Managing Financial Resources &Decision

Task 1

Sources available to a business

Investment from Business angels: there is a shared gain of ownership in return of shareholders

investment in the company. It is a permanent capital available for use because the shares are not

redeemable and so the company has no liability for cash outflow associated with its redemption.

The shared capital is having a high cost thanks to its dividends which aren’t deductible and the

flotation costs in ordinary share are a bit more high than debt one.

Hire purchase- the meaning of hire purchase is that an asset may be purchased without paying

the entire price. “Hire purchase is cheaper than personal loan because the ownership is retained

by the finance company (ie; it is secured) and if you don’t make your monthly payments then

they will have problems.” (Small Business Administration)

There can be easely obtained and they are having a low deposit but the monthly rates that

must be paid are a bit high because of the interest payment on full value that the business wants

to acquire for a short period of time.

Bank Loans – loans are having a legal interest which may be fixed or variable and so they are

secured against assets. The company can get a loan for anything they want in a quick manner as

well as all the funding needed. But there is also disadvantages if the company misses to make a

payment then the company will face serious problems.

Loans from family and friends - loans are having a legal interest which may be fixed or variable

and so they are secured against assets. The company can get a loan for anything they want in a

quick manner as well as all the funding needed. But there is also disadvantages if the company

misses to make a payment then the company will face serious problems.

Implication of different sources

Hire purchase

Legal Implications: Agreement is required

Financial Implications: Tax Credits can be enjoyed; the customer can claim depreciation of their

equipment as tax deduction.

Dilution of control implications: Control over the company’s not diluted but pull-out of asset in

case of default that may hamper operations.

Bankruptcy Implication: None.

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Bank loan

Legal Implications: Subject to asset seizure in case of default‡

Financial Implications: Payment of amortization per month/quarter/ annual should be funded‡

Dilution of control implications: No Dilution of Control

Bankruptcy Implication: if the borrower should enter a state of bankruptcy in the future, the

assets used to secure the bank loan must be used to repay the bank loan before other creditors,

preferred stockholders or common stockholders receive any payment.

Loan from family and friends

Legal Implications: If you decide to finance your business from a friend or family member's

investment, you can prevent misunderstandings by having a formal agreement in place. The

agreement should be witnessed by an independent person.

Financial Implications: Some loans are interest-bearing while some are interest-free.

Dilution of control implications: No Dilution of Control

Bankruptcy Implication: no bankruptcy.

Bank overdraft

Legal implication: must be filled up certain documets regarding the pay requirements and other

documents with repayments.

Financial implication: the business must pay repayment charges.If the company do not pay on

time will be charged penalties.

Control of ownership: the company control is not diluted.

Bankrupcy implication: among the first to be paid from the residual asset of the business.

Appropriate source of finance for business project

Bank loan

Advantages:

Can have fixed or variable interest, they are secured against assets, so they have a legal shared

interest in the investment.They can get a loan for anything they want and they can get it very

quickly. The company gets all the funding they needs.

Disadvantages

The rates of bank overdrafts is higher then loans because carry “interest and fee”,and makes them

expensive as long term borrowing. The bank can recall at any time the entire loan.

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Loan family and friends

Advantages

Lower Interest Rates- One of the biggest advantages of borrowing money from family is that you

are likely to pay a lower interest rate than you could get at a bank or credit union.

More Flexible Repayment Terms-Family members may be willing to negotiate favorable

repayment terms for your new business loans, while traditional lenders will generally be less

flexible.

Disadvantages

Meddling

One potential downside of accepting a business loan from a family member is that the individual

may feel that he or she is now part owner of the company, with a right to call the shots and make

business decisions.

Family Squabbles

Borrowing money from family members and friends is always fraught with peril, and borrowing

money for a business is certainly no exception.

Lack of Clarity

Many people treat loans from family members as informal transactions, but that is a big mistake.

This lack of formality can be a big disadvantage of borrowing money from family members.

Business angel

The advantages of BA funding for your business can include:

BAs are free to make investment decisions quickly

no need for collateral - i.e. personal assets

access to your investor's sector knowledge and contacts

better discipline due to outside scrutiny

access to BA mentoring or management skills

no repayments or interest

Disadvantages of business angel financing

The disadvantages of BA funding for your business can include:

not suitable for investments below £10,000 or more than £500,000

takes longer to find a suitable BA investor

giving up a share of your business

less structural support available from a BA than from an investing company

Hire purchase

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Advantages

“Hire purchase is cheaper than a (‘unsecured’) personal loan because the ownership is

retained by the finance company (ie; it is secured) and if you don’t make your monthly payments

then they will have problems.”(Small Business Administration)

There are quick to obtained and their deposits are lower than loans.

