Managing Finance - Assignment Example

Managing Finance Question 1 b) David and Ruth advise you they are unsure about forming themselves into a partnership for business purposes or operating as a limited company. Advise them of the advantages and disadvantages of both and give your opinion. Answer: Every business reaches a stage where critical financing decisions are needed. The decision to finance your company by debt is dependent on factors concerning economic viability of both options. Another critical factor in this decision is psychological contract of entrepreneur. Many entrepreneurs want to keep a control on their company and do not want to expand at the cost of reducing control. Partnerships offer a chance at sharing risks of the business. Special clauses in partnership contracts can limit involvement of new partners and keep them as ‘sleeping partners’. On the other hand limited companies can limit an owner’s stake in a company. This would mean that incase of bankruptcy an owner will not be liable to any litigations. There are two common types of limited companies private limited companies or public limited companies. Limited ownership companies give entrepreneurs minimum control of operations and decisions. Usually a board of directors elects or appoints a CFO and CEO. In bad economic conditions a limited company can be very beneficial for entrepreneurs as they will not have to pay any dues in case business goes bad. If a business has a very low risk and entrepreneur believes that this will continue for the foreseeable future, than a partnership is more suitable. Partnerships disburse all their profit to the few investors but are not a good option to raise large amounts of capital. For this business partnership is a good option because government has strict controls as to which companies are allowed to become limited companies. A Partnership will help them expand the business, keep control and share risk with a financially stable party. c) Advise them of your opinion on the viability of their business plan including comment on any payments they have omitted to include and any other risks they need to consider. Answer: There are some facts about this business plan which give it viability. First of all the gross profit margin is high at 40% percent. This is always an indication of a good business opportunity. Secondly startup investments are very small; this means the business is liquid. Vehicles are very easy to salvage and rental building keeps initial investment outlay very minimum. Moreover the business is showing positive cash flows only after five moths which show that there is enough growth potential in the business. The food market is always a good market to invest as there is always a consumer base. They have omitted payments for taxes which is a significant amount. Moreover expenses have been taken as period cost whereas most expenses are variable in nature. For example the cost of operating a vehicle will rise with increase in sales. This is because as the number of sales increase so does fuel cost and maintenance cost on vehicles. Moreover utility expenses will also rise with increases in sales. As more sales will be made there will be more telephone calls to customers and suppliers. The electricity bill will rise with sales because increased sales will require more production and machine use will require more electricity. For these very reasons they must include variable costs for these items. Every business is affected by inflation. Although it is commonly believed that increases in input costs can be transferred to customers by increasing sales price, this is however not always the case. Increasing sales price can lead to significant reductions in volume. They must also take into account rising fuel prices which will drive up their transport expenses. The increases in fuel prices and inflation will also force them to increase their withdrawals. Another very important factor ignored by them is labor cost. They will need expert labor to operate their machinery and a driver to drive. Even if we assume that initially they will carry out these tasks themselves, as the business grows they will have to hire new labor. Question 2 At a senior management meeting recently a newly promoted manager, Susan, noticed that spending on furniture, IT and staff training went up sharply at the end of the year. She was told that this was when managers spent remaining monies in their budgets. Susan replied that she thought this was not sensible as money was wasted. Everybody at the meeting agreed but said it was an inevitable consequence of budget systems and that she would be doing it herself soon. Using a model of budgetary control and your understanding of the behavioral implications of budgets, advise Susan whether you think such behavior is inevitable. Answers Budgetary Control is the management function of forecasting budgeted figures for an organization and then comparing those with actual figures at year end. This is basically a control mechanism; at year end performance reviews are made on basis of targets achieved. This is the basic reasons why managers try to reach these targets because performance appraisals are linked closely with budgetary targets. The budgetary control model starts with creation of a master budget which is aimed at preparing all the financial activities for a specified period of time. Various elements in this budget are however forecasted, such as sales, cost and various other economic factors. The management allocates budgets to be spent on activities which ensure future growth for the organization. However sometimes these targets are not met and there is leftover cash. If we assume that Susan was working in Research and Development division, than if an excess R&D budget is leftover it will be assumed that not enough was spent on R&D. This lack of spending will lead to bad performance reviews for managers involved in decision making for Research and development division. They however try to spend extra cash as mentioned on activities that are not providing any significant advantages to the company. Susan is right in her argument. As a senior manager she must take action against all these managers who are not doing their job properly. Excess spending on IT is not the solution to not meeting budgetary targets. Therefore management