Although
Prusa (1990) had earlier stated that alternative approach (based on incentives)
should be used to tackle the transfer pricing problem. Looking at it from the
point of view of Prusa (1900), one might be tempted to hastily conclude that
one of the mission of the OECD which is to promote the expansion of
multilateral trade in an unbiased manner will be defeated if strict measures
that might affect the operations of OECD members is taken. Yet, a second look
at solely relying on persuasion will reveal the moral hazards effects that will
only take a while to prove detrimental to all involved. Take the case of the
banking crisis where moral persuasions were employed to tackle the problem of
toxic assets creation and distribution. To this end, this section is devoted to
the discussion of changes to legislation aimed at reducing the occurrence of
tax avoidances.

INFORMATION
EXCHANGE AGREEMENT

Keen
and Ligthart (2006) stated that tax information sharing amongst tax authorities
of different nations of the world has probably emerged over the last few years
as a central issue on international tax policy agenda. This finding of Keen and
Ligthart (2006) is corroborated by various comments made by key players of the
Organization for Economic and Co-operation Development (OECD). For example, according
to the OECD website (2011), huge progress towards achieving full and effective
exchange of information has been made. This is evidenced by the fact that more
countries of the world are signing the OECD information exchange agreement. The
OECD is relentlessly working towards the development of information network.
This objective of OECD will according to her be achieved through the Global
Forum on Transparency and Exchange of Information for Tax Purposes. The most
recent countries to sign this agreement as at the time of this writing are
Ghana and Liberia.

Pier
Carlo Padoan, Deputy Secretary-General and
Chief Economist to G20 Finance Ministers while making a presentation at the
Seoul, 12 November, 2010 G20 conference happily told the members that more than
500 information exchange agreement have been signed. Bacchetta and Espinosa
(2000) described information sharing amongst tax authorities as an important
element of international tax system. The problem however is that the
international tax information system does not work for all countries due to
some reasons identified by Bacchetta and Espinosa (2000). Dharmapala and Hines
Jr. (2007) while looking at the features of countries that eventually become
tax havens concluded that small, rich, affluent countries with good corporate
governance are likely to become tax havens. The implication of having good
corporate governance is that transparency in information exchange forms the
basis of all dealings Armstrong et al (2011). If the observation and findings
of Armstrong et al (2011) holds, it could then be argued that tax information
exchange is nothing but mere formalities. Notwithstanding these problems, substantial
progress in getting countries both developed and developing in the area of
sharing tax and other fiscal information has been made in the last ten years as
evidenced by the fact that over 500 countries have signed the information
exchange treaty.

According to the report delivered at the Global
Forum annual 3^rd plenary meeting, 14 out of the 25 jurisdictions
that were reviewed in the previous meeting have made significant changes to
their domestic legislations with Belgium still on the talk on how to end bank
secrecy.

2011
CHANGES IN THE TAX AVOIDANCE SCHEME PROMOTERS’ DISCLOSURE REQUIREMENT

Tax avoidance scheme promoter disclosure
requirement is a regulation mandating promoters of tax avoidance schemes to
disclose the extent of benefits that has been made from the use of such scheme.
Since the introduction of the tax avoidance scheme promoters disclosure law in
2004, a lot of changes have been made to it. This section will not in any way
delve into the discussion of detailed provisions of the law but will only
highlight the change that is made in 2011 towards curtailing the activities of
both the users and promoters of tax avoidance scheme.

HMRC opened a consultation with tax advisors, professional
bodies and businesses that will last from the 31^st day of May, 2011
to 31^st August, 2011. The aim of the consultation is to deliberate
on the removal of cash flow benefits from those who use listed high risk tax
avoidance schemes. Although this consultation will not have been concluded
before this research is concluded, it is expected that the outcome of the
consultation will be a reduced use of tax avoidance scheme. This reduction in
use of the scheme might be a temporal one as the promoters will quickly work
out a way within the ambit of the law that will still enable them entice their
clienteles, after all, you do not expect the tax advisors to completely close
shop but to innovate the tax packages.

