Managing Financial Resources and Decisions - Fish Fingers Franchise - Example

Managing Financial Resources and Decisions – Fish Fingers franchise Table of Contents Table of Contents 2 Task Sources of Finance 4 1 Range of sources of finance 4 1.2 Analysis of sources of finance 7 1.3 Recommended sources of finance 7 1.4 Costs of obtaining recommended sources of finance 8 Task 2: Finance as a Resource 8 2.1 Importance of financial planning 8 2.2 Financial information requirements of the different parties involved 10 2.3 Notable information on financial statements 11 Task 3: Training Manual 15 3.1 Analysing budgets 15 3.2 Unit cost calculation and pricing decision 15 3.3 Investment appraisal techniques 16 Task 4: Financial Performance 18 4.1 Financial Statements 18 4.2 Comparison of financial statements as per business types 18 4.3 Interpreting financial statements through ratios 19 Task 1: Sources of Finance 1.1 Range of sources of finance If Mr. Duncan wishes to set up the franchise as a sole trade (sole proprietorship), the available sources of funds are: Banks, syndicates or financial institutions These financers offer secured or unsecured loans. A secured loan would have collateral involved. An unsecured loan is provided on good faith that it would be paid back. Some of the secured loans are mortgage loan and loan against equipment. Some of the unsecured loans are business credit card, bank overdraft and letter of credit (Rao, 2010). Government-backed finance programmes and government grants The UK government offers a variety of finance programmes with easy repayment options aimed at backing start-up businesses through initiatives such as Start Up Loans and Access to Finance (GOV.UK, 2013a; Start Up Loans UK, 2013; Access To Finance NW, 2013). The government also provides sector-specific grants for start up businesses, such as the Access to Work grant (GOV.UK, 2013b). Grants are not meant to be paid back. Suppliers Although not a means of raising finance, suppliers can offer financial breather by providing equipments on credit, mainly through lease or hire-purchase of equipments. Leasing refers to paying a monthly charge for using equipments, upon the cessation of which the equipments go back to the supplier. In hire-purchase, the ownership of the equipments transfers to the user after completing payments (Business Finance for You, n.d.). Bootstrapping Another mechanism of receiving a financial breather, bootstrapping refers to the process of minimising external financing requirements. Some examples include using personal funds, savings or credit cards; maintaining the right amount of staff and inventory; and reducing operational costs (Klein, 2010; Wallace, 2013). Friends and family members The easiest access to financial help is through family and friends, who are also the cheapest source of funds (Rao, 2010). If Mr. Duncan wishes to set up the franchise as a Limited Company, besides the ones mentioned above, additional sources of funds available are: Venture Funds Venture funds are provided by private companies who are willing to invest in a start up business in exchange of a percentage of stake in the business. Some of the venture funds include The North West Fund, Enterprise Ventures and Connect Ventures. Venture funds may offer traditional loans tied with an interest and repayment terms (The North West Fund, 2013; Enterprise Ventures, n.d.; Connect Ventures, 2013). Mezzanine Financers Mezzanine financers extend finance to businesses in the form of a secondary loan (also called subordinate loan), preference capital or a combination of both. Examples include Santander UK plc and European Investment Fund (Santander UK plc, n.d.; European Investment Fund, 2013). Angel investors Angel investors are high net worth people who extend credit to start up businesses in the form of loan that is convertible to equity upon maturity, or equity in exchange of a percentage of stake in the business. Although similar to venture funds, angel investors extend finance even at grass-root stages of business ideas and are ready to take more risks (Horowitz, 2010). Examples include Angel Investment Network, UK Business Angels Association and Angels Den (Angel Investment Network, 2013; UK Business Angels Association, n.d.; Angels Den, 2013). Public equity Public equity refers to the finance that can be raised from the general public by issuing equity shares through a stock exchange or Over-The-Counter exchange (Washington State Investment Board, 2004). 1.2 Analysis of sources of finance Figure: Comparison of sources of finance (Source: Under30CEO, 2013; Advameg, Inc., 2013; Lewis & Kappes, 2013; bizhelp24, 2009) 1.3 Recommended sources of finance Mr. Duncan is not starting a business with a radically new idea, but only opening an outlet of an already famous business. Also, the cost of opening his business does not runs into millions of pounds. Thus, he does not need to approach venture funds, mezzanine financers or angel investors and risk losing ownership over his own business; instead he should opt for cheap sources of debt that will not threaten his ownership. Thus, government grant is highly recommended, with a secondary choice of government-backed financing programmes. Bootstrapping is also advised, along with leasing or hire-purchasing agreements of equipments with suppliers. These will ensure that cost of finance, initial expenditure and operating costs are low, perfect for a start-up business. 