Finance in Hospitality - Assignment Example

Finance in Hospitality Introduction The business and services industries require capital in order to finance the initial costs, maintenance and repair of the business from time to time. The sources of funds available include profits from an already existing business, loans, investors, small business scheme, hire purchase or franchise. This paper seeks to describe these sources, their contribution to the businesses; elements of costs, gross profit percentages and selling prices for products and services, and methods of controlling stock and cash; the budgetary control; the trial balance and financial ratios; and fixed, variable and semi-variable costs. These aspects of finance are discussed below. TASK 1 Sources of funding available to business and services industries There are several sources of funding for business and services industries as follows: Investors; investors are an external source of capital for businesses when the business does not have available internal sources of capital. Investors give the business owners the money in exchange for a percentage of stakes in their business or a promise to repay the money at a specified rate after a specified amount of time. This method helps the business owners finance their operation efficiently, however, it reduces their control to the investors. Small business schemes; small business schemes helpsmall businesses to finance their operations as they do not have a wide capital reserve for their activities. This method helps business owners get access to quick cash but the funds available are limited to considerable amounts. Franchise; this is a method of acquiring additional capital for a small business by attracting more capital to expand. This is an alternative to an expanding a business for some extra cash so as to necessitate growth. This method helps businesses to expand as they offer access to huge deposits of capital. However, the business owner losses some control of the business. Sponsorship; financial sponsorship helps small businesses to invest in capital equipment by participating in leveraged buyout trades. Sponsors provide the money to the business owners, but they are not actively involved in the daily running or the operation of the business and therefore, they reduce the level of interruption and change in the business. Equity funding; this is another way used by businesses to generate money to fund their operations. The business could sell part of itself to an investor such that there is shared ownership. This method of raising the capital helps the business get funding while it is not required to pay interest on the money offered by the investors (Dyson, 2007). The recommended sources of purchasing the new machinery costing £50,000 could be financed through various methods such as; Retained profits; retained profits are internal sources of financing available to the business as a result of past operations of the business which yielded profits for the business which was then saved for future use. The equipment can be bought by using the retained profits. This method is recommended since the business will retain its control. Loan Banks; the purchase of the new equipment can be financed through a loan from the bank as the bank can issue the loan on an interest basis, which then will help the business to purchase the equipment and then pay for it monthly. This method is recommended since it allows the business to pay the loan in instalments while using the capital funds. Hire purchase; hire purchase is a method of instalment credit where the business owner gets the equipment he/she wishes to purchase after the initial payment and then continues to pay for the equipment through instalments until ownership is acquired after the settlement of the final credit instalment. This method of external financing is very common in the purchase of capital equipment, mostly in the business and service industries. Thus, it will be one of the viable options for this business to consider in the purchase of their new equipment. Contributions made by various methods of generating income for a large chain of restaurants Various methods of generating income make crucial contributions to a large chain of restaurants. The income generation methods include; increased sales, sub-letting, grants, financial sponsorship, and tracking mechanisms and sell of unused assets. The contribution made by the given methods includes; Increased sales enable large chain of restaurants to expand. Thechain of restaurants requires more capital to grow and expand and thus, the income generated from increased sales provide the needed finances to effect such ventures. When there are opportunities which emerge for the restaurants to expand or grow, the generated income enables the business to take advantage of the opportunities thereby generating more cash flows. The income generated fromfinancial sponsorshipenables the restaurants to open and grow and in other geographical markets. Considering that this restaurant is a large chain,the income generated will be very useful for the business to expand geographically. This will give the restaurant control over a wide range of coverage geographically. This method allows the business to profits be increased sales for the sponsorship effects. Sale of unused assets provides additional funds to the business as it allows the business to get rid of the assets which are no longer of help to the business for cash. However, the restaurant could incur more costs in case the equipment is needed again and thus requiring a repurchase which will be done at a higher cost. The income generated by the restaurant enables the restaurant to quickly perform the restructuring activities after a recession in the market. The income stored in the restaurant’s reserve enables the business to survive by restructuring when there is need to. During such time, most businesses take to debts to finance their activities, buta