A major challenge in this direction is the
allocation of burden of proof. The allocation of burden of proof according to
the 2010 OECD guidelines is an important aspect of transfer pricing that needs
to be handled with care. The tax administrators in most cases bear the burden of
providing prima facie evidence as to the existence of inconsistencies in a tax
payers transactions – which includes proving that necessary information are
being withheld. This inevitable bitter fact makes it all lot more difficult for
fruitful legal action to be raised against some savvy and crafty MNEs and could
coupled with the fact that MNEs have over time accumulated enormous commercial
power make it more difficult for changes made to tax avoidance promoters scheme
to do much as far as reducing the scope of tax avoidance freedom that MNEs
enjoy is concerned.

RECENT
DEVELOPMENTS IN THE UNITED NATIONS MODEL TAX CONVENTION

In a presentation made at Asian Development Bank (ADB)
13^th Tax Conference that was held in Japan, Kosters (2003) stated
that tax treaties originated from Germany. Unlike the OECD Model Convention
that is updated between every 2-3 years, The UN Model Tax Convention was last
updated in 1998 before the recent 2010 update that is largely a reflection of
the OECD Model Convention.

Transfer
pricing practices according to Sikka and Willmott (2010) are responses to
opportunities that can be exploited in a bid to enhance personal or private
gain by reducing payable taxes in an inappropriate manner. This assertion is
supported by some evidences from both developing and developed economies. What
this recent evidence proving the abuse and misuse of transfer pricing did not
take into account is the recent developments and changes that have been made to
legislations and laws governing transfer pricing, information exchange agreement
and Advanced Pricing Agreement (APA). The discussion of these steps taken to
reduce the prevalence of the use of transfer pricing as a tax avoidance tool
will be the subject matter of section two of this chapter.

While
providing supportive evidence suggesting that tax avoidance is used as income
shifting tool among the OECD countries, Bartelsman and Beetsma (2001) held the
view that baseline estimates suggest that a substantial share of the revenues
from a unilateral increase in the corporate tax rate is lost because of a
decline in the figure reported as taxable profit.

Mehafdi
(2000) while probing into the ethics of transfer pricing observed that this
practice of spending resources in pursuit of cost allocation for tax purposes
does not add value, rather, it generates costs. Looking at this situation from
the economic point of view, it would be safe for one to conclude that
unnecessary cost incurred by managers as a result of tweaking mix of transfer
pricing is a good example of situations where transfer pricing practices are
abused and misused. These costs include the consultancy fees paid to
accountancy firms for transfer pricing services.

INTERNATIONAL TAX COMPETITION AS A
STIMULANT TO TAX AVOIDANCE

According
to Kassicieh (1980), (Brown 1972) shows that some multinationals have a much
larger gross sales figure than many countries’ gross national product. This
could be one of the numerous explanations that can be provided for the increase
in what Edwards and Rugy (2002) referred to as unhealthy international tax
competition. Countries in the bid to attract direct foreign investment
sometimes engage in unnecessary tax shelter and rebate. This practice is an
economic waste that the OECD set out to curb. The increased mobility of cash
flows that globalization brought about is the main catalyst of this problem.
Chen and Smekal (2004) proposed that a model of tax cooperation can solve the
problem of international tax competition and improve the welfare of participating
countries. The problem however according to the authors is the implementation
aspect of this tax cooperation agreement as every country of the world tries to
take advantage of the economic vulnerability of other countries. This proposed
solution of solving international tax competition made by Chen and Smekal
(2004) goes against the comment made by Edwards and Rudy (2002). Edwards and
Rudy (2004) argued that international tax cooperation as a solution to
international tax competition is a dead end as it does not make any economic
sense it does nothing to promote economic growth or solve the problem of
inefficiency in tax system. It is rather too early for one to make a sound
conclusion as to the beneficial effect of the current tax information exchange
that is in my opinion a form of international tax cooperation that may help
reduce the incidence of tax avoidance.

