Introduction
Microsoft Corporation specializes in technology and has a goal of empowering people and organizations in their respective careers. It has an international outreach which enables it to function in a unique way. The company has to adapt to some traditional and local means to maintain its market. From 1975 when it started its operations to date, it has managed to establish its activities in more than 100 countries. The corporation has a world view of mobile-first that encourages technology and experiential concerns.
The cloud computing and storage solutions comprise of the rich collection of data and storage for all its users. It deals with a broad range of software and hardware equipment. Its ambitions in Research and Development include the reinvention of productivity and business processes, building the intelligent cloud platform, and the creation of more personal computing technology. As a result of these and other market and financial concerns, the company faces many financial risks. It has to secure capital for the technological developments. It has to invest in worthwhile projects that achieve the goals of the enterprise.
Microsoft Corporation’s financial report indicates that the company is facing a couple of financial risks in the market (Microsoft 2015 Annual Report 2016, para.221). Some of the risks include the market risk, liquidity risk, foreign investment risk, and asset-backed risk. The company uses hedging policy to safeguard against losses. But sometimes they affect the financial statements.
Financial Risks
The changes in the stock prices portray the equity risk that affects the company. The equity portfolio consists of global developed and emerging market securities (Financial statements 2010). They are all affected by the changes in price. The company has to manage the securities by observing certain global and domestic indices. They also have to relate their economic risk and return to the company’s indices.
Microsoft Corporation also faces the interest rate risk in the market. Although it has a fixed-income portfolio, the company has diversified across the credit sectors and maturities. They consist of investment-grade securities. The management of the credit risk and average maturity of the fixed-income portfolio enables the company to achieve economic returns. The income from this plan enables the company to rank and compare well to others in the industry. It also uses forward purchase commitments of mortgage-backed assets for exposure to agency mortgage-backed securities.
The company also has to be wary of the foreign currency risk. Microsoft also uses hedging to offset the risks. The forecasted transactions, assets, and liabilities maximize the company’s economic effectiveness. The main currencies used include the Canadian dollar, British pound, Euro, and the Australian dollar. It also uses the Japanese Yen (Ridgers 2012). For instance, the company translates the assets and liabilities in foreign currencies at the exchange rate on the balance sheet date. The translation for revenues and expenses happens during the financial year at average rates of exchange. Microsoft uses these avenues to safeguard the company from impending losses.
Due to the scope of work, the company also has a commodity risk. It uses broad-based commodity exposures to boost the returns from the portfolio and diversification. Some of the commodities under exposure include energy, grain, and precious metals. The management of these exposures about global commodity indices assists the company to avoid making significant losses.
Value-at-risk model is critical in estimating and quantifying the market risks. It is the expected loss over a given time. It has a given confidence level in the fair value of the portfolio concerning the volatile market. It is critical for risk estimation and management. The VaR model does not represent actual losses in fair value but as a risk determination and administration tool. The potential changes depend on historical volatilities and correlations among foreign exchange rates, interest rates, equity prices, and commodity prices. The assumptions rely on market conditions. The model does not include other risk factors such as operational, legal and liquidity risks. It deals with the total loss that the company will not exceed at approximately 98 percentile confidence levels.
The company has to keep investing in the Research and Development so that it can continue staying ahead in the market. The past use of this strategy has shown that there is potential for more discoveries. In 2015, the Research and Development got allocations of about $12 billion. It has been a gradual increase since 2013. It is a representative of about 13% of the revenues for those years.
The investment goes a long way in protecting its products and intellectual properties. The mobile technology and experience is a fast growing market. But competition is slowly rising from new developing businesses. Therefore, the company has to consider this as a risk factor that may work to its advantage if it monitors its strategy with keenness. Companies like Sony and Nintendo are slowly coming up with products that match Microsoft’s technology. Apple and Samsung are also coming up with Android powered devices which may provide intense competition in the market.
Activity-Based Costing
It is a costing methodology that identifies organizational activities and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. It assigns most of the indirect costs into the direct costs (Cokins 2009). The model allocates resources to activities. The activities are then assigned to cost objects about the consumption estimates. The model finds costs the areas with high overhead costs per unit and finds ways to reduce them or assign a higher price for costly products.
