AAF044-6 Accounting and Finance
AAF044-6 Accounting and Finance
Introduction
A business is successful with the effective planning system and a strong management structure. The decision-making potential of an organisation is essential that is developed by the strong management system and boosts the confidence of organisations in acknowledging the challenges and overcome the same. At present, due to the turbulent business environment, organisations are found to be potentially facing challenges in meeting their organisational goals that is further hampering the long-term operations. In this context, the current report analyses the corporate objectives of Centrica Plc along with the key features of the company. Additionally, the report also highlights the management issues faced by the company that is impacting the company in meeting its objectives. Furthermore, the report discusses the challenges that Centrica Plc can face while adopting the continuous budgeting system for the first time. Also, the report focuses on understanding why managers may prefer IRR evaluation for discounted cashflows. However, it also highlights the remuneration committee of the company, main functions of audit committee as well as the issues faced by the committee during the reporting year.
Centrica Plc is a UK-based multinational organisation within the energy sector with its headquarters in Windsor. The company engages in supplying gas and coal to the industries and has presently become a market-leader (Centrica, 2023). The company has been operating in the UK and Ireland markets for over 200 years. At present, the company has an employee count of 20,000 from across the globe and a total customer base of 10.3 million. The purpose of the company has been to help the customers live simply, sustainably and affordably. In addition to this, the company has been found to be focusing on five significant values such as “Care, Courage, Collaboration, Delivery and Agility” (Centrica, 2023). Furthermore, acknowledging the challenges of climate change, the company focuses on helping the customers and partners in reaching the situation of net-zero thereby ensuring a positive energy transition. The company plays a crucial role in the process of energy transition as they have been investing “£600m – £800m a year” until 2028 (Centrica, 2023).
The company focuses on providing effective customer services that helps in increasing decarbonisation and helps in providing innovating offerings to the customers with the help of the retail stores (Centrica, 2023). In addition to this, the organisation has focused on optimisation as it supports responsible buying and selling of energy thereby accessing value from green generation. Also, one of the major key feature of the company has been its focus on investing to build up a low-carbon and reliable energy system that includes “flexible peaking generation, power generating renewables, and energy storage through batteries and geological storage” (Centrica, 2023). Also, the company focuses on creating value for the essential stakeholders of the company that includes employees as well. In this regard, it has emerged from the studies that despite focusing on developing a collaborative working environment within the organisation, the company has been facing the issues of employee count.
As emerged from studies, the new CEO of Centrica placed a plan that stated that the 20,000 employees that are working in the company essentially needs to abide by the terms and conditions provided by the company or else they can face job loss situation (Pratley, 2020). This has potentially increased the outrages from the Union representatives. In addition to this, it has also been evident that this has potentially impacted the customer engagement of the company as it lost more than 1 million customers in the past two years of 2018 and 2019 (Pratley, 2020). Hence, it can be stated that it despite potential business strategies, the company has been facing managerial issues that is affecting the company’s capability to achieve the organisational goals and objectives.
Challenges to be faced by Centrica Plc for implementing continuous budgeting system
Budgeting is a crucial element in organisations as it is the process that helps companies to organise their financial resources effectively for a particular year. It further provides an insight on the expected incomes and gains over a financial year and helps the organisations in appropriately setting the financial goals (Williams et al., 2018). As per the words of Schiff and Lewin (2019), budgeting is the financial tool that organisations implements to optimise their financial resource allocation to meet the set financial objective. It further helps the organisations in setting up the cost structure, forecast financial profit levels and other outcomes that improve the financial decision-making capacity. Also, it helps in communicating the financial goals in a transparent manner. Usually it has been found that organisations follow annual budgeting process where they prepare a financial budget and follows the same till the end of the financial year for which it has been prepared (Batt et al., 2021). Annual budgeting is the budgeting system where organisations focus on developing a 12-month budget with the inclusion of projected incomes and gains.
