Managing financial resources and decisions - Essay Example

?TASK P1: SOURCES OF FINANCE AVAILABLE TO SOLE TRADER, PARNTERSHIP, AND PRIVATE LIMITED COMPANY: The most important element for any business is the availability of the funds and finance. Almost all organisations make sure that they have the required funds in order to run the operations of the business in effective and efficient manner. Main issue in the starting of any business or organisation is to search for appropriate source of finance in order to make sure that the start-up funds are available (Johnson, & Scholes 2001). Broadly, the types of sources of finance are divided into two categories namely: 1. Internal sources of finance 2. External sources of finance Different types of business have different sources of funds. The most common types of business are: sole trader, partnership, public limited company, and private limited company. Sole Trader: This form of business consists of one individual owner who is legally not disconnected from the business. But the company and personal accounts are separated. The internal sources of funds for this type of business only include the sale of the goods and stocks. This source of finance is short term as the money from sales of goods is first used for covering the operating expenses of the company (Arnold, 2008). On the other hand, the external sources of finance available to sole trader consist of different loans from banks or venture capitalists. This also includes secured loans, leases, and grants from government. The sale of the goods and stocks is only beneficial in the short term, however the loans from banks can be beneficial for the sole trader for long term financing. The venture capitalists demand for high interest rates (Gitman, 2003). Partnership: This form of business is almost similar to that of the sole trader, but the business is started by the partnership of two and more people. All partners share the ownership and also the liability of raising the funds. The sources of finance available to businesses based on partnership are the same as those of available to sole trader (Arnold, 2008). Same is true for this form of business. The loans from banks and leases are beneficial for long term financing. Venture capitalists can be useful if the idea of the business is innovative the business can bear the cost of high interest (Gitman, 2003). Private Limited Company: In this form of the business, the shares of the business are sold on private basis only by the consent of the board of directors. This type of business is normally popular for the family businesses. The organisation has control over the distribution of the shares and can decide who can own the shares of the company. Private limited company has more long term internal sources of funds. The company can sale the shares and also assets in order to raise finance. Along with this the directors of the company can also decide to issue new shares. The external sources of funds available for the private limited company includes: debentures, loans from banks, grants from government, and also funds from venture capitalists (Khan, 1993). The internal sources of funds like sale of shares can result in diluting the ownership of the organisation. The grants from government can be beneficial for long term financing (Gitman, 2003). P2: IMPLICATIONS OF THE DIFFERENT SOURCES OF FINANCE: Different sources of finance have different implications associated with them. For instance, the option of issuing new shares for the private limited company can result in diluting the ownership of the organisation. Also, different external sources of finance have different implications and influence on the business. All external sources of finance results in increasing the short term and long term liabilities of the company. The internal sources of funds can be beneficial for the private limited companies in the long run but the sole traders and partnership forms cannot use internal sources for the long term objectives and aims (Atkinson, Kaplan, Matsumura, & Young, 2007). P3: EVALUATION OF THE APPROPRIATE SOURCES OF FINANCE FOR CLIENTS RETAIL BUSINESS: The most appropriate source of finance for the client’s retail business in the initial phase is from venture capitalists. Venture capitalists are the firms who provide finance to the new start up businesses who come up with new innovative ideas for the businesses. Other option available for the retail bakery is the loans from banks. Both sources will be beneficial for the retail business of the client. Apart from this, the other sources of finance available for the retail business of the client will be less beneficial or inappropriate for the business. Like overdraft facilities can only be availed in short term and cannot be used for financing for long term objectives and operations (McLaney, 2009). Currently, the company requires funds for the long term in order to make sure that it has the required funds for initial investment and also have considerable amount of working capital in the initial period. So, the client should go for sources of finance which are for long term (Gitman, 2003). In order to raise capital for a retail business, financing can be done from a bank and interest could be paid to the bank. As the business looks profitable, therefore taking loan from bank would not be a bad idea as this would not change the ownership of the company (Gitman, 2003). P4: ANALYSIS AND COMPARISON OF THE COSTS OF DIFFERENT SOURCES OF FINANCE: Different costs are associated with the different sources of finance or funds. For instance, the funds obtained from the venture capitalists have high interest rates as it involves higher risk (McNeil, Frey, & Embrechts, 2005). Also, the option of taking loans from banks results in additional interest payments and makes this option expensive. As mentioned above the external sources of funds results in the creation of liability for the organisation. If an investor invest in the business, then the cost of such capital would be the share of profits however if loan is taken then the cost of such capital would be the interest payments. Also if bonds are floated by the firm, then the cost would be the same as interest payments or coupons would be paid by the firm to the bond holders (Gitman, 2003). P5: IMPORTANCE OF FINANCIAL PLANNING FOR THE CLIENTS RETAIL BUSINESS: Financial planning is very important for any kind of business. Regardless of the stage of business lifecycle, financial planning has a significant role to play in making sure that firm is able to manage its finance properly. Numerous businesses have failed because they were not able to plan and manage their finances accordingly therefore it is important for every business regardless of its size, its structure, its industry and the products and services it is offering, to do financial planning properly so that not only the business is able to survive but flourish as well (Kumar, & Sharma, 2005). Businesses in the retail industry are one of those that have to focus a lot on financial planning because they have to deal with finance on almost daily basis and therefore it is important that they have sufficient amount of working capital so that they can continue their operations and ensure that the organization is able to survive and grow with the passage of time (Johnson, & Scholes, 2001). Because in retail industry, there would be large number of customers buying the cakes prepared and at the same time there would be different suppliers to whom the company would have to pay therefore it is important to have proper financial planning in advance as it will be helpful in ensuring that all the expenses and costs will be covered and at the same time it will be helpful in estimating the amount of money that would be required by the business (Gitman, 2003). Considering the costs and expenses plus other factors like competitors, the price of the product can be set and for that financial planning would play an important role. Financial planning would also play a significant role in forecasting the profitability of the company in the years to come and therefore the client would be able to have a rough idea about the income from selling bakery products. Also because of financial planning, the client would be able to realize areas where the major costs would be incurred and thus steps can be taken to reduce these costs. Not only this, once the business has started, the client would be able to analyze whether he is managing the business properly and up to the potential or not, by evaluating the expected profitability of the company against the actual profitability and therefore he could take necessary steps (Gitman, 2003). TASK 2: P6: INFORMATION NEEDS OF DIFFERENT DECISION MAKERS IN THE COMPANY: The type of information needed by the decision makers would vary in the company for different decision makers. Different people would prefer firms to allocate more marketing budget particularly those people having a marketing background whereas on the other hand some would like to be conservative when it comes to spending money on the marketing expenses of the company. Because there are different departments in an organization and each department would like to have more money or funds available so that they could easily ensure that their targets are met and they are able to produce better performance. And for this reason, marketing department would like to receive higher marketing budget, whereas on the other hand, financial manager might be reluctant to allocate higher marketing budget for marketing activities as he would thought this marketing budget as an expense rather than an investment and it would reduce the profitability of the company and therefore it would hurt the performance of the financial manager because of generating lower profits (Glueck , 1980). Similarly, information required to take decisions would vary for one to another and if someone is from marketing background then he would like to receive information related to consumer buying behaviour, consumer purchasing power, demographics, culture etc on the other hand, if a financial manager is working on the project then he would like to get information related to the cost of the product, different raw materials/ingredients used in making of the product, different expenses etc and then decision would be taken on the basis of such information (Gitman, 2003). P7: IMPACT OF FINANCE ON FINANCIAL STATEMENTS: Financing is one of the most important decisions for any business and financing of the business is one of the those decisions that could impact your business for years therefore such decisions should be taken after carefully analyzing the situation and considering all the pros and cons of the source of the financing. As in the previous section, different sources of financing have been discussed however there are advantages and disadvantages associated with each type of financing. Not only these decisions of financing would impact the profitability and decision making authority of the client but it also impact on the financial statement of the company (Kaplan, and Atkinson, 1998). Loan: One of financing sources that the client has is to raise capital from bank by taking a loan. If the client takes loan from banks then he has to pay certain amount of interest on the loan. When he takes the loan from the bank, then it would