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Financial and funding management in travel and tourism business

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Financial and funding management in travel and tourism business

Management of financial information to analyze them properly is very important for making proper decision about operation and investment of the business. Business needs different internal information about cost, price etc. that helps the management to take decision about operation. Different external and internal information about business helps the management to take decision for project. This report will show how a travel and tourism company CHTC can use this information can analyze them for different decision making purpose.

1.1 Concept of CVP analysis and its importance in financial management of a travel and tourism business

CVP or cost volume profit analysis is one of the important considerations to determine the whole cost structure and profit for the products or services of a business. According to Robinson, (2013), CVP analysis is very powerful tools for financial management that helps the management to make better decision.  Cost volume profit analysis is the process that helps to measure the reaction of profit due to the change of fixed cost, variable cost or quantity of products. For travel and tourism business like CHTC requires this CVP analysis more. CVP analysis has been developed based on different assumptions. Among them the major assumptions are,

The cost of business can be categorized as fixed and variable costs only in the business.  But the major problem of this assumption is that it is really difficult to separate cost into variable and fixed part of cost of business. If the business fails to classify the costs of business, the purpose of CVP analysis may fail (The cost, 2011).

Business cost will follow a linear function where fixed cost and the variable cost per unit remain fixed to a relevant range. But in the real world, it is really unexpected that cost will be fixed forever.

Business follows a linear function for their sales price of services or products. It refers sales price of products or services will remain same for any volume of quantity (Horngren, 2012). But in real business, it is also not rational to think that sales price will remain constant.

So after considering all the problems regarding assumptions of cost volume profit analysis, it can be said that cost volume profit analysis can provide analysis on the reaction of profit over the change of costs, quantity or sales price for a short span of time.

Cost volume profit can be analyzed through the following formula,

Profit = total revenue- total variable cost- total fixed cost

So the equation can be designed as follows,

Profit = SP*Q- VC*Q-FC

Or, Profit = (SP-VC)*Q -FC

Here, SP = Selling price

Q= quantity or volume of products or services

VC= Variable cost

FC= Fixed cost

In the equation, SP-VC refers the contribution margin for the business. CVP analysis provides idea about Break-even for the business i.e. at what point the revenue and cost for the business will be equal and the business will be able to make profit after that point. It also provides idea about safety margin that refers a difference of quantity in current sales from the breakeven point and missing of this difference will push the business to fall below the breakeven point and make loss (Drury, 2012).

CVP analysis is very important analysis of cost and pricing structure of travel and tourism business like CHTC where they can analyze the following matters through CVP analysis.

CVP analysis will help CHTC to set the minimum selling price for its services that will be competitive in the market and also will provide desired profit for the business. Along with this, it helps to measure the minimum level of service activity CHTC should provide to avoid loss in the business through its breakeven and margin of safety analysis. After this, CVP analysis provides the base upon which management of CHTC can make their decision about required level of service activity that will be needed to acquire the target level of profit for a particular period of business. Finally, CVP analysis helps to measure the margin of safety to have idea about that missing out of level of service activity which will push the business to incur loss in operation.

The CVP analysis helps to get the combination of the company. What is the profit generating decision can be easily identified with the help of it. To increase the total profit margin and reduce the cost of the company, the CVP analysis is used effectively in the company. To trade off the variable and fixed cost of the company and make the appropriate changes, the CVP is considered as an effective tool.  All the combinations are possible because of CVP analysis (Bamber et al., 2011).

The CVP analysis helps the managers to take the effective decision of the financial management of the company. A company can easily get the idea of breakeven point if it performs the CVP analysis. The CVP analysis is based on the statistical data. So, the organization can find the possible data and decision of it. A detail snapshot of the company can be possible because of CVP analysis. The managers use the CVP analysis to continue various operations. All the CVP data are specific and requires tremendous data, so it is very beneficial to the company.

1.2 Analysis of pricing methods that CHTC can use to determine price for its services

There are different pricing methods available in business world that can be used to determine the selling price for the business. There are four types of pricing methods that are commonly used in business. They are-

Mark-up pricing or cost plus pricing is a method where selling price is determined by adding mark-up or margin to the total cost of the product or services. Absorption costing method is the full costing methods for business where costs are not separated in variable or fixed type and mark-up is added on total cost (Hilton, 2012).

In market comparison pricing methods, business can determine cost based on comparisons of prices offered in different markets by competitors. It also refers comparisons of prices of similar products to determine the prices of new product or services of the business (Müller-Bungart, 2012).

Through discounted cash flows or net present values pricing methods, business can forecast expected cash flows from the product, discounts them with cost of capital and divides them with units of sales.

Finally value comparison method is used by business by determining price of products or services based on specific value criteria of the business (Nixon and Burns, 2012).

