Implication of Different Sources of Finance - Assignment Example

Task 1 Implication of different sources of finance The different implications which the different sources of finance presents are as Internal Sources Owners Capital: The different advantages and disadvantages are as Advantages: The initial capital need not be repaid No interest needs to be paid on the owners’ capital Disadvantages: There is a limit to the amount the owner can invest Retained Profits: The different advantages and disadvantages are as Advantages: No interest has to be paid on retained profits Need not be repaid to the business Disadvantages: Not available for a new business Business might not have enough profits which can be used to finance the monetary needs Sell of Stock: The different advantages and disadvantages are as Advantages: Quick way to raise finance Helps to reduce the cost of holding stocks Disadvantages: Business will have to sell the stocks at a lower price than the prevailing market price for stocks Sale of fixed assets: The different advantages and disadvantages are as Advantages: Good way to raise finance from long term assets which is not required Disadvantages: Businesses are unlikely to have huge assets base which is not required Time is required to raise the required finance from selling off assets Debt Collection: The different advantages and disadvantages are as Advantages: No additional cost for the business as the business raises the money from the dues in the market Disadvantages: There is a risk that the money raised might impact the overall brand image of the organization External Sources Bank Loan: The different advantages and disadvantages are as Advantages: Predetermined repayments are made at fixed intervals providing an opportunity to make arrangements easily The interest paid on loan is charged as an interest and helps the business to save on taxes Disadvantages: The interest paid might be high and lead towards additional cost Banks might want some assets as security for loan that is provided Additional Partners: The different advantages and disadvantages are as Advantages: The principal amount need not be repaid Interest need not be paid on the principal amount Disadvantages: Dilutes control over business due to more partners Profits will be divided among more people Share Issue: The different advantages and disadvantages are as Advantages: Does not need to be repaid Interest is not paid on money raised through share issue Disadvantages: Ownership can change hand due to issue of shares Dividend has to be paid to the shareholders out of the profits Leasing: The different advantages and disadvantages are as Advantages: Business can start the use of the assets immediately and carry out their operations Payments are spread over different intervals assuring that the business has the required time to make arrangements for the finance Disadvantages: It is an expensive mechanism to raise finance The asset belongs to the finance company Hire purchase: The different advantages and disadvantages are as Advantages: Business can start the use of the assets immediately and carry out their operations Payments are spread over different intervals assuring that the business has the required time to make arrangements for the finance (Diamond, 2004) The asset belongs to the purchaser company Disadvantages: It is an expensive mechanism to raise finance Mortgage: The different advantages and disadvantages are as Advantages: Business can start the use of the assets immediately and carry out their operations Payments are spread over different intervals assuring that the business has the required time to make arrangements for the finance (Diamond, 2004) The asset belongs to the purchaser company Disadvantages: It is an expensive mechanism to raise finance Trade Credit: The different advantages and disadvantages are as Advantages: Business can sell the products and pay to the supplying company later Helps to improve cash flow No interest is paid on the money which is paid after a certain interval of time Disadvantages: Discounts paid on cash payment might not be received Businesses have to manage their cash flows properly so that the person can be paid the money at the appropriate time Government Grants: The different advantages and disadvantages are as Advantages: Need not be repaid back to the government Disadvantages: Not all business is eligible for receiving grants from the government thereby limiting their chance of obtaining the required finance Different appropriate source of finance World Travel Ltd based on the different sources of finance which has been identified and the different implications which are present can look towards the following options Owners Capital: This is the amount which the owner needs to invest in the business from his own sources. Bank Loan: World Travel Ltd can look towards raising money from the bank in the form of a loan so that sufficient capital is available and interest needs to be paid on the loan which is taken by the business Issue of Shares: World Travel Ltd can look towards raising money from the public in the form of issue of shares so that sufficient capital is available and dividend needs to be paid on the loan which is taken by the business Findings World Travel Ltd should look towards raising money from the bank in the form of a loan so that sufficient capital is available and interest needs to be paid on the loan which is taken by the business. The prime reason for raising money in the form of loan is that it will provide the following advantages and