impact not only the balance sheet of the company but would also have an impact on the income statement as well. In the profit and loss statement or income statement the amount of interest that has been paid in that particular period would be shown however in the balance sheet of the company, the outstanding loan that has to be paid by the company would be shown. Therefore the interest would reduce the profitability of the company however it would not take the ownership from the owner (Kaplan, and Atkinson, 1998). Bonds: The other option that the client has is to issue bonds. If the company issue bonds, then the client would receive a total amount of money at the beginning and then he has to pay a certain amount calculated using a specific percentage on the face value of the bond. For instance, if the face value of the bond is ?1,000 and interest rate is 10% then the amount of interest to be paid to the bond holders would equal ?100 in a year. Such a financing option would have somewhat similar kind of impact on the financial statements of the company and this option would also not hurt the ownership of the company. Profit and loss statement would show the amount of interest paid to the bondholders in the period and the interest would reduce the profitability of the company and the total amount of the bond would be shown in the balance sheet of the company (Friedlob, & Plewa, 1996). Difference between Bonds and Loans: Difference between bonds and loans is that the principle of the bond would remain the same and the principle amount is paid at the end of the period to the bondholders however certain amount of loan from the principle is paid to the bank every time along with the interest when a loan is taken. Therefore the principle amount reduces from the first payment in loans but not in bonds as the payment to the banks would include both some portion of interest payment and some portion of principle amount (Gitman, 2003). Shares: The other option that the business has is to float shares in the market. By floating shares in the market, the balance sheet of the company would change however there would be no change in the profitability of the company as the profits will be shared by the shareholders as well because they would also be the owner of the company (Gitman, 2003). Shares are divided into two types; preferred shares and ordinary shares. Preferred shares yield a specific amount of dividend to the shareholders whereas on the other hand, dividends on the ordinary shares would vary according to the profitability of the company and as the earnings of the company would improve, the dividends of the ordinary shares would grow however as the earnings would reduce, it would also reduce the earnings of the ordinary shareholders and it may be possible that ordinary shareholders do not even receive dividends (Gitman, 2003). Preferred shareholders are given preferences when it comes to payment of dividends therefore in the profit and loss statement first the payment of preferred shareholders would be paid and the remaining amount would be paid to the ordinary shareholders (Gitman, 2003). Difference between loan, Bonds and Shares: Both types of sources of finance; loans and bonds would come under the liability section of the balance sheet however preferred and ordinary shares would come under the equity section of the balance sheet indicating that the shareholders are the owners of the company (Khan, 1993). Working Capital / Retained Earnings; Many businesses keep some amount of capital for financial purposes as well and when needed they use this cash. This cash might have been recorded in the balance sheet as retained earnings and in the asset section of the balance sheet it might be shown under the head of cash or bank (Jaffe, 2007). Such capital can also be said as working capital or even retained earnings as it depends on the purpose. If the company uses this cash or capital, then it would not impact the profit and loss statement of the company but would have an impact on the balance sheet as the cash in the assets section and retained earnings in the equity section would be reduced (Gitman, 2003). Venture capitalist is another option for that the client has from where he could raise finance for the business. Venture capitalists can be defined as investors that invest in different business in order to improve their return on the investment. These venture capitalists invest at different stages of business so they might be ready to invest at the beginning of a new venture, or when a business is expanding and then they sell the business at a higher price. It depends on how the client approaches the venture capitalists though usually venture capitalists take some portion from the profits (Ross, S., Westerfield, and Jordan, 2009). The following table summarizes the impact on financial statements of different sources and it is up to the decision makers to decide which mode of financing the client needs to chose and each type of financing would have a different impact on the financial statement of the company: Source Impact on Profit and Loss Impact on Balance Sheet Loans Reduce the profitability of the company Increase the liability of the company Bonds Reduce the profitability of the company Increase the liability of the company Working Capital / Retained Earnings No impact Cash will be reduced and therefore total assets will be reduced. Retained earnings will be reduced and therefore total equity will be reduced. Preferred Stocks Will not impact the profitability of the company, however will reduce the earnings of ordinary shareholders Will increase the equity of the company Ordinary shares They would be the real owner of the company