Managing Financial Resources - Case Study Example

Financial Planning January 1 2015 Table of Contents Introduction 3 Different sources of finance for business 3 Implication of different sources of finance 4 Appropriate source of finance for business projects 5 Cost of different source of finance 6 Importance of financial planning 7 Information need of different decision makers 7 Impact of finance on financial statement 8 Analysis of budget for decision making 9 Calculation of unit cost for decision making 9 Investment Appraisal Techniques 10 Different financial statement 11 Comparison of financial statement 11 Interpretation of financial statement 12 Conclusion 15 References 16 Introduction This paper looks at analyzing the different source of finance and the manner in which it helps in financial planning. This will help the business to take different financial decisions and will help to provide a framework based on which important financial decisions will be taken. This will help to deal with the different areas through which business strengths can be improved and will help to improve the overall quality of managing business. Different sources of finance for business Businesses to finance their needs can look towards different alternatives so that the financial needs of the business are satisfied. Business can look towards either short term finance or long term finance depending on the needs and requirements of the business. The different sources of short term finance for the business is as Bank Overdraft: Businesses can borrow money from banks for a period of time which is usually less than a year through a process of bank overdraft. Banks charge an interest rate on the over borrowed sum. Trade Credit: Businesses purchase goods on credit and pay the suppliers after a period of time which is usually less than a year and is able to finance the business needs. It is normally seen that suppliers give their business partner a certain period of time to pay the dues on the goods purchased and usually no interest is charged on it. Leasing: Businesses to meet their needs obtain different assets on lease and pays the lease amount on it. The business doesn’t becomes the owner of the asset but is able to use the same for a period of time which is determined at the time of entering into the contract and can use the asset to generate future revenues for the business thereby providing an opportunity to finance the business (Binks, Ennew & Reed, 2002) Bank Loan: Businesses also take short term loans from the banks which are for a period of less than one year and pays interest on the borrowed sum. This mechanism helps to provide the required liquidity that the business is looking for. The different sources of long term finance are as Equity: Businesses look to raise long term capital through issuance of shares and raising money from the public. This is a long term source of finance and helps the business to make arrangements for the required infrastructure. Debentures: Similarly like equity shares businesses raise money through the issue of debentures. Debentures carry a fixed rate of return which needs to be paid and the principal is paid after a fixed interval of time Bank Loan: Businesses also take long term loan for the business to meet their different long term needs and pays interest on the borrowed sum. This is a good source for business as the interest on bank loan is charged against profits thereby helping to save on taxes. Implication of different sources of finance The implication for the different short and long term finance are as Short Term Finance: This finance needs to be paid off within a year and is normally used to finance short term needs of the business. This form of finance helps the business to carry out their daily activities and ensures that the business is able to meet its daily needs. Short term finance is normally available after the business has become operational and helps the business to manage their working capital needs. Long Term Finance: This finance needs to be paid off after a year and is normally used to finance the long term needs of the business. This form of finance helps the business to carry meet their infrastructural needs and provides the required capital based on which the business can be developed (Wickham, 2006). Long term finance is available both before the business has become operational and after it has become operational and helps the business to manage their infrastructure capital needs Appropriate source of finance for business projects The different sources of finance which the business will look to have so that business can be carried out successfully are Equity Finance: This finance will help the business to meet the different infrastructural needs and will help the business to raise money which need not be paid till the company dissolves. The equity shareholders will be the owners of the company and will provided dividend which will depend on the profits and the manner in which the organization wants to provide dividend to its stakeholders. This will help the business immensely and will help to meet the different needs easily Debt Financing: This way of finance will look at raining long term debt from the market. The benefit of this mechanism is that it will help the business to gather the required long term finance. Interest has to be paid on the borrowed sum and it a charge against profit which will help to save on taxes and ensure that the business will be better placed over a longer period of time Bank Finance: Businesses through the process will be able to raise short term finance and will be able to meet the different working capital needs and the daily requirements. Since, interest on bank loan is a charge against profit it will help to save on taxes. This mechanism of financing will also help the business to meet the different short term as well as long term needs of the business Cost of different source of finance The different costs which are associated with the different sources of finance are as Tangible Cost: This is the cost associated