DOUBLE TAXATION TREATIES AS A WAY OF
REMOVING MNES MOTIVATION FOR GAMING TRANSFER PRICING

Double
taxation treaties are often viewed as a way of remedying the aftermath of
international tax completion. Chisik and Davies (2004) while examining the
evidences behind the asymmetric FDI and tax treaty bargaining warned that the
role of bargaining should not be ignored while signing double taxation treaties
as a way of eliminating international tax competition which is viewed by many
to be the major incentive that drives multinationals to indulge in activities
that would help them move profits out of territories where the tax landscape is
not so accommodating.

ROLE OF ACCOUNTING FIRMS IN THE
PROMOTION OF TAX AVOIDANCE SCHEMES

Accountancy
firms are the ones championing and encouraging companies to tailor their
transfer pricing strategies in a fashion that will shelter some of the company’s
profit that would have otherwise been taxable. Sikka and Hampton (2005)
provided some evidence of the involvement of accountancy firms in developing
and selling transfer pricing strategy packages to corporations and wealthy
individuals. A good example of accounting firm that does this is KPMG, as
reported in its 2010 annual report

“Our Tax practice performed well
as we put more of our resources into providing class-leading advice on
pensions, international tax structuring, transfer pricing and the management of
indirect taxes” KPMG 2010 annual report.

KPMG
is not alone in this practice of helping multinationals find a way around
taxation as PWC proudly parades them self as award winner in transfer pricing
strategies

“We are International Tax Review’s UK and European
transfer pricing firm of the year…” PWC, 2010

One would not have ordinarily complained if
this award was to be given by another body other than a tax review body. The
implication of this is that accounting firms’ transfer pricing products are
tailored to encourage tax avoidance which is even encouraged by a professional
body. One way or the other, it could be that the objective of the transfer
pricing products designed by these accounting firms for their clients helped
reduce taxes to the extent an award was given for it.

ECONOMIC AND SOCIAL SIDE EFFECTS OF
TRANSFER PRICING ON THE SOCIETY

According
to the estimate of the US Senate, over 100 billion dollars of revenue are lost
from tax evasion every year Organization
for Economic Cooperation and Development (OECD) website (2010).
The implication of this is that fewer resources will be at the disposal of
infrastructures and social welfare administrators such as educational sector,
defence ministry and health administrators.

A
Christian Aid report in May 2008 predict that illegal, trade-related tax
evasion alone will be responsible for about 5.6 million deaths of young and
vulnerable children in the developing world between 2000 and 2015. If this
estimate of the Christian Aid is anything to go by, it could then be concluded
that the over 100 billion dollars of revenue loses as estimated by the US
Senate contributes to the decaying welfare condition of the poor countries. Some
writers in recent time like Tuner (2010) have established a link between tax
avoidances and crime rate. Their argument is a sound one when considered from
the socio-economic perspective. Take the funding of police and other security
agencies for example. When underfunded, the police will have no choice but to
be short staffed and ill equipped to effectively carryout their duties. If not
for the fact that so much revenues has been lost in the form of tax avoidances,
what would have made the UK government to think of withdrawing police force
from the street? No wonder the UK Uncut refused to be put off the street in
their protest against public services cut. Sikka and Hampton (2005) noted that;
the ordinary citizens, equality, democracy, justice and fairness are all
invisible casualties of transfer pricing. They also stated that despite the
record corporate profits and economic growth, over four billion people still
live on less than $2 a day.

