Managing Financial Resources and Decisions - Research Paper Example

Higher National Diploma in Business, Managing Financial Resources and Decisions Contents Higher National Diploma in Business, Managing Financial Resources and Decisions 1 Contents 2 Task 1 4 1.1 4 1.3 5 Task 2 5 2.1 5 2.2 6 2.3 7 2.4 7 Task 3 8 3.1 8 3.2 9 Task 4 12 4.1 12 4.2 13 4.3 13 References 15 Task 1 1.1 The different sources of finance available to Excellence Solution Plc. may include external sources of finance and internal sources of finance. It is evident that the company requires a medium to long term borrowing because it is anticipating paying off the borrowed money in around one year of accessing the external funding. Therefore, the company can opt for debentures, bank loans and selling it shares as effective long term financing methods (Higgins, 2008). Debentures can be a useful form of long term financing. Debentures are a type of loan stocks. Debentures and loan stocks are referred to as bonds in the United Kingdom. The funding of a company’s operations through the use of debentures has become a commonly followed practice in the United Kingdom. Therefore, Excellence Solution Plc. can access debentures as a mode of funding. Share capital is a main form of external financing for a private limited company. Since Excellence Solution Plc. is listed in a premium stock exchange like London Stock Exchange, it would be comparatively easy for the company to sell its shares in the capital market to raise the required finances. Bank loans are usually considered as easily accessible sources of financing. The company may take a term loan which would be repayable at equal monthly instalments and which would carry a predefined interest rate. A bank loan is tax deductible and is feasible for the company because it would help to meet the goal of the company to pay back the loan in a year’s time. 1.2 The bank loans would be easily accessible by Excellence Solution Plc. This is because, the company is an established company and banks and other types of financial institutions are much interested to extend financing to an established public limited company as compared to the small business entities. Taking loans from the bank would ensure that the company does not experience any dilution of control because the banks do not have any say in the decisions and management of the company. The interests paid on bank loans are tax deductible which would be highly advantageous for a company with high scale operations. But, in case of bankruptcy, the loan would act as a major burden because it is obligatory for the company to pay back the loan irrespective of its financial position. For an established public limited company like the case company, it would be very easy to access share capital. Not only are the shares capable of generating high amounts in the capital markets but also, they are likely to be bought by the shareholders in high volumes. Gains from share capitals are taxable. The shareholders have some say in the company and as such there is a degree of dilution of control. The debentures are comparatively less accessible. The debenture holders do not have voting rights in the company. The debenture loans have to be paid off in a fixed date irrespective of whether the company has been written off or is running properly. Gains from these instruments are taxable (Ghosh, 2011). 1.3 Thus, it can be identified that bank loans are the most preferable and feasible financing source for Excellence Solution Plc. The tax advantages and the factor of being able to maintain more control in the company establish that bank loans are the best option for the case company. Task 2 2.1 There may be different costs incurred in both short term and long term funding options. There are very less costs associated with the internal sources of finance. However, the external sources of finance may have related costs. Bank loans have high costs of borrowing associated with them. The long term bank loans generally come with a variable or floating rate of interest. In contrast, the short term bank loans are associated with fixed rates of interests. The interest rates of bank loans are lower than the interest of bank overdrafts. Bank overdrafts are other sources of finance in which the interest paid are generally more than the interest on bank loans. The sale of shares in the stock exchange has certain administrative and issuing expenses associated with listing the shares on the stock exchanges. The fees of listing the shares, distribution, printing and advertising fees are some costs that may be incurred in accessing the mode of financing through the sale of shares (Dyson, 2003). The dividends that are paid by companies to their shareholders are also some costs that are to be incurred to access this mode of finance. Debentures are considered to be expensive financing options because there may be floating to fixed rates of interests associated with them. The nature of the interest payable depends on the type of debenture that is being issued. 