Unit 2 Finance in Hospitality Industry Assignment Solution

Course	Diploma in Hospitality Management
Unit Number and Title	Unit 2 Finance in Hospitality Industry
QFC Level	Level 5
Unit Code	R/601/1789

Task-2

P2.1 Discuss elements of cost, gross profit percentages and selling prices for products and services

A business can be analysed to arrive at its component of expenses, which keep the activity going. It represents the monetary value in the books of the company, spent to manufacture a product or provide a service and encompasses all the time, money and labour expended.
The costs in a retail sales entity such as M&S would be slightly different from a manufacturing business strategy, wherein they would fall into any one of the following categories, namely:

• Material cost e.g. Raw materials, WIP, finished goods
• Labour cost e.g. Wages
• Direct expenses e.g. Hiring and maintenance of equipment
• Overheads e.g. Fuel
  • Selling, distribution and administrative costs

 All the above examples may not be always identifiable in M&S. For e.g. Materials, normally are substances which are key products of manufacture held at various stages of processing. However, in retail environment such as in M&S, where there is no factory like production process and products are procured from supplier’s world-over, and this category would be made up of purely inventory or stock ready for sale.

A direct cost is one which is directly identifiable with the product or service e.g. Materials, labour etc.
Indirect costs are however not immediately identifiable with the product sold to customers e.g. Stationery, insurance, taxes etc.
Costs are also distinguished as Fixed and Variable costs.
Fixed costs are those that remain at the same level, no matter how much the volume of output changes e.g. Rent, taxes etc.
Variable costs vary with changes in output levels e.g. Fuel, labour etc.
Some types of cost may also be semi-variable with a fixed portion and a variable portion e.g. Vehicle running costs which has a fixed element like tax and variable element such as fuel.
A third variety of cost is called the discretionary cost and is one whose level depends upon the discretion of the management e.g. advertising, training costs
Analysis of the financial statements of a company is enabled by the use of various types of ratios and as profits are key targets of any commercial venture, Profitability ratios are the starting point.
These ratios help in 2 ways – a) in reflecting the performance and b) efficiency of operations of the entity.
The Gross Profit Percentage (GPP) sometimes also referred to as the Gross Profit Ratio or the Gross Profit Margin shows the relationship of the company’s profits as a percentage of its Sales. In a sense, it is the key indicator of business efficiency and the higher the number, the healthier the business. The ratio permits one to compare the profits made by companies of differing sizes within an industry, as it is expressed as a percentage and not in absolute terms. We can also infer from the ratio as to what percentage of earnings are available to cover overheads and tax on profits.
                                    GPP = (Gross profit*/Total Sales) x 100

(Where *Gross profit = Total Sales-Cost of Goods sold)

The cost of goods sold (COGS) is the sum total value of all components that went into producing the goods sold. To arrive at the selling price, the seller has to add the mark up or the profit component, which constitutes the Gross Profit (GP).

            Selling price = COGS + Mark up (GP)

Net Profit (NP) is derived from the GP after deducting all overheads, such as rent, salaries and taxes and it constitutes the actual amount earned.
Initially the Trading/Manufacturing account is prepares ascertain the GP and thereafter the Profit & Loss account is prepared to determine the NP.
The concept of Net Sales is the amount after discount or other ‘markdowns’ are priced in and is the amount paid in by the ultimate customer.

P2.2 evaluate methods of controlling stock and cash in a business and services environment

Cash and stock (inventory) make up 2 key components of working capital, the others being receivables and payables. But between a business and a service, there may be differing levels of the two assets, depending upon the nature of industry.
For example, M&S being retail intensive may be looking to convert cash quickly back into stock but this process would be entirely dictated by demand for consumer goods, seasonality and supply from quality vendors. In case of a service organization, the value of inventory may be close to nil even.
Further, a manufacturer may trade on cash and credit terms and may enjoy credit from his suppliers. On the other hand, a retailer may be completely cash driven
Better working capital management is desired to ensure there is no idle cash, save unnecessary costs (e.g. Interest payments), earn interest where possible etc.
Most commonly used methods to control stock and cash are:

• Timely collection of cash and encouraging timely payments from customers
• Cash management services with banker wherein collections are pooled centrally into common account and payment made out from it, for easier management
• Delaying  creditor payments or advance payments
• Better receivables management, saving on collection, defaults and administration costs
• Cash discount terms for early payment by buyers
• Formal Inventory management policy which could advocate

• Just In Time stock delivery from suppliers(JIT)
• Rigorous stock control and accounting with suitable software tracking if possible
• Ensuring against obsolescence of stock and monitoring stock turnover rates

The best method for a business would entirely depend on the nature of business / service. For e.g. Businesses which are dependent on materials which need procurement in large quantities may be required to build up stock at competitive prices and hence may not have much choice like JIT.
Ultimately, an efficient inventory control system must come up with the answers to 2 basic questions ie. (a) How much to order ? and (b) When to order?
A useful method for addressing both these questions would be the EOQ or the Economic Order Quantity model, which is particularly effective in case of businesses with large variable costs, like within the retail sector. This model is based on the formula = 

where A = Demand for the year; Cp = Cost to place a single order and Ch = Cost of holding one unit inventory for a year.
Retail sector entities like M & S may incur costs in disposal of cash through banking and other channels in cash driven economies like in a developing country unlike in the UK where card payments are almost the rule. This can be mitigated to a large extent by encouraging payment through direct Bank transfers through a variety of incentives such as preferential/discounted prices, quicker supply etc. Thus cash handling costs can be done away with. Frequent routing of payments via bank transfers would definitely increase the  need for a close watch over the bank account by means of daily Bank account reconciliation process in order to ensure that every sale is recovered without fail. This definitely augurs well for a better credit management system.