1.4 Costs of obtaining recommended sources of finance The cheapest sources of finance are government grants. Not only are there no rates of interest involved, but even the original amount does not need to be repaid. Government-backed financing programme such as the Start Up Loans initiative offers up to £10,000 at 6% interest for a period of up to 5 years, much like a bank. However, repayment of the principal amount is postponed for 12 months, which results in lower instalments for the first year (Start Up Loans UK, n.d.). Thus, the money saved can be allocated to a better purpose. For leasing and hire-purchasing arrangements, cost of finance can vary greatly. However, most hire-purchase lessors offer payment in two-step model; an interest-free period and a subsequent high-interest period. If one completes payment during the interest-free period, hardly any additional cost is incurred. Moreover, any additional costs incurred are offset by tax deductions from government on the rental lease paid. Task 2: Finance as a Resource 2.1 Importance of financial planning Financial planning refers to the process of managing the economic resources of a company in a way that its goals and objectives are fulfilled with efficient allocation of resources. It is an important process since it provides an updated record of a company’s activities such as debt and equity position as well as available current and fixed assets. It helps in evaluating performance, effectiveness of corporate strategies and earnings vis-a-vis expenses. It ensures that the company is always in a good health and does not spend beyond its capabilities while achieving its goals. Lastly, financial planning is critical to long-term success and continued growth (Business Today, 2011; Prior Network, 2011). Importance of identifying cash shortages and surpluses Cash shortage is a situation when a company has less cash than what is required to run day-to-day activities. It often happens when a company is incurring losses, or when expenses exceed earnings or when it raises less capital than what is required. Cash surplus is a situation is a situation when a company has more cash at hand than what it needs to run everyday operations. It often happens when a company is generating high profits or has drawn a large capital from investors. Both the situations are bad for the company and reflect poor financial planning and funds management. A company should run at an optimum level, when available liquid cash is just as much as what is required. When there is too much cash, it means that the company is not allocating resources efficiently and is bearing extra cost of capital unnecessarily. When there is too little cash, it means the company is not to mitigate business risks and short-term liabilities Implications of inadequate financing If Mr. Duncan’s business is not adequately financed, it would not achieve the equilibrium between earnings and expenses and would result in disproportionately high expenses for the company. Since start-up requires a huge investment, it is of utmost importance to establish the amount of capital that is required. Else, the business would not be able to allocate the money in all the resources it needs to operate. For example, if Mr. Duncan raises £35,000 instead of £38,700, he would either have to settle for poor equipments, or compromise on the restaurant location, or would be unable to meet overhead costs. Overtrading Overtrading is a situation when a company does more business than it can sustain. An example of this situation is rapid expansion of business within a very short time. It leads to expenses greater than available capital, resulting in raising even more funds, incurring further cost of borrowings, reducing profitability (since most of what is earned would be redirected to meet expenses), ultimately leading to collapse of the business model (WebFinance, Inc., 2013; The Law Dictionary, n.d.). 2.2 Financial information requirements of the different parties involved Debt financers charge a fixed rate of interest for the money extended irrespective of company’s performance. Even if a company files for bankruptcy, they have the first right to recover their money. Thus, they are only interested in Cash Flow Statements to know whether the company is going in a positive direction and whether it has sufficient funds to repay its debt. Equity financers look for growth rate and earnings per share. They are interested in the Balance Sheet and Statement of Shareholder’s Equity for checking whether after initial investment the company is self-sufficient to meet the future capital requirements. Moreover, equity investors earn more when a company performs more, so they require long-term forecasts (Evanson, 1999; Krantz, 2012). Mr Duncan and Fish Fingers would require various data, such as growth rate; income and expenses; inventory; effectiveness of strategies and compliance to regulations. In addition, Fish Fingers would like to make sure that the franchise’s growth complements its growth objectives. Figure: Financial information requirements of the different parties (Source: Jones and Bartlett Learning, LLC, n.d.) 2.3 Notable information on financial statements Types of finance and their costs The debt and equity finances together with their costs would appear in the Cash Flow Statement Figure: Cash Flow Statement (Source: McDonald’s Corporation, 2012) Further information on equity financing is given in Statement of Shareholder’s Equity Figure: Statement of Shareholder’s Equity (Source: McDonald’s Corporation, 2012) Assets and Liabilities Assets and liabilities appear on the Balance Sheet. Figure: Balance Sheet (Source: McDonald’s Corporation, 2012) Assets and liabilities reported on the Balance Sheet interact in a number of ways and reflect the financial health of a company. For example, the sum-total of all assets of a company must equal the sum-total of all liabilities, establishing equilibrium. If current assets are just a notch higher than current liabilities, it means the company has the right amount of net working capital. Greater cash/equivalents and less receivable reflect efficient management policies and low inventory reflects efficient utilisation of resources. Lastly, the debt-to-equity ratio reflects the financing strategy of the company and the degree of costs involved. Task 3: Training Manual 3.1 Analysing budgets Budgets refer to estimated earnings, expenses or output of a company in the future. Budgets can be in monetary terms, such as amounts to be allocated to various operations, or in other terms, such as targeted sales in the next fiscal. Budgets involve analysing past trends, setting realistic objectives, forecasting future performance and planning on how to manipulate future performance as per the objectives. Budgets allow a company to create a target for future operations which can be constantly compared with actual results to realign the company’s resources to deliver the desired output (Business Case Studies, 2013). 