1.0 Introduction

This is an informative and analytical report on Sources of finance. The report is written as an assignment of ‘Managing financial resources and decision’ module of the first semester for the evaluation of our understanding and knowledge of the sources of finance to the lecturer Mr. Chamila. This assignment also tests our knowledge on choosing the appropriate source of finance and financial planning. The report also provides analysis of Singer (Sri Lanka) PLC’s balance sheet for sources of finance. All of the information and research for this report is through the World Wide Web.

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2.0 Sources of Finance

Finance is essential for a business’s operation, development and expansion. Finance

is the core limiting factor for most businesses and therefore it is crucial for businesses to

manage their financial resources properly. Finance is available to a business from a variety

of sources both internal and external. It is also crucial for businesses to choose the most

appropriate source of finance for its several needs as different sources have its own benefits

and costs. Sources of financed can be classified based on a number of factors. They can be

classified as Internal and External, Short-term and Long-term or Equity and Debt. It would

be uncomplicated to classify the sources as internal and external.

2.1 Internal sources of finance

Internal sources of finance are the funds readily available within the organisation.

Internal sources of finance consist of:

Personal savings

Retained profits

Working capital

Sale of fixed assets

2.1.1 Personal savings

This is the amount of personal money an owner, partner or shareholder of a

business has at his disposal to do whatever he wants. When a business seeks to borrow the

personal money of a shareholder, partner or owner for a business’s financial needs the

source of finance is known as personal savings.

2.1.2 Retained profits

Retained profits are the undistributed profits of a company. Not all the profits made

by a company are distributed as dividends to its shareholders. The remainder of the profits

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after all payments are made for a trading year is known as retained profits. This remainder

of finance is saved by the business as a back-up in times of financial needs and maybe used

later for a company’s development or expansion. Retained profits are a very valuable no-

cost source of finance.

2.1.3 Working capital

Working capital refers to the sum of money that a business uses for its daily

activities. Working capital is the difference of current assets and current liabilities (i.e.

Working capital = Current assets – Current liabilities). Proper working capital management is

also vital as it is also a source of finance for a business.

Current assets

Current assets are also known as cash equivalents because they are easily

convertible to cash. Current assets consist of Stock, Debtors, Prepayments, Bank and Cash.

These assets are used up, sold or keep changing in the short run.

Stock – this refers to the stock of goods available to the business for sale at a given

time. It is very important to maintain the right amount of stock of goods for a business. If

stock levels are too high it means that too much of money is being held up in the form of

stock and if stock levels are too low the business will lose possible opportunities of higher

sales.

Debtors – are a business’s customers owing money to the business having been

bought the business’s goods or service on credit. If a business has cashflow problems it can

maintain a low level of debtors by encouraging the debtors to pay as early as possible.

Prepayments – these are the expenses paid in advance. The payment being made

even before the expense occurs is a prepayment.

Bank and Cash – Bank is the cash held in banks and cash is money held by the

business in the form of cash. Having too much of money in the form of cash is also not good

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for a business since it can use that money to invest and earn a return but however a

business should have healthy current ratio (current assets : current liabilities) of 2:1.

Current liabilities

Current liabilities are short-term debts that are in immediate need of settlement.

Some examples of current liabilities are creditors, accruals, proposed dividends and tax

owing. These obligations have to be paid within a year.

Creditors – also known as trade creditors are suppliers from whom the business

purchased goods on credit. Paying the creditors as late as possible will ease cash flow

requirements for a business.

Accruals – are the expenses owed by the business.

Dividends proposed – are the dividends payable for the year that is not yet paid.

Tax owing – is the sum of money owing as tax.

2.1.4 Sale of fixed assets

Fixed assets are the assets a company that do not get consumed in the process of

production. Some examples of fixed assets are land and building, machinery, vehicles,

fixtures and fittings and equipment. Sometimes where the fixed asset is a surplus and is

abandoned, it can be sold to raise finance in demanding times for the business. Otherwise

businesses may choose to stop offering certain products and sell its fixed assets to raise

finance. Selling fixed assets reduces the production capacity of a business affecting a

business’s return.