restaurant which reserves most of their generated income will be better suited to survive during such critical times (Dyson, 2007). TASK 2 Elements of cost, gross profit percentages and selling prices for products and services Elements of cost The cost of the products and services in Marks & Spencer can be divided into direct and indirect costs. Direct costs are those costs incurred directly by the company in their daily operations while the indirect costs are not overtly seen as they are hidden in other activities which at the end of the day cost the business. The element of cost is very important since the cost incurred in the production and assembly of the goods and services are transferred to the final sales volume of the product. The direct costs are traceable to the final products or services such as the material costs, consumables, labor costs and direct expenses. On the other hand, indirect costs cannot be traced to the final product or service even though they are incurred during their production. Some of the indirect costs include indirect expenses, administrative costs and burden costs. In Marks & Spencer, the direct costs which are overtly traceable to the final sales volume include carrier bags, food waste and staffing costs while the indirect costs include stationery, telephone expenses, security and electricity (Drury, 2003). Element of gross profit percentages The gross profit percentage can be computed by taking the selling price and then subtracting the costs price from it. The result is then divided by the initial price and then multiplied by 100. Gross profit percentages = [(selling price-cost price)/initial price]*100 The gross profit percentages are utilized to interpret the performance of the business in terms of costs and profits generated from the production. The main purpose of calculating the gross profit percentages is to enable the Marks & Spencer to keep their profits as high as possible while minimizing the level of their costs. The gross profit percentage represents the percentage of money made by the business in the production of their products after subtracting the costs from the sales proceeds. The percentage should be as high as possible so that the business can perform healthily in the market since that shows that the business is making a lot of profits. For Marks & Spencer, the gross profit percentages can be used to show their efficiency employed in their production. The percentages are calculated and averaged annually to show that the business is able to produce enough earnings, which are capable of covering the overheads of the business, taxes on profits, and the target profits expected from the business (Drury, 2003). Elements of selling prices The selling price of the products and services is basedon the costing mechanisms which allow the business to set their selling price at a point which allows them to realize the highest gross profit percentage. Selling price is calculated as follows; Selling Price = (Direct Cost / (100, Expected Gross Profit)) * 100 The cost-price of theproducts and services is the lowest selling price the commodity can ever be sold at since it is the price equal to the production cost. Most prices are set at a value over the cost-price such that the excess becomes the profitrealized from such sales. During competition periods, the business may sell their products at a price which is less that the value of the product but which is slightly higher than the cost-price such that a small percentage of profits are realized (Drury, 2003). Methods of controlling stock and cash in a business and services environment Inventory can be defined as quantity of goods stored by the business which exceeds the needed supply at a particular time and thus is needed to function in the near future. The control of cash and stock enables the business to remain liquid by having enough cash, which is sufficient in meeting its financial obligations as and when they fall due. This enables the businesses to remain solvent by adopting among the following methods. Just-in Time (JIT); this method of stock control requires that only the stock which is needed at a time should be maintained by the business. It holds that the inventory needs to be in the accurate quantity, right quality at the right time. Cycle counting; this method involves the business shutting down for a specified period during which they count all their inventory so that they carry out reconciliation in their books of accounts in case of any discrepancies. Economic Order Quantity (EOQ); this method espouses the reduction in the costs and amount of inventory to be ordered and held by the business at a given time. The major aim to minimize the total inventory cost made up of both the ordering and holding costs. Cash can be controlled by; Closing dormant bank accounts enable the business to avoid unnecessary bank charges. This can also be done through consolidation of bank accounts which the business has very minimal transactions with. As such, only the important bank accounts are left to handle the financial transactions of the business. Reconciliation of the various bank accounts of the business such that the reports prepared can read the same thing on all the bank accounts. To achieve this, the reconciliation should be done regularly in order to avoid discrepancies and allow for easy follow ups in case the discrepancies have already happened. Stock taking; there are several methods of stock taking such as spot checks, periodic stock verification, automatic stock verification, annual stock taking and stock out stores verifications. Stock taking is used to control cash and stock in a business as it allows the business to order only what is needed while making sure that the old stock is finished before opening the new stocks. Stock taking also allows identification of products whichare at the minimum level and which ones are at the maximum level (Drury, 2003). Elements of costs, gross profit percentages