Task-3

Figure.1 Budgetary control system

Now a days all the organizations across the globe have a system of budgetary control installed within the organization. A budget helps the organization to plan in advance and to efficiently allocate the resources. The system of budget is more effective with the comparison of the actual performance of the organization. This helps the organization to understand the areas where more funds were expended and the reasons there of. The process of budgetary system depends on the location of key factor. A key factor is an important element that can impact the levels of production. The budgets are prepared keeping the past results in mind with the future expectations. The budgetary process can not solely rely on the past results. The objectives which impel the preparation of a budget have been outlined below:

1. Helps in developing an overall understanding of the operations of the organization
2. A sense of direction is administered by a budgetary process
3. It is responsible for promoting the process of planning within the organization
4. It is responsible for improving the efficiency of the capital employed by the concern
5. Facilitates the process of control by comparing the results with the actual with the budgeted plan

	Budget		Actual		Variance
Units	100000	Unit/Price	75000	Unit/Price	-25000
Material	15000	0.15	22500	0.3	-7500
Direct Labour	22500	0.225	24375	0.325	-1875
	Material		Labour
Price/Rate Variance	-4500		3750
Usage/Efficiency Variance	-3000		-5625
	-7500		-1875

Material Price Variance: The budgeted material price was 0.15 whereas the actual price was 0.30 which was double the estimated amount. An adverse material price variance suggests the following:

1. The prices of the materials used have increased
2. The bargaining power of the suppliers have increased
3. Discounts lost due to smaller order sizes

Material Usage Variance: The usage variance has also exceeded the budget quantity. Adverse material usage variance points towards the following facts:

1. Unskilled labour has been employed
2. Material wastage has increased due to plant depreciation
3. Lower quality material has been purchased

Labour Rate Variance: The Labour rate also decreased as a consequence there is a favourable variance of 3750. A positive or favourable variance indicates the following:

1. Increase in the supply of labour which has prompted the rates to go down
2. Wrong setting of standard which points to erroneous planning

Labour Efficiency Variance: The labour efficiency has deteriorated. An adverse ratio is an indication of:

1. Employ of low skilled labour.
2. Fall in the level of staff morale
3. Increase in idle time caused machinery breakdown or maintenance etc.

It can be clearly understood that the above variances are due to change in prices of the material and the labour and also the quantity of usage. The budgeted material price was 0.15 whereas the actual price was 0.30 which was double the estimated amount. The Labour rate also increased by almost 50%. As the labour working hours have not been given no analysis of the efficiency can be done.
It is evident from the above that the budget making decision process has not been efficiently implemented within the organization. The organization needs to fine tune the same so as to reduce the variance with the actual performance.

Task-4

Definition

“A trial balance is a list of all the balances contained against each Nominal, as they are sometimes referred to or General ledger account numbers. These consist of both Balance sheet and Profit and Loss accounts.” (E-conomic.co.uk, 2014)
A trial balance is a statement which is prepared with the closing balances of all the accounts. It checks if the debits equal the credits.

Preparation

After a transaction has taken place the same is recorded in the books of accounts. The journal is the fist book of entry. From the journal the records are posted to the respective ledgers. At the close of the accounting year the ledgers are balanced and the balance is posted to the trial balance.

Purpose

A trial balance is a report which checks the arithmetical accuracy of the accounts prepared however it is not able to detect the following errors:

1. Errors of omission: The entire entry was not recorded anywhere.
2. Compensating errors: Two or more errors compensate each other and hence can be traced by trial balance.
3. Errors of principle: Principally wrong entries passed.

Figure.2 Format of trial balance

Profit and Loss
Sales			157165
Less Cost of goods sold:			94520
Gross profit			62645
Interest Received			50
Discounts received			160
			62855
Less Expenses:
Wages and salaries			31740
Rent			3170
Discounts allowed			820
Van running costs			687
Bad debts			730
Doubtful debt provision			91
Depreciation			1630
Net Profit			23987
Balance Sheet
Fixed assets		£	£
Office furniture & Van		7175
Less depreciation		1630	5545
Current Assets
Stock			2400
Debtors		12316
Less provision for doubtful debts		496	11820
Prepaid expenses			230
Cash at bank & hand			4274
Total Assets			24269
Current liabilities		£	£
Creditors		5770
Accruals		212	5982
Financed by
Capital		11400
Add net profit		23987
Less drawings		17100	18287
Total Liabilities			24269

• The purchase of additional furniture would impact the furniture and the creditors. Both these heads would increase by the same amount.
• The bank interest received but not recorded would increase the bank account and the profits.
• Accrued expenses paid would reduce the cash and the accruals.