2.2 External sources of finance

Sources of finance that are not internal sources of finance are external sources of

finance. External sources of finance are from sources that are outside the business. External

sources of finance can either be:

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Ownership capital or

Non-ownership capital

2.2.1 Ownership capital

Ownership capital is the money invested in the business by the owners themselves.

It can be the capital funding by owners and partners or it can also be share bought by the

shareholders of a company. There are mainly two main types of shares. They are:

o Ordinary shares

o Preference shares

2.2.1.1 Ordinary shares

Ordinary shares also known as equity shares are a unit of investment in a company.

Ordinary shareholders have the privilege of receiving a part of company profits via

dividends which is based on the value of shares held by the shareholder and the profit

made for the year by the company. They also have the right to vote at general meetings of

the company. Companies can issue ordinary shares in order to raise finance for long-term

financial needs.

2.2.1.2 Preference shares

Preference shares are another type of shares. Preference shareholders receive a

fixed rate of dividends before the ordinary shareholders are paid. Preference shareholders

do not have the right to vote at general meetings of the company. Preference shares are

also an ownership capital source of finance. There are several types of preference shares.

Some of them are Cumulative preference share, Redeemable preference share,

Participating preference share and Convertible preference share.

Cumulative preference shares – if a company is in a loss making situation and is

unable to pay dividends for one year then the dividend for that year will be paid the next

year along with next year’s dividends.

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Redeemable preference shares – these preference shares can be bought back by the

company at a later date. Normally the date of redemption is usually agreed.

Participating preference shares – give the benefit of additional dividends to its

shareholders above the fixed rate of dividends they receive. The additional dividend is

usually paid in proportion to ordinary dividends declared.

Convertible preference shares – convertible preference shareholders have the

option of converting their preference shares to ordinary shares.

2.2.2 Non-ownership capital

Unlike ownership capital, non-ownership capital does not allow the lender to

participate in profit-sharing or to influence how the business is run. The main obligations of

non-ownership capital are to pay back the borrowed sum of money and interest. Different

types of non-ownership capital:

o Debentures

o Bank overdraft

o Loan

o Hire-purchase

o Lease

o Grant

o Venture capital

o Factoring

o Invoice discounting

2.2.2.1 Debentures

Debentures are issued in order to raise debt capital. Debenture holders are not

owners but long-term creditors of the company. Debenture holders receive a fixed rate of

interest annually whether the company makes a profit or loss. Debentures are issued only

for a time period and thus the company must pay the amount back to the debenture

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holders at the end of the agreed period. Debentures can be secured, unsecured, fixed or

floating.

Secured debentures – are debentures that are secured against an asset. They are

also called mortgage debentures.

Unsecured debentures – these debentures do not have an asset as collateral.

Fixed debentures – have a fixed rate of interest.

Floating debentures – do not have fixed rate of interest and are not tied to any

specific asset.

Bearer debentures – these debentures are easily transferable.

Registered debentures – are not easily transferable and legal procedures have to be

followed in case of a transfer.

Convertible debentures – can be converted to stock at the end of the debenture

repayment date.

2.2.2.2 Bank overdraft

Bank overdraft is a short term credit facility provided by banks for its current

account holders. This facility allows businesses to withdraw more money than their bank

account balances hold. Interest has to be paid on the amount overdrawn. Bank overdraft is

the ideal source of finance for short-term cashflow problems.

2.2.2.3 Loan

Loans are amounts of money borrowed from banks or other financial institutions for

large and long-term business projects such as the development or expansion of the

business. However loans can be substituted by other alternative sources of finance which

are more suitable.

2.2.2.4 Hire purchase

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Hire purchase allows a business to use an asset without paying the full amount to

purchase the asset. The hire purchase firm buys the asset on behalf of the business and

gives the business the sole usage of the asset. The business on its part must pay monthly

payments to the hire purchase firm amounting to the total value of the asset and charges of

the hire purchase firm. At the end of the payment period the business has the option of

purchasing the asset for a nominal value.

2.2.2.5 Lease

In a lease the leasing company buys the asset on behalf of the business and the asset

is then provided for the business to its use. Unlike a hire purchase the ownership of the

asset remains with the leasing company. The business pays a rent throughout the leasing

period. The leasing firm is known as the lessor and the customer as lessee. Leasing is of two

types, namely Finance lease and Operating lease.