and selling price are important aspects as they determine the profitability of the business. Profitability is also affected by the operations of stock and cash and thus, businesses need to control their stock and cash. TASK 3 The budgetary control Budgetary control is very essential in every business as it helps the management of the business with planning and controlling of business activities. As such, when a business planseffectively for the available resources and capabilities, they are able to achieve their set goals. It also helps in the coordination of activities. Budgetarycontrol provides a successful link upon which limited resources are allocated to different areas of application in the business. As such, it is an avenue upon which coordination of activities and resources takes place. Budgetary control also helps in performance evaluation and instilling a sense of responsibility to those in charge of implementing the budget. This is done as the budgetary control seeks to assess the extent to which the allocated finances were applied to the areas allocated to and the success of such applications. For the budgetary control system to be effective and serve the intended purpose, the organization in question should be efficient and sound (Wood & Sangster, 2008). The process of budgetary control consists of six phases which rotate in a cycle. Phase one entails setting of the new budget. This is the first phase of the control cycle and is involved with the original budget which is dependent on the organizational structure in terms of the size. Phase two entails the definition of performance measurements. Performance measurements are the ways in which the performance of the budget is going to be measured against. Some of the measures of performance may include a certain sales target, control of costs within budget, profit targets or setting a specific return on capital. Phase three is concerned with the actual performance where the financial transactions are input into the financial database. Having set the performance measures, the actual performance is effected through the use of capital job numbers or cost centre numbers. Phase four is the comparison stage where the budget is compared with the actual performance. The actual performance is evaluated by comparing it to the original budget which acts as the yardstick in this case. Phase five is concerned with the examination of the variances from the comparison above. The variances in this case represent the differences noticed between the budget and the actual performance. The causes of the variances are investigated and identified in order to aid in future remedy. Phase six entails taking the correct action which is necessary depending on the variances discovered on the budget. The main purpose of undertaking this process is to identify the loopholes and take the necessary action to provide a solution. This stage of the control cycle enables the budget holder to devise some measures which will solve some of the issues identified in the earlier stages. The budgetary control cycle Variance analysis of Yuri’s budget Sales variance = actual sales -budgeted sales = 75,000 - 100,000 = (25,000) Material variance = actual material - budgeted material = 22,500 - 15,000 = (7,500) Labour variance = actual labour - budgeted labour = 24,375 - 22,500 = (1,875) Comparison between Yuri’s prepared budget and the actual performance reveals that there is a difference between the two and the variance is negative. The variance analysis takes into consideration the sales, materials and labour costs. This analysis is set to shed light into the causes of the negative variance in Yuri’s budget. The sales have reduced while the cost of material and labour has significantly gone up. This is a clear indication of things not going in the right direction and causes needs to be examined so as to take corrective action (Dyson, 2007). Possible causes of the negative or adverse variance can be attributed to shortage of market leading to a reduction in the volume of sales. The material costs could also have gone up with the corresponding increase in the profits leading to high costs of materials. Direct labour could also have experienced a rise in costs, which was not foreseen at the time of preparing the budget. Since the market Yuri is operating in is very competitive, the sales could be affected by the increase in the level of competition in the market where Yuri has not been able to catch up due to the shortage of adequate quality and also inadequate skilled and experienced labour(Dyson, 2007). The process of budgetary control is important as it enables the business owners to plan and control their business activities. As such, both resources and capabilities are allocated in line with the objectives of the business and cash availability. Variances arise when the actual and budgeted outcomes of the budget are different. A negative variance indicates that the business spent more than expected and the profits and sales were lower than expected. TASK 4 The source and structure of the trial balance The trial balance is a record of the accounts listed on two sides to record the debit and credit accounts. The trial balance records the entities over a specified period of time. The structure of a trial balance is formatted in a two column schedule with the credit and debit balances recorded on either side. The source of the trial balance is the general ledger. The trial balance cannot be prepared satisfactorily when all the posting to the general ledger are not complete. Transactions are journalised into the general ledger from the individual ledger such as purchase ledger, nominal ledgers, and sales ledgers among others. This includes the summary of the transactions that have taken place over the financial year. All the assets and expenses during that financial year are posted on the debit side of the trail balance while the capital, liabilities and income accounts are posted on