Key Ratios

	Accounts Receivable Turnover
		Sales	$ 157,165.00	13.29653
		Accounts Receivable	$  11,820.00
	Accounts Receivable Turn-Days
		360	360	27.07473
		Accts. Rec. Turnover	$         13.30
	Accounts Payable Turnover
		Cost of Goods Sold	$  94,520.00	17.32087
		Accounts Payable	$    5,457.00
	Average Payment Period
		360	360	20.78417
		Accts. Pay. Turnover	$         17.32

Key Ratios - Ratio Analysis
	2012
Balance Sheet
Cash	4,274
Notes Receivable	0
Accounts receivable, net	11,820
Total current assets	18,724
Total long-term assets	5,545
Total current liabilities	5,982
Total long-term liabilities	18,287
Total shareholders' equity	35,387
Income Statement
Total sales	157,165
Gross profit	62,645
Total operating expenses	38,868
Income (loss) before taxes	23,987
Net income (loss)	23,987
KEY RATIOS
Profitability Ratios
Return on equity	68%
Return on assets	99%
Return on sales	15%
Gross profit margin	40%
Asset turnover ratio	648%
Leverage and Liquidity Ratios
Current ratio	3.13
Quick or acid test ratio	2.69
Leverage ratio	69%
Long-term debt ratio	0.341
Debt to equity ratio	0.686

Task-5

BEP Analysis
Total Fixed cost=$30000, Budgeted no. Of units=10000, Sales=$100000, so S.P/unit=100000/10000=10, Total V.C. =$80000, so v.c/unit=80000/10000=8

BEP and Profitability Analysis

	Prop.1($)	Prop.2($)	Prop.(3)
S.P/Unit	9	11	10
V.C/Unit	8	8	9.5
Contribution/Unit	1	3	0.5
P/V Ratio(Contri/Sales)*100	1/8=11.11%	3/11=27.27%	0.5/10=5%
BEP in units=F.C/Contr per unit	30000/1=30000 units	30000/3=10000units	30000/0.5=60000units
BEP in sales=BEP units*SP/unit	30000*9=270000	10000*11=110000	60000*10=600000
Check
Sales	270000	110000	600000
Less:V.C.	240000(8*30000)	80000(8*10000)	570000(9.5*60000)
Contr.	30000	30000	30000
Less:F.C.	30000	30000	30000
Profit/Loss	Nil	nil	Nil

b) Reqd. Profit=$20000,       So reqd.contr. =F.C. +Profit=30000+20000=$50000

	Prop.1	Prop.2	Prop.2
No. Of units=Contr/Contr. Per unit	50000/1	50000/3	50000/0.5
	=50000	=16667	100000
Check:
Total Contr.=Contr/unit*No. of units	50000	50000	50000
Less: F.C.	30000	30000	30000
Profit	20000	20000	20000

Fixed costs are those costs which remain unchanged with the level of production for example the rent of factory. Variable costs are costs that change with the level of production and can be said to be directly proportional to the change in the level of production. Semi Variable costs are those costs which are fixed to a certain level of production. No cost is fixed in the long run. The proposition 3 is a better proposition as the consumers are getting a better product for the same price.  As the consumers are sensitive to rise in price of a product the organization has to plan its pricing business strategy very carefully. An organization has to consider the price elasticity before the prices can be raised. Proposition 1 offers the same product for a lower price, hence the quality remains the same. Proposition 2 on the other hand is not good for the consumers as the price of the product will move upward. Hence the proposition is the best.

References

McKenzie, W, 2003, 3rd edn, The Financial Times Guide to Using and Interpreting Company Accounts, FT Prentice Hall, Harlow.
Palat, R R, 2006, How to read Annual Reports & Balance Sheets, Jaico Publishing House, Mumbai
Ernst & Young, (2013) Working Capital Optimization, [Online], Available at: http://www.ey.com/Publication/vwLUAssets/Working-Capital-Optimization/$FILE/Working-Capital-Optimization.pdf  [Accessed on 23rd February 2014].
Pew Research Centre, (2014) Fast Food Statistics, [Online] Available at : http://www.statisticbrain.com/fast-food-statistics/ [Accessed on 21st February 2014].
Big Hospitality,  (2012) Fast Food, Trends and Reports, [Online] Available at : http://www.bighospitality.co.uk/Trends-Reports/Quick-service-and-fast-food-sites-make-up-half-of-all-restaurant-meals-eaten [Accessed on 21st February 2014].
Datamonitor Research Store, (2012) United Kingdom, Fast Food Industry profile, [Online], Available at : http://www.datamonitor.com/store/Product/united_kingdom_fast_food?productid=MLIP0123-0015, [Accessed on 22nd February 2014].