overheads 
Showroom expenses, sales office expenses and samples
Administrative overheads 
office rents, lights and heat
Distribution overhead 
payments for warehouse rents, warehouse staffs etc.


Selling price in the current case of Marks & Spenser is based on the summation of direct cost and shared overheads with additional profits. In the words of Nørreklit (2014), the mark up by the companies are influenced by the capital structure and market position of the company. The fact that Marks & Spenser has been market leader in the recent past therefore, the mark up for setting the selling price must also involve the market reputation of the company. However, Marks & Spenser may also opt for the following process for setting up the selling price. 

Apart from these, Marks & Spenser may also opt for conventional pricing method, as it would prove to be effective in determining the gross profit for the company. As mentioned by Li (2010), under conventional pricing method, gross profit can be computed by deducting cost of sales from the revenue of the company. In this context, Messner (2015) stated that the gross profit margin is a financial metric generally used by the business to determine the financial health of the company. The gross margin is determined by deducting cost of goods sold from the sales. The resultant amount is then divided by total sales revenue to determine the gross profit percentage. 

2.2 Evaluation on the methods of controlling stock as well as cash in business and service environment (AC 2.2, M1, M2, M3, D2, D3)

Stock controlling and cash controlling plays a vital role in the growth and development of the organization as it enables vigorous expansion of the operations while also enabling risk taking for entering new markets. In the words of Laux and Leuz (2009), the stock controlling determines the effectiveness of the working capital management and daily operations for an organization. The most effective methods for stock controlling with reference to Marks & Spenser is as under:

  • Computation of economic order quantity
  • Computation of re-order level of the stock
  • Avoiding unnecessary purchase of stock
  • Creation of Just in Time stock management system

The implementation of the above stated methods would enable preventing unnecessary blockage of fund in the inventory while on the other hand also reduce wastage. In addition to this, the above-mentioned methods would also prevent loss of stock with respect to thefts and damages. 

Cash controlling for Marks & Spenser can be evaluated based on the following methods:

  • Preparation of bank reconciliation statement to identify the variances and take decision accordingly
  • Physical random cash counting to minimize miscounts by staffs and lastly, 
  • Implementation of dual control of cash in order to eliminate theft and increase accountability

Based on the above evaluation of stock control and cash control, Marks & Spenser have been recommended to introduce Sage 300 ERP software. The implementation of Sage 300 ERP would enable effective and efficient stock and cash control thus, leading to operational stability and effective working capital management. Moreover, Marks & Spenser have also been recommended to disclose the value of stock and cash in order to prevent misstatements while enabling easy identification of the results.

Task 3:

3.3 Discussion on the purpose and process of budgetary control as well as an outline on the budgetary control cycle (AC 3.3, M1, M2, M3, D2, D3)

As stated by Wyatt (2012), budgetary control refers to the process of spotting the variances and taking corrective actions for controlling such variances. The purpose of budgetary control is as under:

  • Evaluation on the performances of the members to determine the reasons behind the variances while, apprising the members of the organization for the affirmative performances. In addition to this, the budgetary control also pin points the reason behind the variance, which can be used for corrective actions. 
  • Controlling the gap by inducting variance analysis while, ensuring optimum utilization of resources and achievement of specified targets. 
  • One of the prime purposes of budgetary control is to motivate the managers while also strive them to achieve common goals. 

The budgeting process involves the following:

  • Communication of the budget policy and guidelines with the people directly involved in the preparation of the budget
  • Determination of the factors restricting the desired outputs while taking corrective action in order to eliminate them
  • Initial preparation of various budgets
  • Negotiation of budgets with the superiors
  • Reviewing and coordinating the budgets
  • Final acceptance of the budgets and finally,
  • Regular and timely review of the budgets 

As per McLaney and Atrill (2012), the budgetary control cycle comprises of the following seven stages:

Stage 1
Responsibility 
This stage of budgetary control cycle involves clearly   defining managerial responsibilities
Stage 2
Action plan
This stage involves laying down the individual budgets   detailed action plan 
Stage 3
Adherence
In this stage of the budgetary control the managers adhere   to their budgets after getting approval
Stage 4
Monitoring
Monitoring the actual performance and then comparing those   with the budgeted outcomes
Stage 5
Correction 
This stage involves taking corrective action for the   variances in the actual and budgeted results
Stage 6
Approval
This stage deals with the approval for the budgets by the   senior managers
Stage 7
Variance 
This stage deals with the unaccounted expenses that are   subjected to individual investigation


