Finance Sources for Development of a Private Limited Liability Company - Assignment Example

BUSINESS MANAGEMENT TASK 1 Various Sources of Finance Sources of finance can be internal or external. Not every business can use all the sources available and the choice of the right source by a medium level Private Limited Liability Company takes into account the business conditions, interest rates and the costs of financing the same. For the case of softwood Ltd, there are several sources of finance; Venture Capital This is capital obtained from venture capitalists to small and medium sized companies (SMEs) that do not have access to stock markets. These help businesses that require a capital in excess of £100,000. The venture capitalists provide capital, equity and loan finance for various situations in businesses. The case of Softwood lies in one of the many situations for capitalists to lend out capital; growth capital and that would help businesses expand especially funding growth plans. Business Angels These are wealthy businessmen who are willing to invest in small and medium businesses that are showing a high potential for growth. Apart from just providing finances to the business, they are able to provide management advice from their previous experiences and success in business. Loans This is money that is advanced by banks to individuals repayable with interest at a given period of time. Leasing Leasing operates in a situation where the company requires an asset that it cannot directly afford. It approaches another business (mostly a bank) to purchase and then lease it to them for operations. Hire purchase This is a form of credit whereby a customer pays for an asset through instalments. The customer assumes full ownership once the last instalment is paid. Trade Credit In this case, the company would be able to acquire the items from the supplier and the payments will be made later at an agreed period of time. Delayed Payments To Creditors This is an internal method that has the business delaying the amount they are to pay to creditors for a given period and then use the same amount to purchase some assets. Implications of the Sources of Finance Venture Capital The venture capital provided is a form of loan which must be repaid back to the owners within a given period of time. Venture capitalists also add value to a company by corporate governance and also expose the business to extended knowledge in the market. These people do not just invest in any company but very promising companies. Their continued monitoring of the portfolio companies makes the companies lose full control. They may even insist on putting one of their representatives on your management board. Business Angels Just like in venture capitalists, business angels have a lot of controls on businesses that they invest in. in this case, the businesses tend to lose their direct financial and managerial control due to the investment of these angels. Their role of providing management advice to the business has a high positive impact to the business as they introduce the business to high level experiences in the business world leading to success. However, there is a loss of full ownership of the company. Loans Loans from banks are very viable in promotion of businesses because they are given in full upon qualification of being granted the required amount. The implications however of taking a bank loan lie directly in the different interest rates. Long term loans can be paid for overly longer periods and this may jeopardize the progressive development of the business. Banks may also come and acquire the assets of the company if loans are not paid on time. Leasing Leasing requires the company to always be in a stable condition to use these assets. When the ability to use ceases, there is the risk of a take-back and this may negatively affect the company operations especially where the operations were dependent on this asset. Hire purchase The positive implication here is that the company is able to afford and use an asset it cannot afford to purchase directly. However, there are also negative implications. The company may not become financially stable for a long time as it has to service the instalments periodically. Lack of this service may lead to legal implications where the company may be forced to lose the assets back to the company that provided them (Faulkender & Petersen, 2006, p. 23). Trade credit This is a short term form of credit but it has several implications to the business. A business will be able to acquire the supplies and use them for profitable means. However, if the company does not meet the payments at the end of the credit period, there is always a collection of future implications where the creditor may not be willing to do the supplies again. Meanwhile, lawsuits may ensue to try and recover the outstanding amount. Delayed Payments To Creditors The implication of non-settlement is the loss of creditors in the immediate future period. This would negatively impact the business against such stakeholders. Most Appropriate Sources of Finance According to analytical; view of the methods of getting finances above, the best is venture capital for a collection of reasons: It offers value added services such as deep insight in better management advices They also provide information, resources and contacts for success which is involved in company success They provide value added services such as mentoring alliances They therefore do not just provide finances but also extra services that would guarantee success. TASK 2 Costs of Different Sources of Finance as Identified The costs of finances refer to the costs, interests and other charges that are involved in a person or company borrowing money. The costs of venture capital and angel investors are similar. The costs of venture capital are the ownerships of a section of the business and the eventual counsels that the business would be getting. The costs in this case may be more expensive especially when the returns have to go back to the venture capitalist to finance the share he has in the business. The cost of equity financing therefore would include dividends or a share of the profits in the business (Pour, 2011, p. 03). For the loans, the cost of financing is interest. Rates of interest vary and when they are high, the costs of financing them are higher than when they are low. Moreover, the costs of getting a short term loan are higher especially when the repayment period is shorter. Leasing involves a series of contractual, periodic and tax deductible payments. The cost of leasing is the rent that is paid to the owner of the property and the rates vary depending on the lease period. Hire purchase is serviced in instalments. After paying a fixed amount, the instalments are paid over a given period of time and the actual costs of servicing this method of accessing credit is the payment of the instalments as per the contractual agreements. The cost of accessing trade credit, apart from processing costs is the actual settlement at the end of the period. The costs of servicing delayed payments are not quite expensive as there is no requirement that there will be an interest to be paid at the end of the period. Unless there is an agreement of compensation for the period, it can just be a mutual agreement. It has to be noted that there are seemingly hidden costs such as the costs of processing the finances in that the financier always transfers to the recipient. Importance of Financial Planning Financial planning is very important to any business, small or large multinational companies. For Softwood Company, the first importance is that it helps the company develop strong business partnership with its banks. When John Mathew was visiting the bank, he was given sufficient advices on the available financial tools to the company. A good well planned financial plan would help the business access loans on its assets for improvements and expansions. Secondly, another importance of financial planning is that related to income. The company will be able to effectively manage its finances having a clear picture of the available finances as well as those expected. This helps the company to future plans especially in planning. The income requirements to offset tax requirements, profit repatriation and expenditures are clearly instituted. Planning helps regulate cash flow in any business by monitoring expenditure and income patterns in the business. Softwood ltd would be able to do tax planning, prudent spending and careful budgeting would see the company spend in a more wise way than if there was no planning (Jarchow, Morehouse, & Patrick, 2004, p. 104). Planning also brings about financial understanding. In this case, when Mathew the accountant has to be responsible to the stakeholders of softwood, it would be easy to explain to them as well as chatting the way forward as a result of understanding the financial goals set, the decisions to push the entire company to realizing these objectives as well as the analysis of the final results obtained from the operations and the profits realized. Information Required For Decision Makers According to Carroll (2007:9), decision making is basically selection of a possible cause of action from a collection of feasible possiblilities. Financial decisions for Softwood therefore require a collection of ideas to be considered in the process. Since profits are the most important aspects of any organization, the first information requirement is balance sheet information with details of the business assets, liabilities where there would be an indication of the company liquity. Sales and purchases information is important and the specified information is that these must show the individual traders that the sales and purchases were made with. Moreover, there would be a requirement by the decision makers on the purchase of company assets and liabilities. This informationnis particularly important so that the rates of depereciation are categorically calculated and established. Costs relating to wages, salaries and other expenses are supposed to be established to make decisions such as; Cost reduction Increase in sales Profitability raising When to make new purchases and many other decisions. Impact of the Sources of Finance on the Financial Statements The impact of some of the sources of finance would highly depend on the reason for having these sources. For a case like venture capital and business angels, the reason was business expansion where the venture capitalists are to become shareholders in the business (Megginson & Weiss, 1991, p. 45). The impact of this source would be an increase in capital as would be reflected in the balance sheet of Softwood Ltd. Cash an asset would equally increase to reflect the acquired extra capital. The impacts of loans from financial institutions are that it increases the number of creditors that Softwood Ltd would be having apart from increasing the cash held the bank by the company. This would also be a reflection in the balance sheet. Trade credit would impact the creditors section of the balance sheet in the financial statements where it would remain in an unsettled position till the maturity of the period upon which it will be settled. That will again create a reduction in cash as reflected in the financial statements (Carroll, 2007). Task 3 Cash Budget Jan Feb March April May June July Aug Sept Details Opening balances 6000 3170 340 Add receipts Collection from customers - 200 4500 1560 Total cash available 3370 4840 Less disbursements Direct labour 1200 1200 1200 Raw materials 750 750 1000 Variable expense 400 600 600 Fixed expense 480 480 480 480 480 480 480 480 480 Office expenditure 4000 Total disbursements 2830 3030 3280 Cash surplus 3170 340 1560 Cost of Producing a Chair Production of one chair by the company would take to account a collection of features including the fixed costs and the variable costs. In this case, consideration is given to the annual capacity of 12,000 units in which production of 2000 chairs would still lie if the annual additions are to be made. The cost of one chair would therefore be as follows: Description Cost (£) Total cost (£) Direct Labour 5 Direct materials 10 Variable Production Overheads 5 Total 20 Other costs (expressed per unit) Administrative overheads 0.21 Other Fixed costs 0.16 Total 0.37 Cost of one chair 20.37 The proposed