Role Of Financial Resources - Coursework Example

Role Of Financial Resources Coursework Task 1 Internal sources 1. Retained earnings- these are profits plowed back after paying out dividends 2. Advance from customers- these are prepayment from customers, which is used by the firm to run its operation. The firm will offer services while settling the advance from customers. Advance from customers allows the firm to use the funds to meet financial obligation then refund the money by offering services. 3. Account payables - these are funds that the firm is expected to pay to suppliers. The firm obtains services and purchase goods from suppliers in debt. External sources 1. Bank borrowings – these are funds borrowed by the firm in the form of overdraft, the firm can fulfill its short-term financial obligations such paying employee salaries and purchase of inventory. 2. Term loans – these are funds obtained from long-term loans. The firm can finance the large projects and acquire fixed assets using these funds, then repay together with interest (Pike and Neale, 2006). Task 2 a – Assets - these are resources that are acquired by the firm and are used in generating benefits to the firm (Ehrhardt and Brigham, 2013). b- Liabilities - obligations of the firm that leads to the outflow of resources, which must be paid back (Pike and Neale, 2006). c- Income - increase in benefits from inflows generated by a firm’s operations (Pike and Neale, 2006). Task 3 a - 1 - Current ratio Current Ratio = Current Assets / Current Liabilities 2013 30982609 / 26070375 = 1.19 2012 26352617 / 20865335 = 1.26 2011 26228039 / 19930336 = 1.32 2 - Acid test ratio Acid test Ratio = (Current Assets - Inventory) / Current Liabilities 2013 (30982609 – 3721307) / 26070375 = 1.05 2012 (26352617 – 3964155) / 20865335 = 1.07 2011 (26228039 – 18762703) / 19930336 = 0.37 3 – Gross profit percentage Gross profit percentage = Gross profit / Sales * 100 2013 5930124 / 45031292 * 100 = 13.2 % 2012 5476465 / 35210730 * 100 = 15.6 % 2011 6332234 / 44973293 * 100 = 14.1 % 4 - Net profit percentage Net profit percentage = Profit for the year / Sales * 100 2013 2019873 / 45031292 * 100 = 4.5 % 2012 2116789 / 35210730 * 100 = 6 % 2011 2866875 / 44973293 * 100 = 6.4% 5 - Return on capital employed Return on capital employed = Earnings before interest and tax / Total Assets - Current Liabilities 2013 3266572 / (45055891- 26070375) * 100 = 17.2 % 2012 3616387 / (38024981- 20865335) * 100 = 21.1 % 2011 3722715 / (34807029 – 19930336) * 100 = 25 % 6 - Net profit percentage Net profit percentage = Profit for the year / Sales * 100 2013 2019873 / 45031292 * 100 = 4.5 % 2012 2116789 / 35210730 * 100 = 6 % 2011 2866875 / 44973293 * 100 = 6.4% 7 - Stock turnover Stock turnover = Costs of goods sold (Direct cost)/ Inventory 2013 39101168 / 3721307 = 10.5 2012 29734265 / 3964155 = 7.5 2011 38641059 / 18762703 = 2.1 8 - Debtors’ collection Debtors’ collection = Receivables / Sales * 365 2013 26648818 / 45031292 * 365 = 216.0 2012 21687528 / 35210730 * 365 = 224.8 2011 5809654 / 44973293 * 365 = 47.2 9 - Assets turnover Assets turnover = Sales / Total assets 2013 45031292 / 45055891 = 1 2012 35210730 / 38024981 = 0.9 2011 44973293 / 34807029 = 1.3 b – The current ratio measures the firm ability to meet its debt obligations when they fall due. It measures the firm short-term solvency for which creditors expect a higher ratio so that they can be paid in time. However, for shareholders higher current ratio is an indication that the firm is holding too much money in unproductive assets. Acid test ratio is a measure of liquidly of a firm before selling off the inventory. If a firm has low acid test ratio, then it is clear that it has to wait for the sale of inventories to fully cover the short-term obligations (Pike and Neale, 2006) Gross profit percentage indicates a firm operating efficiency before the impact of interests and taxes. A higher percentage is a clear indication that the firm has high internal efficiency. Net profit percentage measures a firm ability to turn sales into net income. It ensures that creditors are paid from profits and that investors get dividends. Therefore, a higher percentage is more favorable than a lower one (Pike and Neale, 2006). Return on capital employed