Assignment Sample on Finance for Decision Making
1. Introduction
Financial performance analysis in post COVID-19 situations is essential to form an effective business plan. Based on the consideration of this concept this report has been constructed where four financial ratios are going to be evaluated. Financial ratios such as profitability, efficiency, liquidity and financial gearing are effective to find out the financial condition of BP Plc. Moreover, financial information of Royal Dutch Shell Plc has been included to compute the actual financial performance of BP Plc in the UK competitive market. It has a great significance to the organization in terms of preparing budget and apprising new investment plans.
2. Evaluate financial performance
2.1. Financial ratio analysis
Financial ratios of BP Plc have been conducted based on the consideration of the last five years of financial information. Moreover, the condition of business is essential to compare with its competitor available in the UK market. Royal Dutch Shell is the big competitor of BP Plc thus, the comparative analysis is going to help in assessing post pandemic situation of business.
2.1.1. Profitability
Earnings capability of BP Plc in the last five years is essential to interpret in the current situation to take effective steps. Return on assets (ROA) is one good profitability ratio which can help in analysing the financial profitability condition. As opined by Appelbaum et al. (2017), business analytics has a massive impact on managerial accounting especially at the time of decision making. The ROA of BP plc in the financial year 2018 was 4.39% that decreased to 1.72% in 20189 and in 2020 it became -9.75%. The main reason behind such decrease is gradual reduction of profit margin (Wsj.com, 2021).
Based on the comparison of profitability ratio, it is visible that performance of Royal Dutch Shell plc has deteriorated from the year 2019. However, Shell has better control over profitability as compared to BP Plc (Shell.com, 2021). [Refer to appendix 1]
2.1.2. Efficiency
The business efficiency condition of BP plc has been conducted with the help of assets turnover ratio. This ratio helps in understanding revenue earning efficiency of organization from each pound of assets. According to Easton et al. (2018), 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. The assets turnover ratio of BP Plc was on rise during the year 2016-2018, however with gradual decrease the ratio became £0.67 (Wsj.com, 2021).
The situation with Shell Plc is the same as BP Plc as the company had £0.94 of assets turnover in 2018 that decreased to £0.45 at the end of 2020. Moreover, the business efficiency condition of BP Plc is better in 2020 as the BP Plc has been able to generate a much higher assets turnover in 2020 (Shell.com, 2021). [Refer to appendix 1]
2.1.3. Liquidity
Cash availability condition in the business is essential to acknowledge before recommending for an investment in a project. Current ratio is one effective financial ratio that helps in understanding the liquidity condition of the business. As opined by Karabarbounis and Neiman (2019), income of business can be enhanced if an organization has sufficient liquid assets in the business. Current ratio in the oil and energy business should be greater than 1.5:1 to have a stable liquidity condition in the business. The liquidity ratio of BP plc was low in 2018 and 2019, although in 2020 the company has been able to enhance the ratio to 1.22:1 (Wsj.com, 2021).
Shell Plc has the advantage in terms of business liquidity condition as maintained above 1.15:1 of current ratio in the past 5 years. However, it is noticeable that the gap of current ratio between BP Plc and Shell Plc in 2020 is negligible as Shell Plc has obtained 1.23:1 of current ratio during that year (Bp.com, 2021). [Refer to appendix 1]
2.1.4. Financial gearing
Financial gearing or leverage ratio has been conducted with the help of debt-to-equity ratio. As cited by Austin and Merlo (2017), analysis of debt and equity available in the business is an effective way to measure the risk involved in the business. The debt-to-equity ratio of BP Plc is 2.13 times in 2020 while Shell Plc has 1.39 times of D/E ratio in the same financial period. Moreover, the ratio is increasing gradually in the past five years which can be a great threat to the business in the near future. The main reason for increase in financial leverage is decrease of equity and increase of debt in the business (Wsj.com, 2021). [Refer to appendix 1]
2.2. Discussion on problems and limitations
- The main limitation of conducted ratio analysis is that it can analyse the historical information, and it is not effective to measure current and future performance.
- Human elements and non-financial factors cannot be measured based on the use of financial ratios.
