Bussines Accounting - Report Example

Part 1. An Overdraft facility Overdraft facility is provided by banks to s when a firm makes payment from its business current account/cashcredit account more than the available cash balance in the account. This is a type of short-term lending obtained by the firms though the loan availed by overdraft facility is to be paid on demand of the bank. The important aspects related to bank overdraft are as follows: The amount borrowed under the overdraft facility by the firm should not exceed the limit agreed between the party and the bank. The bank charges interest on overdraft above its base rate. It is charged for the period till overdraft is availed. Some banks also charge a fee for overdraft facility. It should be noted that an overdraft is specifically meant for short-term requirements of a firm and it does not act as a long term capital. Sometimes the bank asks the firm to provide a guarantee and security to the overdraft availed. As discussed above that overdraft facility is primarily availed for short-term liabilities like accounts payable, so expanding the business through overdraft is not a good plan. 2. A long term loan from financial institution This is a most common way in which SME’s expand their business. As SME’s don’t have the luxury of raising money through issuing securities, the most prevalent way is to take a long-term loan from a financial institution. A business term loan is the most prevalent loan for this purpose. The bank would require financials of the firm for 3-5 years at least and with a guarantee to mark lien. A loan from bank would be passed if the current financial condition of the firm is good and acceptable to bank and the purpose for which you are taking a loan is justified. The minimum rate at which a long-term loan could be financed is a base rate of prime lending rate. However the actual rate at which ban sanctions the loan could be higher than that depending upon the risk bank is taking in investing, the amount of loan availed and the credit history of the firm. I would suggest my friend to expand by the way of obtaining long term loan from a bank. This also provides significant tax shield. 3. A Finance Lease Agreement A lease agreement is considered as the agreement between the owner and the party intending to use that property conveying the right use of the property. Lease does not includes contracts for services, exploring and exploiting natural resources and licensing agreements for items like patents and trademarks. The advantages of leases are as follows: Immediate cash outflow is not required by the lessee for leasing the asset. A purchase option allows the lessee to obtain at the bargain price at the expiration of the lease. The lessee is able to obtain 100% financing. Flexibility for use of funds for tax benefits. Leases can also be structure for allowing manipulation for calculating tax benefits at the end of the year. Though lease remains an important source of expanding through leasing property, plant and equipment but the clauses in lease can go against and it can be used for buying PPE only. It cannot be used for financing current assets of the company 4. A hire purchase agreement for the necessary non-current assets required in the expansion Hire purchase is considered as the term for a contract wherein a firm or an individual agrees to pay for the goods in installments, parts or in a percentage over the period of time. This looks somewhat like leasing for goods and services. In comes into effect when a firm cannot pay for the property at once but is agreeing to pay in installments for the same. It is recommended to go through hire-purchase for financing non-current portion of assets. 5. Formation of a Partnership Another way of obtaining finance for a firm is through formation of a partnership. Though this looks a good idea at one but lot of things are to be taken consideration off. Firstly, forming a partnership will bring money in the business which is required for expansion but it will dilute the holding of my friend. Suppose a partnership of 50:50 is done, then his holding in his company will be down by 50% straightaway. Secondly, as this is not a new business and my friend has been operating it for past few years, the new partner may not be able to understand and get well versed with the concepts. The better way according to me is to issue preferential shareholding to 2-3 people @10% for each rather than making a partner. This will encourage more sensible and knowledgeable investors into the business. So the formation of partnership might bring money to the business but according to me, it will not work well for my friends business. Therefore, according to me raising capital through long term loan from financial institution is the best way to raise money for my friend. Part 2 Four characteristics stated by IASB for the usefulness of financial statements are relevance, reliability, comparability and understandability. These are explained as follows: 1. Relevance: This means that information should be relevant to the decision-making needs of the user. Information is relevant as it influences the economic and technical decisions of the users. The information disseminated should be relevant to the decision making needs of the users. The financial statement of a company should be relevant enough to present the information that is relevant for its investors and users. 2. Reliability: Information in the financial statements must be reliable. Reliability refers to the extent in which the information presented in the financials is representational and faithful, verifiable and neutral. The financial statements of a company should be such that the information presented in it should not favor a particular group but should be reliable for all class of investors and groups. 3. Comparability: Comparability is regarded as the ability to see similarities as well as differences along the events and conditions. The users of financial statements, may it be investors or competitors should be able to compare it with that of the financials of the competitors, company in other industry and even industry averages. To be comparable, information should be presented in the standard format which should make sense to its users. 4. Understandability: The information should be understandable to the user even with not much of accounting and technical knowledge. It should be understandable to all class of users. The company should provide understandable information helping the investors, potential investors and creditors in the process of predicting future cash flows of the firm. Since the expectation of the firms future cash flows affects its ability to pay interest as well as dividends, also affecting market price of the firm. Therefore the information will be understandable enough to all the stakeholders of the firm. References Bhattacharya, S. and A.V. Thakor (1993). Contemporary Banking Theory, Journal of Financial Intermediation 3, 2–50. Berger, A.N., R.J. Herring, and G.P. Szegö (1995). The Role of Capital in Financial Institutions, Journal of Banking and Finance 19, 393-430 Andrade G. & Kaplan, S.N., How costly is Financial distress, Journal of Finance, 1998. - 53. Bragg Steven M. Business Ratios and Formulas, John Wiley and Sons, 2007. - Vol. 3. Daves Eugene F. Bringham & Phillip R. Intermediate Financial Management, Thomson/South-Westren Publishers, 2007. - Vol. 9. Gitman Priciples of Managerial Finance, Pearson Education, 2007. - Vol. 11/E. Hussain, A. A text book of business finance, East African Educational publishers Ltd., 2006. Myers, S.c. & Majluf, N.S., Corporate Financing and Investment Decisions when firms have information that investors fo not have, Jouurnal of Financial Economics, 1984. - 13. Read More