Managing Financial Resource and Decisions - Coursework Example

Running Head: Managing Financial Resources Managing Financial Resources and Decision of 17 May 2012 1. Introduction This paper seeks to accomplish, from the point of view of the owner, the following: (i) to explore the sources of finance available to a business, (ii) to analyze the implications of finance as a resource within a business, and (iii) to analyze and evaluate financial performance of two business entities using given financial ratios and make recommendation as which of them should be chosen as an investment option. 2. Analysis 2.1 Task 1 - The business . 1 Describe the type of business and its ownership. This should include: The businesss name, the form of business organization (Sole trader, partnership or limited company) The business will be named as ABC Company and the same would be limited company as the same would be better than sole trader and partnership because of the limited liability of the owners as an overwhelming advantages as against the first two Limited liability, as name of suggests, would involve less risks for owners compared to sole trader and partnership. Sole traders and general partners can have their separate properties answer for the liabilities of the business organization because of their unlimited liability when the business entities go wrong There is also anonymity, in the limited company as one can appoint nominee officers in said business organization. Such anonymity can be an advantage as to keep some sense of invincibility in some aspects as compared to revealing many possible weaknesses to those who are interested with the company. As compared with a partnership, many problems can be avoided in case of limited company. This would include defining who is in charge and who should own the business and in cases of resignation of a partner that could disrupt the business. Another advantage over the sole trader and partnership could come from better credibility brought from better transparency and certain anonymity in the market place. The effect of this could be some degree of ease in raising loans for the business. Lower tax liabilities compared to a sole trader could also arise. While a sole trader’s tax could reach as high as 40% of net profit, an owners of a limited company can so drawing a salary, which could in effect an avoidance of tax for a higher rate can be avoided Limited liability as an organizations are not without some of the disadvantages however. One is chance of ownership of assets being locked up in the company. There is also less privacy and more transparency because of the need to register companys accounts, officers and shareholders at Companies House. 2.2 Task 2 --The initial cost. Provide detail of items of expenditures you will need to obtain before you start trading. State how much capital will be needed on commencement, and how and where this initial finance would be obtained. Investigate a range of different sources of finance and comment on how they compare. State why the chosen sources of finance are appropriate for your business. The details of expenditures that that the owner would need to obtain before he/she starts trading include the following. He/she would need to spend for the place to rent. He/she would need a land and building which he/she can either buy or rent. In addition, he/she would need of course to buy for inventories to sell. He/she would need to pay for the salaries of sales and store personnel. Basically the amount of capital would be guided by the amount of revenues that the owner could be making per period. The higher the expected revenues, the higher would be the need for expenditures as the same could mean higher space to place goods for sale and serve the customers. The expenditures there could include but capital expenditure and non-capital expenditure. The different sources could come from my investment which can either be in the form of cash or property. Another source from loans which can come from suppliers who will sell the goods on terms. Thus there is need for start-up expenses, start-up assets and start-up financing. There are expenses that occur before the beginning of the plan, and the same would be called start-up expenses before the first month. New companies should spend expenses for legal work, brochures, site selection and improvements, and other expenses to keep the business running (Kieso, et al, 2007). The need for start-up assets cannot be discounted, which may take the form of e cash or the money in the bank when the operation of the company begins. The need to have starting inventory is simply a must as the business of trading simply requires what need to be sold to customers. Other starting assets may also take form equipment, office furniture and machinery. Thus this start –up times would be basically financed from both capital investment and loans. The source of financing where investment of loan would have to be chosen on which is more appropriate. Choosing investment alone over that loan alone may be more possible than vice versa but the best one would be a combination of the two. As to level of combination would have to be decided in terms of the leverage position of the