Finance Lease – this is where the lessee’s monthly payments add up to at least 90%

of the total value of the asset.

Operating Lease – this lease does not run for the full life of the asset and the lessee

is not liable for the full value of the asset. The residual risk is taken up by the lessor.

2.2.2.6 Grant

Grants are funding given to businesses for programs or services that benefit the

community or public at large. Grants can be given by the government or private firms.

For example a grant may be given to open a new factory where unemployment is

high.

2.2.2.7 Venture capital

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Venture capital is the capital that is contributed at the initial stages of an uncertain

business. The chance of failure of the business is great while there is also a possibility of

providing higher than average return for the investor. The investor expects to have some

influence over the business.

2.2.2.8 Factoring

This is where the factoring company pays a proportion of the sales invoice of the

business within a short time-frame to the business. The remainder of the money is paid to

the business when the factoring company receives the money from the business’s debtor.

The remainder of the money will be paid only after deducting the factoring company’s

service charges. Some factoring companies even offer to maintain the sales ledger of the

business. Factoring is of two types: Recourse factoring and Non-recourse factoring.

Recourse factoring – In this type of factoring the client company is liable for bad

debts.

Non-recourse factoring – is where the factor takes responsibility for the payment of

the debtors. The client company is not liable if debtors do not pay back. Non-recourse

factoring is usually more expensive because of the high risks experienced by the factor.

2.2.2.9 Invoice discounting

In invoice discounting the client company send out a copy of the invoice to the

invoice discounting firm. The client then receives a portion of the invoice value. In contrast

to factoring, the client company collects the money from its debtors. Once the payment is

received it is deposited in a bank account controlled by the invoice discounter. The invoice

discounter will then pay the remainder of the invoice less any charges to the client.

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3.0 The financial costs of the different sources of finance

Personal savings – have low costs since they are provided by an owner, partner or shareholder. The owner may charge a rate of interest for the loan provided.

Retained profits – have opportunity cost, that is the money could have been used elsewhere for some other purpose. Otherwise there aren’t any other costs for this source of finance.

Working capital – they do not have any costs other than opportunity cost.

Sale of assets – by selling fixed assets it uses then the firm’s production capacity will diminish. If it sells unused or abandoned fixed assets then only the potential production capacity reduces. Sometimes firms will have to stop offering certain products or services in order to sell its asset and raise finance. The asset may cost much more than what it sold for if it wants to replace it.

Ordinary and Preference shares – dividends has to be paid out of profits to shareholders as a return for their investment in the business. There are administrative costs occurring from issuing shares like stock exchange listing fee, printing and distribution fee and advertising fee.

Debentures – have to be paid a fixed or floating interest depending on the type of debenture that is issued.

Bank overdraft – interest is a little higher than for bank loans and interest is calculated on a daily basis.

Loans – Interest is usually fixed for short term loans, and long-term loans usually have a variable rate of interest. Interest rates are lower than for bank overdrafts.

Hire-purchase – the business ends up paying more than the original value of the asset for its purchase.

Lease – the ownership of the asset remains with the leasing company even after the business pays more than 90% of the asset’s value but however some leasing firms provide the option of purchase of the asset a nominal value.

Grants – are free and have no financial costs.

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Venture capital – the venture capitalist will have some influence over the business and the business will have to share profits with the investor. The investor will want the capital back at a later date.

Factoring – Factors charge a rate of interest of about 1.5% to 3% of the invoice value as finance charges. Interest is calculated on a daily basis. Credit management and administrative fee are also charged and ranges from about 0.75% to 2.5% of turnover.

Invoice discounting – Invoice discounting also charges a rate of interest of about the same but its credit management and administrative charges are lower than a factors because only finance is provided and sales ledger is not maintained by an invoice discounting firm.

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4.0 Advantages and Disadvantages of the different sources of finance

4.1 Personal savings

Advantages

The owner would not want collateral to lend money to the business.

There is no paperwork required.

The money need not necessarily be paid back to the owner on time.

Can be interest free or carry a lower rate of interest since the owner provides the

loan.

Disadvantages

Personal savings is not an option where very large amounts of funds are required.