pricing strategy would be the marginal cost strategy where prices are based on units sold and the actual cost of production. However, the company can also adapt a market oriented strategy if the chair is for export so that the price does not look too exorbitant in the foreign market. Appropriate Machine for Softwood Ltd The appropriate capital budgeting method is that of purchasing from XYZ Ltd. This is because as compared to ABC’s cost (£4 million), the cost of the machine is £3.5 million which is economical for the company. Secondly, by the third year, the machine from ABC will have been serviced and an extra £500,000 in favour of Softwood Ltd will be realized. In addition to the amounts realized in year 4 and 5, the total returns would be £2 million. For XYZ, the extra amount after the third year would be £700,000 in favour of Softwood Ltd. This would realize £2.2 million. It is therefore more economical and profitable to use XYZ. Task 4 Main Financial Statements of a Company There are three major financial statements applicable to businesses; balance sheet, income statement and statement of retained earnings. Balance Sheet It is used to reflect the financial position of a company (shows assets, liabilities and stockholders’ equity). On the structure, the heading specifies four items: Name of company/entity Title of statement Date of the statement The unit of measure Source: (Owsley & Kaufman, 2007) Assets are the resources that are owned by the company. In the example above, the five items under the name assets are the resources that are used in the production of the company’s finished products Liabilities are the debts owned by the company. There are two liabilities in the example given The equity refers to the amount that the owners of the business have contributed to it. Two types of equity exist; retained earnings and contributed capital. The Income Statement This statement defines the accountant’s primary performance measure of a business. This is where revenues are measured against expenses. Source: (Owsley & Kaufman, 2007) When expenses are subtracted from the expenses, the net income is realized as indicated in the figure above. Statement of Retained Earnings The structure of retained earnings statement indicates the heading that indicates the name of the enterprise, title of report and unit of measure. Source: (Owsley & Kaufman, 2007) The elements in the statement indicate how the financial position of the company was affected by net income and distribution of dividends. How Financial Statements Differ In Different Types of Businesses Different formats are assumed when preparing financial statements. Companies assume use of different types of formats depending on a collection of reasons. Selection of a method is based on the function or nature it will serve in the business. The Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) are normally applied in the making of these statements. Different formats exist depending on the size of the business (Martikainen, Perttunen, & Yli-Olli, 1995, p. 43). A sole proprietor would only prepare a very simple profit and loss account as compared to a company that has to prepare based on GAAP and IFRS. Some businesses also prepare single format statements in which there are all expenses classified by function and deducted from total income. Others prepare a multi-step format. Statements therefore differ depending on the size of the business. Analysis the Financial Performance for the year 2013-------------------------277 Name Of Ratio Value Analysis/Implications Gross Profit Margin 49% This is a measure of the company’s efficiency in operations. A high margin like the one found for softwood shows a high operation efficiency Net Profit Margin 30% This shows how much of each pound earned by the company is translated into profits. Return on Capital Employed 36.8% It measures the company’s profitability and the efficiency with which its capital is employed. This shows that the efficiency level is 36.8% Asset Turnover Ratio 94.98 This is a high ratio meaning that the company is generating more revenue per pound of the assets Current Ratio 1.6 This means that the company is in a position to effectively settle its obligations/liabilities Quick Asset Ratio 0.8 This ration measures the company’s ability to offset short term obligations by use of the most liquid assets. This means that only £0.8 of liquid assets is available to cover £1 of current liabilities. Stock Days 142.66 This value gives investors an idea on how long it takes the company to turn its inventory into sales. This value means it takes 142 days to do this. Debtors Days 13.9 This measures how fast cash paid back to the debtors. The value 13.9 means the company takes around 14 days to settle obligations to its debtors Debt Equity Ratio 10.6 This is the measure of the leverage of the company. This high value means the company has been financing its growth with debts (Jonathan, 2004, p. 99). References Carroll, N. V. (2007). Financial Management for Pharmacists: A Decision-making Approach. London: Lippincott Williams & Wilkins. Faulkender, M., & Petersen, M. (2006). Does the Source of Capital Affect Capital Structure? The Review of Financial Studies, 19(1), 21-28. Jarchow, C., Morehouse, D., & Patrick, R. (2004). Capital Sources and Uses. The Journal of Business, 27(2), 101-109. Jonathan, L. (2004). Predicting returns with financial ratios. Journal of financial economics, 74(2), 99. Martikainen, T., Perttunen, J., & Yli-Olli, P. (1995). Financial ratio distribution irregularities: Implications for ratio classification. European Journal of Operational Research, 80(1), 38-45. Megginson, W. L., & Weiss, K. A. (1991). Venture Capitalist Certification in Initial Public Offerings. The Journal of Finance, 46(3), 34-54. Owsley, H. F., & Kaufman, P. S. (2007). Financial Statements. American Bankruptcy Institute Journal, 26(5), 341-353. Pour, N. M. (2011, January ). Identifying Different Sources Of Finance To Plc Advantages And Limitations. Retrieved March 5, 2014, from Kensington College and Business &University of Wales: http://www.academia.edu/466098/Identifying_Different_Sources_Of_Finance_To_Plc_Advantages_And_Limitations Read More