Financial Management for Small Business - Essay Example

Financial Management for Small Business – Week 3 - 6 PART A Discussion Questions The low inventory turnover ratio is dangerous to an organization’s liquidity and cash flow. In order to make an accurate judgment, industry averages should be taken into account – since there is no such information here we will assume that this is well below the industry average. This maybe due to inefficient buying such as overstocking, poor sales – due to various reasons such as the inability of the sales force and even lack of marketing and promotions. Further such a low ratio can cause high levels of risk if there is a drop in the price of goods and also a rate of return of zero or close. Therefore the organization should make immediate efforts not to over stock and to train its sales force and increase its sales. If the ratio was 5.2, YES my answer would be different, however it should be kept in mind that too high a ratio could sometimes mean under stocking which is equally dangerous as over stocking. Making accurate assumptions regarding sales revenue and costs etc along with internal consistency are concepts that are common to both financial statement forecasting and cash forecasting. However when forecasting financial statements the organization also looks at accounts payable, receivable and accruals. This is not the case when it comes to cash forecasting. Cash forecasting does not take into account accruals but rather the actual cash receipts and payments expected. This is necessary if we are to make an accurate forecast as cash forecasts show a picture of the actual cash flow. Forecasting financial statements and cash flow should be carried out by the same group, as that would ensure internal consistency. Accurate cash forecasting is critical to an small businesses as it indicates the cash inflows and outflows that is important to liquidity. Capital Expenditure Analysis The proposed expenditure of $50,000 along with the $15,000 required for refurbishment together will cost the organization a total of $65,000 in terms of capital expenditure. If we were to depreciate the entire asset during a ten-year period then it will be written off at a rate of $6500 per year over a ten-year period. According to projections the profit of the firm will go up by 20% per year and will bring an additional $14,000 annually for the next five years. This means that the firm will earn around $70,000 over the next five years. The capital expenditure or the written off amount would be $32,500 while the earnings from that would be a net increase of $47,500 (after deducting the depreciation of the asset from the profits earned directly from it). Further even if the capital expenditure is depreciated over a five-year period rather than a ten-year period. Still over a five-year period the increase in earnings will exceed the capital expenditure and depreciation of the asset. Therefore it is the opinion of the author that the suggested capital expenditure is reasonable and that it is profitable to the organization. However it should be kept in mind that the above calculations and opinion were based on the financial forecasts and projections that were given. In the event that the expected profits drop below the forecasted level of 20% or the capital expenditure increases above the stated amount then there is a risk that the capital expenditure may cause unforeseen losses to the firm. Further if the actual profits are over the forecast of the capital expenditure is below the said forecast and/or if the acquired asset is sold at a after being depreciated to zero then the organization will stand to gain immensely. Final Project The small business is a home health care service that will provide health care services to its clients – through its products and services. It is the intention of the business owner to fund 25% of the business capital through personal means that would become equity financing and the rest of the 75% of the business capital through debt financing. It has been decided to spend $400,000 on acquiring a property in a commercial area . This property will not be a big showroom but a small showroom in an area that will attract the target customer group. The objective is to promote the products and services of the business but not to store its inventory. The showroom is for the customers to try out the products and make orders but not to physically purchase at the time. It is the intention of the business owner to buy the commercial property by financing it totally. The reason for this is that since it is real estate and the collateral is of good value and it would be easy to raise the finance required from a bank as it will be for the purchase of a fixed asset that has good collateral value and is not just inventory. The asset will be bought as soon as the finance can be raised which should be before the organization starts its business. Any refurbishments and décor should be funded through funds that have been raised from equity finance. And that should not exceed 10% of the property value. The reason for this is to keep costs down and also simultaneously increase the value of the asset immediately. Also since a part of the debt finance will be used for real estate acquisition the organization is reducing its risk because the real estate market specially the commercial real estate market is relatively more stable for investment than any other form of investment and mortgage rates are lower than other types of borrowing rates. PART B Discussion Questions There are two types of financing that are available to organizations – they are equity financing and