Since it is an informal agreement, if the owner demands the money back in a short

notice it might cause cashflow problems for the business.

4.2 Retained profits

Advantages

They need not be paid back since it is the organisation’s own savings.

There are no interest payments to be made on the usage of retained profits.

The company’s debt capital does not increase and thus gearing ratio is maintained.

There are no costs raising the finance such as issuing costs for ordinary shares.

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The plans of what is to be done with the money need not be revealed to outsiders

because they are not involved and therefore privacy can be maintained.

Disadvantages

There maybe opportunity costs involved.

Retained profits are not available for starting up businesses or for those businesses

that have been making losses for a long period.

4.3 Working capital

Advantages

Since it is an internal source of finance there are no costs involved.

No repayment is needed.

External parties cannot influence business decisions.

Will not increase debt capital of the firm so gearing ratio is maintained.

Disadvantages

Opportunity costs are involved.

Is not suitable for long term investments.

Working capital cannot raise large amounts of funds.

Total risk is undertaken by the company.

Using working capital as a source of finance will affect the current ratio of the

business

4.4 Sale of assets

Advantages

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Funds are again raised by the business itself and therefore need not be paid back.

No interest payments are required.

Large amounts of finance can be raised depending on the fixed asset sold.

Would be the ideal source of finance if it was for an asset replacement.

Disadvantages

If the asset is sold then the business would lose opportunities to generate income

from it.

If the business wants to buy a similar asset later on it may cost more than it was sold

for.

If the asset is sold and the money is spent without return then the business is broke.

The asset may be able to generate more income than the purpose it was sold for.

4.5 Ordinary share issue

Advantages

The amount need not be paid back – it is a permanent source of capital.

Able to raise large amounts of finance.

If the company follows a rational dividend policy it can create huge reserves for its

development program.

The dividends need to be paid only if the company makes a profit.

No collateral is required for issuing shares.

It will help reduce gearing ratio

Disadvantages

Issuing shares is time consuming.

It incurs issuing costs.

There are legal and regulatory issues to comply with when issuing shares.

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Possible chances of takeover where an investor buys more than 50% of the total

issued shares value.

Groups of equity shareholders holding majority of shares can manipulate the control

and management of the company.

May result in over-capitalisation where dividend per share falls.

Once issued the shares may not be bought back and therefore the capital structure

cannot be changed.

4.6 Preference share issue

Advantages

Have no voting rights and thus the management can retain control over the affairs of

the company.

Preference shareholders need not be paid if the company makes a loss.

Even if the company makes large profits preference shareholders need to be paid

only a fixed rate of interest.

Has other benefits similar to ordinary share issue such as – no repayment required,

large amounts of capital can be raised, permanent source of capital and no collateral

required.

Redeemable preference shares can be redeemed.

Disadvantages

Even if the company makes a very small profit it will have to pay the fixed rate of

dividend to its preference shareholders.

Preference shares are usually cumulative and thus twice the amount must be paid

the following year if dividends are not paid on the year they need to be paid.

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Taxable income is not reduced by preference dividends unlike debentures where

interest paid reduces taxable income.

Have other drawbacks similar to ordinary share issues such as the cost, time

consumption and legal requirements.

4.7 Debentures

Advantages

Debenture holders do not have rights to vote at the company’s general meetings.

Tax benefits – debenture interests are treated as expenses and charged against

profits in the profit and loss account.

Debentures can be redeemed when the company has surplus funds.

Disadvantages

Debenture interests have to be paid regardless the company makes a profit or loss.

The money borrowed has to be paid back on an agreed date.

4.8 Bank overdraft

Advantages

No security is needed for a bank overdraft.

Ideal for short-term cashflow deficits.

Easy and quick to arrange.

Interest is only paid when overdrawn and on the exact amount needed

Since overdraft is a short term debt it is not included in calculating the firm’s gearing

ratio.

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Disadvantages

There is a limit to the amount that can be overdrawn.

Interest has to be paid on an overdraft that is calculated on a daily basis and

sometimes the bank charges an overdraft facility fee too.

Overdrafts are meant to cover only short-term financing and are not a permanent or

long-term source of finance

Interest is calculated on a variable rate and therefore it is difficult to calculate the

cost of borrowings.