As CHTC is a service providing business, use mark-up pricing or cost plus pricing will be appropriate to determine the price for their services. Through the formula of CVP, price can be determined in this method. It will be as follows,

According to CVP, formula of revenue is,

Revenue = Unit variable cost*quantity+ Fixed cost+ Profit

Or, P*Q= VC*unit +FC+ profit

Now to determine the price, it can be arranged as follows

P = (VC*unit+ FC+ profit)/ Q

In this case, CHTC will have to determine its target profit first.

The problem of comparison method is that it fails to provide a certain explanation of price that may be able to cover the cost. In case of discounted cash flows, future cash flow assumption can be wrong due to the change of market at that period. Finally, defining a particular value added quality will not be optimal for CHTC as the market is very competitive (Cokins, 2014).

1.3 Factors that will affect the profit of CHTC

According to CVP analysis, the factors that can affect the profit of CHTC are variable cost, fixed cost, selling price and amount of customers willing to take the services of holiday trip offered by CHTC.

Due to the change in any item of variable cost, per unit total variable cost may increase or decrease. If the variable cost (£200 per customers) increases, it will decrease contribution margin and thus the profit of CHTC and vice versa. Fixed cost is generally constant and for CHTC, fixed cost is airplane and hotel accommodation cost, around £60000. Increase or decrease of fare of airplane and hotel will cause the increase of decrease of aggregate fixed cost. Increase or decrease of fixed cost will not affect the contribution margin of CHTC but it will affect the breakeven point and thus the profit from the trip (Cokins, 2014). Finally, if the price offered (£800 per customers) to customers or number of customers expected for holiday trip increases or decreases, it will affect the contribution margin, safety of margin, breakeven point and thus profit from the trip.

Now the viability of holiday trip with 90 customers can be measured as follows,

 Amount (£)
Revenues72000
(-) Variable cost18000
Contribution margin54000
(-) Fixed cost60000
profit (loss)-6000

From the above calculation, it is seen that CHTC will incur loss after covering its variable and fixed cost. So CHTC should not go for arranging the holiday trip with 90 customers. To earn at least of £10000 profit, it will require following amount of customers,

We know,

Q= (FC+ profit)/ (SP –VC)

Now,

 Amount (£)
Fixed cost60000
Profit10000
(a) total70000
Sales price800
Variable cost200
(b) Contribution margin600
Amount of customers needed (a/b)117

Here it is seen that to earn at least of £10000 profit from the holiday, CHTC requires 117 customers for the trip which is larger by (117-90) or 27 customers from current level. So CHTC should not go for arranging the trip.

2.1 Types of management accounting information

Management accounting information of a business refers that business information that includes collection and reporting of internal information about operation of the business. This information helps the business management to make decision about business. There are mainly three types of management accounting information in businesslike CHTC can be used for this purpose(Bamber et al., 2011).

Strategic information about business is one type of management accounting information that is collected from internal and external sources of business, collected and arranged by top level management, provides an overall idea about the organization or business, can provide view about long term operation about the business and most of the cases assumptions are used to collect this information (Davis and Davis, 2012). To collect such strategic information is very costly. For example, information about market position and organizational values of CHTC is the strategic information for the management of CHTC.

Tactical information is another type of management accounting information that refers that information that is collected in the primary level of the business, describes daily operation and is prepared on routine basis and generally provides idea about short term and medium term condition of the operation (Cokins, 2014). For example, cost structure, current service level etc. of CHTC is the tactical information for the business.

Finally, operational information is the management accounting information that is processed by lowest level management to ensure the smooth conduct of business. This type of information generally represents short term condition of business information (Daft, 2011). For example, labor cost, amount of inventories or office accessories etc. information of CHTC can be defined as operational information.

There are different techniques that management of a business like CHTC can use to improve their activities and performance. Variance analysis is one of the common techniques to control the performance and activities of the business (Aguinis, 2013). Through the variance analysis management compares the actual operation or results with the budgeted or expected results. If any deviation is found, management track the activity to the root, find out the reason of deviation and take actions to remove the deviance and bring the activities on track. Variance analysis also helps to identify the responsible center for any activity that will help the CHTC management to give proper direction and training to improve the performance. Along with this, introducing motivational process through reward system, on job training process, periodical assessment and control of action etc. can improve the activities and performance as well(Mitchell, 2012).

2.2 Use of investment appraisal techniques as decision making tools

Investment appraisal techniques are those techniques that help the business to measure the viability of any project before making any investment decision as business resources are always limited. There are different investment appraisal techniques that can be used for decision making purpose but among them most common tools are payback period, net present value (NPV) and internal rate of return (IRR) (Holland and Torregrosa, 2011).

