Sources of Finance the Business Is Using - Assignment Example

Topic: Timing Section 1. Sources of finance: you need to explain what sources of finance the business is using (Financial documents). For example using your own capital, obtaining a bank loan, arranging a bank overdraft etc The source of financing as based on the cash flow statement is partly by owner’s capital, partly by bank loan and partly also by operation This can be seen cash inflows during the month of April, 2006 as shown from cash flow statement as follows: Sales £17,726.80; Capital £10,000.00; Bank loan £15,000.00. 2. You need to explain in detail the capital budget, sales budget, purchases budget and overheads budget, accompanied by an explanation of where the figures have come from e.g. bank loans where drawn from Halifax bank etc. Capital budget is a plan for capital expenditure for the year ending December 31, 2007. Capital expenditure represents items that are normally bought once at the start of the project. In the case of Star of India, capital expenditure includes the equipments, furniture and fixture and vehicles. These items are forecasted needs and their acquisition or purchase is at the start of the year. As to how they will be paid are reflected in the cash out flows under the cash flow statement. The Sales budget is basically a function quantity demanded and selling price per quantity. In the case of the Star of India, the quantity demanded is represented by the number of customers which are first estimated on a daily basis and then converted monthly with one month assumed to be 28 days. It is the monthly number of customers that was used in calculating the total revenue per month. To compute for the revenue per month certain percentages of customers for the month are assumed to purchase given types of food items and beverage and given the assumed number of buyers for the said products, the same is multiplied with the average prices for each products which are assumed to be constant throughout the year. The purchase budget is prepared after the sales budget. This must be so because the one needs to know how much will be sold based on the demand in terms of expected number of customers in relation to given price, which are normally prepared with due consideration to competitors’ prices and with a desired level of profit. The purchasee budget takes into consideration the prices and quantity of process inputs like raw materials for cooking (meat), catering supplies, toiletries and the like. In the case of Star of India the purchase budget included a certain pertain of sales budget for each menu (product) that are available to customers for sale. These products include the following: Mediterranean Starters, Asian Starters, Charcoal Grill and Tandoori Specialities, Asian Curries and Savoury Rice dishes, Desserts, Beverages, Beer and mixed drinks and Red & White Wine. Overhead budget is a financial plan for business expenses that are not directly related to the product. These expenses are still considered necessary and ordinary for the business since the level of sales of operation of the business would inevitably require the incurring of said expenses. These expenses include the following: Vehicle Expenses, Rent, Salaries, Advertising, Electricity, Telephone Bill, and Gas. Overhead budget is different from the purchase budget in that under the purchase budget what was purchased was directly related to the product and service for sale like the meat and toiletries. The overhead budget is different from the capital budget in that the in the latter, the cash payment is normally one time while in the overhead budget; the cash payment is normally through out the year. 3. Cash flow statement: you need explain what the cash flow statement show. Does it have a negative net cash flow or negative closing balance any month? Why does this occur? The cash flow shows no negative figure, which means that throughout the year everything is positive. These positive figures show that company will not need additional financing aside from those prepared in the budgets. This is a good indication that there is no cash deficit of the business that would require financing and that may indicate working capital requirement of the business. This is also a sign of good financial management since some business may fail for not doing well in working capital management. 4. Breakeven forecasts: comment on how many items/customers you need to breakeven and your margin of safety – must all be very detailed!!! Breakeven can be computed by knowing the fixed cost, variable cost of the business. Total fixed cost is assumed at £ 154,507, which is computed by taking the total budget for overhead and deducting one item called gas (considered as variable cost). The number of customers to breakeven is 16,662 and the margin of safety is 30,798 customers. The breakeven point in number of customer is the point where the total cost is equal to total revenues. At that point, there is no profit whatsoever. This is precisely the purpose of breakeven analysis, to determine at what point or at how many customers, which are of course assumed to purchase given amount of food products for sale, may the business decide to stop or continue operation. Margin of safety on the other hand is the excess of total (budgeted or actual) sales over the break even sales in pounds. The greater the margin of safety therefore, the better is prospect for the business. This breakeven analysis is also important because operating just below the breakeven point does not necessarily mean that business must be stopped since an operation may be necessary in order just to recover the fixed cost. This argument must be made since fixed cost is unalterable, meaning they are incurred even without operating. The best example is the rent expense. The moment that a contract was perfected by Star of India with the owner of the building, it will have to pay rent whether it will prepare food for sale for the period or not. But there is a point where it is not advisable to really pursue business in the short run under the breakeven analysis. It must be pointed out that the breakeven analysis is only for short run decision making, since it is possible to lose during the early years but earn on coming future years. 