indicates how a firm can generate business from capital employed. It is a measure of efficient use of capital in generating profits (Hirschey, 2009). Stock turnover measures the efficiency of managing the firm's inventory in controlling the cost of purchasing. Stock turnover, therefore, determines the number of turns of restocking the inventory. Debtors’ collection is an indicator of the financial soundness of the customers. If customers take the long period to pay receivable then the firm needs to hasten collection of these debts before they turn into bad debts. Assets turnover measures the firm's ability to manage its assets in the production of profits. If the firm has the low assets turnover ratio, then the firm is struggling to invest assets efficiently and may point to costly debt financing (Hirschey, 2009). c – The current ratio for the firm is low, which points to a troubled financial management. The current ratio should be greater than 1 so that suppliers can feel confident that they will be paid in good time. Acid test ratio the firm improved from 0.3 to 1, but this is still low. However, the firm has a poor performance and might need to sell the inventories in order to meet much of its short-term debts Gross profit percentage for the firm is low pointing to poor efficiency by the firm. Net profit percentage has been reducing from 6.4% to 6% to 4.5%, a clear indication that the firm is not efficient. Return on capital employed for the firm at 17%, points to the poor employment of capital. The return has been declining pointing to the difficulty facing the firm. Stock turnover for Al-Sham Engineering Company has improved over the years from 2 to 8 to 11 turns a year. A turnover of 11 is still low pointing that the firm is holding too much stock. Debtors’ collection keeps on rising at the firm from 47 to 225 to 216, which points that customers are facing serious financial problems. Increased collection period leads to difficulty in turning sales into profits Assets turnover of 1 on average for the three years is a clear indication that the firm is performing very poor in terms of returns to investments. Task 4 a – First, interest paid for loans causes the huge outflow of funds earned from the profit. Second, increased debts’ collection turnaround starves the firm off the funds required to meet short-term obligations hence resorting to borrowing (Hirschey, 2009). The firm needs to reduce the collection period to be less than 30 days and increase the stock turnover to avoid holding excess inventory that might not fetch the desired profit. The firm should reduce borrowing from the bank since interests are increasing the expense. The firm needs to increase efficiency by ensuring timely collection of debts. b – In controlling costs, a budget will allow the firm to minimize the variable cost and reduce overspending. Figure 1: break-even chart The firm operates at the loss when production is lower. As the production and sales increases, the profit increases until it can cover the total cost fully (Baker & Powell, 2005). A meeting point between profit and total cost, the firm can break-even and manage the cost by ensuring that any increase in variable cost such as increased in labor cost, is within the desired range such that profitability is not affected. Although it is difficult to manage the fixed cost such as legal reserve, the firm needs to ensure availability of free cash flow by reducing debts and account receivables. c – The firm will have to grapple with lower profits as it increases costs because the marginal benefit keeps reducing with increased interests’ expenses and stock holding cost. Due to lack of efficient operations in handling the receivable, the firm will have wait for long to receive the money from debtors, thereby hurting profitability. Reference list Ehrhardt, M., & Brigham, E. 2013. Corporate finance: A focused approach. Mason, O: South-Western Cengage Learning Pike, R., & Neale, B. 2006. Corporate finance and investment: decisions & strategies. Harlow: Financial Times Prentice Hall. Baker, H. K., & Powell, G. E. 2005. Understanding financial management a practical guide. Malden, MA: Blackwell Pub. Hirschey, M. 2009. Managerial economics. Mason, O: South-Western Cengage Learning. Read More