Overdrafts can be recalled by the bank at any time if not stated in the agreement.

4.9 Loans

Advantages

Large amounts can be borrowed.

Suitable for long-term investments.

The lender has no say on how the money is spent.

Need not be paid back for a fixed time period and banks do not withdraw at a short

notice.

Interest rates are lower than for bank overdrafts and are set in advance.

Disadvantages

Collateral is needed.

The amount borrowed has to be repaid at the agreed date.

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Interest is charged.

Loans will affect a company’s gearing ratio.

4.10 Hire purchase

Advantages

The business gains use of the asset before paying the asset’s value in full.

The payment is made in affordable instalments.

Hire purchase instalments are taxable expenditures.

At the end of the payments ownership of the asset is transferred to the company.

Payments can be made from the asset’s usage and return of the asset.

Disadvantages

Ownership remains with the lender until the last payment is made.

The asset will cost the company more than the original value.

If payments are not made on time the lender has the right to repossess the asset.

If the asset is required to be replaced due to breakdown or because it is out-dated in

which case the payment may still have to be made and the asset replaced.

4.11 Lease

Advantages

The amount in full need not be paid in order to start using the asset.

The total cost and the lease period is pre-determined and thus helps with budgeting

cashflow.

In an operating lease, payments are made only for the usage duration of the asset.

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Lease is inflation friendly where the agreed rate is paid even after five years when

other costs increase due to inflation.

It is easier to obtain a lease than a commercial loan.

Disadvantages

The ownership of the asset remains with the lessor even after payments but

however in a finance lease the option is provided to buy the asset at a nominal

value.

In a finance lease the lessee ends up paying more than the value of the asset.

Lease cannot be terminated whenever at lessee’s will.

4.12 Grants

Advantages

Grants do not have to be paid back.

There are no costs involved in obtaining a grant.

Disadvantages

Grants are given on certain restrictions and laws imposed by the government.

Not all organisations are eligible for grants.

Grants are given freely and therefore are very competitive because lots of firms try

for the same source of fund.

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4.13 Venture capital

Advantages

Venture capitalists invest large sums of money in the business.

They may also bring a lot of experience and expertise along with the money.

Since they become owners by investing in the business they have equal interests in

the business’s success.

Venture capitalists are only periodical investors wanting to exit the business at some

stage.

Disadvantages

The profits will be shared with the investor.

Acquiring venture capitals is a lengthy and complex process where a business plan

and financial projections must be submitted to the potential venture capitalist

As an owner of the business the venture capitalist may want to influence the

strategic decisions and take control of the business.

4.14 Factoring

Advantages

A large proportion of money is received within a short time-frame.

The sales ledger of the business can be outsourced to the factor.

The money collections from debtors are undertaken by the factoring company.

Helps a business to have a smooth cashflow operation.

Non-recourse factoring protects the client company from bad debts.

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Disadvantages

The business has to pay interests and fees for the factor for its services.

The cost will be a reduction on the company’s profit margin.

Lack of privacy since the sales ledger is maintained by the factor.

Costumers would not like factoring companies collecting debts from them.

4.15 Invoice discounting

Advantages

The client company receives the money in a short period.

There is some amount of privacy since the sales ledger is maintained by the client

company and only some invoices are submitted for immediate cash.

Less costly than factoring since the sales ledger is maintained by the client company.

Unlike factoring customers are not aware of invoice discounting since the debt

collection is undertaken by the client firm.

Disadvantages

Debt should be collected by the client company itself and thus resources and time

are wasted in debt collection.

Sales ledger has to be maintained by the client company itself.

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5.0 Choosing an appropriate source of finance

There are many sources of finance available to a business. Finance is needed for several purposes and different purposes need sources of finance which are most suitable to them. When choosing an appropriate source of finance some factors have to be considered.

The factors that need to be considered when choosing an appropriate source of finance are:

The amount of money needed

The urgency of funds

The cost of the source of finance

The risk involved

The duration of finance

The gearing ratio of the business

The control of the business

5.1 The amount of money needed

This is the amount of finance the organisation wants to raise. Not all sources of finance provide all amounts of funds. Some sources are not able to raise large amounts of funds whereas others are not flexible enough to put up for the small sum of money the business requires. Therefore it is necessary to identify the amount of money needed by the company to choose a suitable source of finance.