disadvantages Advantages: Predetermined repayments are made at fixed intervals providing an opportunity to make arrangements easily (Abor & Biekpe, 2007) The interest paid on loan is charged as an interest and helps the business to save on taxes (Abor, & Biekpe, 2007) Disadvantages: The interest paid might be high and lead towards additional cost Banks might want some assets as security for loan that is provided References Abor, J., & Biekpe, N. (2007). Small Business Reliance on Bank Financing in Ghana. Emerging Markets Finance and Trade, 43(4), 357-395 Diamond, D. (2004). Financial Intermediation and Delegated Monitoring. Review of Economic Studies, 51, 393-414 Task 2 Cost of different sources of finance World Travel Ltd while looking to select the medium of finance will have to encounter different financial cost associated with source of financing which are as Personal savings: usually have low cost as the funds are provided by the owner but the owner might charge interest on the money which has been provided to the business (Abor & Biekpe, 2007) Retained profits: don’t have any cost with the usage only for the fact that it could have been used some other place or for some other object which is usually foregone when the investment is made in a particular direction (Abor & Biekpe, 2007) Working capital: has the cost associated with opportunity cost as investing in the business would mean that another opportunity has been foregone and could have been used in other areas Sale of assets: will result in reducing the production capacity or giving up some products or services which the business carried on. This strategy usually impacts the future potential and creates doubt on the long term working strategy which has been adopted by the business (Abor & Biekpe, 2007) Issue of shares: results in the payment of dividend which is the cost for the business as organizations usually look to provide dividend to the shareholders for the risk they have undertaken for investing in the business. In addition to it the other cost for the business is cost associated with listing fee, printing and stationery and other cost associated with the issue of shares (Abor & Biekpe, 2007) Debentures: results in the payment of interest which is predetermined and fixed at the time of issuing debenture and is a cost for the business Bank overdraft: will result in the payment of interest which is usually higher than the interest on loan and is calculated on a daily basis which the business has to pay Loan: will result in the payment of interest which is usually fixed and determined at the time of taking loan (Abor & Biekpe, 2007) Hire purchase: will result in the business paying a fixed amount of money after fixed interval of time which will finally result in paying more than the actual value of the asset for which the hire purchase has been carried out Leasing: will result in the fact that the business will have to pay a fixed sum after fixed interval of time but even after paying the required sum the asset will remain with the leasing company even after all the instalments and payments have been made by the business (Abor & Biekpe, 2007) Government grants: have no cost associated with it as they are free and has no fee associated with it Invoice discounting: has a interest which needs to be paid as when the business discounts the invoice the amount which the business collects is lower than the amount of the invoice. This is due to an interest or charge which has to be paid so that the person who undertakes the risk gets the money before the scheduled time Importance of financial planning World Travel Ltd needs to ensure that they are able to develop appropriate strategies and identify the manner in which financial planning will satisfy the different needs of the business. The importance of financial planning for World Travel Ltd can be looked through the following Income: Financial planning will help World Travel Ltd to decide the future needs of finance associated with the payment of taxes, the monthly expenditure and savings. This will help World Travel Ltd to plan for the required finance in advance and ensure that they don’t fall in a financial crunch (Financial Planning. 2013) Cash flow: can be monitored as World Travel Ltd can look at the different spending patterns and expenses which they encounter. This will help them to develop proper cash budgeting programs and plan the tax needs in a proper manner (Financial Planning. 2013) Capital: Proper financial planning will help to understand whether the capital has increased or not for World Travel Ltd (Financial Planning. 2013). This will help to plan for the different investment which the business will need in the future and ensure appropriate strategies in that direction Financial Understanding: Better financial understanding will be availed if the financial planning is appropriate and the future financial needs are correctly identified (Financial Planning. 2013). This will help to give better control over the finances and improve the entire process of budgeting and managing cash. Assets: Proper financial planning will help to understand the asset base and the manner in which the asset base have grown and provided an opportunity through which better business opportunities can be identified (Financial Planning. 2013). This will help to ensure that the business will be able to find whether the strategies adopted has helped them to develop their business Better decision: can be ensured through financial planning as it will help to understand the financials of the business and will thereby help to develop strategies and mechanism through which the decisions will improve (Financial Planning. 