debt financing. There is also a third option, which is a combination of the two. In this case George maybe looking at debt financing as a an easier option for him to raise. Also he maybe seeing a lot of potential in his business currently and like to have sole control and propriety over it – so he believes that financing it with debt is better and he can pay off the debts soon. If he decides to go with the equity financing option then he may have to share control and management of the business with another individual or individuals. Further depending on the type of equity he will have to share the profits ins terms of dividend and unlike debt financing he will not be able to free the firm of the equity by paying the principal and interest, but may have to buy out the other shareholders at a higher price if the business does well. When looking at investing in a small business it is not only the financial position of the organization that needs to be looked at but rather the non-financial position too. Before investing in the business it would be prudent to look at the liquidity, current and quick ratios to ensure the firm is liquid. Further it would be necessary to look at the investment rate of return. The management capabilities of the personnel should be taken into account along with the market potential for the products and services of the organizations. The competitors, buyer and supplier powers, the entry and exit barriers in the industry and last but not least it is also necessary to compare the organization’s liquidity ratios etc against industry standards and an assessment of the organization and its potential should be carried out before investing and even after. Lease Vs. Buying Decision Buying 20 units at $1000 per unit would cost the organization $20,000 while leasing 20 computers for $5000 per year for a four years again would cost the organization $20,000. Therefore in total when you look at the cost to the organization at face value there is no difference. However there are many differences and pros and cons to both aspects and the decision should be looked at from different angles and an appropriate decision made as to if the organization should lease or buy the equipment. We will first look at buying the equipment the consequences, the advantages and the disadvantages and then go on to look at the consequences of leasing equipment the advantages and the disadvantages. If the organization is to buy the equipment it will own the equipment outright and can dispose of it at anytime and buy new equipment if deemed necessary, further at the end of four or five years the organization can also sell the equipment for a reduced value and use the funds to buy new equipment. The organization can also depreciate the equipment. The downside of buying the equipment outright is the capital investment and opportunity cost of it. If the equipment is deemed obsolete before it is fully depreciated the organization can loose out and at the end of its life it will need to be disposed by the organization, which may cost. Further repairs and upgrades to the equipment will all have to be to be borne by the organization. If the organization is to lease the equipment, then the initial capital investment is minimal. Also depending on the contract that it has signed upgrades and maintenance maybe be borne by the lessor. Further the organization will not have to worry about disposing the equipment at the end of the four years nor depreciate the cost. The downside to all this is that the organization is in a contract for four years and may not be able to get out of it without losing out in the event they want to change equipment for some unforeseen reason. Also they don’t own the equipment at the end of the four year period and have to pay an additional sum if they are to own the equipment. Therefore as you can see both options have an upside and a downside and both options will have to looked at closely along with the lease agreement before the organization makes a decision. Final Project It is the intention of the business owner to fund 25% of the necessary capital through personal savings and the 75% of the necessary capital through debt financing. Since the debt financing will be quite a large amount it will be raised by approaching several different financial institutions. The owner has decided to buy a showroom costing around $400,000 using debt financing – the entire mortgage will be funded through a bank and this is done because it is easier to raise funds for purchase of commercial real estate as it makes good collateral and debt servicing costs are relatively cheaper on mortgages than for other types of debt financing. The thinking behind raising 25% of the necessary capital through equity financing or personal funding and the rest through debt financing is because the owner does not wish to have a business partner who would want to be involved in the day-to-day operations of the business and therefore has decided to fund the necessary capital on her own. However if she were to come across an investor who would like to be a silent partner or who would not insist on being involved in the day to day management of the organization then she would certainly look at raising equity finance by letting this individual invest in the business. However the owner still prefers to go it on her own as she believes there is a lot of potential in the business and is very sure of her capabilities to handle the business and take it to the next level and expand and is sure she can do all the initial work on her own and make an excellent profit. She will either sell a part of the business as it expands