Disadvantages

The rates that a company must pay monthly is a bit higher,because they pay interest an a

full value even that the company want’s to acquire him for a short period of time.

In this source of finance are hidden fees that can make a worse deal,so the company must

“shop widely” before making the deal.

In order to finance your business Glen you must choose the appropriate source of finance for

your business taken into consideration that you may take out a loan from a bank over a period of

time but must repay it through interest, another way of raising money is through bank overdraft

which gives you the opportunity to take out money from your account and then put it back but the

bank will fix him a maximum limit for your overdraft.

Task 2

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The cost of different source of finance

Bank loan

The cost of debt financing (loans) is interest. The cost of equity financing (investments) could

include dividends or a share of the profits. Comparing the two may involve a cost of capital

calculation and analysis. We will see costs of different source are performing in business.

Hire purchase

Interest rates which are charged for financing- the rates are favourable to assets having high

resale value and are considered “soft” because of their low resale value and which will be given a

less favourable rates.

Business angels

Business angels (BAs) are wealthy individuals who invest in high growth businesses in return

for equity in – ie a share in the ownership of - those businesses. Some BAs invest on their own,

others as part of a network, syndicate or investment club. BAs are often experienced

entrepreneurs themselves and therefore, in addition to money, they bring their own

skills, knowledge and contacts to the company.

Loan family and friends

Unlike other forms of traditional finance, funding from family and friends is typically offered

on flexible terms. Friends and family may agree to a longer repayment period and may seek a

lower rate of return than traditional lenders. On a practical level, little or no security is required

and the repayment can be tailored to your financial projections.

Interest represents the cost of financing but there is also an equity cost which include shared

profits and dividends and comparing the two costs will involve an analysis of the cost of capital

calculation.

“According to Thomas Kenny, in the investment world, opportunity cost is the cost of

choosing one option over another. Opportunity costs are invisible on your personal balance sheet,

but they are a very real consideration when making investment decisions. As for example at the

beginning of the year, you receive a bonus and decide to invest it. After researching the choices,

you decide to invest in high yield bonds.”

www.yourmoneycounts.com

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Opportunity costs represent a financial benefit which enable the company to measure its

decision outcomes by comparing it with the revenue or profits that the business would have if it

had picked the right option.

Another cost it might be the total fixed costs which is also an opportunity cost incurred in the

production on short term and which do not depend of the output quantity. This cost as it can be

seen from its name is a fixed cost. These costs must be paid as long the company is having a short

run business.

“It has been recommended that the benefits and costs of projects should be discounted by the

social rate of time preference for consumption, but only after costs have been adjusted by the

shadow price of investment to reflect the fact that forgone private investment has a higher social

return than present consumption.” Partha Dasgupta, Amartya Sen, and Stephen Marglin, Guidelines for

Project Evaluation, (Vienna: United Nations Industrial Development Organization), 1972.

The importance of financial planning

“It is important to plan finances in order to reap long-term benefits through the assets in hand.

The investments that one makes should be structured properly and managed by professionals

through financial planning. Every decision regarding finances can be monitored if a proper plan

is devised in advance. Financial planning helps in increasing cash flow as well as monitoring the

spending pattern. The cash flow is increased by undertaking measures such as tax planning,

prudent spending and careful budgeting.” (Celeb Financial planners Global)

For any business it is important to have financial planning in order to provide guidance for the

company’s overall activities and their finances to be handled within the business. Financial

planning importance can be also seen from the business cash flow movement into the business.

So for companies it is a bit difficult to be stable financially if they do not have a financial plan.

Financial planning is key for success because without it the company is bound to lose its

financial grip and then to have disastrous results. Financial planning importance is best seen

when the business is confronted with a situation that concerns an outstanding rising cost and

debts. So in order to be prepared for any situation the company must prepare a proper financial

plan.

Raising capital for the business is an important part of the financial planning structure. Once

you’ve started a business you need to calculate the amount of expenditure you will incur and the

amount of capital you have to raise to cover that expenditure. All businesses require an initial

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investment to meet their requirements. Innovative ideas to raise capital have led to the growth of

large corporations.

The tough environment explains much of the recent merger and acquisition activity, with

planning businesses seeking scale to drive profitability.