Payback period refers the period a business takes to recover its investment from an opportunity or project. But it cannot provide any certain decision about the viability of a project as it cannot consider the cash flows after the payback period and it also cannot consider the time value of money. Net present value refers net benefit a business can earn from a project. It can provide a certain decision because it regards all the cash flows from a project along with time value of money.

Internal rate of return refers the rate of return a business can earn from its investment in a project. NPV and IRR can provide most reliable decision about the viability of a project. Positive NPV refers the project will provide net benefit to the project after covering all costs and investment, so the business should accept the project. On the other hand, negative NPV refers the net loss from the project and the business should reject the opportunity (Dayanada, 2012). In case of comparing among projects, project with higher positive NPV will be accepted by business. Higher IRR of a project than its cost of capital for the project refers the project should be accepted.

Now these investment appraisal techniques can be used by taking an example of a project for CHTC. We are going to initiate a project like constructing a hotel for the tourists. All the costing and other required tools are used here successfully. Now we can use investment appraisal techniques to measure the viability of constructing the hotel. It is an investment project. The required cash flows and other factors related to this project are as follows,

Analyzing the viability of constructing a hotel with the help of financial appraisal tools

PeriodExpected cash flows(£)
178000
282000
385000
498000
5100000
6110000
Initial investment280000
Cost of capital8%

Table: expected cash flows and other factors related to project

Payback period of the project will be,

Period (Months)Expected cash flowsCumulative cash flows
0-280000-280000
178000-202000
282000-120000
385000-35000
49800063000
5100000163000
6110000273000
Payback period3+(35000/98000)3.36

Table: calculation of Payback period.

So the CHTC will be able to recover its initial investment within 3.36 months.

NPV of the project,

PeriodExpected cash flowsDiscount factor at 8%DCF
1780000.925972222.2
2820000.857370301.8
3850000.793867475.7
4980000.735072032.9
51000000.680668058.3
61100000.630269318.7
a. Total DCF  419410
b. Initial investment280000
NPV  139410

Table: Calculation of NPV

Here it is seen that the project provides positive NPV to CHTC. So, CHTC should go for constructing the hotel.

Now the IRR of the project will be as follows

PeriodExpected cash flowsDiscount factor at 6%DCFDiscount factor at 12%DCF
1780000.943473584.90570.892969642.9
2820000.890072979.70810.797265369.9
3850000.839671367.63910.711860501.3
4980000.792177625.1790.635562280.8
51000000.747374725.81730.567456742.7
61100000.705077545.65940.506655729.4
Total DCF  447828.909 370267
NPV  167828.909 90267
IRR{167829/(167829-90267)}*(12%-6%)13%

 Table: Calculation of IRR

According to above calculation, IRR of this project is higher than the cost of the project, 8%. So CHTC should take the project.

3.1 Writing a paper that explains financial statement analysis to the directors of CHTC

Introduction:

Financial statement of a business reports the overall condition of the business in case of current and future performance. It helps the business to disclose and report financial information to its users so that they can make decision about the business (Robinson, 2012). In a business, three major financial statements are used to collect information and measure its performance. Financial ratio is the common tool that can be used for analyzing the financial information to measure its stability through profitability, liquidity and investment analysis. This paper will show these aspects by considering the financial statements of travel and tourism business.

Planning to collect and organize data

To interpret the financial statement, financial accounts of ABTA, a large travel and tourism company in UK, have been considered here. To calculate the ratios, profit and loss account and balance sheet will be used here.

Ratios and interpretation

 20142013
Profitability ratios  
Gross Profit margin93.2%88%
Net profit margin6.40%1%
Liquidity ratios  
current ratio13.0914.45
Cash ratio12.3413.53
Investment ratios  
ROE13.33%0.16%
Return on investment3.6%4.26%

Table: Ratios for ABTA

Profitability ratios measure the profit potentiality of a business (Bull, 2014). Through gross profit margin we can measure here that how much profit ABTA can retain after meeting its direct service related cost. Here we see the ratio has increased in 2014 than previous year that refers ability of ABTA to retain more profit after meeting all direct cost has increased. Again through net profit margin, we will be able to measure that how much profit ABTA can retain after meeting all its operating costs. Here we see the ratio has increased highly in 2014 that refers the high increase of ability in retaining profit after meeting all operating costs.

Liquidity ratio measures the ability of business to meet its short term obligations (Wiehle, 2013). Through current ratio, we can measure the ability of ABTA in meeting its short term obligation with its readily marketable assets i.e. current assets. Current ratio of ABTA for 2014 is 13.09 means it has £13.09 current asset to meet £1 current liabilities. Though it is quite high, it has decreased from previous year that refers the decreased of ability in meeting short term liabilities. Through cash ratio we can measure the ability of ABTA in meeting its short term liabilities with immediate cash item of business. Though this ratio is also high for ABTA, it has decreased from previous that indicates the decrease of ability to meet short term liabilities.