TAX HAVENS AND TAX AVOIDANCE

Tax
haven which according to Dharmapala and Hines Jr. (2007) is more predominant in
countries that are well governed is any country that is known for helping
individual and corporate bodies avoid paying taxes. Some tax havens now
advertise their status as safe tax haven – Belize for instance. What this means
is that by stacking your money in a safe tax haven or routing your funds
through their country, information about you and your financial dealings will
not be given out to tax authorities of other nations. On first thought, one
might think that all hope is lost as far as curbing the activities of tax
havens are concerned considering how Belize managed to escape sanctions that
would have crippled her economic activities to becoming the most sought after
safe offshore of tax avoiders, drug traffickers and money launders haven. As
real as this might look, things are beginning to change as countries like;
Austria, Switzerland, Luxembourg, Liechtenstein, and Andorra are beginning to
relax their bank secrecy laws which will allow certain movement of funds
tracked and reported to the relevant fiscal agency for necessary actions. More
of these positive steps will help ensure that tax dodgers will really have to
work hard before they will have economic justification for engaging in tax
avoidance. Also, the case of Belize is however an exceptional case as no other
country is known to have successfully replicated what Belize did.

Modern day management accounting thinking and theory has made us understand that over reliance on financial aspects of decision making is a big mistake that has encouraged many suboptimal decisions in the past.

In this article are some non qualitative matters of investment appraisal processes that have long been neglected and relegated to the background.

4 SERIOUS INVESTMENT APPRAISAL PROCESS FACTORS THAT THE BUSINESS SCHOOLS WILL NOT TEACH YOU

MANAGERS’ REALITY

This is what most writers and researchers call managers motivation. What it is called does not matter, so long as the theme of discussion points towards one direction. For a project to see the light of the day, managers and key players that are needed to execute the project must believe in that project. The project must closely align with their epistemological assumption. It will not make any sense if you ask someone who has phobia for figures and calculation to lead a theme of mathematical research. This does not mean that people from different works of life cannot carryout and execute a project that is outside their domain, what I am pointing at here is that analysis and understanding of managers reality should be incorporated into the capital budgeting processes. By so doing, most challenges that will be encountered in the course of implementing a project will be easily dealt with as a result of the motivation of the project team players.

PUBLIC RELATIONS PERCEPTIONS

Wise and successful companies understand what it means to build a brand and maintain it. It takes ages to build reputation and respect but only takes one singular action to damage all that were built. How the general public perceive a company’s implementation of a project can send a wrong signal that will in turn cause heavy damage to a company’s public image. Any project that can potentially cause damage to a business’s corporate image should be out rightly rejected- irrespective of the short-term financial benefits that it might bring. One way of finding out if the launch of a project might cause uproars is to conduct a survey. This can be outsourced to a survey specialist company so as to protect the image of the company.

VULNERABILITY OF A PROJECT

This is one aspect that many companies never even think about. A lot of loopholes have in the past been created as a result of project approval and execution. The introduction of a new project by nature comes with slight changes in the way things are being done in a company. These changes more often than not create vulnerable points in the internal control and security systems of a company. My experience in fraud examination has shown me that fraudsters always tend to be happy whenever new major project is being launched in their department or company. Care should therefore be taken to ensure that the implementation of a project. This should be an integral part of the strategy analysis of a business venture.

OFFSPRING BENEFITS

What this means is that a business should be forward looking when making a decision on whether to execute a project or not. The cash flow of a particular project are not considered in isolation but in the light of the stimulating effect that it can have on the bottom line of other products and services. Proactive and successful managers understand that sacrificial projects form parts and parcels of an overall entity. This however is not the same thing as not evaluating a project before embarking on it.

CONCLUSION

We have been able to understand the importance of those qualitative factors of investment appraisal that acts as the main pillar upon which quantitative factors are built on. In fact, finance professionals now rely on non-monetary factors when doing business valuation.

Just like fire cannot hold in the absence of any of the three elements (heat, oxygen and fuel) found in fire. Any manager that is not assigning the write weight to non quantitative elements of capital budgeting is inviting business failure. The points raised and discussed here together with develompement and implementation of sound business ethics is the key to surviving this ever increasing harsh competitive business environment.

Good business ethics or corporate governance:

Business ethics or corporate governance can be seen as the moral urge that keeps a business free from all forms of guilt. It is normally enshrined into the code of conduct that acts as a guide to business operations in most entities. Business ethics must be implemented for it to make any sense whatsoever. It is better not to have code of conducts than to have an ‘unimplemented code of conducts’.