or bring in bigger investors with additional financial strength and necessary expertise when it is time to expand at a larger scale. PART C Discussion Questions There are three different valuation methods that are available to businesses. They are Income-based valuation, Asset-based valuation and Market-based valuation methods. In the case of Sarah’s business as it is a service-oriented business an income based or a market-based approach to valuation is the best approach. Each of these methods has its advantages and drawbacks and within each of these methods there are specific techniques that are used to value the business. If Sarah owned a golf club business then she could have used either one of the above mentioned valuation methods or even the asset based valuation method. If Sarah were to use the market based valuation method then some of the facts that have to be taken into consideration would be organizations of same size, same industry and same region. While the income based approach will look at the net present value. In the market valuation method the size of the firm will be the most important factor to consider. When a small business ventures into foreign trade it is imperative that the organization protects itself against the ups and downs and fluctuations in the foreign exchange market. Depending on the stability of the economy in the domestic market and that of the country where the organization is exporting to. Therefore hedging in order to avert financial losses will be a good idea. Since this is a small business that is under consideration it is a good idea and a safe one to get into hedging sooner rather than later. This is because the sensitivity of a small business to changes in the foreign exchange market causes greater risks than it would if the organization was bigger and able to handle financial downturns – this is the objective of hedging. Outsourcing Business Valuations In this report the author looked at two different valuation companies. One based in Dallas Texas and the other based in the United Kingdom. Erickson Partners LLC is based in Dallas, Texas and provides services in the valuation, litigation and also in an advisory capacity. They have expertise working across a multitude of industries and value both tangible and intangible assets. While they believe that no two valuation techniques are the same they have identified the common elements of the valuation process that would lead to an expert quality report. Further they identify and isolate the needs of the entrepreneur or business, understand the environment the organization is operating in, performs due diligence, prepares the necessary reports and last but not least even explains and defends the report (About Us). The charges for their services vary according to the needs of the organization. However as you can see such an organization is a boon to a small business as all the necessary services are covered under one roof and the organization further the organization is large enough to meet the specific and unique needs of a small business. Valuation Consulting is based in the United Kingdom and has served clients in the European region and North and South America across a multitude of industries. The organization provides many different types of valuations ranging from valuations for allocation of purchase cost, corporate conflict litigation support and testimony fair valuations and even Tax valuations for private clients (Services). Again the charges of this organization depend on the service provided and they too operate as a one stop shop and can be of equally good value to a small business. This can be said because the organization is large enough to have expertise to meet the needs of the small business. Final Project Initially it is the intention to market the products and services of the organization within the home state then to mover outside of the home state and also to expand the business internationally starting off in Canada and then moving to Europe. Initial research has shown that there is a high demand for the products and services offered by the organization in Canada and EU region and the owner believes that she will be in a good position to exploit the market opportunities in a year or so of launching the business. This is because she feels that she needs to concentrate on the home market first, get a feel of the business then look at the international market more in detail – in terms of government rules, regulations, exchange rate markets, foreign trade, shipping and handling, return policies internationally etc. Therefore the owner feels that once she launches the business and also has started generating an income she maybe able to divert some of that revenue toward the building of the website and also hire a firm or specialist on a contract basis to look into the above mentioned factors that will be crucial to the implementation of the international marketing arm of her business. The organization provides products and services and she feels that providing international services needs more planning and organization but owing greatly to the internet she feels that marketing and selling her products outside of the United States should not be too difficult. As a first step in this direction she hopes to have a corporate website set up with a payment gateway that will enable her to accept credit card payments online and she will to sign up with a courier or long distance shipping company that would handle the delivery of the products to the final customer. PART D Discussion Questions The family can choose to sell a part or all of the father’s shares to another agreeable party