2013). The overall mechanism which also ensure that the business will be able to improve effectiveness in their decision making Information need of different decision makers The different decisions which are taken by the different departments and person within the organization require different information. This is due to the fact that better decisions can be arrived and the overall value of decision making will improve. Some of the information needs identified for different decision makers in World Travel Ltd are as Tour Planner: will require information regarding the different locations, the hotels, the cost, places to visit and customer needs so that a tour can be planned based on the customer needs. This will help to maximize the overall effectiveness of the decision making process and will ensure that decisions are better Operational Manager: will need information regarding the progress of the tour, the new developments, the areas where the business is facing problems and process which will shape operational efficiency. The operational manager will have to work on different areas and transform their mechanism of carrying out business so that better effectiveness is achieved Human resource manager: will look towards ascertaining that World Travel Ltd has the required employees who will help them to carry out the different functions. In addition to it the bench strength of employees, the remuneration and incentives that have to be provided to the employees, the training required and all issues associated with human resource has to be dealt by the human resource manager Financial Manager: will look at information pertaining to cash flows, expenses, income and other financial information so that proper needs for the future can be ascertained and appropriate strategies based on it can be developed. The overall mechanism for the financial manager should be aimed towards improving the financial planning process and ensuring that the business is able to manage the finances properly Impact of finance in financial statement The finance which the business has impacts the financial statements in different ways which further has an impact on the business working in different ways. Some of the manner in which the finance will impact the financial statement of World Travel Ltd are as Impact the stock prices: Finances have an impact on the financial statement as it will show whether the business has sufficient liquidity or not. This will thereby impact the share prices and might either make the share prices go up or down depending on the impact the finance creates on the financial statement (Arthur, 2013). This is an important aspect as it will thereby impact the future potential of the business Financing Decision: Finances have an impact on the financial decision as if the business is not able to manage financial liquidity it will impact the different decisions which has been taken by them (Arthur, 2013). This could lead towards liquidity crunch and could also make it difficult to carry out the daily operations. This will impact the overall progress of the business and make it difficult for the business to take new decisions Attract new investors: Finances have a role in attracting new investors as if the business is financially sound then it helps to attract new investors (Arthur, 2013). This provides an opportunity through which new people can be attracted and will provide an opportunity through which the development of business will become possible. This will also help to manage and attract more investment for the future and will create new opportunities through which business prospects will improve References Abor, J., & Biekpe, N. (2007). Small Business Reliance on Bank Financing in Ghana. Emerging Markets Finance and Trade, 43(4), 357-395 Arthur, L. (2013). The Impact of Financial Statements. Retrieved on April 1, 2014 from http://smallbusiness.chron.com/impact-financial-statements-23794.html Financial Planning. (2013). Ten reason why financial planning is important. Retrieved on April 1, 2014 from https://www.blueshorefinancial.com/ToolsAdvice/Articles/FinancialPlanning/TenReasonsWhyFinancialPlanningIsImportant/ Task 3 Types of budget There are different types of budget which World Travel Ltd can use for their daily activities and so that they are able to carry out better financial planning and ensure that the process helps them to gain financial effectiveness. The different types of budget which is available are as Master Budget: This is a comprehensive budget which provides complete description of all the activities which the business looks to carry out over the financial year. The master budget comprises of different components like cash budget, budgeted income statement and budgeted balance sheet which provides complete information regarding the manner in business decisions will be taken in a fiscal year (Shpak, 2013). Master budgets also include different interrelated budgets of different departments which are used by different departments to decide their targets and performance standards which will act as a point in determining their performance. Operational Budgets: This budget involves the day to operational activities which includes the revenues and expenses which the business incur from their daily operations. The revenues for this budget is represented by the sum collected from selling different product and services whereas the cost are the operational cost involved in making the