3.4 Reviewing the variances analysis of Yuri’s budget along with reasons behind the variances (AC 3.4, M1, M2, M3, D2, D3)

The analysis of the variances for Yuri suggested that the comparison between the actual results and the budgeted results for the cutlery manufacturer had high amount of variances for both material and labour. The reason behind this mainly involved the shortage in adequate standard of steel and the inexperienced workforce. This was quite evident from the details of price rate variance and usage efficiency variance pertaining to the material and labour used. There was an adverse variance of 25000 units in the units sold for Yuri. This variance for the cutlery manufacture would have been due to the inability of Yuri to produce the budgeted units while also due to the loss of market share. The material variance of adverse GBP 7500 was due to the increased use of materials, which would have possibly been due to the inexperienced workforce. In addition to this, the adverse variance of GBP 1875 with respect to direct labour would have been due to increased in the number of employees in order to make up for the loss due to inexperienced workforce. 

Task 4:

3.1 Assessment on sources and structure of trail balance (AC 3.1, M1, M2, M3, D2, D3)

As mentioned by Lalli (2012), the main sources of trail balance are the purchase ledger, sales ledger and general ledger. The purchase ledger highlights the details of the personal accounts like creditors while the sales ledger highlights the details of the debtors. Furthermore, the general ledger comprises of the real as well as nominal accounts, which includes assets and equity, income and expenses respectively. The structure of the trail balance is as under:

The trail balance comprises of two main columns namely the debit side and the credit side. The listings under these columns are made as follows:

  • Assets in debit column
  • Liabilities in credit column
  • Expenses in debit column
  • Equity in credit column
  • Revenue in credit column

*Refer to appendix for an example of trail balance

3.2 Evaluation on the business accounts, adjustments and notes (AC 3.2, M1, M2, M3, D2, D3)

In the books of R Riggs 

Adjusted Profit and Loss Account 

For the year ended 31 December 2015

                                                                £                           £

Sales                                             157,165

Less Cost of goods sold:                                                                                                                                               94,520

Gross profit                                                            62,645

Discounts received                                                                                                                                 160                                  

Bank interest received             500                                

                                                            63305

Less Expense:

     Wages and salaries                                        31,740

     Rent3,170

     Discounts allowed                                820

     Accrued expenses                                                                                                        200

     Van running costs                                                687

     Bad debts                                     730

     Doubtful debt provision                                                                                              91

     Depreciation                                    1,900                   39338

Net Profit                                                                                                    23,967


In the books of R Riggs

Adjusted Balance Sheet 

As on 31 December 2015

                                  £                        £                         £

Fixed assets

     Office furniture & Van                                           8,175

Less depreciation                                               1,900                6,275

Current Assets

     Stock2,400

     Debtors                                   12,316

Less provision for doubtful debts496           11,820

     Prepaid expenses         230

     Cash at bank & hand4,924                            19374

       Total Assets                                                                25649


Current liabilities

     Creditors                                                        6,770

     Accruals                                                 612                  

                            6,982

Financed by

     Capital                                                                                                                                                                  11,400

     Add net profit23,967

Less drawings17,100

                                                           25649


4.1 Calculation and analysis of financial ratio in order to offer consistent interpretation of historic performances (AC 4.1, M1, M2, M3, D2, D3)

Ratio 
Formula
Calculation
Figure
Gross profit 
Gross profit / Sales * 100
(62645 / 157165) * 100
39.85%
Net profit margin
Net Profit / Sales * 100
(23937 / 157165) * 100
15.23%
Current ratio
Current Assets / Current liabilities
(18874 / 5657)
3.33
Acid test ratio
(Total Current assets – inventory –   prepaid expenses) / current liabilities
(18874 – 2400 – 230) / 5657
2.87
Debtors’ payment periods 
365 / (Net credit sales / Average   accounts receivables)
365 / (157165/ 11820)
27 times 
Creditors’ payment periods
365 / (Trade creditor/  Average accounts payables) 
365 / (94520/ 5657)
21.84 times
Stock turnover ratio
Cost of goods sold / Average   inventory
(94520 / 2400)
39.38 times


The financial ratio analysis of R Riggs for the period ended 31st December 2015 suggested that the favourable financial performance by the company during the year. The gross profit from the company was 40% while the net profit was 15.23%. This implied that despite high direct expenses the company was efficient in maintaining its indirect expenses. However, the current ratio of the company is 3.33, which implies that R Riggs have not been efficient in maintaining its current assets. However, the acid test ratio of the company implied that the main issue in the current obligations maintenance was with respect to the quick assets. The financial ratio analysis of the company also suggested that the debtors’ turnover period was higher than the creditor’s turnover period, which also contributed to the inefficiency in working capital management. However, the stock turnover ratio of the company was around 40 times implying that during the year the total stock were sold 40 times. 

