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Managing Financial Resources and Decisions

Task 1

Funds are required to run or fulfilling the daily requirements of business. Funds mainly are of two types:

1.      Short-term finance - This is required to fulfill the daily requirements of business or working capital requirements.

2.      Long –term finance -   This type of fund is required when a firm wants to expands its business or for its growth. 

1.1

A) Sources of Finance Available to Unincorporated Business

·                     Small Business Loan: -One of the most primary sources of finance available to unincorporated business is to raise loan from bank (short-term loan/ long-term loan). Raising loan from bank becomes a difficult task if the firm does not have a good credibility. Sometimes raising loan from bank becomes a cumbersome task as the cost of raising loan from the bank is always higher.

·         Retained Earnings: - Another source of finance is retained earnings.  Profit generated at the end of year need not be fully distributed, some of the profit can be retained for future so that it can be used during the shortage of money.

·         Additional partners: - Another source is an admission of a new partner.  New Partner will bring his share of capital that capital will help the firm to grow and expand its business.

B) Sources of finance available to incorporated business

·                     Equity shares: - Equity share is a share in the share capital of the company. The money raised by the issue of equity shares is termed as "Equity Share Capital". Equity shareholders are the real owners of the company. Equity shareholders get the dividend in return.

·                     Debenture and bonds: - Debenture is the one of the most important sources for incorporated business. Company find it to raise the loan from the bank, so they prefer to raise money from debenture as for taking a loan they have to disclose everything to a bank which they find unsuitable. So they convince people by offering the higher rate of interest than banks, to invest their money in the form of Debenture and Bonds. These are known as creditors of the company. They get fixed rate of interest in return.

 

1.2

Internal sources of finance include all those sources, which are generated from within the business. External sources include all those sources that lie outside an organisation. Internal sources like Retained earnings, funds from the sale of fixed asset. External sources like issuing share and debentures of the company.

·         Implications for using internal sources of financeand external sources of finance

 

1.                   Dilution of control and ownership: - Raising funds from internal sources will not create any dilution of control and ownership. On the other hand, issuing funds from external sources like the issue of equity share dilutes the control and earnings of existing equity shareholders.

2.                  Cost effective: - internal sources are very economical as compared to external sources as external sources include the payment of interest and dividend as well as floatation cost.

3.                  The obligation of interest and installment payment: - External sources like the issue of equity share and debentures involve the obligation to pay the interest or dividend irrespective of the profits earned by the company.

4.                  Growth: - The External source of financing helps the business to grow faster as it increases the competitive rate of the firm and helps it to grow faster. Growth needs a lot of funds which can be raised only by external sources of finance.

5.                  Dependent: - Internal sources are a dependable source of finance as raising money from internal sources does not depend on investor’s choice and market condition. We can use the retained earnings at any time without anyone’s permission.

 

1.3

Most appropriate sources of finance for Clariton Antiques Ltd.:-

As this company has two choices either to take more loan as it already has taken some loans from the bank (known as debt) and the second option is to go public (known as equity) i.e. raising money by the issue of shares.

But, this decision will depend upon several factors which are followed as: -

·         Cash flow position of the company: - If the company has a strong cash flow position then it can take more loans as more loans involve more payments of interest for which the company should have enough cash.

·         Risk: - Raising funds from loans is much risky as compared to raising money from the public as taking loans include the obligation of timely payment of interest and redemption of principal amount on maturity. So, it will increase the risk of the firm.

·         Flexibility: - If the firm uses more loan to raise funds it will lose its flexibility to raise the further loan. The company should maintain some borrowing power.

·         Control considerations: - If the company does not want to dilute the control then it should go for raising the loan. As the issue of equity share will dilute the control.

·         Return on investment: - If the ROI of the company is greater than the rate of interest on the loan, then it can use more loans to increase the rate of return on share capital.


 

Task 2

2.1

Analysis of Cost of Finance

The Cost of Finance or Finance Cost is the amount that becomes due on account of procurement of funds. It can be in the form of interest or share of profit etcetera. The Clariton Antiques Ltd has two options of Financing £ 0.50 Million, offering 20% stake in the profit or obtaining a loan according to the agreement that is 1% as Loan Processing Fees and 2% Annual Percentage Rate as interest.