product (Shpak, 2013). These budgets are further broken down on monthly, weekly or any other basis that the organization deems fit and helps to make adjustments and changes to the plan for the entire year. Cash Flow Budget: This budget helps to examine the inflow and outflow of cash on a daily basis and shows the manner in which the business is able to meet its daily expenses from the revenues. Having a cash flow budget determines the point where the business has little or no cash and provides the required time through which necessary arrangements can be made so that the different needs of the business can be satisfied (Shpak, 2013) Financial Budget: This budget helps to explain the inflow and outflow of money on a corporate scale arising from the core business activities and deals with item of capital nature. This budget provides information relating to fixed assets and liabilities and the manner in which the different capital assets are managed by the business (Shpak, 2013). Executive managers use this assets to decide the value of the shares, the performance standards and even provide information regarding the future expected growth of the organization. Static Budget: These budgets are those where the expenditure to be made remains fixed irrespective of the sale which is incurred. The budget provides department wise expenditure which states the upper limit of the amount of expenditure which the various department can incur and are not allowed to cross the threshold limit which has been provided to them (Shpak, 2013) Calculation of Unit Cost & Relevant Pricing Decision The unit cost for a product is estimated so that the correct cost for each product can be identified and based on it correct business decisions in relation to pricing can be made. The estimation of unit cost price is done both for fixed cost and variable cost so that the correct cost can be identified. An example highlighting the manner in which fixed cost are estimated is as Realistic week worked in a year = 46 Estimated productive hours per year = 30 Total Fixed estimate cost = 20000 Total hours worked = 46 X 30 = 1380 Hourly fixed cost = 20000 / 1380 = 14.5 Variable cost of item = 30 Time needed to prepare one item = 2 So Total cost per unit = Variable Cost per unit + Fixed Cost per unit = 30 + 14.5 X 2 = 59 The estimation of unit cost is done as shown above and estimating the unit cost correctly helps to improve the manner in which business pricing decisions are taken. This will help the business to decide whether producing and selling a particular product as a predetermined price is correct or not. This will help the management to identify products or services which are productive and contributes to the bottom line and products which don’t have a large impact on the long term prospect of the business. The overall phenomenon thereby will be impacted due to it and will result in changing the overall basis based on which pricing decisions are taken. Project Appraisal Techniques The different performance appraisal techniques which World Travel Ltd can use to find out whether the investment they are making in different directions are areas are beneficial or not. This will help the business to estimate the future earnings based on the present situation and will provide an opportunity to determine projects which are better to be carried out. The different performance appraisal techniques are as Net Present Value: This method looks towards discounting the future estimated revenues and cost to the present initial investment so that the business can identify whether carrying out different operational activities will be beneficial or not. This method helps to select or reject an investment based on the future potential of the project and provides a framework through which better business decisions will be taken (Spending. 2013). For example suppose the future earnings for a project is $10000 for 5 years and the estimate cost at the beginning is $28,000. The discounted rate is 8% then the future earnings will be discounted to find out whether the business will earn or loose and then decide the investment decision Internal Rate of Return: This method looks at finding out the minimum returns which will be required so that the business is able to earn the investment within a stated period of time. This mechanism helps to determine the minimum return which is required every year so that the business is able to cover all its cost (Spending. 2013). For example suppose the initial investment is $28000 and the minimum year which the investment should be covered is 4.2 years will help to find out the minimum return which is required so that the entire cost is covered. Benefit / Cost Ratio: This method look to divide the discounted net revenues by initial investment so the ratio can be identified which will help to find out the weather investing in better than the cost involved (Spending. 