Corporate branding:

Corporate branding  is the concerted efforts of all stakeholders in a business that is aimed at positively projecting a business to the outside world. Most companies have in the past misused this public relation tool by sending out the wrong signal to the general public. In this our modern age where knowledge and thinking have been greatly advanced, companies are increasingly being left with no option but to be good in all ramifications.

Strategy formulation:

It is a well known fact that businesses and corporate bodies are formed with the sole aim of meeting already identified objective. These objectives may or may not be hard coded, but they surely do exist. The plans and actions taken to make these objectives materialise is collectively called strategies. While the process of identifying and weighing those actions/plans is known as strategy formulation process.

It is not my intention to write a full fledge article on the phrases briefly described above. My aim in this article is to throw more light on the importance of business ethics as far as building public relations of a company is concerned. The points raised and discussed here can be applied to virtually all works of life. It does not matter what sector of the economy you are operating from.

IMPORTANCE |BENEFITS OF GOOD BUSINESS ETHICS

Brand analysis and strategy analysis has shown that business ethics contributes more to the long term survival of a business than most variables that most managers ignorantly consider to be important.

Boost in the morale of workers:

The first benefit that a company gets from having a workable and functional business ethics in place is the trust and total dedication of members of staff. The workers will be assured that they are working in a going concern (a company that is not expected to die within the next few years) company. What this means is that they are sure of medium term job security. The benefit of having workers that believes in an entity’s project is the most important intangible asset that any business can have. By having workers with positive work attitude, customers will be given the best service that will meet and surpass their expectation.

Good and sustainable customer loyalty:

Because customers get the best services from happy workers created by the presence of operational business ethics, little or no further efforts will be exerted in order to win and retain customers. In fact, delivering and guaranteeing customer satisfaction is all that a business needs to do so as to gain customer loyalty. Some people have however argued that there is no more such thing as life time customer loyalty, but customer retention can be significantly increased if customers are convinced that they always get quality service.

Profitability:

The natural thing that will happen to a business that can keep her customer is a boost in bottom line. Business ethics which include creation of a favourable working environment created happy workers which in turn attract and retain profitable customers. This is just a natural phenomenon of ‘success begets successes.

Sustainable and steady growth:

The flow continues. You will agree with that profitability is the foundation of sustainable and steady growth. Liquidation and bankruptcy is the only option left for unprofitable business ventures.

Survival of heated competition and Safety from legal perspectives:

A company that is built around sound business ethics is always better placed to face the ever increasing competition in our current tough business world. An ethically sound company will always be favoured both by law and other corporations. Take the issue of bidding for contracts for instance. Organizations that operate within the ambit of the law are more competitively positioned than a company with a bad reputation.  

CONCLUSION

In this article, care has been taken to articulate the relationship that exists between good business ethics and some success variables in business. The importance / benefits of business ethics on corporate branding and business strategy formulation cannot be overemphasised. In fact, any business that really want to survive this ever knowledgeable customer driven time of ours should have sound business ethics incorporated into the fabrics of all business processes and investment appraisals.

USES OF BUSINESS STRATEGY

Business strategy can be used by both internal management team and external valuation professionals of business concern. Management team rely on her business strategy to achieve competitive edge over other competitors. The plans of a company are evaluated (some people see it as investment appraisal) in the light of obstacles and other challenges that surround the activities of a company.

Probing questions are asked in an attempt to verify the validity of plans and actions upon which a company’s tactics is built. Some of the questions are:

Can our advantages be easily copied by competitors? One of the difficult questions that managers of a firm can ask in order to test the validity and durability of their strategy revolves around the duplicability of her actions, activities, tactics and procedures. If a company’s ways of achieving set objectives and goals are not unique to her, it then means that such ways of doing business cannot be called a strategy. For a strategy to make any economic sense, it must be near impossible for competitors to replicate or copy it.