who will partner the son in the business affairs. Otherwise the son can buy over the total or part of the shares if he is not willing to share the running and management of the organization with another individual other than his father. If the father is totally bought out then he can invest the money he receives and ensure he has an income for the rest of his life – if only a part of his shares are sold he can still continue to receive the profit in the form of dividend. Another option that the son can look at is to convert the father’s share equity into debt equity so as to ensure that the father receives an income whether the firm does well or not. Again he can receive dividend for a part of the equity that is not converted and receive interest and even be bought out for the part that is debt equity. Small businesses being exempt from disclosing certain information makes it unnecessary for the small business owner to complete certain types of paperwork to encourage investors as a result it would be easier for the small business to raise funds than it would have been if the exemptions were not in place. Further the probability of a small business misappropriating funds is much less than with a bigger organization, therefore it is not too bad an idea that small businesses are exempt from certain disclosure needs. However while this is all good for the small business and is a regulation to be lauded we should also remember that small business investors are individuals who know the business owner and may not exercise enough caution when investing the exemption regulations will only add to the risk faced by the investor. Final Project Depending on the international market and the business owner’s interest in exploiting the market once the initial website is up and running and she has international demand for her products – she will look at two ways of expanding further into the international arena. She would either like to franchise her business or bring in venture capitalists to fund the business further and expand it abroad. However in order to do either of this the business owner feels that she will need to give the international business a good chance to grow and that may take a few years depending on market conditions and also her own ability or the ability of those that she hires to exploit the international market. The timeframe that she is looking at within which to make a decision regarding expanding her international operations is within three to four years of venturing into the international arena. Which means that she would explore that idea depending on the first five years of financials and demand for her products and services both locally and internationally. However it should be stated here that the owner is more inclined to look at franchising her business in Canada and Europe rather than bringing in venture capitalists especially if the franchising idea is viable in the European countries such as the United Kingdom and Nordic countries where she wishes to market her products in. By franchising she feels that she can have foreign expertise and be able to customize the business to suit the needs of the said market very well with a local flavor but at the same time keeping to her level of service and vision and still making a handsome profit off the business itself. Given below is the updated financials for Home Healthcare Agency incorporating the new fixed asset that will be purchased and the projected international revenue to be from 2009 through to 2013. Angels Who Care Projected Profit and Loss Accounts 2008 2009 2010 2011 2012 Sales $2,500,000 $3,200,000 $3,400,000 $3,800,000 $4,500,000 Cost of Sales $850,000 $920,000 $950,000 $1,200,000 $1,700,000 Gross Profit $1,650,000 $2,280,000 $2,450,000 $2,600,000 $2,800,000 Officers comp $200,000 $210,000 $220,000 $230,000 $250,000 Website   $20,000 $5,000 $5,000 $5,000 Salary Wage $540,000 $600,000 $620,000 $750,000 $800,000 Rent $120,000 $120,000 $120,000 $120,000 $120,000 Taxes $250,000 $300,000 $450,000 $500,000 $500,000 Interest Paid $24,000 $24,000 $24,000 $24,000 $24,000 Amort & Dep $50,000 $50,000 $50,000 $50,000 $50,000 Advertising $24,000 $35,000 $75,000 $150,000 $250,000 Benefits- Pension $60,000 $70,000 $80,000 $100,000 $120,000 Other SG&A Exp $250,000 $250,000 $260,000 $275,000 $300,000 Net Profit $132,000 $621,000 $551,000 $401,000 $386,000 Angels Who Care Projected Balance Sheet 2008 2009 2010 2011 2012 ASSETS   Cash $50,000 $75,000 $75,000 $100,000 $150,000 Receivables $38,000 $44,000 $60,000 $39,000 $24,000 Inventory $850,000 $920,000 $950,000 $1,200,000 $1,700,000 Other Current Assets $30,000 $40,000 $64,000 $60,000 $40,000 Showroom $400,000 $400,000 $400,000 $400,000 $400,000 Fixed Assets $600,000 $600,000 $600,000 $600,000 $600,000 Other Non-Current Assets $132,000 $621,000 $551,000 $401,000 $386,000 Total Assets $2,100,000 $2,700,000 $2,700,000 $2,800,000 $3,300,000 LIABILITIES   Accounts Payable $50,000 $65,000 $100,000 $135,000 $165,000 Loans/Notes Payable $1,500,000 $1,500,000 $1,500,000 $1,500,000 $1,500,000 Total Current Liabilities $25,000 $310,000 $200,000 $240,000 $435,000 Total Liabilities $1,575,000 $1,875,000 $1,800,000 $1,875,000 $2,100,000 Net Worth $525,000 $825,000 $900,000 $925,000 $1,200,000 Total Liabilites & Net Worth $2,100,000 $2,700,000 $2,700,000 $2,800,000 $3,300,000 (Financial Statements partially extracted from BizMiner website) Works cited About Us, Erickson Partners LLC, retrieved on January 25, 2008 from Services, Valuation Consulting, retrieved on January 25, 2008 from Small Business Financial Profile (January 2008), BizMiner, retrieved on January 17, 2008 from Read More