3.2 Unit cost calculation and pricing decision There are two aspects of the cost of producing a product, the fixed cost that remains independent of the number of units produced, and the variable cost which is proportional to the number of units produced. Examples of fixed cost are rents for equipments and compensation of employees. Examples of variable cost are total cost of raw materials and transportation costs. Unit cost can be calculated as Pricing is an important aspect of business since it is not sufficient to recover only the cost of goods sold. Market-based pricing: Price is set depending on the apt price perceived by the customers, the price range of competitors and the ability to make a profit within this price range. Cost-based pricing – Standard approach to cost-based pricing is charging the unit cost of production and a standard mark-up. The distribution of the different costs and desired profit within the cost of production and mark-up creates three types of pricing Gross-margin pricing, where it is difficult to estimate per unit cost (such as per unit labour cost in service industry) and the prices includes the costs and profit margin as a single component Direct-cost pricing, where overhead expenses and profit constitute the mark-up and all other expenses are estimated and included in unit cost Full-cost pricing, where all the costs incurred for production are estimated and included in unit cost; and mark-up includes only profit Different cost-based pricing approaches are used based on the sector a company is in and its ability to determine actual per unit cost (Goodfellow Publishers, n.d.; Middle East Technical University, 2010). 3.3 Investment appraisal techniques Once capital is raised for a business and invested in the operations, it is very essential to measure the performance of the invested capital since the purpose of the investment is expectation of earning profits, besides recovering costs. There are 3 types of investment appraisal techniques: Payback Period - It refers to the time required to recover the original investment. This technique helps to decide the investment that would recover costs in the least time. It ignores the maximum returns an investment would generate over its lifetime. Average Rate of Return (ARR) – It is defined as the average return on investment that a project would give. This technique helps to decide the investment that would generate maximum profits over time, but does not account the drop in value of money over time due to inflation and other reasons. Net Present Value (NPV) – It is defined as the average return on investment that a project would give in today’s monetary value Figure: Net Present Value (Source: AccountingExplained, 2013) Where i = rate of return required by the company R = income stream expected from the investment over the years NPV discounts future income in today’s monetary value. For example, what costs £2 today may cost £5 after 2 years. Thus, if £5 is the expected earnings after 2 years, it is reasonable to assume that the investment would actually return £2. Due to this consideration, NPV technique is far superior to Payback Period and ARR techniques (S-cool, 2013; AccountingExplained, 2013; Kaplan Financial, 2013). Task 4: Financial Performance 4.1 Financial Statements Financial Statements refer to documents that convey the financial health and performance of a company. They help in analysing the current financial position of a company and help in formulating financial plans for the future. The various types of financial statements are Income Statement / Profit and Loss Account, Cash Flow Statement, Statement of Retained Earnings and Balance Sheet. 4.2 Comparison of financial statements as per business types The table below lists the various types of financial statements, their purpose and the type of businesses where they are appropriate 4.3 Interpreting financial statements through ratios Some of the most important ratios that help in understanding the financial position from the financial statements are: Debt-Equity Ratio, which helps in understanding the debt and equity proportions in the capital structure. Higher debt means higher obligations of repayment, whereas higher equity means higher returns to be paid to financers. It is an important ratio for a company’s internal management. Current Ratio, which explains the firm’s ability to meet its short-term liabilities with its current assets, such as cash, bank balance and inventories. Quick Ratio, which explains the firm’s ability to meet its short-term liabilities with its current assets that exclude inventories. It is an important ratio for debt financers who determine short-term liquidity of the company. Return on Equity, which explains the net income generated per unit of equity capital. It is a very important ratio for equity financers who expect maximum return on investment. Net profit margin, which explains the net profit after tax per unit of sales revenue. It reflects efficient cost-management of the company and is important for the management. Earnings per share, which calculates the amount of profits (after payout of preference share dividends) earned by a single equity share. It is very useful for equity financers (Utah Valley University, 2003). Mr. Duncan wishes to start a franchise and has around 25% of the capital requirement in his savings balance. He can raise the remaining through government-backed financing and grants to enjoy low cost of finance and sole ownership. He can even avail private financing but needs to make sure that he holds majority-stakes. Various financial statements can satisfy the requirements of different financers and various financial ratios can help Mr. Duncan track the performance of his business. Thus, it is recommended that he proceeds with his business plan. Reference List Access To Finance NW, 2013. How We Can Help. [online] Available at: [Accessed 17 December 2013]. AccountingExplained, 2013. Net Present Value (NPV). [online] Available at: [Accessed 17 December 2013]. Advameg, Inc., 2013. MEZZANINE FINANCING. [online] Available at: [Accessed 17 December 2013]. Angel Investment Network, 2013. About us - UK Angel Investment Network. [online] Available at: [Accessed 17 December 2013]. Angels Den, 2013. ABOUT US. [online] Available at: [Accessed 17 December 2013]. bizhelp24, 2009. 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