When a company uses ABC, it is easier to estimate the cost elements of the product, activities, and services. The information is relevant for decision making on whether to eliminate the goods and services that bring losses to the company or eliminate the ineffective processes. It can also guide the management on the pricing strategy such that the overpriced products and services can have a low price. The allocation process may change to a more profitable one that still delivers the product and gets much better yield than before.
ABC supports a company’s strategic decisions such as pricing, recognition, and measurements that lead to process improvement initiatives. ABC helps to understand product, customer costs, and profitability based on production and performance processes. Therefore, ABC has become a reliable methodology for business transactions.
As compared to the others, ABC seems to be expensive and difficult to implement for the small gains. It gives poor evaluations of the cost. It is manually driven and hence prone to many mistakes. ABC’s main concerns are about the expenses. It, therefore, slows processes in the service and administration. Due to the lumping up of costs attached to activities such as staff time, it may lead to favoring certain scenarios that are not better off compared to other profitable ones.
ABC has various advantages because of its ability to help businesses determine costs and prices. It is applicable for broader levels of the organization and also for partial views. It helps the management to point out inefficient products, departments, and activities. The model is helpful in the proper allocation of resources on profitable areas of the business. The organization can also use it to control costs accurately right from the product level to departmental levels. It eliminates costs that are not necessarily benefitting the organization. Whenever the organization is pricing products, ABC helps to fix prices with analytical resolutions. It helps in the budgeting processes. It also drives behavioral incentives by making the workers cost conscious. It provides a clear response resulting in increased pressure from the regulators.
Traditional costing assigns average overhead cost rates. It does not provide accurate costs because it does not include the non-manufacturing expenses (Cokins 2009). The traditional costing does not determine the actual overhead costs that affect specific products. It becomes interesting to note that both the traditional methods and the Activity-Based Costing are applicable. But ABC model is more accurate and concise on the costing technique. It is important when overhead costs are high and for internal applications. The traditional method is applicable when overhead cost is low and mainly for external needs.
Root Limited Cash Budget.
The estimated ending cash balances for the first three months are -£31,200 in January, -£24,400 in March and -£80,600.
Root Limited would have to borrow cash in the first month of the year. In January, the company makes a loss of £31,200. If it borrows about £50,000, then it may lead to better performance in the following month. For instance, it may reduce the loss in February to about £6,400. In March, the company should invest more cash into the business. Since most of its payments are in receivables, then it can secure an investment of about £100,000 so that it has some operating balance (Epstein 2012).
The budgeting process affects people in the organization from top-down and bottom-up. Hopwood realized that the top management had a wrong notion when preparing budgets. They imposed budgets on the workers. However, the human and social factors became essential because the affected people can also make the budget that is suitable for the organization. Participation budgeting builds the morale of the staff. They tend to work towards achieving what they put in the budget. Although it takes more time to prepare it eventually develops an all-inclusive budget. It is a democratic process that allows the workers at all levels to determine the kind of budgeting that is suitable for the organization.
Participation in the budgeting process leads the organization’s leadership to embrace the laborers in decision making. The workers feel that the organization values them by including them in such strategic decisions that determine their future. But some workers may tend to use this process to award themselves bonuses and other benefits so that they gain more at the expense of the strategic view (Epstein 2012).
The participatory budgeting takes more time and includes some unnecessary things that may not lead to the growth of the organization. Due to inadequate skills in budgeting, the workers may not come up with a suitable budget. It may take another group of expatriates to review and make amendments. The labor cost is relatively high. The best way is to have preliminary budgets that begin at the bottom, and as they go up the hierarchy management chain, there is constant review and corrections.
The organization can overcome reluctance to participation by making the staff know that it affects their work positively. The management can arrange for an all inclusive meeting to train the members in the budgetary process (Financial statements 2010). Sometimes the management is reluctant in involving the staff on the same issue. The staff can consult the management through the supervisors and unions to allow them or their representatives to participate. The staff may be reluctant because they do not have a clue on financial matters. The organization can allow some of the accounting teams to help them.
Payback Period.