the credit side. Correctly posted ledger account produced a trial balance which agrees as both balances agree with each other (Wood & Sangster, 2008). The trial balance makes use of the double entry concept of accounting where a transaction is entered twice; on a credit side and on a debit side. This makes sure that both balances agree. This method also ensures that all the transactions are recorded and that errors are easy to be seen should there be discrepancies in the balances. Since the trial balance is used during the preparation of financial statements, it allows for errors to be corrected before the final report is prepared. The format of the trail balance is as follows; Name of the business Trial balance Date Account Debit Credit Assets Liabilities Equity Income Expenses $ $ $ $ $ Adjustments on the journal entries The adjustment is done on the journal entries which are recorded in the ledgers in order to correct the accounts and update them before preparing the financial statements. Adjustments are done in order to ensure that the revenue and expenditure of a given financial period match. Most of the adjustable accounts are caused by accrued expenses, prepaid expenses, accrued incomes and prepaid incomes. Since they are not consumed in the year under investigation, they are adjusted such that the accounts to be prepared are only those for the current financial year. In the following cases; i. Additional furniture worth £525 was purchased on credit on 3 March 2012 but were not recorded The furniture is recorded the same as in cash purchase only that this transaction is on credit. As such, the furniture account will be debited with $525 while the payable account will be credited with the same $525 in line with the double entry concept. The transaction will be like; Date Account Name Debit Credit 3 March 2012 Furniture Payable $525 $525 To record the purchase of furniture on credit ii. The business receives interest of £50 on their deposit from the bank on 30 December 2012 but this transaction was not recorded This transaction leads to increase in both income in terms of capital and cash because of the interest. As such, the double entry will lead to a debit in the Cash account and a credit in the Finance Income account. The transaction will be recorded as follows; Date Account Name Debit Credit 30 December 2012 Cash Finance Income $50 $50 To record the receipt of interest on deposit from the bank iii. Accrued expenses of £200 were paid on 4 June 2012 but were not recorded Since the expenses had been incurred in the previous accounting period, but not the current one, the expense account was debited while the expense payable account was credited. The actual transaction will be recorded as follows; Date Account Name Debit Credit 4 June 2012 Expense Expense payable $200 $200 To record payment of accrued expense Financial ratios i. Gross profit and Net profit margin Gross profit = sales –cost of goods sold= 157, 165-94520= 62645 Net profit margin=Net profit/Sales 23,937/157,165= 0.15 ii. Current and acid test ratio Current= Current Assets/Current Liabilities 23,894/5,657= 4.22 Acid test ratio= (Cash +Account Receivables + Marketable Securities)/Current Liabilities (4,424+12,316)/5657) = 3 iii. Debtors and creditors payment periods and stock turnover Debtor’s payment periods=Average gross receivables/ (annual net sales/365) 11,820/ (157,165/365) =27days Creditor’s payment periods=Net credit sales per year/365 5,245/365= 14days Stock turnover= Cost of goods sold/Average Inventory 94,520/ 2,400 = 39.4 The business is not doing as well as it would be doing given the circumstances. The Net profit margin is very low, meaning that the earnings per a unit of sales are very low. The creditors are also able to pay faster for their dues in the business while the business takes longer to pay their own debtors. Furthermore, the inventory takes longer before being slow which is an indication of low production and inefficiency in the business. Thus, the business should adopt measures which will improve their ratios and in turn make the business more efficient. Some of the strategies the business can adopt are the control of stock and cash to make sure that the ash is only sued for productive purposes and to cut down on materials and costs which can be saved. The business can also take advantage of the discount given by creditors on prompt payment of their credit purchases so that they can save and improve their stock turnover. This will increase the efficiency of the business (Wood & Sangster, 2008). The trial balance is prepared in order to assist the business owner to make financial statements and financial reports about the financial performance of the business. The trial balance gets its figures from the ledgers maintained by the business. The accounts are adjusted in order to allow only those accounts needed for the financial year to be obtained. Financial ratios are used as a benchmark for interpretation of business performance. TASK 5 Fixed, variable and semi-variable costs As a business grows, some of the costs change while the other remains the same. This concept of accounting is called cost behaviour and is used to differentiate the different types of costs in a business. The study of the cost behaviour is very important for any business person as it enables them to understand which changes in the business will trigger which types of costs in order to make proper preparations before any changes. These costs are differentiated into fixed, variable and semi-variable costs (Dyson, 2007). Fixed cost A fixed cost is the type of cost which remains the same despite the changes in the level of activities of the business. For instance, rent is an example of fixed costs. As such, the rent cost does not change with the changes in the level of production of the business because one is expected to pay the same amount of rent even if there has not been any activity or production in the business. Since the rent