Assignment Sample on Decision Making for Finance
1. Introduction
Analysis of financial performance in post COVID-19 situations is a vital step to sketch an effective business plan. Depending on the same parameters, the concept of this report is constructed using four independent financial ratios, which are going to be critically evaluated. Financial ratios such as profitability, efficiency, liquidity and financial gearing are efficient and effective methods to find out the financial stability of BP PLC. Also, financial information of Royal Dutch Shell PLC is also incorporated to calculate the actual performance of BP LC in the competitive market of UK. It is of great importance of the organization in ways of forming budget and creating new investment plans.
2. Evaluate financial performance
2.1. Financial ratio analysis
Based on the information provided for the past years, financial ratios have been calculated for BP PLC. Also, keeping in mind the condition and stability of the competitor establishments which are blooming in the UK market. To name, Royal Dutch Shell is the highest competitor of BP PLC and thereby competitive analysis between the two shall help to truly assess the post pandemic business stability.
2.1.1. Profitability
To calculate and analyse the working and financial performance of BP PLC, the accounts of previous years need to be taken into consideration. Return on assets (ROA) is an effective profitability ratio that will analyse the financial profitability conditions. “Business analytics has a massive impact on managerial accounting especially at the time of decision making” (Appelbaum et al., 2017). The ROA of BP PLC in the financial year 2017-18 was 4.39% that stooped to 1.72% in 2018-19 and in 2019-20 it dropped down to -9.75%. The ideal reason behind this huge fall is gradual reduction of profit margin (Wsj.com, 2021).
On the basis of the comparison of profitability ratio, it is fair to state that the performance of Royal Dutch Shell PLC has also marginally fallen from the year 2019. Yet, Shell has more effective grasp over profitability as compared to BP Plc (Shell.com, 2021). [Refer to appendix 1]
2.1.2. Efficiency
We have used asset turnover ratio in order to analyse the business efficiency condition. In order to understand the efficiency of revenue earning in the organization through each pound of assets, this ratio is most effective. “Comparison of total assets available in the business with total revenue made by the business is a good process to interpret the financial condition of the organization” (Easton et al.,2018). The assets turnover ratio of BP PLC was at its peak during the year 2016-2018, although with gradual decrease, the ratio became as low as £0.67 (Wsj.com, 2021).
The condition of Shell Plc is not very different from BP PLC as the company had a turnover in assets worth £0.94 in 2018 that decreased to as low as £0.45 by the end of 2020. Adding to that, the condition of business efficiency of BP PLC is better in 2020 as BP PLC has been successfully able to procreate much higher assets turnover by 2020 (Shell.com, 2021). [Refer to appendix 1]
2.1.3. Liquidity
The availability of cash condition in a running business is very vital to take into consideration beforehand suggesting for any form of investment in a project. Current ratio is the most effective financial ratio that helps us to understand the liquidity position of the business. “Income of business can be enhanced if an organization has sufficient liquid assets in the business” (Karabarbounis and Neiman, 2019). In order to have stable liquid conditions in the oil and energy business, current ratio should be greater than 1.5:1. The liquidity ratio of BP plc was subsequently low in 2018 and 2019, although in 2020 the company was able to squeeze the ratio up till 1.22:1 (Wsj.com, 2021).
Shell Plc has the upper hand in terms of business liquidity condition as it was maintained above 1.15:1 of current ratio in the past 5 years. However, it is duly noted that the space between current ratio of BP Plc and Shell Plc respectively in 2020 is negligible as Shell Plc had obtained 1.23:1 of current ratio during that year (Bp.com, 2021). [Refer to appendix 1]
2.1.4. Financial gearing
With the help of debt-to-equity ratio, financial gearing (aka leveraging) has been conducted. “Analysis of debt and equity available in the business is an effective way to measure the risk involved in the business” (Austin and Merlo, 2017). The debt-to-equity ratio of BP PLC was at 2.13 times, while Shell Plc had it at 1.39 times of D/E ratio over the same financial period of 2019-20. However, the ratio has been gradually increasing over the past five years which is potentially a great threat to the business in the upcoming days. The ideal reason behind the increase in financial leverage is the decrease of equity and increase of debt in the business (Wsj.com, 2021). [Refer to appendix 1]
2.2. Arguments on the problems and limitations:
- The main limitation of ratio analysis being conducted is that it analyses historical information, which is not the most effective method to determine current and future performance.
- Human elements and non-financial factors cannot be measured on the basis of the use of financial ratios.
- Time value of money and inflation impacts are ignored while evaluating financial ratios (Easton et al. 2018).
2.3. Recommendations
As per the evaluation of financial performance of BP Plc it is recommended to the organization to enhance sales revenue in the business. Profitability condition of the organization made a poor performance in 2020 and increase of revenue will be effective to sustain profitability condition of the business.