company in relation to is need to be perceive as not too risky for other investors to the company. Too much equity is not good as it would mean losing a chance to user other’s money that could maximize profit for the company. Task 3. -- Financing everyday activities. Provide details of your business costs and how you intend to finance them. State why chosen sources of finance are appropriate for the above venture. The details of the owner’s business costs would include the cost for inventories which must be replenished everyday considering that the retail business would entail such thing. To finance them would be best served by having a good source from suppliers. Thus normally the best financing is available is the accounts payable financing as the same will have to appear as Accounts Payable account in the balance sheet. This can be of course complemented by bank borrowing from banks and other financial institutions. Note that the Accounts Payable financing are from suppliers while the latter financing is from banks. This second sournce would therefore be involving the use of interest expense. Thus everyday financing would be best finance from the most efficient sournce of working capital funds from the suppliers and lenders. If the owners cannot supply the same from the said source, the financing could still come from additional investment as compared with the initial investment. The investment could appear as Paid-in capital in the balance sheet. Should there still be insufficiency, financing can come from other sources like friends and family members could come as a result. If the same is still not sufficient, the owner can still opt for long-term financial like borrowing from long-term loans if the everyday need would need some capital expenditure that would to require the need to purchase long-term assets. Task 4) --The cost of finance. For all types of finance you have selected, provide an analysis of the financial and non-financial costs of obtaining this finance. State advantages and disadvantages of each selected source of finance From the types of finance as selected, there is need to provide an analysis of the financial and non-financial costs of obtaining this finance. The financial cost of obtaining loan as sournce of finance would include the interest expense as cost of money. Seldom loans are borrowed that do not bear interest expense. Sometimes interest expense could be very high as banks could require higher interest expenses for riskier loans. Thus the higher the amount that would be borrowed, the higher would be interest expense. The non-financial cost would include the burden of having to face the risk of bankruptcy as one gets more into loan rather than equity financing from the owners. One selected source of finance is the equity financing where the investors would just opt to bring his/her assets into business like cash, properties and other investments. There is the advantage of better credibility in the eyes of customers as one would be more willing to face risk in the light of the uncertainty of the business. The financial cost of this source is the implied need to provide earnings from the investment. In limited liability Company, one can opt to have earnings taken from the company as a way to compensate oneself from the investment. The advantage of this financing is less pressure of providing oneself with the earnings since the owners may just decide to reinvest earnings for expansion. Compared with debt financing, the obligation to pay interest for debts become paramount with or without the profitability of the business being realized in an accounting period. This could be stressful for companies to pay money for interest during financial hardships of the company. The advantage and disadvantage of each selected source of finance has to be balance by considering both the finance and nonfinancial cost. If the final analysis every decision has its financial effect hence each source will have to be computed on their effects to profitability of each choice. That which will therefore produce more wealth for shareholders or owners should be chosen. Task 5 -- The future. In the future your business will hopefully become successful and achieve growth and expansion. Will the way you finance your business change from those you selected on the commencement of your business? In the future this business, the owner will hopefully become successful and achieve growth and expansion. The way that this owner will finance the business will change from those this owner selected on the commencement of his/her business. When one starts business one is actually facing a greater uncertainty compared to when it has already started. When just starting one must bring an asset to generate revenues, hence the need to put capitalization which cans either be through investment by the owner for loans from creditors. The moment however that the same is started, the company can now use the results of operation or profits as part to finance the business. Instead of withdrawing the profits by the owners, the same can be reinvested. Part B You have a friend who has recently inherited several thousands of pounds. Your friend wishers to use some of the money to buy