Information needs of different decision makers

In a company the financial department generates lots of financial information that helps decision-

makers in the “decision-making process”:

“Owners would use the return on capital employed ratio to work out how much money they will

receive back for their investment and decide whether to increase their stake in the firm or

withdraw their capital.

Managers will compare last year’s results with current performance using ratios. They will also

compare what sales figures and budget projections are in line with actual figures. They will then

make decisions based on this information which will affect the operations of the firm.

Employees/Trade Unions would use financial information to look at the overall health of the

organization and decide whether their jobs are safe or if it is a good time to negotiate a pay rise.

Creditors will normally be suppliers who will be interested to see if the firm is meeting its

demands and in a position to pay its suppliers. Future contracts could depend on such issues.

Banks are interested in the financial information published by the firm as they will gain insight

into how capable the firm is of paying back any loans or mortgages they may have currently with

the lender.”

http://www.bbc.co.uk/bitesize/higher/business_management/finance/users_financial_info/revision/1/

The impact of finance on the financial statements

“Financial statements can have an impact on how easy it is for a business to get financing. If a

company is trying to take out a business loan, the lender will typically want to look at the

financial statements of that company. If the information on the financial statements is not

flattering, it may negatively impact the ability of the company to borrow money. Lenders usually

only want to invest in companies that have good financial numbers.”

Source(s)://smallbusiness.chron.com/impact-financial-statements-23794.html

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Companies are financing their business most of the time through loans and borrowing. But

organisations who provide loans are seeking interest payments. The costs of interest represent the

price fro obtaining a loan and it shows how much money must pay in interest for the entire period

of the loan. The profit generated keeps the company in a good standing position and the money

amount available for lending replenished.

In order to take financial decisions managers are looking for information in the company

financial reports such as financial statements and cash flow.

The statement of cash flow is an important logical tool for managers, investors and creditors,

even though managers are more apprehensive with cash flows statement prepared as a branch of

the budget process.

Bank loan

Loans are represented as liabilities on the balance sheet. When a business secures a loan, it

records it as an increase in the appropriate asset account and a corresponding increase in an

account called loan or something more specific if the business has more than one loan. As time

passes and the business begins to reduce its debt through regular loan payments, the loan account

decreases correspondingly with the assets being used to make the loan payments.

Banks, in the normal course of business, assume financial risk by making loans at interest rates

that differ from rates paid on deposits. Deposits often have shorter maturities than loans and

adjust to current market rates faster than loans. The result is a balance sheet mismatch between

assets (loans) and liabilities (deposits). An upward sloping yield curve is favourable to a bank as

the bulk of its deposits are short term and their loans are longer term.

Equity investment:

When you, co-owners or investors make an equity investment in your company, you increase the

amount of additional paid-in capital under owner's equity. Because your company's balance sheet

must balance, the cash used to pay for the equity investment gets recorded as cash under short-

term assets. If an investor contributed an asset, then the asset's value gets recorded under long-ter

m assets.

Equity investments typically take the form of cash contributions. However, owners or investors

may contribute other assets that your company needs to operate its business. For example, an

equity investor may contribute a printing press to a printing company in exchange for equity in

the business.

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Task 3

Budgets

The objective of the operating budget is to provide managers with the ability to plan, organize,

staff, and control the operations to accomplish the mission for the fiscal year. They provide a

coordinated plan of action which is design to achieve the estimates reflected in the budget.

Managers are required to produce detailed plans to enable the implementation of the long term or

strategic plan.

Decision making is a process in which an organization is choosing one course of action from

possible alternatives. In this process it may be used certain tools and techniques.

With the surplus the company will be able to buy a better equipment, to hire new staff, expand

its business by creating a new brand or refurbishment the business.

The calculation of unit costs

Cost per unit is a measure of a company's cost to build or create one unit of product. Often,

calculating the cost per unit isn't so simple, especially in manufacturing situations. Usually, costs

per unit involve variable (costs that vary with the number of units made) and fixed costs (costs

that don't vary with the number of units made).

Variable costs (direct materials) vary in proportion to the units produced, though this cost

declines somewhat as volumes unit increase due to purchasing discounts .Fixed costs should

remain unchanged no matter how units are produced through can increase as result of additional

capacity being needed.

Cost per unit calculation is: (Total fixed costs + Total variable costs) / Total units produced

The cost per unit decline as the number of produced units increases because the total fixed costs

spread over a larger unit numbers. Thus, the cost per unit is not constant.