If the company opts for raising the finance by offering stake in the business, the company will have to distribute (Pay) 20% of the overall dividend amount e.g. £ 1,600 in 2016, to the Financiers and 20% of the Net Assets of the business shall be owned by the Financiers (We- Finance Ltd.)

If the company opts for loan financing, the ownership will remain intact. The company shall be liable to pay initial Loan Processing Fees of £ 5,000 and an Annual Interest of £ 10,000. This will lead to tax saving in the hands of the company of £ 2,980 (Approximately). So the net Annual Interest Cost shall be £7,020.

2.2

Importance of Financial Planning

The Financial Planning refers to the efficient procurement of the funds for the company as well as its utilisation in achieving the goals of the organisation.

Concerning Budgeting

A budget is a summary of desired financial statement items keeping in mind the normal budgeting capacity of the business. Making a choice between both the options affects the budgeting a lot. This is because the finance which will be obtained through loan will make the firm more leveraged. The earnings before interest and taxes will not be affected much since in both the cases the same amount is obtained except the amount which is paid as Loan processing fees. Any rational company having higher debt amount will always have a higher Earnings per Share.

Concerning Implication of Failure to Finance Adequately

The Company needs to analyse well in advance the amount to be raised, and the source it should be raised. A wrong selection of the source of finance may lead catastrophic results involving financial loss. Since in the given case the company is already leveraged with Debt portion so further obtaining loan may make it over leveraged and the firm may not be able to pay the interest.

Concerning the Over-trading: - The over-trading refers to the increase in the trading of stock of the company. With more amount of debt the over-trading situation shall be boosted up, and it may lead to financial distress. Over trading situation with lower debt may prove to be raising the demand for the share and making in more beneficial for the company.

2.3

Assessment of Information for Financing the Takeovers: - Different persons will have different information requirements for making the decision of financing the takeover. From the perspective of Partners, the merger synergy of the business is very important, and together with that, the takeover should not be over financed. So information related to that may be useful for the partners. From the perspective of the venture Capitalist (We- Finance Ltd.), the debt-equity ratio of the company shall be useful. For the Finance Broker, the purpose for which the funds are to be provided and the repayment schedule prepared by the company is a matter of concern. So these are the information which may be needed by the different person from their respective perspectives.

Impact on the Financial Statements of Decision regarding Source of Finance: -

If the firm goes for the option of Venture Capitalist that is offering the 20% stake in the business, the company shall loose the share in the ownership of the company. The leverage ratio will fall, and the financial risk will reduce. It is also known as the safe side.

 If it goes for Loan financing, the Debt Equity Ratio of the company will increase. Hence the company's financial structure will be more leveraged. The ultimate Financial Risk will increase. Generally, if the existing Debt Equity Ratio of the company is higher then, for the purpose of obtaining further finance, the loan shall not be approved by the financial institution.

Task 3

 

3.1

ANALYSIS OF CASH BUDGET: -

 S.NO

November

December

January

February

March

April

May

June

July

SALES

   150,000

   150,000

   300,000

   450,000

   600,000

   300,000

   300,000

     75,000

   150,000

 

 

 

 

 

 

 

 

 

 

TOTAL

7500

120000

22500

22500

45000

67500

90000

45000

45000

CASH

 

7500

120000

240000

360000

480000

240000

240000

60000

COLLECTED

 

 

15000

22500

30000

15000

15000

3750

7500

 SUM

7500

127500

157500

285000

435000

562500

345000

288750

112500

 

A collection of the firm will be as follows: - Collected within the month of sale, 5percent; collected the month following the sale, 80percent; collected the second month following the sale, 15 percent.

ADVICE on decisions that can be taken to improve their financial position:

·         Cash budget should be prepared in such a way that enough cash should be the hand of the firm so that it can meet its working capital requirement.

·         The company should do less cash transaction so that enough cash is generated within a month.

·         The company should perform a good forecast of sale. It should have a good information system.

·          The company should strict to its rules and regulations for credit.

3.2

As the company Clariton Antiques ltd is not engaged in the production and usually cost per unit is derived from the variable costs and fixed costs incurred by a production process, divided by the no. of units produced. So for a company like Clariton Antiques ltd., there are many factors which determine the cost per unit.

·         The goal of the firm: - If the company goal is to capture market share then cost per unit will be less, but if the goal is to earn the profit then cost per unit will be high. The low pricing policy attracts more customers. This strategy of competitive pricing ultimately leads to increase the market share of good.