On the contrary, continuous budgeting system refers to the method where organisations focus on updating budgets as per the market changes and the performance of the same (Kunnathuvalappil Hariharan, 2020). Continuous budgeting or rolling budgeting system help organisations in developing a flexible financial planning that further provides them opportunity to make adjustments as per the market fluctuations. Following the study of Alexander (2018), continuous budgeting process provides a scope to the organisations in preparing budget considering real-time data that further improves the financial decision-making system. It helps organisations by providing a long-term financial outlook that further helps them in strategically developing the future financial plans. Based on this view, it can be stated that implementation of rolling budget or continuous budget can be of immense benefit for organisations at present as it can help the companies in addressing the current market complexities and prepare the budgets accordingly.
In this context of discussion, referring to the implementation of the budgeting processes into the financial system of Centrica Plc, it can be stated that the company can face significant challenges that can partially reduce the competitive position of the company in the UK market. Changing the budgeting system from annual budgeting to rolling budgets, a robust change management is essential (Nguyen et al., 2018). In this regard, the employees within the company can refrain from adopting the new changes due to lack of understanding of the continuous budgeting concept. This can further create challenges for the company as it can impact effective implementation of the budgeting system. In this context, it is essential for the employees to acknowledge the change management system and understand the significance of the continuous budget system. Furthermore, at the present situation of outrages from the employee union, it can be challenging for the company to integrate the new system as collaborating with employees in this situation can be difficult. Also, it can be difficult to make the employees adopt the new system due to lack of training regarding the same.
On the other hand, there can be a cultural change within the organisation as employee might refrain from accepting the decision of changing the annual budgeting system. In other words, as continuous budgeting incorporates a total ne method of preparing budgets, therefore, it can be challenging for the employees to adopt a new budgeting method especially when the company is facing such employee-related issues that is affecting the overall operations of the company. Moreover, in the UK, Brexit has increased the challenges of staff shortage which potentially reduces the efficiency of the organisations in managing operations (Lynch et al., 2019). In this situation, implementing the new approach of budgeting can require recruitment of new employees within the company who have expertise and knowledge regarding the creation of rolling budgets. Therefore, the challenge of staff shortage can create challenges for Centrica Plc for integrating the system.
Furthermore, the Russia-Ukraine war has impacted the energy sector in the UK as it has increased the prices of wholesale gas by 40% since the beginning of the same (Ralston, 2022). Moreover, there has been a continuous market fluctuation due to the war situation that is impacting the operations of the companies as well. In this context, implementing continuous budgeting system can be challenging as it can reduce the efficiency of the company in predicting the market trends and prepare the budget accordingly. Also, this can create budgeting errors which can further reduce the effectiveness of the financial planning system of the company (Weller et al., 2019). On the other hand, in order to implement continuous budget, it is essential for the company to have effective and transparent communication system across departments. In this regard, it can be challenging for the concerned company as without an integrated communication system, it is difficult for the company to communicate the market changes and implement the same to the budgets and update them for further usage.
Moreover, for implementing the continuous budget system, reassessing the financial resources in a continuous basis is essential (Bhimani et al., 2018). In this respect, following the issues faced by the company such as surge in the energy prices and loss of customers, it can be challenging for the company to continuously monitor the market changes and update the allocation process thereby impacting the internal stability and management systems. Thus, referring to this discussion, it can be stated that implementing the budgeting system for the first time can be significantly challenging for the organisation as it is likely to face management challenges as well as social and financial challenges.
Critical analysis of manager’s preference for IRR for evaluating discounted cash flows
Capital investment appraisal is the technique which is concerned with organisational management decisions related to projects or investing in fixed assets and reflects how to finance them to achieve corporate goals. With the help of this assessment based on the outcome, several alternative proposals and investments can be compared and make the most effcetiuve decision (Sangster, 2019). This approach is used to reflect ts the potential risks and profitability of a certain investment along with determining the required period to recover the invested initial amount. However, as per Hunjraet al., (2021), the assumptions made in this appraisal technique such as the cashflows and discounting rates may increase complexity and influence the outcome of the measurements. This capital investment appraisal technique includes several financial matrices based on which the investors make decisions such as; “NPV (Net present value), IRR (Internal rate of return), ARR (Average rate of return) and payback period”. Among these financial matrices, investors prefer NPV the most as it considers the time value of money.