costs do not change with production, it is a fixed cost. Even when the total fixed cost remains the same despite the changes in the activities of the business, per unit costs change with the level of production. The relationship between the activities of the business and the per unit fixed costs are inverse such that an increase in the productivity of the business causes a small Average cost per unit while the reduction in production leads to an increase in the Average cost per unit. For example, if the rent payable is $1,000 per month, then the unit fixed cost of 1 unit will be $1,000 while that of 50 units will be $1000 divided by 50 which will be $20. Variable cost A variable cost is a cost which changes with the changes in the level of activity of a business. As such, the costs increase proportionately with the increase in the production level of the business. A common example will be the cost of production material. The cost of the material will change depending on the amount of units produced. For example, if the cost of producing one unit is $100, then 1 unit will cost the business only $10 while 50 will cost $500 and 100 will cost $ 1,000. In this case, the total variable cost changes with the changes in the production, but the unit variable cost remain the same. Semi-variable cost A semi-variable cost has features which are common to both fixed and variable costs. Some activities in the business say require that part of the costs be fixed while the rest of the costs are varied depending on the level of production. For instance, a production involving renting a business premise with a machine used in production may require that a fixed amount of rent be paid and an additional cost for operating the machine. As such, the costs of rent will be fixed while the variablecost of operating the machine may be charged as $10 per hour of operating the machine. The electricity cost can also be semi-variable where one is required to pay for the fixed costs of line rent which is not dependent on the unit of electricity consumed and another variable cost of the cost of units of electricity consumed which increases with the increase in consumption. Break even position in units and in value terms Proposal 1: Reduce the selling price of each unit by 10 per cent. Break even position in units = Fixed Cost / (Unit Price - Variable Unit Cost) Unit price=100, 000/10,000= $ 10 -1%=9 Variable cost = 80,000/10,000 = $8 = 30,000/ (9-8) = 30,000 units Break even position in value terms =30, 000 units *9= $270, 000 Proposal 2: Increase the selling price of each unit by 10 per cent. Break even position in units = Fixed Cost / (Unit Price - Variable Unit Cost) Unit price=100, 000/10,000= $ 10 +1% = 11 Variable cost = 80,000/10,000 = $8 = 30,000/ (11-8) = 10,000 units Break even position in value terms =10, 000 units * 11= $330, 000 Proposal 2: Stimulate sales by improving the quality of the product, which would increase the variable cost of the unit by £1.50 per unit. Break even position in units = Fixed Cost / (Unit Price - Variable Unit Cost) Unit price=100, 000/10,000= $ 10 Variable cost = 80,000/10,000 = $8 +1.5 = 30,000/ (10- 9.5) = 60,000 units Break even position in value terms =60, 000 units * 10= $600, 000 The number of units required to be sold in order to meet the profit target Proposal 1: Reduce the selling price of each unit by 10 per cent. Profits= sales-costs Sales= (fixed+variable costs) + profit target Sales = (80, 000+30,000)+ 20, 000 =130, 000/9 = 14, 444 units Proposal 2: Increase the selling price of each unit by 10 per cent. Profits= sales-costs Sales= (fixed +variable costs) +profit target Sales = (80, 000+30,000) + 20, 000 =130, 000/11 = 11, 818 units Proposal 2: Stimulate sales by improving the quality of the product, which would increase the variable cost of the unit by £1.50 per unit. Profits= sales-costs Sales= (fixed +variable costs) + profit target Sales = (80, 000+45,000) +20, 000 =145, 000/10 = 14,500 units Recommendations I think proposal three should be adopted as it has the highest break even units and consequently the highest break even value. This will lead to the highest profits for the business. The proposal also has the lowest number of units which are required for the business to achieve its profit targets. With the least amount of units, large profits will be realized compared to the other two proposals. Furthermore, the proposal needs the least amount of units to make profit target. Conclusion The analysis in this paper reveals that there are several ways in which a business can raise funds for its operations. Apart from the initial investment to start the business, funds are needed to expand the business and especially to take advantage of opportunities as and when they arise and thus, there are choices of the sources of funds. The funds are meant to enable the business to make more profits. Costs in business are both direct and indirect and they determine the amount of profits the business makes. Another aspect eminent in profit making is the stock and cash control which enables the business to use the funds for only important operations. This is also achieved through budgetary controls. It is also imperative to note that business profitability is affected by fixed costs, variable costs, and semi-variable costs and this can be properly shown by analysis of the financial ratios. For instance, a business with fixed costs of $300 and variable costs of $ 200 will have their profits reduced by $500 while a business with fixed costs of $200 and variable costs of $100 will have their profits reduced by $350 which leads more profits the one with more costs. Bibliography Dyson, J. R. (2007). Accounting for Non-Accounting Students.Financial Times/Prentice Hall. ISBN: 9780273709220. Wood, F. & Sangster, A. (2008).Business Accounting 1.11th edition. Harlow: Pearson Education Ltd Drury, C. (2003). Cost and Management Accounting: An Introduction. 5th edition. London: Thomson Learning Read More