PRICE/UNIT= (Direct material+ direct labour+ Direct expenses+ Over heads) /total production 

In calculating the unit price we are using the unit price formula such as:

Total cost + (%)total cost

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The viability of a project (3C)

The viabillity a project is to put out in business some benefits that will contribute to strategic

goals.For the benefits to be maximised the project and the planning should be written.

Net Present Value is a technique it will take account of the time value of money and therefore

the opportunity cost.

Net Present Value

“Net Present Value (NPV): By this technique it will take account of the time value of money

and therefore the opportunity cost. Aan also adjust the discount rate to take account of the

different level of risk inherent in this investment. It can also combine this technique with

sensitivity analysis to quantify the risk of the investment.”

(The Accounting Hypotheses,2011)

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Task 4

The main financial statements

“Financial statements can have an impact on how easy it is for a business to get financing. If a

company is trying to take out a business loan, the lender will typically want to look at the

financial statements of that company. If the information on the financial statements is not

flattering, it may negatively impact the ability of the company to borrow money. Lenders usually

only want to invest in companies that have good financial numbers.”(JORIND 10 (2), June, 2012. ISSN

1596 - 8308. www.transcampus.org./journals, www.ajol.info/journals/jorind)

Balance Sheet, also known as the statement of Financial Position, presents the financial

position of an entity at a given date. It is comprised of the following three elements:

Assets: Something a business owns or controls (e.g. cash, inventory, plant and machinery, etc)

Liabilities: Something a business owes to someone (e.g. creditors, bank loans, etc)

Equity: What the business owes to its owners’.

Income Statement - Income Statement, also known as the Profit and Loss Statement, reports

the company's financial performance in terms of net profit or loss over a specified period.

Organisations put out financial statements such as the income statement, balance sheet and

statement of cash flows. When these financial statements are released, they can have large

impacts on the business and on the investors of the company.

Appropriate formats of financial statements for different type of business

There are differences between the format of financial statements for different types of business

such as sole trader, partnership business and Limited Company.

Each of these companies has different economic sectors so they use different financial

statements with different format in order to satisfy those sectors. Sole traders use simple financial

statements because this report serves only for the company’s owner. It may not have a balance

sheet and income statement just the need to show the profit and loss compared with a Limited

Company which has a prepared financial report and generally accepted accounting principle.

On the other hand for partnership business, financial statements have relation with the owner

profit and interest which contributes to the capital of the company. The statements analyzed the

capital and the profit of the companies.

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In contrast for Limited Company, financial statements reflect the current and non-current

assets, sales, profits, costs of income tax and earnings.

Interpretation of financial statements using appropriate ratio

Ratio of profitability

Operating Margin Ratio it is used by the companies to measure the strategy of pricing and to

operate the efficiency,this is a ratio that derives from the division of operating income by the net

sales.It measure the proportion of companies revenue left over after incurring variables such as

wages and raw materials.

Operating Margin Ratio=Operating Income/ Net Sales

Return on Total Assets Ratio (ROTA) it is used to measure the company earning before the tax

and interest against the net total assets. It represent an indicator which shows the effcetively the

companies assists are being used to generate earning before any tax and interest.

EBIT =Net Income+ Interest Expenses + Taxes.

Ratio of liquidity

Current Ratio represent a financila ratio used to evaluate the company current position by

evaluating the curent assets with the current liabilities.

Current Ratio= Current Assets/ Current Liabilities.

Quick ratio or acid test ratio used in order to measure the company capacity to utilize the near

cash to settle immediately the current liability.

Ratio of efficiency

The Days Sales Outstanding ratio it takes information from the company income statements and

balance sheet and shows the time the business takes to return their receivables into cash and the

number of days of its accounts receivable.

“DSO = (Total Accounts Receivables/Total Credit Sales) x Number of Days in the period whose

analysis is being done”

The Inventory turnover ratio is being used by companies to test their efficiency and how rapid

move their goods. They use the formula: “Inventory Turnover Ratio = Net Sales / Inventory”.

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REFERENCES

Jordan, Stephen A. Ross, Randolph W. Westerfield, Bradford D. (2010). Fundamentals of

corporate finance (9th ed., Standard ed. ed.). Boston: McGraw-Hill Irwin. p. 89

Subhash C. Jain - Marketing Planning & Strategy

Financial Management,2011

Celeb Financial planners Global

WordPress,2011

JORIND10(2),June,2012.ISSN1596,8308.www.transcampus.org./journals,www.ajol.info/

journals /jorind)

Small Business Administration

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