Financial Markets and Bank Management - Assignment Example

Financial Markets and Bank Management Question a) Under the current estimated balanced sheet amounts of the business, the workingcapital of the business will be as calculated below. Working capital = current assets – current liabilities (Brigham & Houston, 2009) Current assets = £559,000 Current liabilities = £400,000 Working capital = £559,000 - £400,000 = £159,000 Similarly, the working capital is likely to change if the proposed amendments individually and all together are undertaken as reflected in the computations below. (1) Debtors estimated at 20% of projected sales Projected sales = £1,550,000 Debtors = £1,550,000 * 20% = £310,000 Working Capital = £661,000 - £400,000 = £261,000 (2) New equipment purchased at £25,000 Cash = £40,000 - £25,000 = £25,000 Working capital = £159,000 - £25,000 = £134,000 (3) Creditor estimated to be 15% of projected sales Projected purchases = 15% * £900,000 = £135,000 Working capital = £159,000 - £135,000 = £24,000 (4) All together Current assets = £311,000 + £310,000 + £25,000 = £646,000 Current liabilities = £135,000 + £200,000 = £335,000 Working capital = £646,000 - £335,000 = £311,000 Accordingly, the working capital of the business will increase if the proposed amendments are realized. (b) The working capital and the financial ratios provided for the business in the last four financial years provide a vital base of responding to the client’s request. Accordingly, the financial ratio of gearing ratio under financial structure depicts the debt level of the firm is improving from previous financial year. This is because the 94% of gearing ratio 2014 implies the level debt finance is 94% of equity finance while in 2013 it stood at 104%. This indicates that less assets are attached to debt finance compared to equity finance that is instrumental in ensuring the firm is not financially constrained in future in servicing the bank loan using its assets (Suresh & Paul, 2010). In addition, the amount of profit that to sales indicates that the firm has enhanced management of costs that is vital in enabling the increase from 1.6% to 2.4% in 2013 and 2014 respectively. Thus, the firm has potential of building adequate retained earnings in future to service the bank loan and interests when they fall due (Brigham & Houston, 2009). However, the times of interest cover reflected in the calculated financial ratios for 2014 and 2013 financial years reflect that the ability of the firm in settling interest obligations when they fall due using earnings before interest and taxes is reducing. This has the potential of causing the firm to default servicing the interest financial obligation when they fall due in future (Sornette, Ivliev, & Woodard, 2012). However, the ability of settling the interest obligation by two times using earnings before interest and taxes is positive signal the firm has financial strength of settling interest obligations when they fall due in future. Another aspect of the firm in obeying its obligation in servicing the extended bank loan is profitability ratios attached. Even though the profitability of the firm has remained positive in the last four years as reflected by the financial ratios, the profitability strength of the firm has been reducing as reflected in the previous financial year’s gross and net margin ratios. Thus, the potential of the business in facing financial difficulties in settling the bank loan using generated profit is likely to arise under the given trend (Suresh & Paul, 2010). Furthermore, current and acid ratios that measure the ability of a firm to service current financial obligations using current assets depicts the liquidity strength of the firm are declining. Thus, the potential of the firm in failing to settle interest and principal amount in future is likely to arise in future that might cause the bank to incur losses (Fabozzi & Drake, 2009). Owing to the financial position reflected on the firm by the financial ratios, the loan should not be extended. Question 2 Extending an overdraft to a client should be informed by the liquidity strength of the client’s financial trend. This implies the ability of the client in maintaining positive cash flow trend and been able to offset cash financial obligations when they fall due. The ability of a client in maintaining a positive cash flow and offsetting cash obligations ensures that the client is able to service the overdraft interests and principal amount when they fall due (Fabozzi & Drake, 2009). Accordingly, the decision to offer Shao the requested overdraft should be informed by the extent of him been able to settle the cash financial demand in future promptly as agreed in the agreement. An intensive analysis on the current and potential future financial position of Shao demonstrates that the overdraft request should not be granted. One of the aspects that demonstrate if Shao is capable of servicing the overdraft amount and interests accrued is his spending rationale. The spending behavior of Shao depicts that he has the potential of consuming more than he generates due to his unplanned spending. This has the potential of hindering a positive cash flow in future that is essential in enabling one to service an overdraft obligation and interest when they fall due (Sornette, Ivliev, & Woodard, 2012). Thus, Shao has high potential of causing Shao to default the overdraft obligations in future that will cause loss of revenue for the bank. In addition, the overdraft growth trend that Shao is facing depicts that he is likely to face financial difficulties in future to settle financial obligations. The overdraft amount that Shao is facing has been rising steadily that means granting an overdraft worth £10,000 will heavily in debt him in future financial obligations. Consequently, the potential of Shao to face financial constrains in meeting the high financial obligations will be higher. Furthermore, the current earnings per month that Shao earns compared to current expenses and expected school fees payment per term of his younger son demonstrates he is unlikely to keep positive cash flow in future. This is because the earnings per month are less compared to the fixed expenses that Shao will be facing in future (Fabozzi & Drake, 2009). Thus, Shao will be unable to service the financial obligations of overdraft loan granted in future due to financial constraints. Consequently, it is irrational to extend the overdraft request by Shao since it has the potential of causing the bank to suffer losses in future due to his high default risk. References Brigham, E. F., & Houston, J. F. (2009). Fundamentals of financial management. Mason, OH: Thomson/South-Western. Fabozzi, F. J., & Drake, P. P. (2009). Finance: Financial Markets, Business Finance, and Asset Management. Boston, OH: John Wiley & Sons Inc. Sornette, D., Ivliev, S., & Woodard, H. (2012). Market risk and financial markets modeling. Berlin: Springer. Suresh, P., & Paul, J. (2010). Management of banking and financial services. Noida: Pearson. Read More