Finally investment ratios measure the ability of business to generate return from investment of fund (Hilton, 2012).). Through ROE, we can measure the ability of ABTA to earn return from equity capital employed. The ratio has increased highly in 2014 that refers ability and efficiency of ABTA has increased highly in generating profit from investing equity capital. ROI helps us to measure ability of ABTA to generate return from investment fund. But the ratio has decreased from previous year that refers the decrease of ability too.

Findings and conclusions

From the above discussion, we can say that the ability to earn profit has increased for ABTA but the ability to meet short term liability has decreased. The efficiency in circulating capital has increased for ABTA but ability to generate return from investment has decreased. So in current situation, the business is financial stable but in the long run the stability may not sustain.

4.1 Sources of finance CHTC can use

To obtain £25 million funds for constructing own hotel, following internal and external sources can be used. Here construction of a hotel needs financial support from the long term sources as it is the long term project.  A company can construct a hotel with the funds from short term sources. Both internal and external long term sources are essential for constructing the project.

Internal sources of finance

There are different internal sources of finance are available for CHTC to obtain fund. CHTC can also use retained earnings reserve if available.  It is the only internal long term source of finance in the organization. A company can raise the capital of funds for the project as there is no requirement is necessary for taking this fund. There is no additional cost for this type of financing (Bamber et al., 2011).

External sources of finance

CHTC can issue shares to its shareholders to obtain the needed fund. This source will provide equity fund to the business. Dividend is considered as cost of this fund but according to law dividend payment is the distribution of profit and so tax is not reduced due to this payment that makes this source costlier than other sources (Rosset al., 2012). Besides these, there are some other long term external sources of finance that can be selected for the collection of funds. These are the borrowings, the asset securitization and the higher purchase agreements. The finance lease is also another important ling term source to meet the needs of finance in the company.

Taking loan from commercial bank or financial institutions can provide CHTC such large fund against interest which is the cost for the source. According to law, interest is financial cost for business and thus reduces tax payment. So the source is less costly from equity source. CHTC can use lease financing source rather constructing the hotel against rent too (Davis and Davis, 2012).

Conclusion

After completing the above discussions, it can be said that a business needs to asses and manage different aspects of a business while making decision about the operation of the business. The management of CHTC, a travel and tourism company should focus on these factors more carefully as it operates such business which is seasonal and profit can be made only making proper decision for the business period.

References

  1. Aguinis, H. (2013). Performance management. Upper Saddle River, N.J.: Pearson Prentice Hall.
  2. Mitchell, D. (2012). Performance management. Chandni Chowk, Delhi: Global Media.
  3. Holland, J. and Torregrosa, D. (2011). Capital budgeting. [Washington, D.C.]: Congress of the U.S., Congressional Budget Office.
  4. Dayanada, D. (2012). Capital budgeting. Cambridge, UK: Cambridge University Press.
  5. Robinson, T. (2012). International financial statement analysis. Hoboken, N.J.: John Wiley and Sons.
  6. Bull, R. (2014). Financial ratios. Oxford: CIMA.
  7. Wiehle, U. (2013). 100 IFRS financial ratios. Wiesbaden: Cometis.
  8. Ross, S., Westerfield, R. and Jaffe, J. (2012). Corporate finance. Boston: McGraw-Hill/Irwin.
  9. Robinson, R. (2013). Cost. New York: Farrar, Straus and Giroux.
  10. The cost. (2011). Los Angeles, CA: Anti-.
  11. Horngren, C. (2012). Cost accounting. Englewood Cliffs, N.J.: Prentice-Hall.
  12. Drury, C. (2012). Management and cost accounting. London: Chapman and Hall.
  13. Hilton, R. (2012). Managerial accounting. New York: McGraw-Hill.
  14. Müller-Bungart, M. (2012). HSMAI Revenue Management Strategy Conference. Journal of Revenue and Pricing Management, 7(1), pp.119-120.
  15. Nixon, B. and Burns, J. (2012). Strategic management accounting. Management Accounting Research, 23(4), pp.225-228.
  16. Bamber, L., Braun, K. and Harrison, W. (2011). Managerial accounting. Upper Saddle River, N.J.: Pearson Prentice Hall.
  17. Davis, C. and Davis, E. (2012). Managerial accounting. Hoboken, N.J.: John Wiley and Sons.
  18. Cokins, G. (2014). Performance management. Hoboken, N.J.: John Wiley and Sons.

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