Sources of Finance and Financial Planning - Case Study Example

Table of Contents Case: 1 Stubbs Rubber Ltd. 3 Introduction 3 Discussions on Each Sources 4 Bank Loan 4 Bank Overdraft 4 Merits of Bank Loan and Overdraft 5 Suggested Alternative Source of Finance 6 Recommendations 6 Case: 2 Calcula Ltd. 7 Introduction 7 Identifying and Assessing Appropriate Sources of Finance 7 Recommendations 9 Case: 3 Pedan Limited 10 Introduction 10 Evaluating the Different Sources of Finance 10 Recommendations 11 Case: 4 13 Financial Planning 13 Importance of Financial Planning 13 Analysis of Financial Reports 13 Assets 14 Liabilities 15 Income and Profit Loss 15 Application and Use of Appropriate Techniques as a Means of Investigation 17 Conclusion 18 References 19 Bibliography 20 Case: 1 Stubbs Rubber Ltd. Introduction Companies are exposed to financial sources for expanding business by means of scheme funds, bank borrowing, loan stocks, issuing new shares or right shares in the capital market, government sources, retained earnings, by means of venture capital, or through franchising (Food and Agriculture Organization of United Nations, n.d.). All these are the sources of finance or it can be said that these are the way to accumulate fund for the machinery but instead of seeking these sources, the owners should find out a way of minimising the burden through credit facility and other similar options. Hire purchase is one of the ideal options for owing the machine. It denotes a fixed period installment loan which is secured by the purchasing item as collateral. In this case the buyer has the possession of the assets but not the ownership during the period of repayment. Again leasing can be proved to be another suitable option as with this mechanism the owners need to obtain only contractual, tax deductible and periodic payment. Discussions on Each Sources Bank Loan Bank borrowings are a vital financial source to the companies. Short term loan for up to maximum of three years may be in the form of an overdraft, where interest is charged at a variable rate on the principal amount. Medium term loans are generally for the period of three to ten years. The rate of interest thus charged for a medium term loan will be a set of margin that depends on the credit standing and the riskiness of the borrower. Briefly, banks loan is offered with a fixed amount for a fixed term with regular fixed repayments. The interest of loan for a simple bank loan is always less than interest paid for a bank overdraft (Food and Agriculture Organization of United Nations, n.d.). Bank Overdraft A bank overdraft is a form of a settled cash-borrowing limit prearranged with a bank. It furnishes a flexible way of managing cash flows and there by provides one with short-term funds if one doesn’t have adequate money (TheSite, n.d.). Merits of Bank Loan and Overdraft Bank Loan Overdraft Larger amounts can be borrowed. There is a wide flexibility for changing the amount borrowed within the limits. Interest rate is lower and, Regular repayments help to plan cash flow. Interest is paid only for the borrowed amounts. (Tutor2u, n.d.). Suggested Alternative Source of Finance The company is currently having an overdraft facility of £3, 00,000 which is on unsecured basis. And the company is willing to go for medium term loan for a repayment period of 10 years for an amount of £2, 00,000. As a means of sourcing finance overdraft chosen is perfectly all right since there is a larger flexibility on both the amount borrowed and interest paid. But alternatively, hire purchase can be suggested being a form of installment credit which will help the owner of the company to afford the machinery with a facility of smaller amount of repayment over gradual period of time with absolute ownership at the time of final payment of credit. A second alternative ‘leasing’ can be suggested other than hire purchase. Although same as hire purchase with the only exception that in leasing the ownership of the goods is not obtained as in hire purchase. But the downside to this approach is that there is a probability of complexity in future as there may be conflict between a lesser and a lessee out of discrepancy. Also in lease, the ownership of goods is not transferred and it is costly as compared to the other. Recommendations After analysing the situation of the company, it can be suggested that comparatively hire purchase is the superior option as the owner will get the ownership after a certain period which is not possible in case of leasing. Most importantly the owners need not to utilise the overdraft facility for a long period or to take loan from bank. Case: 2 Calcula Ltd. Introduction Calcula Ltd performed very well in terms of profitability in its first year of operation itself. It is also evident that the company has a strong customer base. Even the company has enjoyed a good flow of order from the customer side. Therefore it is quite obvious that they do not have any issues related to working capital but the company is lacking in terms of capital and fixed assets. Identifying and Assessing Appropriate Sources of Finance It is very essential for any business to identify the various sources of capital that are available and to assess the appropriateness of the selected source for the business. Sources of finance are mainly classified into two which are internal sources and external sources. Among the internal sources, the various types of finances available are like; personal savings, retained profit, working capital and sales of assets. The external sources are again classified into two which are ownership capital and non-ownership capital. The ownership capital includes ordinary shares and preference shares. Whereas the non-ownership capital includes debentures, overdraft facilities, hire purchase, other loans, grants from government, lines of credit from the creditors, venture capital, factoring and leasing. Calcula is a public limited company and hence it has a wide opening towards selecting financial sources. The company