For example borrowing a commercial loan for a small and short-term cashflow problem is unwise because loans may have a minimum amount that can be borrowed so taking a bank overdraft would be wise where money can be borrowed in small sums and bank overdrafts can be paid back quickly. Therefore the amount of money required is a key factor in choosing a source of finance.

5.2 The urgency of funds

This refers to the amount of time the business can spend on collecting funds. If the business has plenty of time before its financial needs need to be met then it can spend time searching for cheap alternatives of sources of finance. On the other hand if the business wants the money as soon as possible then it would have to make some cost sacrifices and

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accept a source of finance that may even cost higher. The urgency of funds needs to be identified also because certain sources of finance need more time to be raised than other sources of finance.

For example issuing shares is a very long and complex process where there are legal requirements and then the potential shareholders have to be informed (advertising) and after all these the money is collected through the process of application and allotment which takes more time.

5.3 The cost of the source of finance

Different sources of finance have different costs as discussed above. It is always more profitable to a business to seek and obtain cheaper sources of finance. Sometimes however the time does not permit organisations to look for cheaper sources of funds. Internal sources of finance are always cheaper than external sources of finance.

5.4 The risk involved

The risk involved is the certainty of receiving returns for the lender on the investment made using the finance. In simpler words it is the sureness of success of the project. If the provider of finance is not confident that the project in which his money is invested in is less likely to reap returns then the lender would be reluctant to provide the business with funds. In this case the money can be secured against an asset as collateral which will encourage the lender to lend.

5.5 The duration of finance

This is the time period for which the money is needed. It can be for a short-term (within one year), medium-term (one to five years) or long-term (five years and more) time period. By identifying the length of requirement of finance the organisation can eliminate inappropriate sources of finance and choose a source of finance that is more suitable for the required timeframe.

5.6 The gearing ratio of the business

The gearing ratio plays an important role in the availability of the sources of finance since the gearing ratio shows the ratio of debt capital to the total capital of a business. If a business is high geared then commercial lenders will be unwilling to give loans because the business is already operating on more loans than equity capital. A high geared company will have to pay more of its profits as interests on loans and other debt capital. That being the

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case potential lenders fears the business’ ability to be able to cope with more interest payments and debt settlement.

5.7 The control of the business

The existing shareholders of a company would be reluctant to issue shares because this would cause a dilution in control of the business. Issuing shares in public limited companies also gives opportunity of takeovers to outside parties. The same can be said for venture capitalists where the money is invested as equity and being owners the venture capitalists have the right to influence how the business is run. The existing shareholders and owners of a business who would not want any change to arise in the control and ownership of the business would disregard sources of equity finance.

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6.0 The impact of several sources of finance on the financial statements

Financial statements keep record of a business’s trading year (Trading, profit and loss account) and show the financial position of a business as at a date (Balance sheet). Obtaining finance from different sources bring about a change in the financial statements. This portion of the report investigates how each source of finance is recorded and affects the financial statements.

Personal savings –

Personal savings when lent to the business are considered as loans. The amount lent will appear as Long-term liabilities on the balance sheet. If any interest payments are to be made they will be recorded in the profit and loss account and charged against profits.

Sale of assets –

Sale of assets will reduce the value of fixed assets on the balance sheet. The profit or loss made on the sale of asset will be recorded in the profit and loss account for the year. The depreciation of the asset along with its original price will be removed from the balance sheet.

Ordinary shares and preference shares –

The issue of ordinary shares and preference shares increase the vale of equity capital in the balance sheet. If the issued shares market price is greater than the nominal value of the share then share premium is also increased in the balance sheet. The number of shares issued is also displayed in the balance sheet and for preference shares the rate of dividend is also shown. The dividends paid to the shareholders are recorded in the appropriation account after tax is deducted from net profit.

Debentures –

Debentures are a type of debt capital. The value of debentures along with the rate of interest and the repayment date is presented in the equity and liabilities section of the balance sheet. The interest paid on debentures is reduced from profits before tax is charged.