·         Competitor’s Price: - Change in the prices of competitors directly affects a firm behaviour. If the competitor's price is low, then firm needs to decrease its price to capture the market share, but at the if it will not change the price it means firm wants to earn more profits.

·         Price - Quality Relationship: - Quality of product determines its price. If the quality of goods is very good, then even customers are ready to pay high prices for it but if the quality of the product is not good customers will not pay high prices for it.  

3.3

Payback period of Investment 1

 

year

Investment 1

Investment2

1

1.6

0.877

1.4023

0.80

0.7016

2

2.8

0.769

2.1532

1.40

1.0766

3

3.4

0.675

2.295

2.00

1.35

4

3.6

0.592

2.1312

2.40

1.4208

5

4.0

0.519

2.076

2.30

1.1937

6

4.2

0.456

1.9152

2.60

1.1856

Sum

 

 

11.9378

 

6.0283

cost

 

 

-8.60

 

-4.40

NPV

3.3738

 

2.5283

 

RATE OF RETURN OF BOTH PERIODS

                  INVESTMENT 1 = 3.378 / 8.60 *100

                                                =39.23%

 

                  INVESTMENT 2 =2.5283 / 4.40*100

                                                = 57.46%

 

PAYBACK PERIOD

INVESTMENT 1 =4+0.0174/2.076

= 4.008 YEARS

 

INVESTMENT2 =3+1.2718/1.4208

                       =3.895YEARS

We can analyse everything by the above giving information that investment 2 gives the better rate of return.


 TASK 4

4.1

Key component of financial statements:-

·         INCOME STATEMENT: - Income statement is also known as the statement of profit and loss. It shows the results of business operation during an accounting period. It shows the income and expenses of the business. It calculates the net profit or loss earned by a firm during an accounting period.

·         Statement of cash flows: - Cash-flow statement is a statement which shows the inflow and outflows of cash. It is prepared according to the Accounting standard-3 on cash flow statement. It consists of three activities: - operating activity, investing activity, financing activity. By this, we will able to know that how much cash inflow/outflow from these three activities.

·         Statement of changes in equity and gains: - It is also known as the Statement of Retained earnings. It determines the change in owner's equity in an accounting period due to change in reserves comprising the shareholder's equity. A change in shareholder's equity comprises the following statements: - Net profit and loss, increase or decrease in reserves, payment of dividends, etc.

·         Statement of financial position: - It is another name for BALANCE SHEET of the company. It considered being the most important financial statement. It consists of two sides debit and credit; debit side represents the ASSETS of the company whereas, CREDIT side represents the liabilities of the company.

·         Notes to financial statements: - Statement of Financial Position/Balance sheet is supported by the notes giving details about the items represented in the Balance sheet.

4.2

Financial statements presented by Clariton antique Ltd. to that presented by sole proprietorship or partnership are different as the formats used are completely different. Even both the formats have two sections: - Assets and Liabilities, both types must balance; Assets must be equal to liabilities. The main difference is in their presentation.

·         In companies, there is a prescribed format for balance sheet according to the section 410A of the Companies Act, 2006 on the other hand in the partnership or sole proprietorship there is no prescribed format.

·         Company's Balance Sheet is presented in the vertical format, while partnership or sole proprietorship Balance Sheet is presented in horizontal formats.

·         Notes to accounts are made in company’s balance sheet. There are no notes to accounts in partnership balance sheet.

·         The equity portion is represented in a different manner in the partnership or sole proprietorship as compared to that of companies.

4.3

 APPROPRIATE RATIOS TO COMPARE THE FINANCIAL STATEMENT OF THIS YEAR WITH PREVIOUS YEAR

 

·         CURRENT RATIO

This ratio shows the short-term financial soundness of the company. Higher the ratio means higher the capacity to meet its current obligations. The ideal current ratio is 2:1. In 2015 the current ratio was 0.23, but in the next year, it increases to 0.10 which is a good symbol, which shows the increased capacity of the company to meet its current obligations.

·         LIQUID RATIO

The liquid ratio is found out to measure the liquidity. It is based on highly liquid assets i.e. those assets which are quickly converted into cash. The ideal liquid ratio is 1. In 2015 the liquid ratio was 0.08, and in 2016 the liquid ratio is 0.18. In both years the ratio is less than one which indicates the poor short-term financial position.