has shown an outstanding performance in its first year as it has made a turnover of £5, 00,000. The business has been very successful and its customer base has increased rapidly, putting a strain on its working capital and administrative resources. In this situation, the appropriate source of finance that should be selected by the company will be to use the retained profit. (Bized, 2010). Company may pay dividend out of retained profit. The company should use its surplus retained profit in order to meet the regular working capital or to buy new equipment or pay dividend. By using the retained profit, the company will also be able to minimise the issue of cost. It will also help to avoid chances of change in control that may result from an issue of new shares. The proposed company must confine its self-financing in the course of retained profits since its shareholders should be paid a sound dividend, in order to the practical expectations, yet if the directors would relatively maintain the funds intended for re-investing. In this way the selected source is appropriate to above context. Recommendations Apart from all these another two suitable factors exists and those are factoring and invoice discounting. Both of these will be proven as a good option as the company has experienced huge orders and loads of receivables. In simple terms, both the mechanism can be considered as the sale of receivables. Factoring can be referred to as the assets securitisation and a way to finance the company. In this case finance companies use to collect the debts on behalf of a company and keep the interest. But in case of invoice discounting the administration of collection of the receivables do not use to change. Now after analysing the nature of Calcula Ltd., it can be suggested that invoice discounting will be the best option for the company. With this method privacy will be maintained. Even their valuable customers will not feel disturbed for different kind of reminder alert from an unknown company and Calcula Ltd. will also able to accumulate a huge fund at the same time and can raise their capital simultaneously. Even as per the views of many scholars invoice discounting is an appropriate option for an organisation like Calcula Ltd. which is having a huge customer base. Case: 3 Pedan Limited Introduction The formation of a private limited company (Pedan Limited) requires an estimated capital of 250,000 pounds. The objective of their business is commercializing a new technique invented by them intended to enable scientists to identify and capture DNA through a process of amplification. It can be assessed that the type of work requires a heavy investment and technology would assist the work for advanced outcome within lesser time. Evaluating the Different Sources of Finance Pedan limited can be exposed to bank loans, government grants, and venture capital as a source of financial capital. Each is discussed below: Loans (Mainly From Banks) The proposed company can opt for bank loan as this is the most easily available sources of finance and is also affordable for any business in their start up phase. Banks may ask for collateral against loan. Being into the scientific innovation business the proprietors may provide some assets for instance private laboratory in this case in which the owners work on their innovations. Government Grants Pedan Ltd. may go for government grants initially. The government has an interest in assisting small firms, especially the one using environmentally beneficial production methods, business related to scientific innovations and any businesses that will set up and create jobs in areas of high unemployment. Also, the business purpose of the company is widely exposed to the government grants. Venture Capital The venture capitalists are the fund managers who usually invest amounts of £100,000 to £2 million in promising new business ventures. The business of the company is in the domain of one of the highly valuable businesses as it deals with the scientific work and hence draws the attention of the venture capitalists at large. The venture capitalists will seek to make a profit by investing when the firm is new, seeing the business become successful and grow, and then selling the investment at a high price. Recommendations It can be recommended that loan from a government bank will be apt selection as it will also enhance the scope of acquiring government subsidies and grants. For this the company needs to prepare a project on which bank will again conduct the feasibility study. The procedure might be complicated but it can be ensured that bank will definitely grant the loan for such a valuable and innovative initiative. Even the proposed way will also be helpful for qualifying the criteria to get the government subsidy. Case: 4 Financial Planning Financial planning is the process that is being represented before an individual, an organisation, or even a country by presenting current financial position and the essential adjustment in the spending pattern in order to meet the goals. Importance of Financial Planning Financial planning is the most significant part of any business. This acts as a guide for overall business operations. Financial planning presents a structure that paves the way on how finances will be handled within the organisation. Analysis of Financial Reports It is through a financial plan that the financial reports are analysed. Financial planning is otherwise impossible without analysis. Whenever a business examines its financial records, it's able to see the growth and present condition of the business. Financial planning helps to compare different situations and allows for a detailed understanding of how cash is earned and expended in the business. For instance, in the case studies analysed above, it is observed whenever a company requires funding either through fresh capital, further capital for start up or expansion the background of the business is analysed at the outset. A bank will sanction loan amount only after the