Managing Finance Resources and Decisions - Assignment Example

Managing Finance Resources and Decisions TASK 1. SOURCES OF BUSINESS FINANCES Most businesses fail in their operations or start –up due to lack of finances for their operations or due to the poor choice of financial sources (Lecture-1PPt, n.d). Businesses require finances for starting their operations and for expanding their activities a start-up or continuing businesses. The sources of finances could be either internal or external, but business can choose a combination of sources which they can use to get funds to finance its operations (Lecture-3PPt, n.d). This study explores internal and external sources of funds for various businesses. Also, it focuses on legal and financial implications of various sources of funds which managers should consider before choosing the most relevant sources. In addition, the study discusses the costs of various sources of business finances since they influence the relevance of various sources of business finances. Finally, the study uses the case study of British Rail Ltd Company to determine to examine the sources of its finances why they are relevant to it. Although there are various sources of finances, various sources are appropriate for a particular business thus the managers should be able to evaluate the sources appropriate for their businesses (Lecture-1PPt, n.d). 1.1. Internal sources of finances 1. Owners’ contribution The business owners can invest their resources in business from personal savings, friends’ contributions or donations, etc. It is appropriate for any business because the business since it is cheap and available for business use throughout business life (Lecture-1, n.d). Advantages: There are no interest charges and the owner of the business maintains full control of the business (Brigham & Houston, 2009). Disadvantages: The owner is at risk of bankruptcy in case the business starts facing financial hardships. Also, it limits the amount available for investment into the business to what the owner has for investment (Maynard, 2013). 2. Sale of assets. A business can raise additional cash by disposing off some of its fixed assets that are less effective (Lecture-1, n.d). The source is appropriate for any businesses that have assets to dispose off. Advantages: Sale of assets enables the business to raise funds from under-utilized or inefficient assets that would otherwise continue to depreciate (Brigham & Houston, 2009). Disadvantages: It is not effective for raising finances required urgently. Also, some organizations may not have assets to dispose off in the time of need (Tarantino & Cernauskas, 2009). 3. Retained profit Retained profit refer earnings realized after the closure of trading period that has been ploughed back into the business for expansion (Lecture-1, n.d). It is suitable for all types of businesses that make profits from their activities. Advantages: The business is not obliged to repay the amount, and no interest charges. It is convenient to the business since it is cheap and depicts business operations efficiency (Allen et al., 2013). Disadvantages: The funds are available for established business and have been making profits. Also, it is limited to the organizations that make an adequate profit from their sales (Tarantino & Cernauskas, 2009). 4. Sale of stock. A business with unsold stock can sell them to raise additional funds from the profit realized from the sales for carrying out its operations. It is appropriate for any business having unsold stock as a quick source of additional cash (Walsh, 2008). Advantages: Sale of stock helps the business to reduce the cost of maintaining stock, and it enables the business to raise additional cash quickly (Walsh, 2008). Disadvantages: The business may have to dispose of stock at a relatively reduced price to attract buyers (Lecture-1, n.d). 5. Debt collection Debts arise when businesses sell some of the stock at a deferred payment. Business can collect the amount owed by debtors to raise cash. It is appropriate for any business offering credit facilities (Walsh, 2008). Advantages: Debt collection is a routine business activity thus the method is beneficial since the business does not incur additional expenses to raise funds through debt collection (Jobber, 2012). Disadvantages: Sometimes debtors may not pay their debts thus compelling business to write them off as bad debt (Godfrey & Chalmers, 2007, p. 87). It is unavailable for businesses dealing with cash sales only. 1.2. External sources of funds 1. Bank loan This is whereby the bank advances funds to the borrower at an agreed interest and is payable at a specified period. It is appropriate for well established businesses that have established credit worthiness (Arnold, 2008). Advantages: The repayment of the interest charges and the principal amount is distributed over the loan period thus offering the borrower an opportunity to plan for repayment (Jobber, 2012). Disadvantages: It is appropriate for business with established credit worthiness. The interest charges make it expensive source of business finances (Lecture-1, n.d). 2. Leasing This is whereby the business makes arrangement with a finance company to obtain the assets by paying some charges for use. It is appropriate for any business (Brigham & Houston, 2009). Advantages: The business can plan for payment since the cost is distributed over the lease period. Also, the business gets possession of the equipment without upfront payment (Lecture-1, n.d). Disadvantages: The cost of leasing assets is higher than its cash price. It is owned by the finance company during the lease period (Allen et al., 2013). 3. Share issue This entails raising more capital by issuing additional shares to the public. It is suitable for a limited company and public limited companies (Tarantino, 2010). Advantages: The Company is not required to repay the amount, and there are no interest charges (Allen et al., 2013). Disadvantages: The business spreads its ownership to the new shareholders and has to share its profit given as divided with shareholders (Jaber, 2009). 4. Additional partners A partnership business can raise additional cash by recruiting more partners. The partners’ contributions and share of proceeds are dependent on agreement (Power point, n.d). It is applicable to partnership business. Advantages: It is a cheap source of finances since there is no interest payable on the additional capital, and also the additional funds are not repayable (Kimmel et al., 2010). Disadvantages: The business proceeds and managerial powers are shared among the partners (Lecture-1, n.d). 5. Overdrafts This is a bank service that allows particular clients to with overdrawn funds on their accounts through cheque even though they have no money in the bank (Power point, n.d). It is applicable to continuing businesses that have established creditworthiness. Advantages: It is cheaper compared to bank loans, and provides business with cash security to continue the operations during cash outflow and cash inflow transition periods (Allen et al., 2013). Disadvantages: It is expensive if extended for a long period. Furthermore, the client pays interest charges on the amount overdrawn thus raising the cost of running a business (Jaber, 2009). 6. Trade credit Trade credit is where the business takes the ownership of goods but makes the payment at a differed period. It is appropriate for well established business with good credit rating (Brigham & Houston, 2009). Advantages: It enables a business to generate cash from assets and use the same cash to repay the debt. There are no interest charges if debt is cleared in time (Tarantino, 2010). Disadvantages: It may inconvenience the business as they attempt to ensure there will be sufficient cash to repay the debt in due time. Also, it hinders the business from enjoying cash discounts (Lecture-1, n.d). 7. Hire purchase This is an arrangement whereby the business makes down the payment and takes the possession of the asset while the remaining balance is cleared in regular basis over the hire purchase period. It is appropriate for any business in need of purchasing assets (Dyson, 2004). Advantages: It enables business to make an effective plan on payment since the cost of hire is spread over an agreed period. The business can obtain and use an asset without the need for upfront payment. The business gets opportunity to buy the asset after clearing all repayments (Power point, n.d). Disadvantages: The cost is relatively higher than paying in cash for the same asset and the owner can repossess the goods in case of default in payment (Maynard, 2013). 1.3. Legal and Financial Implications of Different Sources of Finances 1. Share Issue Legal implications: Raising additional cash through issue of shares limits the shareholders liabilities to the shares they own. Only limited companies can use this method while sole traders and partners have no legal right to issue shares (Kimmel et al., 2010). Financial implications: This source is convenient to the business since it is long-term and is dividends are only payable when the business has realized profits (Lecture-2, n.d). 2. Additional partners Legal implications: The business must be registered as a partnership with or without limited liabilities and operations last for a specified period (Mott, 2012). Financial implications: The contributions of the partners are subject to agreements, and it results to sharing of managerial powers (Rutherford, 2014). 3. Hire Purchase Legal implications: The parties must write and sign an agreement for hire purchase stipulating the terms of the agreement (Allen et al., 2013). The hirer has to pay the deposits and instalments in full before they can purchase the product. The default in payment gives the seller power to repossess the assets. Financial implications: it is available in form of goods and not cash thus it cannot satisfy need for immediate cash. However, it releases business finances for use in other more pressing issues (Mott, 2012). 4. Bank loan Legal implications: The borrower and the lender must adhere to the banking regulations in regard to interest changes and security requirements (Mott, 2012). Financial implications: The use of collateral as security for bank loan ties business assets that would have been used to generate income for the business (Lecture-2, n.d). 1.4. Cost of different sources of finances The cost of personal savings is the lost interest income the owner may have charged. The cost of retained profits is the opportunity cost since the money invested in the business could have been invested elsewhere (Dyson, 2004). Sale of assets reduces business output due to diminishing capacity. Issuing shares cost of dividends paid to the shareholders and other administrative expenses incurred in the process of issuing shares. The cost of Lease is that the ownership of goods remains with the financing company. Loan has a cost due to interest charged on the amount borrowed. The cost of hire purchase is the extra charges the business pays at the cash price (Rutherford, 2014). The cost of trade credit is the lost cash discounts and higher prices for the goods above cash purchases. Cost of overdraft is the interest charges in the amount overdrawn. The cost of additional partners is the sharing of profit among the partners. Debt collection has a cost of bad debt in case the debtors fail to clear their debt. Share issue imposes cost to the company is the profit shared in as dividend to shareholders (Dyson, 2004). Case company: Samuel Taylor ltd (STL). Samuel Taylor Ltd is a UK based company that offers “innovative, precision engineering to markets throughout the world.” The company offers products with stylish bonding of bond and precious metal, stamped and assembled products such as Headed Parts and rivets, Microprofile Tapes, Welded Contacts Assemblies etc (Samuel Taylor Limited, 2013). The company can raise cash to finance its operations from bank loans, share issue, lease, hire purchase, retained profit, overdraft, debt collection, trade credits, sales of assets, and sales of stock. It is a limited company well established and trading in the security exchange market because its financial needs vary with a period over which the amount is required and the amount ranging from small to very huge amount thus they can use a variety of ways to raise funds. However, the company cannot use additional partners since it is not a partnership business and cannot use owners contribution since the owners are shareholders thus it is appropriate to issue shares for additional cash (Brigham & Houston, 2009). Conclusion Various businesses use different sources of finances to conduct their operations. The choice for the appropriate source of business funds depends on the cost of the source, legal and financial implications of the sources used. Businesses require funds for short-term and long-term financial obligations. The business should align its needs for funds with market requirements for accessing the funds and ensure they use the most appropriate source of its funds. TASK 2 2.1. Financial planning All businesses require finances in order to be able to conduct their activities. Financial planning is the management effort to ensure the business has steady cash for its operations for short, medium and long-term operations. They achieve this by structuring their goals, policies, processes, strategies and budgets of the business activities (Cox & Fardon, 2003). Decision makers use various sources of information for decision making. This study explores ratio analysis, basic financial statements, break-even analysis and cash budget as tools for decision makers (Lecture-2PPt, n.d). Adequate planning enables decision makers to manage the business effectively by maximizing returns and minimizing losses. 2.2. Significance of financial planning Appropriate planning of business finances ensures availability of funds for the business both in short-term medium and long-term period (Lecture-2, n.d). Adequate financial planning attracts investors who are willing to commit their finances to a business with the prospect for growth. Also, proper financial planning enables a business to manage risk and ease uncertainty by enabling the business to have sufficient funds to cope with emerging market issues. In addition, financial planning promotes business stability by ensuring a sound balance between cash inflows and cash outflows of the business. Furthermore, adequate financial planning promotes business profitability which is essential for business stability and expansion (Lecture-3, n.d). 2.3. Components of financial planning The business managers should be able to understand various business components that must be managed effectively in order to ensure business success (Lecture-3, n.d).). a) Break-even Analysis The basics of breakeven analysis are to categorize different costs that dependent on units of output (variable costs) and cost that are independent of a number of units produced (fixed costs). The essence of break-even analysis is to match the total of fixed and variable costs with proceeds from sales to realize the break-even point or the production level where the business does not make either loss or profit (Allen et al., 2013). This information is essential because it enables the business managers to plan a unit of output they should produce in order to make a profit. Also, it guides the managers in setting the price of the commodities in order to achieve business objectives (Britton & Waterston, 2006). b) Ratio Analysis Ratio analysis provides a snapshot of business performance to the stakeholders in various key areas of the business for decision making (Arnold, 2008). The basic ratios include profitability ratios, debt management ratios, market value ratios, asset management ratios and liquidity ratios. Ratios are essential for comparing the business performance over a period and for comparing different firms in the industry. They enable the stakeholders to determine whether the business has improved or deteriorated over time (Lecture-3, n.d). For example, liquidity ratios such as quick ratio and current ratio determine firm’s ability to satisfy it short-term financial obligations without stressing the business financially (Godfrey & Chalmers, 2007, p. 87). Debt management ratios analysis provides information on the firms’ ability to meet is future financial obligations without straining the business financially. It is essential for estimating investors return on equity (Lecture-3, n.d). Market value ratios provide information regarding the stock price, the market value and the book value of the firm’s assets as stated in the financial report. Examples of market value ratios include market-to-book ratio and price-earnings ratio. Asset management ratios are used to evaluate the business efficiency in generating revenue from the sales and assets management. "The profitability ratios such as profit margin and return-on equity determine business efficiency in generating income and debt management" (Britton & Waterston, 2006, p. 221). c) Cash budget Cash budget provides information regarding cash inflow and cash outflow of the business over a given period (Arnold, 2008). Cash budget is essential in order to determine the availability of cash in the business to meet its financial obligations and ensure there is no idle cash resources in the business that would otherwise have been used for other productive activities. Cash budget enables the business to evaluate the amount of credit it can advance to customers without straining itself financially, and it determines when business is in dire need of financial assistance. Finally, the cash budget helps to determine where the business cash is being spent momentarily (Lecture-3, n.d). d) Basic financial statement "Balance sheet depicts the financial position of the business at a given time." It shows the resources owned by the business owner and those that belongs to other people (Lecture-2, n.d). It is essential making decisions regarding methods of raising business finances and establishment of asset base for the business. Income statement shows how business is creating revenue from trading activities. It is essential for decisions such as improving marketing efficiency and reduction of cost of production to improve profitability and it depicts how cash gets into and out of business. It is essential for decisions related to increasing cash inflows and reduction of cash outflows (Cox & Fardon, 2003). 2.4. Financial information for decision making There are various business stakeholder interested with different financial information for making different decisions. A major concern of many stakeholders is the information regarding business profitability, liquidity, assets, plans for growth, share earnings," etc (Allen et al., 2013, p. 346). For example of decision makers are: Shareholders They are interested in performance of the business since they have invested their resources and would like to know how effectively that resources are being utilized for decision making. Employees They have interest in business profitability and its potential for future growth since they earn salaries from that business and assurance of job security from future revenue of the business (Arnold, 2008). Government Require financial information for taxation purpose. Financial analysts Require information offer effective advance to the business Consumers Want to know whether they will continue enjoy goods and services (Lecture-5, n.d). Suppliers Are interested to know whether they will continue contract with the organization 1. Financial Statement TERRACE HILL COMPANY BALANCESHEET AS AT 30TH SEPTEMBER 2011. Non Current Assets Notes Restated £000 Investment properties 1 21,393 Property, plant and equipment 176 Investments in equity accounted associates and joint ventures 1,419 Other investments 6 Intangible assets 3,336 Deferred tax assets 5,710     32,040 Development properties 72,961 Trade and other receivables 1 14,191 Cash and cash equivalents   11,630     98,782 Total assets   130,822 Bank loans 2 (36,230) Deferred tax liabilities   —     (36,230) Trade and other payables 3 (16,541) Current tax liabilities   (3,109) Bank overdrafts and loans 4 (26,808)     (46,458) Total liabilities   (82,688) Net assets   48,134 Called up share capital 4,240 Share premium account 43,208 Own shares (609) Capital redemption reserve 849 Merger reserve 7,088 Retained earnings 6 (6,642) Equity attributable to equity holders of the parent   48,134 Non-controlling interests   — Total equity   48,134 Source: (Terrace Hill Group plc, 2012). Notes 1. Trade and other receivables are liabilities “recognized at fair value and amortized at effective interest rate minus provision for impairment.” 2. Bank loan are long-term finances obtained from the bank. 3. Business liabilities to traders resulting from services offered. 4. Bank overdraft and loans are short-term borrowings from the bank payable within a month. 5. Retained earnings are the business profit maintained for expansion of business operations. 2. Income statement TERRACE HILL COMPANY INCOME STATEMENT FOR THE YEAR ENDED 30TH SEPTEMBER 2011   Notes £000 Revenue 1 67,766 Direct costs   (61,333) Gross profit   6,433 Administrative expenses   (4,343) Profit on disposal of investment properties   — Impairment of associated undertakings   (1,000) (Loss)/profit on revaluation of investment properties   (4,128) Operating (loss)/profit   (3,038) Finance income 2 508 Finance costs 3 (5,097) Share of joint venture and associated undertakings post tax (loss)/profit   (2,612) (Loss)/profit before tax   (10,239) Tax 4 (184) (Loss)/profit from continuing operations   (10,423) Total comprehensive income   (10,423) Equity holders of the parent   (10,423) Non-controlling interest   —     (10,423) Equity holders of the parent   (10,423) Non-controlling interest   —     (10,423) Basic earnings per share 5 (4.94)p Diluted earnings per share 6 (4.94)p Source: (Terrace Hill Group plc, 2012). Notes 1: Revenue is the sales value of the business from trading activities. 2: Financial income is revenue reported at the end of trading period. 3: Financial costs are expenses incurred during the trading period. 4: Tax is deduction from income and paid as tax to the government. 5: Basic earnings per share are profit distributed to the number of ordinary shares as share revenue to shareholders. Sources of finances in financial statements Bank loans, share premium, merger reserve, bank overdraft, retained earnings, trade and other receivables, trade and other payables, capital redemption reserve and intangible assets. Conclusion Various business stakeholders require information about the performance of the business in order to make a decision on various issues. The stakeholders are managers, customers, employees, government, suppliers, shareholders and the community where the business is operating. Break-even analysis, financial statements, cash budget and ratio analysis offer decision makers with appropriate information regarding the business performance. A different study is essential to establish the accuracy of various sources of information for decision making. Bibliography Allen, R., Hemming, R. & Potter, B. (Eds). (2013). The International Handbook of Public Financial Management. UK: Palgrave Macmillan. Pp. 1-928. Arnold, G. (2008). Corporate Financial Management. UK: Financial Times Prentice Hall. Pp. 1- 996. Brigham, E. F. & Houston, J. F. (2009). Fundamentals of Financial Management (12th Ed). Cengage Learning. Pp. 1-752. Britton, A. & Waterston, C. (2006). Financial Accounting. UK: Financial Times Prentice Hall. Pp. 1-350. Cox, D. & Fardon, M. (2003). Financial Management. UK: Osborne Books Ltd. Pp. 1-227. Dyson, J. R. (2004). Accounting for Non-accounting Students. UK: Financial Times Prentice Hall. Pp. 1-580. Godfrey, J. M. & Chalmers, K. (Eds). (2007). 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