Are there legislations in place or potential legislation to hinder us? For strategies to have economic value, it must be free from all forms of contravention to existing laws and flexible enough to adjust to new laws. So, managers need to seriously evaluate the legal implications of all the components of her strategies before committing them to longer term plans.

How do the public perceive us? Part of the process of testing a company’s strategy is to conduct a form of public opinion survey so as to have an insight into what the general public think about our company. The benefit of doing this is that the chances of making costly mistakes will be reduced. Strategy that gets the nod from the public is a sign pointing at the soundness of the planned tactics.

Can we sustain our momentum? There is no point starting a programme if you do not have the will power to continue living up to expectation. A company will quickly lose all her customers if she cannot keep up the quality customer service that it spends a lot to build. Think carefully before you launch a new tactics. The customers might well be happy with you if they hadn’t tested the excellent service.

Do we have the right workforce to execute our plans? Strategy as sound as it may be will be reduced to nothing if a company does not have the right mix of manpower to execute the plans. Knowing where a company’s workforce lies is a good planning tool to planning.

The above five questions are just some of the forensic questions that helps us find out inherent and potential weakness in our business model so as to take corrective action. The list of possible questions that can be asked are endless, let your imagination be the driving force.

From the perspective of the external valuers, useful insight can be obtained by carrying out a reverse engineering on the strategy of a company. Since financial analysts and investors operate from the outside, they often make use of lenses. One of such lenses is the financial statement. The external analysts in addition to using accounting information ask the following questions:

What industry is the company operating in? Finding out what industry a company is operating in helps determine the suitability of the kind of strategy that is being implemented. What works well in the pharmaceutical industry may not work in food processing industry for instance. This is why it is very important for an analyst to have an understanding of an industry before attempting to value a business in the same.

What is the knowledge capital of the company? Business evaluators from the outside need to ask questions about the quality of the management team of a company of choice. Common sense draws our attention whenever things are not adding up. A team that comprises of managers that have failed in their entire past attempt to implement a strategy successfully cannot be trusted to execute a similar or better strategy. This does not undermine the fact that people change, but great caution need to be exercised.

How innovative is the company? Trends in the sector that a company operate in raced an important question of whether a company can meet up with the technological wave of the nature of the business. Technology Company for instance needs to have a good record of responding to changes in technological development.

It is obvious from the above discussions that analysis of business strategy is the key to understanding the prospects of a business and making progress in our effort to attach monetary value to the future payoffs that we expect from a company- valuation.

Old economy is the phrase used to describe businesses that existed in the era of bricks and mortar businesses- when success largely depends on a company’s physical size (warehouses, number of staff, amount of goods in the warehouse as inventories, etc.

New economy is used to describe companies that are intellectually based. Most IT and consulting firms are in this class. A good example of a new economy is Google

Brand protection and brand management online and on the internet is a very sensitive aspect of a business that needs to be taken seriously especially in this information age. Cyber snaring has costed a lot of businesses that would otherwise do well fortune.  Cyber snaring is a technical jargon used to describe the reputation war and attack that take place on the internet. This is different from all sorts of internet identity theft that is rampant today.

WAYS OF PROTECTING YOUR ONLINE / INTERNET BRAND PROTECTION METHODS

This hub will give you practical guide on how to protect your brand both online and offline. Though most of the hub will be talking about online and internet brand protection but, a section of the hub will be used to give some useful tips about offline brand protection.

WHAT IS BRAND?

As simple as this may sound, a lot of people still get confused over what the term brand means. This section of this article on brand protection will explain what a brand is to you in a simple and non technical manner.

Brand is good manners. Good manners in this context simply means; good conduct and good behavior. A company that has good manners will; motivate its staff, its customers (the king), its suppliers and the community at large. Good manners have butterfly effect- ability to start little and spread rapidly.

WHY D WE NEED TO PROTECT OUR BRAND ONLINE?