The NPV is a financial metric that reflects the total value of an investment opportunity and reflects its present value of cash inflow and outflow based on a certain rate of discounting factor (Dai et al., 2022). Thus, it becomes the most useful tool which reflects the present value of the potential revenue incurred from an investment and ensures the most effective decisions. Moreover, IRR is another great capital investment appraisal technique which denotes the potential profitability of an investment along with the risks. IRR is the value at which the value of NPV becomes zero (Liu 2022). In this regard, to enable more effectiveness in the decision-making process ARR is the financial matrix that helps address the annual profitability of an investment. Similarly, in order to indicate the period that an investment may take in recovering the initial invested amount payback period can be considered. Thus, all of these matrices are helpful in making more effective and accurate decisions related to any investment but only the NPV and IRR consider the discounting factor. Hence, this study will reflect the circumstances of selecting IRR while carrying out discounted cashflow evaluations instead of NPV.
Managers generally prefer IRR over NPV as it indicates the more instinctual value of profitability in percentage form which is more analysable and comparables with other alternatives. Moreover, according to Huang et al., (2022), IRR represents the rate at which the value of NPV of the cash flows will be zero hence the managers feel much more secure and predictable. The outcome of IRR also can be used as a benchmark by comparing the same with the expected rate of return of the managers. If the value of IRR goes up to the expected rate, then the investment will be accepted and if not then it will be rejected. Thus, it helps in shaping the decisions of the managers. However, along with several benefits, IRR has some drawbacks as well. IRR is suitable for the measurement of the profitability of investments which has cash flows in the same pattern. In the case of projects having different cash flows, the use of NPV will be more suitable than IRR. Moreover, based on the research of Wang (2021), the valuation of IRR only considers the cash flow, not the initial investments. Hence, having the same value of IRR may have a different initial investment amount which may disrupt the decision-making process. Apart from this, IRR is helpful as it considers the time value of money and encourages comparison with market rates which helps the company in achieving their corporate objectives.
Analysis of audit committee of Centrica Plc
Based on the Centrica group’s decision-making procedures and policies to reflect any recent updates made to the policies, general guidelines and strategies, this governance gets changed and reformed. The board of directors includes Scott Wheway Chairman, Chris O’Shea Group Chief Executive and Kate Ringrose Group Chief Financial Officer (Centrica, 2023). The board is responsible for maintaining the responsibilities of this group of companies to ensure and implement compliance with the general guidelines, strategies and policies in the UK. Moreover, as per Centrica (2023), the government structure of this company is committed to sustainable development goals (SDGs), climate action, diversity and inclusion, decentralised structure and compliance with industrial law. Centrica’s Governance and Sustainability System is focused on the process of a continuous monitoring system and reviewing the progress of the business operations to conform to the circumstances and facts and ensure that it remains relevant to the best practices and benchmarks in the area in which the Company operates.
Furthermore, based on the overview of Centrica (2023), as set by the Company’s Corporate Governance System, the Audit and Compliance Committee of Centrica is an internal committee included in its board of directors having executive powers. This committee has been developed for consulting and informative purposes which involve making proposals and advising its scope of activities and function as prescribed in the company’s governance. Moreover, as per the demonstration in Centrica (2023), the audit committee are responsible for risk management and internal controls like internal audit, review of the system of risk management and internal controls, fair, balanced and understandable, internal monitoring and risk management, looking after the risk department, audited accounts, financial information, non-financial information and sustainable development, compliance unit, irregular and improper financial conduct, related party transactions, business separation of activities compliance, and tax policy compliance.