2.2 Financial planning is an important part of financial management. The financial planning of a business is done in order to make periodic projections of the business with respect to incomes and expenses that are likely to occur. A financial plan is important for allocating the resources and finances properly, taking decisions regarding the management of finances and some other business aspects and for evaluating the need for resources that may arise in future. A financial plan makes a company equipped to face any unforeseen circumstances and help to identify any chance of a crisis or urgent need in the business (Brown, 2003). Thus, the financial plans are important to assess the present financial position of the company as well as to define the future business objectives, take critical business decisions and for efficient management of finances in the company. 2.3 The users of financial information of a business are of two main categories. These are the external users of information and the internal users of information. The external users of information include the credit rating agencies, individual and institutional investors, shareholders of the business and the general public (Cox and Fardon, 2008). The credit rating agencies use the financial information published by the company to assess and rank the financial position of the company. The government may use the information for assessing if the company pays its taxes properly. The regulators or authorities may need the financial information for analysing whether the company publishes its annual report in compliance to the regulatory and financial standards. The investors use the financial information mainly for making investment decisions regarding their investments in the stocks and shares of the company (Bierman, 2003). The internal users of information include the employees, managers and owners. The managers and owners use information for taking decisions regarding the running of the company. The employees may need the information for analysing the credibility of the business and to assess the security of their own employment. 2.4 Share capitals are included in the balance sheet. The ordinary share values and preference share values are added to the share capitals in the balance sheet. Also, the number of issued shares is mentioned. The rate of interest and date of repayment of borrowings like long term debts and debentures are entered in the liabilities side of the balance sheet. Long term debts are included in the long term liabilities section. The general expenses and interest expenses are documented in the income statement. Any changes in the invested capital or financing capital are included in the cash flows (Shapiro, 2005). Task 3 3.1 a) Creative company Total cost in the year = Fixed cost +Variable cost= £70,300 + £73,100+ 60,000* £21= £1403400 Variable factory overhead = 4+3% *4= £4.12 Direct material= 8+0.03*8= £8.24 Direct labour= 7+4% *7= £7.28 Variable cost= £21.64. Total cost for next year= £70,300 + £73,100+ 60,000* £21.64 =£1441800. For a Profit of 18%, revenue should be 1441800+ 18% *1441800= £1701324 Selling price per unit =Revenue/number of units= 1701324/60,000= £28.36 b) EOB Toys Ltd i) Sales Budget Sales Budget for 2014       Units sold Sales Quarter 1 800 8000 Quarter 1 1800 18000 Quarter 1 3800 38000 Quarter 1 6800 68000 Total 13200 132000 Inventory 5200   ii) Production budget Production Budget for 2014       Units produced Production cost Quarter 1 6000 60000 Quarter 1 7000 70000 Quarter 1 9000 90000 Quarter 1 12000 120000 Total 34000 340000 Inventory 5200   3.2 a) Traditional absorption costing   Total cost (in £)   Cost per unit (in £)       Plus   Double Plus Setup costs 73200 3.05   3.05 Special parts handling 60000 2.5   2.5 Other materials handling 63000 2.625   2.625 Order handling 19800 0.825   0.825 Other overheads 216000 9   9 Total overhead costs 432000 18   18 Direct cost of production   12   24 production costs per unit   30   42 b) Activity Based Costing   Total cost (in £)   Cost per unit( in £)     Plus Double Plus Plus Double Plus Setup costs 73200 24400 3.05 1.01666667 Special parts handling 60000 15000 2.5 0.625 Other materials handling 5250 262.5 0.21875 0.0109375 Order handling 1980 141.428571 0.0825 0.00589286 Other overheads     9 9 Total overhead costs     14.85125 10.658497 Direct cost of production     12 24 production costs per unit     26.85125 34.658497 c) Activity Based costing is a practical and relevant method of allocating costs. In this example, according to the activity based costing method, the production costs per unit of both the products are identified to be lesser than that in the traditional costing method. Since, the ABC method is more relevant, therefore, the prices per unit of Plus should be more than £26.85 and the price per unit of Double Plus should be more than £34.66. The prices should be set to achieve the required profit percentage. If the expected profit percentage is 20%, the selling price of Plus should be £32.22 while that of Double Plus should be £41.60. [Calculation: Selling price of Plus= £26.85+ 20% of £26.85= £32.22. Selling price of Double Plus= = £34.66+ 20% of £34.66= £.41.60.] 