5. Projected profit and loss statement: you need to comment on what the profit and loss statement shows. Is the business profitable? The Projected profit and loss statement shows a net profit margin of 46% which means that every £ 100 made as sale, the business earns about £ 46. The business is profitable even it we use gross margin at 75%. The high gross margin of 75% means that without considering the overhead expenses, the business earns as high as 75% for every sale made or services rendered. Add this to the fact that the ROA is and return on equity (ROE) is above 100%. (See appendix A) 6. Balance sheet: Comment on the balance sheet with detailed explanation and what it shows. What does this mean for the business? The balance sheet will show the assets, liabilities and equity of the owners. It is an indication of the financial position of the business. Any stake holder of the business would be interested in looking at the balance sheet since; the same will tell how wealthy the business is. A healthy company is expected to increase assets and capital after a period of time. An increase in said two accounts would indicate that there is basis to believe that the business does earn and therefore worth dealing with by a creditor, investors or even an employee. Tax authority too will be interested for income tax for if the business is earning. In addition a good business is also expected to pay off liabilities hence total liabilities must decrease, as a rule, over a period of time unless additional financing is made to expand business. The balance sheet would be best appreciated by relating the same with income statement, especially on the concept of return on assets and return on equity. The first ratio indicate how much will the business get for every asset used in business while the second ratio would indicate how much would the company get for every investment of the owner or owners. In both ratios, the numerator is net income from the income statement while their denominators are balance sheet accounts. The significance of ratios will be better appreciated later. 7. Each number above must be 1 page each, effectively using financial concepts accurately with a detailed judgment of how and where the figures have come from e.g. market research – Banks, competition analysis, target market, factors affecting demand, questionnaire results etc. make it up to make it sound realistic. The financial figure above may be prepared by an accountant of a business consultant supporting the feasibility of the business. It could come as a result of market business research. The sales budget is a function of demand price and quantity demanded. Hence if the demand price is what the market tells and if the quantity demanded is supported by the capacity the business to service that level of business activity then there is basis to use the sales budget. The validity of the purchase budget will have also have to reflect internal consistency among the various financial figures presented as case facts. From the submitted purchase budget there is no evidence to show invalidity of the assumptions and computations made. Section 2: 1. Make a basic judgment about the viability of the business plan e.g. Do you think the business would be successful? Is the idea a good one? Is there a demand for it? Do you have evidence of this – e.g. factors affecting demand, competition analysis etc – make it up to make it sound realistic. Would it face much competition? Would people come to your business other then competitors? Why? Do you think the business will gain much market share? The success of the business is a function of the business acumen of the management and the viability of the business proposal in relation to the given facts, both internal and external. Assuming the figures are correct, we have to presume that there was a demand analysis that was previously made otherwise there would be no basis to make the sales budget. Competition is also an external factor that the company may not control. A business entering an industry must accept the reality of competition. When we say competition there are other companies offering the same products and services as our business. Since our business approximates that of a restaurant business, other restaurants in the vicinity where we are going to our business are presumed to exist. This is the reason why location of a restaurant business is material if not paramount consideration in this kind of industry. One reason for this truism in restaurant business is that restaurant must follow where people go. Customers want accessible, secured and convenient place to go, good, nutritious and safe food to eat, and affordable prices and good service from restaurant employees, of which players in industry should continuously find out to get the loyalty of customer. 2. Would it face much competition? Would people come to your business other then competitors? Why? Do you think the business will gain much market share? As far as competition is concerned, it is a function of the profitability of business. Business people engage in business because they believe they have a better use of their money than keeping them in the banks. The fact that the return on assets (ROA) of the business is 105.5 % would indicate that it is earning and therefore competition is expected. (See appendix A) As to whether customers would prefer my business as compared to my would-be competitors is a function of value to them. Are my prices reasonable? Is my food good? Is the place of my business convenient and accessible? Is my service of quality desired by my customers? These are some of questions that every customer asks and the questions also that a business have to answer if it wants to stay in business that I choose. 