3. Budgeting and performance management
Managerial accountant of an organization uses budget as an effective tool in the business to make effective control in the business. Budget has several positive elements that help management in making effective decisions and control in the business. However, it also has several drawbacks that may put negative effects in the business. This section of report has been constructed to assess such positive and negative elements of budgeting that may affect the business of BP Plc in the upcoming period.
3.1. Advantages
Positive elements of budget planning and budgetary control may help BP Plc to reach the ultimate business goal. Therefore, such advantages are as follows:
Profit maximization
Maximization of profit is essential for BP Plc and it can be possible with the planned bigotry control. As per the view of Adi and Lestari (2020), a strategic budget prioritizes the goal of business and conducts the plan accordingly. BP Plc is currently struggling in generating profit in the business thus, profit maximization is essential for the business and which can be possible with budget planning.
Effective coordination
Coordination between several departments in the organization is the key driver for effective business management which can be possible with the help of budget planning (Bergmann et al., 2020). Therefore, it can be stated that BP Plc will be able to get the advantage of fast and organize control over all departments in the business if the organization implements a budget in the business.
Clarity of business goals and target
Business goals and targets in the post COVID-19 situation have been changed drastically, it is essential for the management to make aware of new plans and policies in the new normal situation. According to Eckstein and Buck (2018), budget planning helps financial managers to allocate capital in the business in accordance with the business goals. Hence, budget panning in BP Plc will be effective for the organization to establish transparency in the short term and long-term business goals.
Correction of performance constantly
Development and progress are the key elements of budgetary control, it helps business to make improvements based on the actual result. As per the view of Dokulil, Dvorský and Popesko (2018), correction of budget is necessary to sustain the business performance. Hence, BP Plc will get the scope to make improvement in the business based on the consideration of actual short-term results.
3.2. Disadvantages
The negative factors in preparing budget in the business is need to be taken into consideration, therefore, the disadvantages are as follows:
Prediction of uncertain future
The post pandemic situation in oil and energy is full of uncertainty, and it is hard to make 100% effective predictions about the future in the current situation. According to Olszewska (2019), prediction of costs in the business is the first step of forming a budget. Hence, it is clear that BP Plc will face a problem in estimating business cost due to COVID-19 impact.
Conflicts in departments
Budget encourages work according to the plans thus delays in one department causes a chain reaction between the dependent departments. Interruption of material supplies in the business can be a serious reason that may raise conflicts between departments.
Employee demotivation
Following a budget plan can be demotivating for employees available in the business as they may lose creativity and innovation. As per the view of Adi and Lestari (2020), budget prioritizes the main aim and goal of the organization. Presently the goal of the organization is to maximize profit of the organization thus, employee motivation and encouraging factors might get sacrificed in the process.
3.3. Approaches to drawing up financial plan
3.3.1. Activity based approach
Financial plan of BP Plc can be constructed with the use of Activity based approach; this approach emphasizes on the expected cost of business. The company will be required to consider cost drivers and processes involved in the business. According to Eckstein and Buck (2018), an activity-based approach in financial planning helps in forming realistic and reliable budgets for the business operations.
3.3.2. Incremental approach
Incremental approach focuses on the percentage change of expenditures in the previous period. According to Bergmann et al. (2020), incremental approach is widely dependable on business analysis. Therefore, it can be stated that historical data plays an essential role in preparing an incremental budget for the organization.
3.4. Critical evaluation of performance management
Performance management can be beneficial for the organization in making effective business decisions as it monitors and evaluates the work of employees. Quality of environment enhancement is the main goal of performance management. Based on the consideration of employee performance a good and reliable decision in the business can be made.
4. Investment appraisal
BP Plc has planned to adopt a project namely “EV-only ultra-fast charging hubs”, it is expected that the project will require an initial investment of £50 million (Bp.com, 2021). It is essential for this research to critically assess risk and return possibilities from this investment option before establishing a full-scale investment. Therefore, the adopted two appraisal techniques are as follows:
4.1. Net present value (NPV)
| Cash flows (£m) | Cash Flows | DCF @10% | PV (@10%) | DCF @25% | PV (@25%) |
| Year 0 | (50.00) | 1.00 | (50.00) | 1.00 | (50.00) |
| Year 1 | 12.00 | 0.91 | 10.91 | 0.80 | 9.60 |
| Year 2 | 12.46 | 0.83 | 10.30 | 0.64 | 7.98 |
| Year 3 | 12.94 | 0.75 | 9.73 | 0.51 | 6.63 |
| Year 4 | 13.44 | 0.68 | 9.18 | 0.41 | 5.51 |
| Year 5 | 13.96 | 0.62 | 8.67 | 0.33 | 4.58 |
| Year 6 | 14.50 | 0.56 | 8.19 | 0.26 | 3.80 |
| Year 7 | 15.06 | 0.51 | 7.73 | 0.21 | 3.16 |
| Year 8 | 15.64 | 0.47 | 7.30 | 0.17 | 2.62 |
| Year 9 | 16.25 | 0.42 | 6.89 | 0.13 | 2.18 |
| Year 10 | 16.87 | 0.39 | 6.51 | 0.11 | 1.81 |
| NPV = | 35.40 | (2.14) |
Table 1: Net present value of the project
(Source: Created by the learner in MS Excel)
Net present value is a good investment appraisal tool that helps in measuring profitability of an investment option. As per the view of Baum, Crosby and Devaney (2021), use of investment appraisal techniques helps investors to choose one investment option when there are multiple options available. It has been assumed here that the project will be able to generate £12 million of cash flow at the end of the first year of investment. Moreover, there will be 3.86% growth in cash flows in the next 10 years. Based on the consideration of such assumptions, NPV of the project has resulted in £35.40 million at the end of 10 years with a 10% discounting factor (Bp.com, 2021).
4.2. Internal rate of return (IRR)
| Cash flows (£m) | Cash Flows | DCF @10% | PV (@10%) | DCF @25% | PV (@25%) |
| Year 0 | (50.00) | 1.00 | (50.00) | 1.00 | (50.00) |
| Year 1 | 12.00 | 0.91 | 10.91 | 0.80 | 9.60 |
| Year 2 | 12.46 | 0.83 | 10.30 | 0.64 | 7.98 |
| Year 3 | 12.94 | 0.75 | 9.73 | 0.51 | 6.63 |
| Year 4 | 13.44 | 0.68 | 9.18 | 0.41 | 5.51 |
| Year 5 | 13.96 | 0.62 | 8.67 | 0.33 | 4.58 |
| Year 6 | 14.50 | 0.56 | 8.19 | 0.26 | 3.80 |
| Year 7 | 15.06 | 0.51 | 7.73 | 0.21 | 3.16 |
| Year 8 | 15.64 | 0.47 | 7.30 | 0.17 | 2.62 |
| Year 9 | 16.25 | 0.42 | 6.89 | 0.13 | 2.18 |
| Year 10 | 16.87 | 0.39 | 6.51 | 0.11 | 1.81 |
| NPV = | 35.40 | (2.14) |
| IRR = ra + {Na * (rb – ra) / (Na – Nb)} | |
| Where, | |
| ra = Lower DCF = | 10% |
| rb = Higher DCF = | 25% |
| Na = NPV at ra = | 35.40 |
| Nb = NPV at rb = | (2.14) |
| Therefore, | |
| IRR = | 24% |
Table 2: Internal rate of return of the project
(Source: Created by the learner in MS Excel)
Internal rate of return is another widely used investment appraisal technique that helps in focusing risk involved in the investment option. As cited by Li and Trutnevyte (2017), investment appraisal technique helps investors in cost optimization. The anticipated cost of capital for the considered project is 10%. Internal rate of return of the project indicates the certain cost of capital or discounting factor at which projects NPV becomes zero. The calculation has been formed by comparing two net present values with the use of different discounting factors. Based on the conducted calculation, the internal rate of return of the project has resulted in 24% (Bp.com, 2021).
4.3. Implications of investment
Implication of the investment plan should be conducted based on the evaluation of external factors of the project. It can be noticed that the investment appraisal has been made with consideration of several assumptions and expectations. Therefore, it is essential for the organization to assess the actual situation of the business and make effective plans.
4.4. Risk and uncertainty (Sensitivity analysis)
Based on the conducted net present value and internal rate of return, sensitivity analysis of the project can be made. As per the view of Lindvall and Larsson (2017), sensitivity analysis is a crucial part for the investment appraisal of the project. The NPV of the project is £35.40 million which is a good return against the investment of £50 million. On the other hand, the outcome of IRR is 24% while the discount rate is 10%. Therefore, the risk of the project is low due to having a good portion of difference between IRR and cost of capital.
4.5. Recommendation
Based on the analysis and interpretation of results obtained from the use of investment appraisal techniques, it is clear that the project is attractive for the organization. It is recommended to the management of BP Plc to consider the implication process before investing in the project. Furthermore, it is suggested to the organization to select a suitable investment option to finance the project.
4.6. Methods of financing the project
BP Plc has two alternative sources to finance the project, such as debt financing and equity financing. According to Laird and Venables (2017), financing option of a project required to be made based on consideration of the time factor of the investment. The project of BP Plc has a lifespan of 10 years; thus, the organization should take long term finance. Debt capital can be obtained in the business based by taking loans from the financial institutions. On the other hand, the company will be required to issue shares in the financial market to collect equity share capital. It is suggested to BP plc to finance the project with debt financing option as the cost of capital of this financing option is low, and risk factor is low.
5. Conclusion
As per the discussion on the financial condition of BP Plc it can be summarized that the profitability condition of the organization has deteriorated in the financial year 2020. It can be concluded from the evaluation of financial ratios that the organization needs to improve its financial performance to stay competitive in the market. Moreover, budget planning and performance management has a great impact over the business in better control of the business process. Based on the use of investment appraisal techniques it has been found that the project of BP Plc has good scope to get successful in the near future.
References
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