with interest paid on bank loan and debt financing, dividend paid on equity financing, dividend paid to the debenture holders and other cost associated with the process of raising finance Opportunity Cost: It is the cost which the business had to forego due use of finance for different purposes. For example using retained earnings for the same business is the cost which has been foregone and could have been used for other new projects. In a similar manner using the finance for different purposes would mean that the cost associated with using the finance for business opportunities is foregone. Tax: It is the cost which is associated with the profits which the business has been able to achieve and needs to be paid to the government. This is a cost for the business as more and more profits would mean more taxes which has to be paid by the business and is a cost for the business. Importance of financial planning Financial planning is an important aspect for business as without financial planning the business won’t be able to meet the different financial needs of the business. A business who doesn’t plan the different sources of finance and the manner in which the finance will be used would find it difficult to meet the different needs of the business. Improper financial planning would result in a financial crisis and could make it difficult to meet the different expenses (Cosh & Hughes, 2000). A proper financial planning would mean that the business is able to bring efficiency in the manner the finances will be raised and used. This will help to decide the future course of action as it will direct the business to decide the different areas through which overall business planning is improved. Proper financial planning would mean that the business would be placed in a better way. This would help to bring optimization in their strategies as they will be able to decide the manner in which different resources are allocated. This will help to remove the different bottlenecks which are present in relation to finance and will help to decide the manner and direction through which the business performance would improve. This will also help to improve the overall manner of planning and would help to develop the required dimensions through which the overall business performance especially in association with financial planning would improve. Information need of different decision makers The important decision makers who need financial information and the different financial needs the business will be able to meet are as Purchasing Department: needs information regarding the financial performance so that they are able to find out the present financial condition so that based on it different inventories can be purchased (Drever, 2006). This will help to ensure that the business doesn’t fall into a financial contagion and is able to gain effectiveness Budgeting Department: will need financial information so that they are able to make arrangements for the future financial requirements. This will help them to prepare better budgets as the different sources of finance which they will get and based on it the areas where the finance will be spent can be made. This will improve accuracy and will multiply the overall effectiveness of budgeting Shareholders: require financial information so that they are able to understand the manner in which the organization has performed and will thereby help them to gauge an understanding of the performance in the future. This will also help the shareholders to understand the performance and based on it their investment strategies can be decided. Impact of finance on financial statement The impact and the manner different finances are present on the financial statement are as The assets and liabilities of the business are reflected on the balance sheet whereas the different cost associated with the process of raising finance is shown in the profit and loss statement. This thereby helps to ensure that the different financials are properly highlighted and it represented in the financial statements The interaction of asset and liabilities helps to understand the owner’s equity which the business has and is the amount of investment which is made by the owners of the business (Broadcast, 2010). This is represented in the assets side of the balance sheet and is prepared under the International Accounting Standards. Every financial statement has to be prepared based on certain standards and International Accounting Standards is one which is followed by the business to bring uniformity and to facilitate comparison between different organizations. Analysis of budget for decision making The different budget which are prepared and helps in taking better financial decisions are as Cash Budget: This budget will bring forward the different sources through which finances will be raised and will also highlight the different sources where the finances will be spent. This is the primary budget and will contain details of other budget like marketing budget, advertising budget, operating budget and so on Marketing Budget: This budget will highlight the different areas of marketing where the budget will be spent and the manner in which the business will gain from it. It will cover areas like promotion, advertising, free samples and so on Advertising Budget: This will highlight the different areas where the business will look to advertise on and the benefits which the business will get based on it. It will cover areas like television advertising, radio advertising, print advertising and so on Calculation of unit cost for decision making The calculation of unit cost is as follows and is being shown in the following example Total Revenues = Units Sold * Selling Price = 8000 * 250 = 2000000 Variable Cost per unit = Direct Material + Direct labor + Variable Overhead + Variable selling and distribution overhead = 100 + 50 + 30 + 10 = 190 Total Variable Cost = 8000 * 190 = 1520000 Contribution Income Statement Revenues 2000000 Variable Cost 1520000 Contribution Margin 480000 Fixed Cost 300000 Net Income 