- Time value of money and inflation effects 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%) |
| Year 0 | (50.00) | 1.00 | (50.00) |
| Year 1 | 12.00 | 0.91 | 10.91 |
| Year 2 | 12.46 | 0.83 | 10.30 |
| Year 3 | 12.94 | 0.75 | 9.73 |
| Year 4 | 13.44 | 0.68 | 9.18 |
| Year 5 | 13.96 | 0.62 | 8.67 |
| Year 6 | 14.50 | 0.56 | 8.19 |
| Year 7 | 15.06 | 0.51 | 7.73 |
| Year 8 | 15.64 | 0.47 | 7.30 |
| Year 9 | 16.25 | 0.42 | 6.89 |
| Year 10 | 16.87 | 0.39 | 6.51 |
| NPV = | 35.40 |
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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Appelbaum, D., Kogan, A., Vasarhelyi, M. and Yan, Z., 2017. Impact of business analytics and enterprise systems on managerial accounting. International Journal of Accounting Information Systems, 25, pp.29-44. Available at: https://www.academia.edu/download/55763984/Impact_of_BA_and_Enterpise_systems_on_managerial_accounting.pdf
Austin, P.C. and Merlo, J., 2017. Intermediate and advanced topics in multilevel logistic regression analysis. Statistics in medicine, 36(20), pp.3257-3277. Available at: https://onlinelibrary.wiley.com/doi/pdf/10.1002/sim.7336
Baum, A.E., Crosby, N. and Devaney, S., 2021. Property investment appraisal. John Wiley & Sons. Available at: https://books.google.com/books?hl=en&lr=&id=4-ASEAAAQBAJ&oi=fnd&pg=PP1&dq=Investment+appraisal&ots=GLTtXlkZbR&sig=F2pE4NrJRwcY9b_SP_HGqRvUfSg
Bergmann, M., Brück, C., Knauer, T. and Schwering, A., 2020. Digitization of the budgeting process: determinants of the use of business analytics and its effect on satisfaction with the budgeting process. Journal of Management Control, pp.1-30. Available at: https://link.springer.com/content/pdf/10.1007/s00187-019-00291-y.pdf
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Dokulil, J., Dvorský, J. and Popesko, B., 2018. Budgeting and czech companies: connected concepts or two different worlds?. Scientific papers of the University of Pardubice. Series D, Faculty of Economics and Administration. 44/2018. Available at: https://dk.upce.cz/bitstream/handle/10195/72001/Dokulil_Dvorsky_Popesko.pdf?sequence=1&isAllowed=y
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Easton, P.D., McAnally, M.L., Sommers, G.A. and Zhang, X.J., 2018. Financial statement analysis & valuation. Boston, MA: Cambridge Business Publishers. Available at: https://www.fau.edu/graduate/faculty-and-staff/programs-committee/docs/02202019/NCP-ACG5176.pdf
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Appendices
Appendix 1: Financial ratio analysis
| BP PLC [BP (U.K.: London)] | |||||
| Profitability Ratios | 2020 | 2019 | 2018 | 2017 | 2016 |
| Net Profit Before Tax | (19,094.00) | 3,839.00 | 9,727.00 | 3,629.00 | (3,153.00) |
| Total Assets | 195,804.00 | 222,830.00 | 221,558.00 | 204,410.00 | 213,099.00 |
| Return on Assets (%) | -9.75% | 1.72% | 4.39% | 1.78% | -1.48% |
| Royal Dutch Shell PLC A [RDSA (U.K.: London)] | |||||
| Profitability Ratios | 2020 | 2019 | 2018 | 2017 | 2016 |
| Net Profit Before Tax | (22,420.00) | 17,152.00 | 23,635.00 | 10,797.00 | 1,527.00 |
| Total Assets | 277,456.00 | 305,217.00 | 313,438.00 | 300,940.00 | 332,841.00 |
| Return on Assets (%) | -8.08% | 5.62% | 7.54% | 3.59% | 0.46% |
| BP PLC [BP (U.K.: London)] | |||||
| Efficiency Ratios | 2020 | 2019 | 2018 | 2017 | 2016 |
| Net sales | 140,652.00 | 218,224.00 | 224,055.00 | 186,523.00 | 135,632.00 |
| Average total assets | 209,317.00 | 222,194.00 | 212,984.00 | 208,754.50 | 213,099.00 |
| Assets turnover ratio | 0.67 | 0.98 | 1.05 | 0.89 | 0.64 |
| Royal Dutch Shell PLC A [RDSA (U.K.: London)] | |||||
| Efficiency Ratios | 2020 | 2019 | 2018 | 2017 | 2016 |
| Net sales | 132,546.00 | 266,537.00 | 288,951.00 | 237,003.00 | 173,120.00 |
| Average total assets | 291,336.50 | 309,327.50 | 307,189.00 | 316,890.50 | 332,841.00 |
| Assets turnover ratio | 0.45 | 0.86 | 0.94 | 0.75 | 0.52 |
| BP PLC [BP (U.K.: London)] | |||||
| Liquidity Ratios | 2020 | 2019 | 2018 | 2017 | 2016 |
| Current Assets | 53,390.00 | 56,308.00 | 55,991.00 | 55,419.00 | 54,880.00 |
| Current Liabilities | 43,746.00 | 55,554.00 | 53,578.00 | 47,848.00 | 47,225.00 |
| Current Ratio | 1.22 | 1.01 | 1.05 | 1.16 | 1.16 |
| Royal Dutch Shell PLC A [RDSA (U.K.: London)] | |||||
| Liquidity Ratios | 2020 | 2019 | 2018 | 2017 | 2016 |
| Current Assets | 66,348.00 | 69,967.00 | 76,541.00 | 70,526.00 | 70,059.00 |
| Current Liabilities | 54,099.00 | 60,105.00 | 61,097.00 | 58,967.00 | 59,746.00 |
| Current Ratio | 1.23 | 1.16 | 1.25 | 1.20 | 1.17 |
| BP PLC [BP (U.K.: London)] | |||||
| Financial gearing Ratio | 2020 | 2019 | 2018 | 2017 | 2016 |
| Total Debt | 133,206.00 | 146,810.00 | 141,825.00 | 130,187.00 | 134,725.00 |
| Total Equity | 62,598.00 | 76,020.00 | 79,733.00 | 74,222.00 | 78,374.00 |
| Debt to Equity Ratio | 2.13 | 1.93 | 1.78 | 1.75 | 1.72 |
| Royal Dutch Shell PLC A [RDSA (U.K.: London)] | |||||
| Financial gearing Ratio | 2020 | 2019 | 2018 | 2017 | 2016 |
| Total Debt | 161,477.00 | 161,444.00 | 154,413.00 | 154,711.00 | 180,281.00 |
| Total Equity | 115,979.00 | 143,773.00 | 159,025.00 | 146,230.00 | 152,560.00 |
| Debt to Equity Ratio | 1.39 | 1.12 | 0.97 | 1.06 | 1.18 |
(Source: MS Excel)
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