The rule is simple, protect your brand or watch it die! Investors and the general public have in recent time develop huge appetite to grab and digest negative information faster and spread it in a speed equivalent to that of light. Most of this information is posted on the webpage of a website- mostly social websites.

Manually, managers of company may have to struggle in vain for some time before realizing that negative news (usually false) has been moving round about her. Again, a tracking system aides a dedicated team or staff that invests some time to read all that are posted on the web about the company. This is a strategy that vibrant multinationals use to effectively manage their investment.

How to protect your brand

Brand protection in this information age is relatively simple as most attack on company’s brand is done on the internet. There are dedicated soft-wares that can be used to monitor an entities brand online. All that the company needs to do is subscribe to the online brand protection service provider.

When you subscribe to any company of your choice, a dashboard will be created for you where all information that contains your company’s name, trademark, etc is displayed. What the business now needs to do is assign two or three workers- depending on the size of the company- to read these webs information to see if they are good or bad.

If they are bad, the swift action to take is to contact the site owner or file a report to the appropriate authority for immediate action. The fact is that most of these comments are posted by users different from the site owner. So, instituting a legal action is usually not the first step to take. Making counter posting is what I recommend that company’s representative do first and then send a message to the webmaster requesting that the post be pulled down.

The above simple process has saved companies millions that would have been lost in revenue if brands are not properly managed.

Another simple thing that can be done is to subscribe to Google alert and other forms of alert. This is free but also effective. The only problem with this method is that alerts are not sent from all websites.

In whatever you do, remember that brand represent promise about the services that we can deliver. You don’t need to be told that promise is a debt and as such needs to be redeemed. As hard as this might be, it is even harder if businesses don’t take time to make the right investment in brand management!

The issue however is, how are these investments going to be evaluated in the light of prevailing circumstances so as to achieve companies objectives? That brings us to the topic of this hub, to explain what an investment appraisal is and review some arguments that are cropping up now in the academics against the traditional accept-reject criterion.

Investment appraisal is a scientifically based advice on which project to choose and which one not to choose. There are basically three methods used in investment appraisal process. They are

• Accounting rate of return,
• Payback period, and
• Discounted cash-flow

The third is the most important and will take a better part of this hub that however does not mean that we are not going to look at other once. Like I said before, the argument is heating up. I will just explain the traditional idea and then point out some vital points raised in the academics; Accounting and Finance department, University of Glasgow to be precise.

ACCOUNTING RATE OF RETURN METHOD OF INVESTMENT APPRAISAL

Accounting rate of return (ARR) compares annual earnings over a period of time with the amount invested. The averaging is to solve the irregular earnings. This is also known as Return on Capital Employed (ROCE).  ARR or ROCE can be calculated in different ways, the most popular way of calculating the ROCE is the one I will be discussing here.

Average annual earnings after depreciation X 100

                                Initial investment

Any project that does not meet the minimum ARR will be rejected. One major disadvantage of ROCE is that it ignores time-value of money and the minimum targets are subjectively set.

Some of the advantages of ARR are: Easy to calculate and understand, and Helps to keep a business focused

PAYBACK METHOD OF INVESTMENT APPRAISAL

Payback (PB) is defined as the time that lapsed between initial outlay and final recoupment through cash inflows. It has similar advantages and disadvantages with the ROCE method of appraising investment.

DISCOUNTED CASH FLOW

Discounted cash flow (DCF) methods of appraising investments are the most widely favoured methods of evaluating the worthwhile-ness of our projects. The reason for this is that DCF methods take into account of the time value of earnings (money). The amount of money expected at the end of a given period is called the terminal values.

Two or more sets of cash flows can either be compared on a terminal values basis or on a discount basis. Both ways are equally correct, it does not matter which method is used, what will bring confusion is when they are used consistently over time.

The present value approach will be adopted in this hub. In common parlance, PV is seeing the money that will be received later in the future from their present values and then compare them. Outflows of cash are given a negative sign while inflows of cash are given a positive sign.

The resulting difference that comes from the summation of both the positive and negative PVs is called Net Present value (NPV).