180000 Total Cost = 1520000 + 300000 = 18200000 Units sold = 8000 Unit Cost per unit = 18200000 / 8000 = $2275 Thus, unit cost helps to find out the cost based on which the business can decide their pricing decisions. Investment Appraisal Techniques The different investment appraisal techniques which can be used to find out whether a project is feasible or not are Payback Period: This will help to understand the minimum period which the business needs to work on so that the business is able to cover the cost and thereby generate profits after it. This will highlight the minimum lock in period and will show the period after which the business will be able to generate profits Discounting Cash Flow Techniques: This mechanism helps to convert the future cash flows into the present value by using the estimated time period and rate of discount which the business ascertains (Carey & Flynn, 2005). This helps to understand whether the business idea is feasible if the net present value of future returns is more than the investment which is made by the business Internal Rate of Return: This mechanism helps to understand the minimum rate of return which the business needs to achieve so that they are able to cover their cost and earn profits from the different business idea which has been generated. This will help to find out the rate of return which needs to be achieved so that business idea becomes feasible and is able to cover all its cost Different financial statement The different type of financial statement which is prepared is as Balance Sheet: It shows the different assets and liabilities on a particular date and shows the financial position of the organization Profit & Loss Statement: It shows the profit or loss that the business is able to make over a period of time and shows the manner in which the business has performed over a period of time which is usually a financial year Cash Flow Statement: This ratio shows the manner in which the different cash inflows and outflows are measured and identified so that the user is able to find out the different areas through which cash has been generated and used Comparison of financial statement The different financial statements for British Petroleum is as Figures in $’000 2011 (in millions) 2010 (in millions) 2009 (in millions) 2008 (in millions) Sales Revenue 386463 308928 246138 367053 EBIT 39817 (3702) 25124 34283 Profit after Tax 26097 (3324) 16759 21666 Trend Analysis Sales Revenue 105.28 84.16 67.05 100 EBIT 116 (10.79) 73.28 100 Profit after Tax 120.45 (15.34) 77.35 100 Interpretation of financial statement The interpretation of different financial ratios is as Gross Profit Margin: This ratio highlights what is left from sales after deducting the cost of goods sold and act as a source for meeting additional expenses and future earnings. The graphical representation is as: The gross profit margin has decreased slightly owing to higher cost of goods sold, however the same is not much of a worry for the company but factors affecting the same is to be examined and tuned in for future success. Net Profit Margin: This is the real profit that a company earns after meeting all its expenses. A higher ratio indicates better earning and better cost control. The graphical representation is as The results show a decline in the Net profit margin which is a concern for the company as it has failed to control over its costs and expenditures. Serious problems may arise if the company is unable to control its costs and expenditure and may lead to sustainable losses in the future. Return on Assets: This ratio acts as a tool to understand how effectively and efficiently an entity has been able to generate revenues from optimal utilisation of its assets. The graphical representation is as The results show a declining trend in the return on assets ratio which is primarily due to declining profits and is a major concern for the company as it shows under utilisation of the assets of the company and more assets than required leading to unnecessary blockage of funds. This is based on the below mentioned calculations Ratio Formula 2010 2011 Current Ratio Current Assets / Current Liabilities 878,685 / 354,779 = 2.47 times 908,854 / 389,208 = 2.34 times Quick Ratio (Current Assets – Inventories) / Current Liabilities (878,685 - 240,400) / 354,779 = 1.79 times (908,854 -348,738 ) / 389,208 = 0.69 times Gross Profit Margin Gross Profit / Sales * 100 811,994 / 1,487,527 * 100 = 54.6% 909421 / 1,687,733 * 100 = 53.8% Net Profit Margin Net Profit / Sales * 100 145,988 / 1,487,527 * 100 = 9.81% 119,139 / 1,687,733 * 100 =7.05% Return on Assets EBIT / Avg. Total Assets * 100 125,825 / 2,210,319 * 100 = 5% 53,418 / 2,419,965 * 100 = 2.20% Conclusion The report thereby helps to present the financial importance and the manner in which the different financial resources will be met. This will help the business to take different financial decisions and will help to provide a framework based on which important financial decisions will be taken. This will help to deal with the different areas through which business strengths can be improved and will help to improve the overall quality of managing business References Broadcast. (2010). Small Business Struggle for Loans. Retrieved on March 9, 2015 from http://www.abc.net.au/insidebusiness/content/2010/s2963470.htm Binks, M., Ennew, C., & Reed, G. (2002). Information Asymmetries and the Provision of Finance to Small firms. International Small Business Journal, 11, 35-36 Cosh, A., & Hughes, A. (2000). British enterprise in transition: growth innovation and public policy in the small and medium sizes enterprise sector 1994-1999. University of Cambridge, Cambridge Carey, D., & Flynn, A. (2005). Is bank finance the Achilles’ heel of Irish SMEs? Journal of European Industrial Training, 29(9), 712-729 Drever, M. F. (2006). Determinants of Liquidity for Australian Small and Medium-Sized Enterprises (SMEs). University of New England, Armidale Wickham, P. (2006). Strategic Entrepreneurship. New York, Harlow: Financial Times Prentice Hall. Read More