Moreover, environmental challenges such as biodiversity loss, and climate change, and identification of opportunities arising from the ecological and energy transition are other challenges for the organisation which has influenced its production process and customers’ interests and preferences. Apart from this, other challenges like carbon emission reduction targets, grid capacity, flexibility and investment uncertainty are also considerable for Centrica. As per Centrica (2023), the ambition to make carbon emissions net zero is one of the greatest issues. It has increased operational cost expectations of the customers and influenced its profitability. Balancing the demand for renewable energy and the cost structure is quite challenging for the organisation. Moreover, the government of the UK also has established several laws and rules related to the protection of the environment which also has increased complexity in business operations. In this respect, resistance to change by the stakeholders is also one crucial factor which also has become a great challenge for Centrica.
As found from the clarification the increment in cost structure is the biggest issue for the organisation which needs to be cut down to increase profitability. In order to do the same, Centrica needs to develop an effective incentive plan and investments in research and development to enable opportunities for cost reduction. Moreover, as per Appiah-Kubi et al., (2021), to attract private investors and international traders developing incentives including tax credits and favourable investment policies and strategies needs to be considered. Transparency and flawless communication with the stakeholders will enable stakeholders’ engagement and ensure support of several energy projects. As the demand for electricity energy in the UK has declined hence the organisation needs to hold several social awareness programs to spread knowledge regarding the benefits of using renewable energy and ensure sustainability in the environment. Furthermore, developing resilience plans to address the impact of market changes, climate changes and potential threats to the organisation can be helpful in crisis management.
Conclusion
This current assignment has helped in understanding the ways in which evaluation of a company needs to be done so that a comprehensive report can be developed. This report has ascertained the usage of IRR instead of NPV in discounted cashflow evaluations which revealed the benefits of IRR. Similarly, I have found IRR only considers cash flow instead of initial and failure in ensuring the project has a different cash flow which is one of its drawbacks influencing the decision-making process. The use of IRR has improved my decision-making strategy and made me able to rank the investment opportunities. Moreover, knowledge of the function of the audit committee has provided me with insight related to the contribution to a company’s risk management and financial reporting. I have gained an overview of internal control evaluation and the overall internal audit process.
The increment cost structure and the fallen demand for electricity energy in the market have resulted in increased operational costs which influenced profitability. I can say the increased cost is the biggest barrier to this organisation along with the climate change; carbon emission reduction targets and failure in addressing the opportunities are also considerable. However, the study further helped me in understanding that continuous budgeting system is beneficial for companies, however, it can be challenging for the mentioned organisation due to management issues, Brexit, lack of integrated communication system and Russia-Ukraine war.
Reference List
Alexander, J., (2018). Financial planning & analysis and performance management. John Wiley & Sons.
Appiah-Kubi, S.N.K., Malec, K., Phiri, J., Maitah, M., Gebeltová, Z., Smutka, L., Blazek, V., Maitah, K. and Sirohi, J. (2021) Impact of tax incentives on foreign direct investment: Evidence from Africa. Sustainability, 13(15), p.8661.
Appiah-Kubi, S.N.K., Malec, K., Phiri, J., Maitah, M., Gebeltová, Z., Smutka, L., Blazek, V., Maitah, K. and Sirohi, J. (2021) Impact of tax incentives on foreign direct investment: Evidence from Africa. Sustainability, 13(15), p.8661
Batt, C., Rikhardsson, P. and Karlsson, T., (2021). Exploring the impact of organizational context on budgeting. Corporate Ownership and Control, 18(4), pp.134-151.
Bhimani, A., Sivabalan, P. and Soonawalla, K., 2018. A study of the linkages between rolling budget forms, uncertainty and strategy. The British Accounting Review, 50(3), pp.306-323.