3.3 a) Average Annual profit = £100,000 Average investment = £ (200,000+20,000)/2= £110,000 ARR=100,000/110,000= 9%. An average accounting return of 9% indicates that the project is not exactly viable because the ARR is less than the cost of capital which is 10%. b) Payback period =700,000/800,000= 0.875 A payback period less than one year indicates that the project is highly feasible (Ross, 2009). c) NPV= -700,000+ {800,000/ (1+0.01).93}] +20,000 = -700,000+ {800,000/ (1.10) 0.93] +20,000 = -700,000+ 800000/1.093+20,000 =-700,000+732,141+20,000 = £52141. A positive and high NPV indicates that the project is highly viable and is expected to be profitable as well. d) IRR: -700,000+800,000/ (1+r).93] +20000 =0 Or, 800,000 / (1+r) 0.93=680,000 Or, (1+r) 0.93=800,000/680,000= 1.17 Or, 1+r = 1.17 1.075 i.e. R=1.18-1= =.18 or 18%. The IRR should ideally be more than the cost of capital (Richard, 2011). The IRR is almost double that of the cost of capital in the example. Therefore, it hints at the high feasibility and expected profitability of the investment. The NPV method is the most efficient method of investment appraisal. NPV considers factors like economies of scale, lending rates and market rates, time value of money and cash flows. This makes the method more practical and efficient (Helferty, 2001). The use of NPV results in clearer concepts for decision making regarding the viability and profitability of a project. Task 4 4.1 Financial statements are used to provide financial and accounting information about a company. The main financial statements are the balance sheet, profit and loss account and cash flow statement. The balance sheet represents the financial position of a company at a particular date and is prepared for a specific period. The profit and loss statement includes a summary of the gains and the expenses incurred by the company for a period. The cash flow statements are used to document the net cash flows from financing, operating and investing cash inflows and cash outflows (Berman, Knight and Case, 2008). 4.2 The financial statements of sole traders are simpler because these reports are not used for publishing and are intended for internal use. A sole trader may not keep a balance sheet and an income statement. A sole trader only needs to show its profit and loss account. A public limited company has to mandatorily prepare all the financial statements according to principles of IFRS and GAAP. For partnership firms, the income statement is prepared first as the net income or loss becomes a part of the statement of partner’s capital (Martin and Baker, 2011). The statement of partner’s’ capital is used to analyse the profits and capital of the company which are circulated within the company. 4.3 The liquidity position of Sainsbury Plc. is stronger than that of Morrison Plc. This is indicated by the fact that the current ratio and acid test ratio for Sainsbury is more than that of Morrison. This indicates that Sainsbury is more equipped to meet its short term obligations by using its current assets. The profitability position of Morrison is better than that of Sainsbury. The gross profit margin, net profit margin and returns from the company indicate that Morrison is more efficient in generating profits as compared to Sainsbury. The higher EPS and dividends paid by Sainsbury indicate that the shares of this company are better investment stocks as compared to that of Morrison (Jackson, 2007). Also, the factor of gearing is better for Sainsbury as indicated by the interest cover ratio. The efficiency of Sainsbury Plc. is also indicated to be stronger than Morrison Plc. from the key asset utilization rations. The overall ratio analysis indicates that Sainsbury is at a financially stronger and more stable position as compared to its competitor Morrison Plc. References Berman, K., Knight, J. & Case, J. 2008. Financial Intelligence. Harvard: Harvard Business Press. Bierman, H. 2003. The Capital Structure Decision. New York: Springer. Brown, K. 2003. Investment Analysis and Portfolio Management. Boston: Thompson Learning. Cox, D. & Fardon, M. 2008. Management of finance. Worchester: Osborne Books. Dyson, J. R. 2003. Accounting for Non- Accounting Learners. Long Acre: Pitman. Ghosh, A. 2011. Capital structure and Firm performance. New Jersey: Transaction Publishers. Helferty, A. 2001. Financial Analysis: tools and techniques. New York: McGraw Hill. Higgins, R. 2008. Analysis for financial management. New Jersey: McGraw Hill. Jackson, J. 2007. Financial Management. New York: Cengage learning. Martin, G. S. & Baker, H. K. 2011. Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice. New York: John Wiley & sons. Richard, A. 2011. Quantitative Investment Analysis. New York: John Wiley & sons. Ross, S. A. 2009. Capital structure and the cost of capital. New Haven: Yale School of Management. Shapiro, A. 2005. Capital budgeting and investment analysis. New Jersey: Pearson Hall. Read More