Payback Period = Initial Investment/Annual Cash Flow = £4.29 years
Pink Thai Restaurant should invest in the new oven because the payback period is short. It has a payback period of 4 years and a few months.
Accounting Rate of Return
It has a high Average Rate of Return. At 11.53%, Pink Thai Restaurant can invest in the new oven.
Net Present Value
Present value of a cash flow = Future cash flow/ (1+Discount Rate) ^6 = (-10,237.10/ (1+0.15) ^6)-17,000 = £-21,425.78
The Net Present Value is negative. It would be advisable not to invest in the new oven because the NPV is not positive.
Payback period is typically the length of time that will be available to an investor or investors to recover their investment (Ridgers 2012). It is also the length of time that a business takes to pay the cost of the investment. If it takes a longer time to recoup that cost or that investment, then the company or investor may opt out of the investment. If it takes the shortest time possible, it encourages investment.
Payback period is usually the cost of the investment per Annual Cash Inflows. For instance, Pink Thai Restaurant’s payback period for purchasing a new oven was 4.29 years. The time is shorter than the given six years. It is relatively and desirably a short period that would enable the restaurant to recover the cost of investment. It is also the time taken to break even the cost of investment. It is easy to use for business plans and easy to understand. One constraint about this method is that it does not take into consideration the time value of money, risk, financing, and even opportunity cost. It has no explicit criteria except that the payback period should not take forever. For Thai Restaurant, any cash flows beyond four years and six years are not considered by the method because it focuses on the shorter period.
NPV is the potential change in the Restaurant’s investment of £17,000 caused by the project while accounting for the time value of money (Davis & Nairn 2012). The Restaurant considered the initial cash outflow of £17,000 and the continuous cash inflow per annum. The discount rate that reduced the cash flows to what they would be today was 15%. The NPV concerns itself on a single factor which is the cash flows. In the 15% Discount Factor column the discount becomes smaller for further discount periods. Thai Restaurant has a negative Net Present Value. The result could just be approximations that may not be realizable.
Basing on Thai’s NPV, which is negative, it is prudent to reject the investment in the new oven. The positive thing about NPV is that it accounts for the time value of money. It is better than the Payback period, the ARR and the Internal Rate of Return. In case there are different or conflicting results between NPV and IRR, then NPV is the most preferred method to use. The problem with NPV is that it bases its decision on estimations. The estimates are sensitive to changes in the future cash flows, residual values and the cost of capital. It also does not account for the project size.
Accounting Rate of Return is the ratio of estimated accounting profit of a project versus the average investment. The average accounting profit is the arithmetic mean of accounting income expected each year during the project’s lifetime. The average investment is the average of the sum of the beginning and ending book value of the project (Davis & Nairn 2012). For a project to be acceptable, the ARR must be equal to or greater than the required rate of return. Thai Restaurant’s ARR was approximately 11.53%. The method is easy to calculate and recognizes the profitability factor of the investment. However, it ignores the time value of money. It has consistency problems. Another challenge is that it uses the accounting income and not the cash flow. It is not useful for projects with high maintenance costs.
Most businesses base their investment decisions on the principle of time value of money, the period to recoup the investment and the financial risks involved (Financial statements 2010). The majority of the investment decisions examine time. If the time limit for recovering the cost of investments is short, then the investment is acceptable. If the investment or cost of capital takes a longer period, then it is mostly advisable to reject the plan. The Payback period, Accounting Rate of Return, and the Net Present Value have the same concerns. It is only the AAR that includes the discounting rate as a determinant for the investment. Otherwise, they all reject or accept the investment basing on its positive or negative returns, and the time taken to recover the cost of capital.
References
Cokins, G. 2009. Performance management, John Wiley & Sons, Hoboken, New Jersey.
Davis, J & Nairn, A. 2012. Templeton’s way with money, Wiley, Hoboken, New Jersey.
Epstein, L. 2012. The business owner’s guide to reading and understanding financial statements, Wiley, Hoboken, New Jersey.
Financial statements. 2010. BPP Learning Media Ltd, London, UK.
Microsoft 2015 Annual Report. (2016). Web.
Ridgers, B. 2012. The economist book of business quotations, Profile, London, UK.