Centrica (2023) Annual report of Centrica. [Online] Available at: https://www.centrica.com/investors/results-reports-and-presentations/annual-report-2022/[Accessed on 6 January 2024]
Centrica (2023) Net zero and the challenges for the UK energy sector. [Online] Available at: https://www.centrica.com/stories/2020/net-zero-and-the-challenges-for-the-uk-energy-sector/[Accessed on 6 January 2024]
Centrica, (2022), Centrica plc Annual Report and Accounts 2022, Available at https://www.centrica.com/media/lj2nlycx/centrica-annual-report-and-accounts-2022.pdf [Accessed on 6 January 2024]
Centrica, (2023), Our Strategy and Business Model, Available at https://www.centrica.com/who-we-are/our-strategy-and-business-model/ [Accessed on 6 January 2024]
Centrica, (2023), Values and Culture, Available at https://www.centrica.com/who-we-are/values-and-culture/ [Accessed on 6 January 2024]
Centrica, (2023), Who we are, Available at https://www.centrica.com/who-we-are/ [Accessed on 6 January 2024]
Dai, H., Li, N., Wang, Y. and Zhao, X. (2022) March. The Analysis of Three Main Investment Criteria: NPV IRR and Payback Period. In 2022 7th International Conference on Financial Innovation and Economic Development (ICFIED 2022) (pp. 185-189). Atlantis Press.
Huang, J., Tong, J., Wang, P. and Zheng, X. (2022) March. Application and Comparison of NPV and IRR Methods in the Company Investment Decision. In 2022 7th International Conference on Financial Innovation and Economic Development (ICFIED 2022) (pp. 71-78). Atlantis Press.
Hunjra, A.I., Shaheen, I.B., Niazi, G.S.K. and Rehman, I. (2021) Investment appraisal techniques and constraints on capital investment. Actual Problems of Economics, 2(4).
Kunnathuvalappil Hariharan, N., (2020). Rethinking budgeting process in times of uncertainty.
Liu, Y. (2022) July. Evaluation Method Based on NPV and IRR. In 2022 2nd International Conference on Enterprise Management and Economic Development (ICEMED 2022) (pp. 816-820). Atlantis Press.
Lynch, P., Whitaker, R. and Cygan, A., (2019). Brexit and the UK Parliament: challenges and opportunities. Brexit and democracy: The role of parliaments in the uk and the european union, pp.51-79.
Nguyen, D.H., Weigel, C. and Hiebl, M.R., (2018). Beyond budgeting: review and research agenda. Journal of Accounting & Organizational Change, 14(3), pp.314-337.
Pratley. N, (2020), Centrica left it far too late to tackle its problems, Available at https://www.theguardian.com/business/nils-pratley-on-finance/2020/jul/16/centrica-left-it-far-too-late-to-tackle-its-problems [Accessed on 6 January 2024]
Ralston. J, (2022), Ukraine conflict and impacts on UK energy, Available at https://www.energy.gov/sites/default/files/2022-07/3.%20Energy%20%26%20Climate%20Intelligence%20Unit%20_%20Ukraine%20conflict%20and%20impacts%20on%20UK%20Energy.pdf [Accessed on 6 January 2024]
Sangster, A. (2019) Capital investment appraisal techniques: a survey of current usage. Journal of Business Finance & Accounting, 20(3), pp.307-332.
Schiff, M. and Lewin, A.Y., (2019). The impact of people on budgets. In Management Control Theory (pp. 209-218). Routledge.
Wang, Y. (2021) December. The development and usage of NPV and IRR and their comparison. In 2021 3rd International Conference on Economic Management and Cultural Industry (ICEMCI 2021) (pp. 2044-2048). Atlantis Press.
Weller, C.E., Estep, S. and Hendricks, G., (2019). Budgeting the Future. Center for American Progress, April, 2.
Williams, J.R., Haka, S.F., Bettner, M.S. and Carcello, J.V., (2018). Financial & managerial accounting: The basis for business decisions. McGraw-Hill.
Know more about UniqueSubmission’s other writing services:
