Managing Financial Resources & Decisions - Assignment Example

nаging Finаnсiаl Rеsоurсеs & Dесisiоns Name Institution Course Date Task 1 1.1 Sources of finance There are two types of sources of finance that can be used by mark to finance his business. Internal sources of finance These are the funds that have been generated from the business mark has been engaging himself in and has saved. For example, mark may use all the profits or a small percentage of the retained profits from the business in expanding his small business to a limited company. In addition, mark may decide to stretch the existing capital by ensuring that he pays his dates by negotiating payments for later dates. The family members of mark can decide to support him with capital and grants to start his new limited company. This amount of money may or may not be refundable to the family1. External sources of finance These are sources of finance that are independent from the operations of the business unit. These include loan capital and share capital. Loan Capital: This is the amount of money that is used to start a business and is not equity capital. In most cases it is obtained from the bank as a bank loan which is paid with interest. Bank loans are obtained as long-term loans which are repaid after a specific number of months or years hence a loan maybe short term or long-term. Share Capital: This is the amount of money that is obtained by trading shares of a company for cash. Since mark wants to expand his business operations to that of a limited company, he has to use share contribution as one of the conditions set in sourcing funds for limited companies. Shares are the amount of money which is contributed to the members or shareholders of the private limited company. Leasing of Property: This is when the business organisation decided to use the resources of another person without buying them for a specific number of time. For example, if mark does not have enough cash to purchase a baking machine for larger production or a larger premise he can decide to lease. Sale of assets: this is the amount of capital that is raised from selling some of the assets that the company may not need in the course of its expansion. For example, if the business organisation is expanding to large scale some of the machines which were used for small scale production may not be used in large scale production hence can be sold to generate funds for expansion or purchase of machinery for large scale production2. 1.2 Implications of Various Sources of Finance Loans: Loans can be debenture loans with fixed interest or varying interest. In addition, loans which are obtained from banks are usually secured with assets from the business organisation. This implies that when the new business organisation fails to generate enough cash to repay the loans, the loan company or bank reserves the legal right to repossess the assets. This means that the business organisation will not be able to carry out its operations. In addition, the bank which is the lender takes the priority over the owners of the company in case the business fails and the loan is repaid even after failure of the business3. Sale of assets: The sale of assets should be considered with great caution. This because should the company sell an asset that is crucial in it activities than it is likely to get affected in its operations as it will be affected in its capacity to deliver services and products. Retained profits: This is the amount of money that has been retained back to the business organisation for expansion of the business. The implication is that the business organisation should not invest all its profit since the owner, Mark may not have any amount of profits for other operations such as family use. However, since it is not repaid, mark may consider using his profits to finance his business activities. Leasing of property: Leasing allows the business organisation to employ a large number of employees at a reduced cost. This is because leasing allows the increase in productivity due to high operational capacity. In addition, leasing avoid unnecessary costs as the company pays for the resources required. However, leasing has some disadvantages such as high fixed costs which are paid on a monthly basis. This means that even if the business organisation makes loss, it has to pay the fixed charges of the leased property since it is fixed. Moreover, leasing means that the company has to be committed to the lease contract for the agreed period. Leasing allows the business organisation to evaluate the resources that may be crucial for the business operations before fully acquiring the assets. This means that the business organisation is saved the burden of purchasing assets and resources that may result to high costs of operations. 1.3 Recommended Sources of finance Since mark is s ole trader who wants to expand to a limited company, he needs a lot of capital to start expand his business operations. The best sources of finance include loans from the bank, his savings from the profits he earned in previous business operations. Long term loans from the bank and other financial institutions will give mark the necessary capital to finance his business activities. Although the loan has to be repaid, mark has the experience and knowledge to run his business so as to make profits to enable him repay his loan. This is because finances from his savings may not be enough to cater for the expansion of the business activities. However, the use of his savings is recommended as one of the sources since they are not repaid with interest and do not pose any risks to the business organisation. In addition to loans, mark may also decide to lease properties for his expansion business. This is because the new business has not yet fully developed hence mark will only lease those assets that he require. This ensures that he runs his business activities at a reduced costs than when he decides to purchase the assets for expansion4. Task 2 2.1 Cost of Finance Different sources of finance have different costs that are associated with. This means that before a business organisation decides on the source of finance to use, the managers should consider the costs associated with the various sources of finance. Capital Loans: the costs associated with capital loan is interest that is repaid after a certain period. This implies that before an individual decides to borrow money from the bank or any other financial institution, he or she should be able to compare different lending rates. In addition, the business organisation should compare the interest rates and retained earnings of the company to determine whether the loan is appropriate at the lending rates of the bank. Depending on the type of loan such as long term or short term the interest rate varies. Long term loans have a lower rate as compared to short term loans such as overdrafts which attracts high interest rates5. Leasing: Leasing also has its own costs which includes ownership of the property. When a business organisation leases a property, the property belongs to the leasing company and they reserve the right to change or make changes on the premises which may affect the operations of the company. Although the business organisation reduces it operational costs, leasing require the business organisation to pay a lump sum costs for the leased property. The maintenance cost of the leased property sometimes shifts to the business organisation. This means that the business organisation bears extra costs in repairing and maintaining the property depending on the terms of the lease. Hence, before an organisation cab lease a property. One should analyse the terms and cost of maintaining the property so as to avoid unwanted costs. Retained Profits: this is the profit retained from the profits of the business. The costs of retained profits is less than the other forms of capital such as loans. This is because retained earnings excludes all the taxes and transactional costs of the business organisation. Hence, retained profit costs is determined by evaluating the opportunity costs and determine how the profits can be used in expanding new business. I real essence retained earnings have no costs in that it reduces the amount of dividends given to shareholders of a limited company6. 2.2 Importance of Budgeting A budget involves a financial plan used by a business organisation to manage its funds. This plan lists all the revenues or sources of finance of the company and the ways in which the finance of the company are used. Hence, budgeting acts as a forecast of the company revenue, expenditure and profits. A budget is able to regulate the amount of money spend in the business organisation. This is because the budget list the most crucial ways in which finances are spends hence enhances the better management of finance in a company. Hence, budgeting allows a company to plan for big expenditure which may have caught the company unprepared. Moreover, budgeting is important as it reduces interest expenses of the company and increase financial control through enhanced cash flow. Budgeting also allows the managers of a business organisation to predict any future shortfalls in cash enabling the company to establish ways of securing finances or make some adjustments in payables. 2.3 Information required for a reliable financial planning In order to establish and implement a budget and other financial planning process, a financial planner is required to gather the necessary information for financial planning. This include the total assets the company has, liabilities, expenses, total revenues and sources of revenues as well as ways in which the business organisation will spend the money. The organisation is required to determine all the total income of the business organisation and evaluate whether the income will be able to support the business activities of the company. In addition, the business organisation should list all its assets and their values before planning for future growth or expansion. The expenses of the company are also evaluated to see whether they can be met by the identified sources of revenue to be used by the company. It is also important to provide financial planner with information on sales, profits earned and the earnings per share for those companies listed in stock exchange7. 2.4 Impact of sources of finance on financials The financial statements of a business organisation are affected by the ease at which a business organisation is able to get finances from different sources. Financial statements include income statements, the balanced sheets, and cash flows of the company. Such financials have an impact on investment and influences the investment decisions of investors. For example, a company that decides to use capital loan and other form of credit in financing its business activities should be able to evaluate its earnings and expenses for the previous and current fiscal years8. This is to ensure that the business enterprise is able to cover for all the interest that are charged by the lending institution before there is any availability for equity. Hence, cash that has been borrowed from the bank and other financial institutions should be invented in projects that have excess cash flow and revenues so as to reduce the costs of repaying the loan. For companies that are trading in the stock exchange, the shares have an impact on the financial statements of the firm. This is because the financial statements should be prepared and reported in such a way that they conform to the IASs formatting. The sale of assets in a business organisation affects the balance sheet of the company by affecting the total assets. In addition, then sale of assets affect financial statements by increasing the net income in the financial statements despite the reduction in the capital invested. On the other hand, leasing of assets reduces the expenses of the firm hence reducing expenses in their financial statements. Hence, in making decisions on the source of finance, managers should consider the sources of finance which have positive impacts on the financial statements of the company9. Task 3 – Scenario (a) 3.1). Alpha Limited Cash budget For the period of July- December 2009 3.2). Packaging costs; they are costs incurred in the packaging of the products to make it appear more appealing to the customers. When the packaging cost is high, the price of the product is also high. Selling expenses; they are cost directly relating to sales. . When the selling expenses are high, the price of the product is also high Delivery costs; they are costs of availing the product to the customer convenience. When delivery costs are high, the price of the product is also high. Alpha Limited Trading Profit and Loss Account For the Period Ending December 2009 Task 3. Scenario (b) The project appraisal method of evaluating the validity of the projects is Net present value and Profitability index approaches. Net present Value method = Total Present value - Initial cash flow + residual value Machine A Year Cash flows PVIF= 1/(1+k)^t Present Values 1.0000 205,000.00 0.9091 186,363.64 2.0000 205,000.00 0.8264 169,421.49 3.0000 200,000.00 0.7513 150,262.96 4.0000 170,000.00 0.6830 116,112.29 5.0000 80,000.00 0.6209 49,673.71     Total P.V 671,834.08     Less: Initial Capital 700,000.00     Add: Residual Value 60,000.00     Net Present Value 31,834.08             Profitability Index 0.959762968 For Machine B Cash flows PVIF= 1/(1+k)^t Present Values 130,000.00 0.9091 118,181.82 130,000.00 0.8264 107,438.02 180,000.00 0.7513 135,236.66 230,000.00 0.6830 157,093.09 220,000.00 0.6209 136,602.69   Total P.V 654,552.28   Less: Initial Capital 700,000.00   Add: Residual Value 20,000.00   Net Present Value (25,447.72)         Profitability Index 0.935074692 Machine A has a positive NPV of 31,384.08 while Machine B has a negative NPV of (25,447.72). Therefore, Machine A is preferred over machine B. Reason: It has a positive Net Present value greater than that of Machine B. Using Profitability Index Approach; Machine A has a PI of 0.959762968 while Machine B has a P.I of 0.935074692. Therefore, Machine A is preferred over Machine B. Reason: None of the machines has P.I value greater than 1. However, Machine A has a value close to 1 as compared to Machine B. i.e. A higher P.I Task 4- Scenario (c) 1.1 The main financial statements are the balance sheet, income statement, cash flow statement. a) Balance sheet/ Statement of financial position It is used to report the financial position of accompany. i.e. the amount of assets, equity and liabilities. b) Income statement/statement of comprehensive income It is used to report the amount of profit the company makes during the trading period. It therefore measures the performance of the business. It is an analysis of revenues versus expenses. c) Statement of cash flows It indicates the amount of cash flow and outflows of the business. It is composed of receipts and payments. The statement subdivides receipt and payments into three categories. i.e. operating, investing, and financing activities. 1.2 Business differs in term of the components of the financial statements. The difference comes from different nature of business. For instance, a manufacturing company is different from a commercial bank in terms of the balance sheet items. Example, the balance sheet of the commercial bank will have deposits to other bank, customer deposits and loan amount. Contrary, in a manufacturing company the loan amount does not appear in their balance sheet. 1.3 a) Liquidity Ratios Current ratio = Current assets/ Current liabilities Health Ltd = $120,000/$ 25,000 = 4.8 Fork Ltd = $ 160,000/$ 64,000 = 2.5 Both the companies have a current ration greater than 2. However, Health Ltd has a greater ratio than Fork Ltd. Therefore, it has a strong liquidity position. Quick ratio = (Current assets- Stock)/Current liabilities Health Ltd = ($120,000 – $ 50,000)/$ 25,000 = 2.8 Fork Ltd = ($ 160,000 - $ 60,000)/$ 64,000 = 1.5625 The Health Ltd quick ratio is greater than that of Fork Ltd. Therefore, it is more liquid than Fork. It is able to quickly convert assets to liquid cash and offset debts. b) Efficiency ratio Stock/ Inventory turnover = Cost of sales/ Average stock Heath Ltd = $ 220,000/ $ 50,000 = 4.4 Fork Ltd = $ 730,000/ $ 60,000 = 12.17 Fork Ltd has a higher stock turnover ratio compared to Health Ltd. Therefore, it is easily able to convert stock into sales. Total asset turnover = Annual Sales/total assets Health Ltd = $ 270,000/$172,000 = 1.57 Fork Ltd =$ 810,000/$ 214,000 = 3.79 Fork Ltd has a higher ratio than Health Limited. Therefore, it is able to easily able to turn assets into sales as compared to Health Ltd. c) Profitability Gross profit margin = Gross profit/ sales *100 Heath Ltd = ($ 50,000/$ 270,000)*100 = 18.52% Fork Ltd = ($ 80,000/$810,000)*100 = 9.88% Health Ltd has a higher ratio than Fork Ltd. Therefore, it is more efficient in production than Fork Ltd. Return on Total assets = Net profit/ Total assets *100 Heath Ltd = ($ 30,000/$ 172,000)*100 = 17.44% Fork Ltd = ($ 30,000/$ 214,000)*100 = 14.01% Health Ltd has a higher ratio than Fork Ltd. Therefore, it makes more profit from the investments of its assets in unit terms i.e. a shilling of investment in the total assets. Bibliography Booker, Jill. Financial Planning Fundamental. (Sherbrook, CCH Canadian Limited, 2006). McLaney, E., & Atrill, Peter. Accounting: An Introduction. (California: Jean Morton, 2010). 588 Nikbakht, Ehsan. Finance. (New York, Barron's Educational Series). 200 Hirsch J, Walz U. Financing Decisions along a Firm's Life-cycle: Debt as a Commitment Device. European Financial Management [serial online]. November, 17/5, (2011), 898-927 Păun, Cristian. International Financing Decision: A Managerial Perspective. Review of International Comparative Management / Revista De Management Comparat International 13/3, (2012), 411-425 Pop, Mugurel Gabriel Sorin, and Gheorghe Stâneanu. "Implication of Decisions of Financing Policy on the Financial Profitability and Stability of the Company." Annals of the University Of Oradea, Economic Science Series 21/1, (2012), 399-404 Read More