shares for your advice. From the FTSE 100 companies, select two companies of my choice of the same field. Using the internet details of the companys published accounts for the last two years. Task 1--Explain the purpose of the main financial statements (i.e. trading profit and loss account and balance sheet) Suggest two other users of financial statements other than investors, and suggests why they might be interested in reading them. The purpose of the main financial statements would be to include providing relevant and reliable financial information for the decision makers. Other than the investors, two other users would include the creditors and government. Shareholders would be interested in the how much they will maximize their wealth from their investments (Brigham, and Houston, 2002). Thus, they would need a basis to gauge how much their wealth has increased over a given period. Since they make investments with a company of their choice, which they expect to produce profits above normal from alternative investments or options (Helfert, 2001). Creditors which may include lender and suppliers. Lenders refer to financial institutions that make money available to debtors. They would want the money they lent to come back to them with some compensation also for the risks they face, like the investors. Lenders supply also capital to the business but as distinguished from the shareholders, lenders are not owners of business. They do therefore place their trust to investors or shareholders as their agents in managing the business for them (Brigham and Houston, 2002). Although they are interested also in profitability on business like the investors, they are more interested in the liquidity of the company so that these lenders may be paid on time so that they can continue doing their business. Suppliers can be considered very closely similar to lenders. The only difference is that lenders lend money while suppliers lend goods and services. Government would want to collect proper taxes hence they need the financial information from companies as basis. Task 2 - Briefly explain the differences between formats of the financial statements. The two formats would include the single and multi-step for income statement purposes. Some businesses more particularly sole traders prepare a single step income statement format. The format would show that e all expenses classified by function and are deducted from total income or revenues. This would indicate simplicity as an advantage as one would readily see the bottom line without giving significant with each item of expenses. On the other hand, a multi-step format is possible that would show cost of sales being deducted from sales to show gross profit (Meigs, Meigs & Meigs, 1995). From the gross profit, operating expenses could then be deducted next to produce net operating income. From the net operating income could be deducted other income and expense to give income before tax. The advantage for the latter is better presentation for purposes of generating better analysis for the decision maker. An example is the knowledge of how much mark-up was used to sell the product before operating expenses could be estimated. Thus if one can estimate the level of operating expenses it is easier to decide pricing to ensure profitability. Balance sheets can be considered basically the same except, one could more detailed if one wants to add notes to allow better decision making as in multi-step format for income statement. Task 3 - Show formula for two investment ratios of your choice, and explain what they are measuring.( You are not required to calculate them). Answer: The two investment ratios would include the return on equity (ROE) and price earnings (P/E) ratio. Return on equity would normally measure the attractiveness of an investment by relation the net income from the business to the total amount of investment made by the investor. The ratio would be telling the investor would be getting enough from the investment option chosen. Price earnings ratios on the other hand measure the price per share of a stock to the earnings per share of stock. The higher the P/E ratio would mean that the investors are more willing to take as regard an investment compared to other investment alternatives. Task 4 - With reference to your financial statements, calculate for each of company given ratios. Two profitability ratios for latest year would be computed under the following formulas: Return of Assets = Net Income/Total Assets Return on Equity = Net Income/Total Equity Two liquidity ratios for latest year would be computed under the following formulas: Quick ratio = (Current Assets -Inventory)/Current Liabilities Current Ratio = Current Assets/Current Liabilities Gearing ratio would be computed as follows: Debt to Equity Ratio = Total Liabilities/Total Equity Two working capital ratios Quick ratio = (Current Assets -Inventory)/Current Liabilities Current Ratio = Current Assets/Current Liabilities Note that working capital is the difference between current assets and current liabilities and therefore a measure of liquidity hence current ratio and quick ratio may also be used ROCE ratio for latest year would be computed under the following