3. Make a realistic and detailed judgment about the financial viability of your financial plan. E.G. are the financial forecast based on realistic figures? Does the breakeven chart show that it is viable or not? Are you likely to breakeven? What is your margin of safety? Does the cash flow show that it is viable or not? Does the profit and loss show that it is viable? Does that business make enough profit? Does the business generate enough income to live off? Whether the financial figures in the forecast are realistic is also influenced by external and internal factors. External factors refer to the selling price of the product and to the purchase price of things that I need in business. If they reflect market prices, they should be taken with realism. The best way to do this is take a product and check its price in the market. For example, take the price of Mediterranean Starters for 3 pounds. If this is competitive and affordable then it is true. If all other items are truly reflective of reality, then there is basis to take the assumption as realistic. As to the purchase budget there is estimate as to number of kilos of meat that will be bought and in the absence of price of meat to estimate the validity of the assumed quantity, we can only assume that they are correct. The same is true with the catering suppliers. There was no breakdown as to how many and how much each item cost, hence we can only assume. As to the internal factors, it is a function of internal analysis and consistency of the figures. Based on the ratios produced and the relationship of accounts to other accounts, there is no evidence to grossly indicate that they could not happen and there they may be taken as reasonably realistic. Therefore assuming the figure is correct because the assumptions are realistic, there are enough bases to say that the business is viable. Under the cash flow statement appear the positive cash balances at the end of very month and its cash inflows tally with those in the sales budget and the profit and loss statement and its cash outflows tally with those of the purchase budget and the overhead budget, therefore, there is basis to agree with its consistency. 4. Ratio analyses - evaluate the business plan accurately using appropriate evaluation tools. Calculate the return on capital employed and gross and net profit margins for the business. What do these shows - explain? Comment on the ability to reward and repay investors. The profit and loss statement also indicates high level of profit with annual net profit margin of 46% return on assets of 105.5% and return on equity of 111.68% (See appendix A). Such level of profitability is too hard to refuse. One item that must not be missed out however is the inclusion of loan repayments as part of expense under the profit and loss. Unless it represents interest expense for borrowing in the amount if £ 15,000, such should not be part of expenses but only part of cash outflow. Assuming the profit and loss will be adjusted, net income will further increase hence making further profitability. As earlier explained, net profit margin of 46% means that for every group of customer spending 10 pound, the business entity earns 4.6 pounds. The return on assets is very attractive at 105.5%, indicating that within a year, the business more than earns what it manages in terms of asset for the year. This indicates a remarkable manager which exhibits maximum utilization of assets employed in business. The high return on equity at 111.68% shows that Star of India would more than please its investors If we assume that the loan repayment of £ 4,274 for the year as interest expense for the £15,000 bank loan, and therefore an assumed interest rate of 28% (by dividing interest by the amount of principal), and assuming that is the cost of capital (which is of course too high in UK) the business will exceedingly perform well at return on equity of more than 100%. (See appendix A) 6. Include viable marketing, production and financial alternatives in your assessment of the business plan, based on your understanding of the financial information generated by your evaluation. – when including alternatives it must be based on the financial documents and this must be the most detailed of all – up to 1 and half pages. As to marketing viability, this is an external factor. Taking from industry news that almost 90% of restaurant business in UK is independently owned (BBC News, 2000) is good news for us since our competitors are not big companies that have so many resources to unleash so as to defeat us in competition. It also confirms are earlier theory that restaurant is an influenced much by the location of the business. The production aspect is a function of the capability of the business to really deliver the product or service. We must make is sure that we have the place for our business; that our equipments, utensils, furniture and other fixed assets investments are functioning well as designed. We must also have our employee’s commitment and competence to deliver the goods and service to customers specially those in charged of operations. The viability of the financial alternatives would seem to give us the go signal given the profitability of the proposition. The alternative that we have will be the bank interest for funds invested at Star of India would have. Hence our decision to pursue the restaurant business of Star India must really take into consideration the opportunity cost of just having the money at the bank at a given interest rate. Bibliography: 1. BBC News, (2000), UK tourism looking for tips, {www document} URL http://news.bbc.co.uk/1/hi/business/698572.stm, Accessed March 12,2006 2. CPAClass.com, (2006) Financial Ratios, {www document} URL http://cpaclass.com/fsa/ratio-01a.htm, Accessed March 12,2006 Appendix A Ratios Net profit margin = Net Income/ Total Revenues 286802.9 46.00% 623459 Gross Profit margin =gross profit / total revenue 468525.3 75.15% 623459 Return on Assets = net income/ total assets 286802.9 105.52% 271802.9 Return on Equity = Net income/ total equity 286802.9 111.68% 256802.9 Read More