action must be taken against employees who could not meet budget targets and tried to falsify information. Question 3 Published financial accounts are there to serve a variety of users. The income statement and balance sheet of the Burberry Group* (a well known, high end clothing company) are given below. For each of the three users below, select the five ratios which you think provide the most important information and explain the reasons for the selection. a) A potential investor Answer: Profit margin This is a very important measure of viability of an investment. Profit margin is basically the difference between selling price and input costs. This is thus the amount that a company actually retains after paying for its expenses. Investors want to maximize their wealth by investing in companies therefore higher profit margins are very important from their perspective. Industries with naturally high profit margins are attractive to investors. Therefore if a corporation has a small profit margin it will not be a good investment. Return on equity This is a measure of what return the company is generating with the investments given to it by its investors. Equity is basically what investors have contributed to a firm in terms of cash. Return on equity is a comparable figure. An investor when making an investment decision can compare return on equity to other options and judge the best option for investment. Return on investment should therefore be as high as possible from an investor’s perspective. Current ratio It is the most common ratio and reflects the working capital situation. This ratio basically reflects the management capability of a firm. If current ratio is very low an investor gets the signal that cash and short term assets are not being managed effectively. This is a very bad sign from an investment perspective and would revoke an investment decision. Earnings per share The most important ratio from an investor’s perspective shows how much return the company is actually earning. It is calculated by divided total earnings by number of shares outstanding. This can give an investor a very easy method of calculating amount he will earn on each share bought. Dividend payout ratio Some investors are more interest in dividend rather than capital gains. For such investors dividend payout ratio shows how much is being disbursed as dividends. b) A potential employee Answer Retention Ratio The retention ratio is a very important ratio from an employee’s perspective because it gives an idea that what portion of earnings is being kept from investors. If retention ratio is high employees can expect less bonuses and smaller increments. Sustainable Growth rate Employees interested in a long term career can be very interested in sustainable growth rate. Usually sustainable growth rate is a reflection of the growth an employee can expect. A company not growing itself will not be able to provide growth opportunities to its employees. Profit/Employee This shows what profit a firm earns per employee. As profit earned by employee increases so does chances of getting raises and bonuses. Firms with low profit/employee are more interest in layoffs because it’s a sign of overstaffing. Quick Ratio The quick ratio holds significance because it shows if a firm is capable to pay its employees on time. Low quick ratios show bad cash management and little scope of bonuses. Capital Employed/ Employee This ratio reflects if there is room for growth in a firm. If this ratio is very small it usually means that there is not enough room for growth for n employee. c) A potential supplier Answer: Creditor Days As the name suggests this ratio tells how long it takes a firm to pay its creditors. Most suppliers do business on credit, if this is too high than it’s an alarming sign for suppliers. Inventory turnover A low inventory turnover suggests that the business is not converting its inventory into sales. If a business does not convert its inventory quickly enough into cash it would mean that it would need a longer credit period. Most suppliers do not give a credit period of longer than three months therefore they need to see inventory turnover. No of days payable This ratio shows the number of day on average taken to pay suppliers. A large number of days payable would suggest that business takes a lot of time to payback its suppliers. Quick ratio This ratio reflects the cash situation of a business. If quick ratio is very low it suggests that business doesn’t have enough cash and might be facing cash flow problems. Companies with low quick ratios are usually avoided by investors as they are not able to pay back their debts on time. Gross Profit margin Suppliers usually calculate this ratio as well to get an assessment if the business model of their buyer is viable enough. If this ratio is very low there is the risk that business might face financial problems. d) Select one only of the sets of ratios and write a report to the user concerned giving information on how Burberry has performed over the period shown and provide an opinion on whether the individual should enter into the suggested relationship with them. Your report should also point out any further information which needs to be considered. Answer: Ratios   Profit margin 0.554141 Return on equity -0.0011 Current ratio 1.357718 Earnings per share 30.2 Dividend payout ratio - The business is a good for investment. The alarming ratio is a negative ROE. This is basically because there was a £ 116.2 million charge for goodwill impairment. As this is a onetime charge it should not be included into investment decision. The high profit margin of almost 56% shows that the business is a very attractive investment opportunity and will show future growth. The current ratio is also promising and shows that the business will not face any problems in the near future when it comes to financing in short term. Moreover there is almost a £200 million increase in revenues which is also a promising sign. There are however some information gaps. As there was no statement of cash flows, we cannot calculate actual cash performance for the period. This has also disabled calculation of dividend payout ratio. Ratios are most useful for comparison purposes. The investor should benchmark these ratios with industry averages before making any final decisions. Read More