formulas: ROCE = Operating Profit/(Total Assets-Current Liabilities) The combined computed ratios as explained above would be summarized below: 2011 2012 MKS Tesco Return of Assets 8% 6% Return on Equity 23% 16% ROCE 16% -112% Quick ratio 0.37 0.45 Current Ratio 0.74 0.64 Debt to Equity Ratio 1.75 1.86 Task 5 -- From your findings of task 4, undertake a ratio analysis of the organization comparing profitability, liquidity and gearing position of both companies. Also, recommend your friend in which company shall he/she invests. Profitability considers the changes in sales and profit of the two companies. Revenues and Expense of M&S and Tesco show many things about the past performance of the companies in the past five years, by comparing their averages. The increase from 2007 to 2011 is really very minimal every year. From 5% in 2008 compared to 2007, it has remained stagnant in 2009 but in 2010 and 2011 slightly increased was recorded at less than 6% and 2% respectively. Averaging at 3% for the past five years, the growth rate is less than the average experience by Tesco at 7% for the same period. Tesco experienced a consistent growth for the past five years. See Appendix A in relation to Appendix B and Appendix B-1 As to profitability the range of 23 to 42% or an average of 31% return on equity for the past five years for M&S and 16 to 18% for Tesco could really be a more favourable financial performance for M&S as compared to Tesco. M&S appears to have competitive advantage due to higher profitability (Porter, 1998). An advantage is of course the results of decision made after considering internal and external factors including that of the economy (Slavin and Slavin, 2010, Arnold, 2008, Baumol, and A. Blinder , 2008). There could be the application of careful planning and/or strategic management in business (Pearson, 1999, Plunkett and Attner, 1985). For M&S investors, it would mean that for every 100 pound sterling investment from stockholders, they investors expect returns of about 23 to 44 sterling, compared to Tesco investors earning only about 16 to 18 pound sterling per year from the same period. By combining the slower growth in revenues but higher in profitability with the other, it would mean that the MKS was doing better in managing its resources as compared to Tesco. As to liquidity, which is the capacity to meet a company’s currently maturing obligations, two companies may be compared It is normally measured using the current ratio and the quick asset ratio (Meigs, Meigs & Meigs, 1995, Johnson, et al, 2003). The current ratios of M&S averaged at of 0.65 while that of Tesco averaged at 0.67. On other hand, the quick asset ratios for same years for the same years showed respectively an average of 0.29 and 0.46 respectively indicating better liquidity for Tesco. See Appendix A in relation to Appendix B and Appendix B-1. M&S’ solvency is higher as against Tesco with five year average of 2.29 as 1.99 debt to equity ratio. As solvency would refer long-term capacity to keep up one’s strength over the long term, Tesco is stronger. However, the higher debt to equity ratio, derived dividing the total debt of the company divided its total equity; higher solvency for MKS actually produced higher profitability. See Appendix A in relation to Appendix B and Appendix B-1. (Marks & Spencer, 2012: Reuters, 2012a, Reuters, 2012b). 3. Recommendation Between M&S and Tesco, this paper recommends the M&S because of higher profitability despite lower profitability and less attractive solvency. Generally, the higher the profitability, the better is the wealth generation. Appendix A Comparative average ratios for two companies for the past five years; sources (Reuters, 2012a, Reuters, 2012B) Appendix B – Summary of Financial from M&S: Source (Reuters, 2012a) Appendix B –1. Summary of Financial from Tesco: Source (Reuters, 2012b) References: Arnold, R. (2008). Economics. Cengage Learning Baumol, W. and A. Blinder (2008) Economics: Principles and Policy. Cengage Learning Brigham, E. and Houston, J. (2002) Fundamentals of Financial Management, London: Thomson South-Western Helfert, E. (2001). Financial Analysis: Tools and techniques: a guide for managers. McGraw-Hill Professional Johnson, et al (2003). Financial Accounting. Tata McGraw-Hill Kieso, et al (2007). Intermediate Accounting. John Wiley and Sons Marks and Spencer (2012). M&S Annual Report for 2011. Retrieved 15May 2012 from Meigs, R,. Meigs, W., & Meigs, M. (1995) . Financial Accounting. New York: McGraw-Hill Pearson, G. (1999) . Strategy in Action. Prentice Hall Financial Times. Plunkett and Attner (1985) . Introduction to Management. Boston, Massachusetts: Porter, M. (1998). Competitive advantage: creating and sustaining superior performance: with a new introduction. Simon and Schuster Reuters (2012a). Financial Statements from 2007 to 2011. Retrieved 15May 2012 from < http://www.reuters.com/finance/stocks/incomeStatement/detail?stmtType=CAS&perType=ANN&symbol=MKS.L > Reuters (2012B). Financial Statements past five years. Retrieved 15 May 2012 from < http://www.reuters.com/finance/stocks/incomeStatement/detail?stmtType=BAL&perType=ANN&symbol=TSCDF.PK Slavin and Slavin (2010) Economics. McGraw-Hill Read More