2013). Having a ratio of more than 1 will confirm to the fact that the business will gain from investing in the project and will provide the required direction based on which investment has to be made References Shpak, S. (2013). Five Types of Budgets in Managerial Accounting. Retrieved on April 1, 2014 from http://smallbusiness.chron.com/five-types-budgets-managerial-accounting-50928.html Spending. (2013). Overview of Appraisal Methods & Techniques. Retrieved on April 1, 2014 from http://publicspendingcode.per.gov.ie/overview-of-appraisal-methods-and-techniques/ Task 4 Main Financial Statement The different type of financial statement which needs to be prepared is as Balance Sheet: It shows the firm’s financial position on a particular date or a particular point of time. It helps to understand the financial health and provide useful information pertaining to different financial as it looks to demonstrate the assets, liabilities and equity composition which the business has Income Statement: It shows the profit or loss which the business has earned over a financial year and presents the revenues, expenses and profits for the entire organization. It focuses on revenues and cost and presents the different transactions which has taken place within a financial year Changes in Owner’s Equity: It shows the changes in owner’s equity from one financial year to another financial year. It shows amount of equity which is held by the owner to which income is added and dividend is subtracted to arrive at the final equity value Cash Flow Statement: It shows the different cash receipts and cash payments which have been made use cash as a main source to make entries. It shows the different cash receipts and cash payments which have been made uses cash as a main source to make entries. Different Formats of Financial Statements The different formats of financial statement which needs to be prepared are as Balance Sheet: the Performa of which is as Income Statement: The Performa of which is as Change in Owner’s Equity: The Performa of which is as Cash Flow Statement: The Performa of which is as Financial Ratios World Travel Ltd to improve their overall relevance of the financial decisions need to use different financial ratios which will help to improve the overall relevance of financial data. The different ratios which they need to prepare are as Liquidity Ratios: This ratio will help to determine the liquidity of the business and is presented in two form as Current Ratio: shows the ability of the business to pay its current debt from current assets and is calculated as current assets / current liabilities. World Travel Ltd has current assets as 5240 and current liabilities as 2030 making the ratio to be 2.58 i.e. 5240 / 2030 ensuring that the business has sufficient liquidity to pay off their current debts. Quick Ratio: shows the ability of the business to pay its current debt from current assets after removing inventories and is calculated as current assets / current liabilities - inventories. World Travel Ltd has current assets as 5240 and current liabilities as 2030 and inventories as making the ratio to be 1.50 i.e. 5240 - 2200 / 2030 ensuring that the business has sufficient liquidity to pay off their current debts. Activity Ratios: helps to understand the manner in which the business has been able to use the different assets to carry out their daily operation and are as Inventory Turnover Ratio: which shows the number of times inventory is revolved in an accounting year and is calculated as Cost of goods sold / average inventory. World Travel Ltd has cost of goods sold as 10380 and inventory as 2200 (opening) and 1850 (closing) as making the ratio to be 5.13 i.e. 10380 / (2200 + 1850) / 2 ensuring that the business has revolved inventory more than 5 times. Total Assets Turnover Ratio: which shows the number of times assets is revolved in an accounting year and is calculated as Sales / average total assets. World Travel Ltd has sales as 17300 and total assets as 8790 (opening) and 7305 (closing) as making the ratio to be 2.15 i.e. 17300 / (8790 + 7305) / 2 ensuring that the business has revolved assets more than 2 times Profitability Ratio: shows the profits which the business has been able to make in an accounting year by carrying out the different operations over a financial year and is calculated as Net Profit Margin: shows the final profit which the business has earned from carrying out their operations and is calculated for a financial year. It is calculated as net profit / Sales * 100. World Travel Ltd has net profit as 1917 and sales as 17300 making the ratio to be 11.1% i.e. 1917 / 17300 * 100 ensuring that the business has managed to earn profits from their normal operation Gross Profit Margin: shows the profit which the business has earned after removing the direct cost associated with the business and is calculates as gross profit / Sales * 100. World Travel Ltd has net profit as 6920 and sales as 17300 making the ratio to be 40.0% i.e. 6920 / 17300 * 100 ensuring that the business has managed to earn profits from their normal operation Leverage Ratios: will help to understand the manner in which the business has been able to maintain a balance between equity and other forms of financing and will help to analyze the capital structure of the firm. It is as Debt Ratio: which shows the total debt which the business has in comparison to the assets and helps to understand whether the business will be able to cover the liabilities. It is calculated as total liabilities / total assets. World Travel Ltd has total liabilities as 3130 and total assets as 8790 making the ratio to be 35.6% i.e. 3130 / 8790 * 100 ensuring that the business has can pay their liabilities out of their assets Long term debt to equity: which shows the long term total debt which the business has in comparison to the assets and helps to understand whether the business will be able to cover the liabilities. It is calculated as long term debt / owners equity. World Travel Ltd has long term debt as 1100 and owners equity as 5660 making the ratio to be 19.64% i.e. 1100 / 5600 * 100 ensuring that the business has can pay their liabilities out of their equity and has a good equity base. Read More