Will increase the equity of the company Venture Capitalists No impact Equity will increase but it depends TASK 4: P11: MAIN FINANCIAL STATEMENTS: There are four main or basic types of financial statements and they include balance sheet, profit and loss statement, statement of changes in equity and cash flow statement. Balance Sheet Balance sheet of the company reflects the financial position of the company. Financial position can be described as the summary of firm’s assets, liabilities and ownership equity. Assets of the company show the value of the total resources the firm has on that particular day whereas the liabilities and equity section show the sources of funds. The difference between assets and liabilities is equal to the equity of the company and it is also referred to as net worth of the company. Balance sheet of the company helps the shareholders, management and investors to know the amount of liabilities that the company has in comparison to the equity it owns and if the liability of the company increases too much in comparison to equity then it becomes riskier and therefore steps should be taken accordingly (Friedlob, & Plewa, 1996). Balance sheet is important as it reflects the financial position of the company at a given time. Profit and Loss Statement Profit and Loss Statement or the income statement reflects the profitability of the company. Broadly, Profit and Loss Statement includes revenues and costs of the company. Costs and expenses of the company are deducted from the total revenues of the company in the income statement to show the profits earned by the company during that particular period. Profit and loss statement are prepared for a period of time like one month, one quarter, six months, one year etc and Profit and loss statement shows the profitability of the company for that whole period unlike balance sheet that shows the financial position of the company at that particular time. Profit and loss statement of the company is also helpful for the investors and management to know areas where the most cost is incurred so that they could take steps accordingly to improve the profitability of the company. Profit and loss statement is important because it shows the profitability of the firm throughout the period (Gitman, 2003). Statement Of Changes In Equity Statement of changes in equity is another important financial statement as it reflects the changes that have incurred in the equity section of the balance sheet throughout the period. Statement of changes in equity would include changes that have occurred in the retained earnings. Also if the company pays dividends then it will also be included in this statement. Similarly, any changes in the shares of the company would also be recorded in this financial statement (McLaney, 2009). Cash Flow statement Cash flow statements are considered as one of the most important financial statements as it includes all the transactions related to cash that have incurred throughout the period. All the expenses that have been paid by the company to its vendors or others would be recorded in the cash flow statement of the company. Similarly all the revenues that the company earns would be recorded in the cash flow statement as well. Therefore cash flow statement has a significant role to play as it is helpful for the management to know the amount of cash they must have to tackle different situations (Gitman, 2003). P12: COMPARISON OF APPROPRIATE FORMATS OF FINANCIAL STATEMENTS FOR DIFFERENT TYPES OF BUSINESS: Financial statements can be formatted in different types according to the business. If the business is a sole proprietor then simple format of financial statements might even do the job however the financial statements become complex as the ownership of the company becomes more complex. In contrast to simple financial statements for a sole proprietor, a corporation whose stocks might be floating in the market along with several bonds that have been issued, then such an organization needs to prepare proper financial statement audited by auditors (Kaplan, and Atkinson, 1998). The sole trader can generate balance sheet and profit and loss account for more than one time in a year for his or her personal reference. Same is true for the partnership businesses. However the limited companies are required to generate balance sheet and profit and loss account every year for the reference of the shareholders (Gitman, 2003). Reference list Arnold, R 2008, Economics, South-Western Cengage Learning: Mason, OH. Atkinson, A, Kaplan, R, Matsumura, E, & Young, M 2007, Management Accounting. Pearson Prentice Hall: New Jersey. Friedlob, G, & Plewa, J 1996, Understanding balance sheets, John Wiley & Sons, New York. Gitman, L 2003, ,Principles of Managerial Finance, Addison-Wesley Publishing: Boston. Glueck , W 1980, Business Policy and Strategic Management, McGraw-Hill, New York. Jaffe, J 2007, Corporate Finance, Pashupati Printers Pvt Ltd, Delhi. Johnson, G., & Scholes K 2001, Exploring Corporate Strategy: Text and Cases. 6edition, Prentice-Hall, London. Kaplan, R, and Atkinson, A 1998, Advanced Management Accounting. Prentice-Hall, New Jersey. Khan, M 1993, Theory & Problems in Financial Management, McGraw Hill Higher Education, Boston. Kumar, R, & Sharma, V 2005, Auditing: principles and practices, Prentice Hall, New Delhi. McLaney, E 2009, Business Finance: Theory and Practice, Pearson Education, New Jersey. McNeil, A, Frey, R, & Embrechts, P 2005 Quantitative Risk Management: Concepts, Techniques, Tools. Princeton University Press, New Jersey. Ross, S., Westerfield, R., and Jordan, B 2009, Fundamentals Of Corporate Finance Standard Edition, McGraw-Hill, New York. Read More