·         GROSS PROFIT RATIO

This ratio indicates the relationship between gross profit and net sales. Higher the ratio lower will be the cost of goods sold. In 2015 the ratio was 14.34%, and in the year 2016, it has been slightly increased to 14.18% which is a good sign for the company.

·         NET PROFIT RATIO

This ratio is found out to know the efficiency in business. Higher the ratio higher will be the efficiency. In 2015 the ratio was 1.89%, but in 2016 it has been increased to 2.63%, it means the company is progressing with increase efficiency.

·         DEBT-EQUITY RATIO

This ratio is considered to be one of the most important ratios to judge the financial position and soundness of the company. In general lower the ratio lower will be the financial risk. From the year 2015 to 2016 the ratio has been decreased slightly, it means the financial risk is decreasing.


 

References

Accounting for Non-Accounting Students (6th ed). (2004). 1st ed. Pearson Education UK.

Alanzi, K. (2015). Non-traditional Accounting Students and their Academic Performance in Cost Accounting. Global Review of Accounting and Finance, 6(2), pp.31-39.

Atrill, P. (2009). Financial management for decision makers. 1st ed. Harlow, England: FT/Prentice Hall / Financial Times.

Atrill, P. and McLaney, E. (1997). Accounting and finance for non-specialists. 1st ed. London: Prentice Hall.

Drury, C. (2001). Management accounting for business decisions. 1st ed. Australia: Thomson Learning.

Drury, C. and Drury, C. (2005). Management accounting for business. 1st ed. London: Thomson.

Dyson, J. (2004). Accounting for non-accounting students. 1st ed. Harlow: Financial Times Prentice Hall.

Fatimah Abd Rauf., Amla Abu., and Radziah Mahmud., (2007). Financial accounting for non-accounting students. 1st ed. Kuala Lumpur: McGraw-Hill Education.

Gowthorpe, C. (2003). Business accounting and finance. 1st ed. London: Thomson Learning.

Guilding, C. (2002). Financial management for hospitality decision makers. 1st ed. Amsterdam: Elsevier Butterworth-Heinemann.

Hoggett, J. (2009). Accounting. 1st ed. Milton, Qld: Wiley Australia.

Razana Juhaida Johari., (2006). Cost accounting for non-accounting students. 1st ed. Petaling Jaya: Pearson.

Ryan, B. (2004). Accounting and finance for non specialists. 1st ed. London: Thomson Learning.

 

 Appendices

Appendix 1: Cost of Finance

 

Particulars

 £'000

 £'000

Option 1

Offering 20% stake in the business :-

 

 

Net Assets

 

 

Total Assets

              785.00

 

Less:-  Non Current Liabilities

              167.00

 

              Current Liabilities

              317.00

     301.00

 

 

 

 

Amount Received

 

     500.00

 

 

 

 

Total

 

 

     801.00

 

 

 

 

20 % Thereof

 

     160.20

 

 

 

 

Total Dividend (Annual)

 

          8.00

 

 

 

 

Dividend Cost to be distributed to We- Finance Ltd

 

          1.60

 

 

 

 

Option 2

Obtaining Loan:-

 

 

 

 

 

 

Amount Received

              500.00

 

 

 

 

 

Processing Fees ( 1% )

 

          5.00

 

 

 

 

Annual Interest Payment

                10.00

 

 

 

 

 

Tax Saving on Interest

                  2.98

 

Net Annual Cost

 

          7.02

 

 

 

 

 

Appendix 2: Ratio Analysis

SL. No.

PARTICULARS

2016

2015

1

Current Assets

           105.00

              71.00

2

Current Liabilities

           317.00

           309.00

3

Inventories

              47.00

              46.00

4

Liquid Assets

              58.00

              25.00

5

Gross Profit

           178.00

           175.00

6

Net Profit

              33.00

              23.00

7

Sales

        1,255.00

        1,220.00

8

Debt

           484.00

           470.00

9

Equity

           301.00

           276.00

 

 

 

 

1

Current Ratio (1/2)

0.33

0.23

 

 

 

 

2

Liquid Ratio (4/2)

                0.18

                0.08

 

 

 

 

3

Gross Profit Ratio(5/7)

14.18%

14.34%

 

 

 

 

4

Net Profit Ratio(6/7)

2.63%

1.89%

 

 

 

 

5

Debt Equity Ratio(8/9)

                1.61

                1.70