4.2 Recommendation on appropriate future management strategies (AC 4.2, M1, M2, M3, D2, D3)

Based on the above financial ratio analysis, R Riggs has been recommended the following:

  • Follow proper cash flow management procedure to ensure additional cash and cash equivalents are reinvested into the business
  • Implement Sage 300 ERP software for stock controlling
  • Take steps to reduce the expenses as it would result in increased profitability
  • Control credit period while on the other hand, maintain business relation with the suppliers to reduce the minimum reorder quantity and extent credit period
  • Increase investments in advertisement as it would result in increased sales thus profitability. 

Task 5:

5.1 Categorization of cost under fixed, variable and semi-variable (AC 5.1, M1, M2, M3, D2, D3)

Fixed cost

In the words of Keller, 2012), fixed cost are those cost which remain unchanged despite the change in the volume or activities. For instance, fixed cost for Leicester Square Hotel’s operations. 

Variable cost

Variable costs are those costs which change based on the volume of certain activity. For instance, the variable cost for food per room in a hotel in hospitality industry. 

Semi-variable cost

The semi-variable costs are those cost, which contain both fixed and variable components. For instance, electricity expenses and telephone bills in hotel and other businesses

5.2 Calculations for contribution per products and explanation on the cost/ profit/ volume relationship (AC 5.2, M1, M2, M3, D2, D3)

Proposal 1:

 
per unit
proposed change 1
total
Sales revenue
10
9
90000
less variable expenses
8
8
80000
Contribution
2
1
10000
less: Fixed cost
3
3
30000
Budgeted loss
-1
-2
-20000


break even units
12223
break even value
110000
number   of units required to be sold in order to meet the profit target 
14445


Proposal 2:

 
per unit
proposed change 2
total
Sales revenue
10
11
110000
less variable expenses
8
8
80000
Contribution
2
3
30000
less: Fixed cost
3
3
30000
Budgeted loss
-1
0
0


break even units
10000
break even value
110000
number   of units required to be sold in order to meet the profit target 
11819


Proposal 3:

 
per unit
proposed change 3
total
Sales revenue
10
10
100000
less variable expenses
8
9.5
95000
Contribution
2
0.5
5000
less: Fixed cost
3
3
30000
Budgeted loss
-1
-2.5
-25000


break even units
12500
break even value
125000
number   of units required to be sold in order to meet the profit target 
14500


5.3 Justification for the acceptance of the proposal based on short-term management decisions (AC 5.3, M1, M2, M3, D2, D3)

Based on the above calculation, the proposal 2 should be accepted. The reason behind this is that the number of units required to reach the target profit of GBP 20000 is least moreover, at the current production of 10000 units, the sales revenue meets the cost. In addition to this, the other two proposals would require higher number of units to be produced in order to reach the desired profits of GBP 20000. In addition to this, the other two proposal under current situation would lead to loss while also require higher unites to reach break even. 

Conclusion (D1)

Based on the above evaluation of the sources of finance for new machinery purchase, the sole trader has been recommended to use the retained earnings and sale all the non-performing assets. In case the amount still fall insufficient for purchase, then the sole trader may opt for private investments from family or friends. The reason behind this is that it would eliminate the cost implication for the sole traders the repayments terms are also flexible in case of private investments. The most appropriate method for income generation for the large chain of restaurant is increment in sales; commission based business and letting, subletting. The analysis of the variances for Yuri suggested high amount of variances for both material and labour due to shortage in adequate standard of steel and the inexperienced workforce. Furthermore, the company has been recommended to accept the proposal 2 as it is more profitable. While, R Riggs has been recommended to control credit period and maintain business relation with the suppliers to reduce the minimum reorder quantity and extent credit period. 

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