financial reports of a company like in case of Calcula ltd which made a turn over of £ 5, 00,000 in its first year that satisfied the bank in providing finance. Assets It is through an efficient financial planning that the valuation of assets in a company is best monitored. Since the financial reports hold records of the expended, earned and remaining assets, financial planning becomes crucial in keeping an up to date record of the company’s resources. With the help of financial planning the current assets, the fixed assets, and the tangible assets of the business are analysed. The valuation of assets through financial planning is important as in times of need or liquidation or as a means of internal financial sources these assets can be sold out for assistance. Again bank may ask for collateral before providing loan thus asset valuation is very significant for any company. Liabilities Just as the financial reports hold record of the assets of the business, they also hold a detailed report on the liabilities of the business. A proper financial planning is required to analyse the company’s long term debt and owner’s equity and current liabilities. The same assist the business to maintain track of the liabilities that is due in close proximity to future and also assist the company to sketch the finance and allocate its resources to its debts before they create any trouble for the operation. For instance, in case of Stubbs Rubber Ltd there is an overdraft of £300,000. And this is required to be valued while seeking any further financial assistance from banks as there are certain limitations on the overdraft facility. Income and Profit Loss The financial planning requires reviewing the financial reports in order to encourage an understanding of profit loss and income. This is significant as it helps the business entities to identify its sales or revenue, net income, gross profit, operating expenses. With the clear understanding of all these factors, a venture can be analysed whether it is profitable and need any improvement. Pro-Activeness On examining the financial reports through the process of financial planning, different conditions like problems, losses and gains can be predicted. Thereby it increases pro-activeness of the business as a whole. Financial planning enables the top management level to think and re-think about the current situation of the business and likewise realise several business opportunities through financial planning (eHow, 2010). Application and Use of Appropriate Techniques as a Means of Investigation This section will discuss about the various tools that are available to prepare a financial plan for the development of a business. The various tools or techniques for investigating the financial status of a business are discussed here under: Basic Financial Statement – This comprises of the balance sheet and statement of income analysis. Ratio Analysis – This is a means by which individual business performance is compared with its competitor’s business. Statement of Income – This is used in order to forecast future probable income. Break-Even Analysis - A method allowing the small business persons to calculate the sales level at which a business recovers all its costs or expenses. Cash Flow Statement – It is a budget statement that reflects the cash outflow and cash inflow to a business. Pricing Formulas and Policies – This is utilised in order to compute profitable selling prices for services and products of a business. The business owner/manager utilise these concepts in order to control the evolution of the business in an effective way practices sound financial management thereby increasing the likelihood of success. Conclusion From the analysis of provided four cases, various sources of funding for different requirements have been determined. All the four cases were different therefore proposed procedure was also varying. Now, the overall analysis can be summarised in respect of cases. For purchasing any fixed assets for an existing company hire purchase mechanism can be applied. In case of a well performed company in terms of profitability, facing deficiency for capital and fixed assets should obtain invoice discounting as a tool of utilising the receivables. Again in case of research work or any other operation which may have environmental and social value can also seek for government subsidies. These are the ultimate findings from the cases and justification of selecting these mechanisms had been described in the previous discussion. References Bized, 2010. Sources of Finance. Financial Accounting. [Online] Available at: http://www.bized.co.uk/learn/accounting/financial/sources/index.htm [Accessed November 04, 2010]. eHow, 2010. The Importance of Financial Planning for a Business. Business Financial Planning. [Online] Available at: http://www.ehow.com/about_6811455_importance-financial-planning-business.html [Accessed November 04, 2010]. Food and Agriculture Organization of United Nations, No Date. Bank Lending. Chapter 7-Sources of finance. [Online] Available at: http://www.fao.org/docrep/w4343e/w4343e08.htm#bank%20lending [Accessed November 04, 2010]. TheSite, No Date. Overdrafts. Money. [Online] Available at: http://www.thesite.org/homelawandmoney/money/creditanddebt/overdrafts [Accessed November 04, 2010]. Tutor2u, No Date. Bank Loans and Overdraft. Finance. [Online] Available at: http://tutor2u.net/business/gcse/finance_bank_loans_overdrafts.htm [Accessed November 04, 2010]. Bibliography Ethix, 2006. The Financial Planning Industry Is Based Upon A Six Step Process Designed To Ensure A Successful Outcome. Six Step Process. [Online] Available at: http://www.ethix.co.za/info.php?cpc=102 [Accessed November 04, 2010]. Gowthorpe, C., 2005. Business Accounting and Finance for Non-Specialists. Thomson Learning. Rice, A., 2003. Accounts Demystified: How to Understand Financial Accounting and Analysis. Prentice Hall Business. Tuller, L. W., 2007. Finance for Non-Financial Managers: And Small Business Owners. Adams Media. Read More