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Bank overdraft –

This appears in the balance sheet as a current liability since it is a short-term debt and has to be paid back within a year. The interest charges and bank overdraft fee if charged are deducted from the profit and loss account before tax is charged.

Loan –

Loans are long-term debts and therefore come under long-term liabilities in a balance sheet. The loan when displayed on a balance sheet will usually contain information about the repayment date and the interest charged on the loan. The interest is charged in the profit and loss account.

Venture capital –

This is an amount of money invested in the business as equity capital and thus comes under equity capital in the balance sheet. The return for venture capitalists is a share of profits which is recorded in the appropriation account.

Factoring and invoice discounting –

This does not appear in the balance sheet. However the money received from factoring and invoice discounting can show higher balances of cash. The interest charges and fee is recorded in the profit and loss account.

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7.0 The information needs of different decision makers

Different decision makers will want different information about the company regarding their interests in the business. A long-term lender will always want to know the gearing ratio of a company while the short-term lender will want to know about the liquidity ratio of the business. The information for different parties is all taken from financial reports, cashflow and financial statements such as the balance sheet and profit and loss account. The manager needs accounting information to take managerial decisions since all functions of an organisation are tied to the financial strength of a business. Using the financial statements, the financial stability and profitability of an organisation can be analysed and interpreted. Using this information the interested parties make decisions regarding the business.

The business’s financial statement can be analysed in a number of ways. Some of them are horizontal analysis, vertical analysis, trend analysis and ratio analysis.

Ratio analysis

The ratio shows the relationship between two relevant items in the financial statement. The relationship is shown as a ratio or as a percentage. Different ratios calculable on a business’s financial statements are:

Liquidity ratios –

o Current ratio

o Quick ratio / Acid test ratio

Working capital ratios –

o Stock turnover ratio

o Average debt collection period

o Average credit taken from creditors

Profitability ratios –

o Return on capital employed

o Gross profit margin ratio

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o Profit before interest and tax/Sales

o Profit after tax/Sales

Financial stability / Solvency ratio –

o Financial gearing ratio

o Debt/Asset ratio

o Interest cover ratio

Investment performance ratio

o Dividend per share

o Dividend yield

o Earning per share

o Price-Earnings ratio

o Interest yield

o Redemption yield

The above ratios being calculated the performance of the business can be assessed and necessary decisions can be taken by relevant parties. Due to limited time the ratios have not been explored in detail.

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8.0 Financial planning

Importance of financial planning

Financial planning affects the terms and conditions on which the business will be able to obtain funding required to establish, maintain and expand the business. Financial planning influences the raw material a business is able to afford, the products it is likely to produce and whether the business will market its product efficiently. It will affect the resources the business is able to acquire to operate and it will be a major determinant of the success of the business.

A financial plan not only help the business to understand what it wants to do but also helps the business understand how to achieve it.

A healthy financial plan consists of the following:

The basic financial statements Ratio analysis Budgets Break-Even analysis Pricing formulas and policies Types and sources of capital available to finance business operations Short and long term planning considerations necessary to maximise profits

The business owner/manager who understands these concepts and uses them effectively to control the evolution of the business is practicing sound financial management thereby increasing the likelihood of success.

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9.0 Singer (Sri Lanka) PLC

Singer is a public limited company that was established in 1877. Today Singer is a large, diversified company unlike any other in Sri Lanka. It is a member of the worldwide franchise Singer. Beginning with sewing machines, Singer’s product portfolio consists of a range of household, industrial and financial categories.

Given below is Singer (Sri Lanka) PLC’s balance sheet.

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9.1 Identifying sources of finance in Singer (Sri Lanka) PLC’s balance sheet.

Fixed or Non-current assets that can be sold are potential sources of finance that is categorised as sales of assets

o Property, Plant and Equipment = LKR 1,419,011,146 Working capital is current assets minus current liabilities

o Working capital (7,855,964,730 – 6,302,249,382) = LKR 1,553,715,348 Retained earnings are the accumulated earnings of a company

o = LKR 373,951,178 Share capital

o = LKR 629,048,050 Loans and borrowings

o = LKR 1,383,661,616

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10.0 Conclusion

Sources of finance is available from variety of sources but each source has its own cost and benefits. It is important to choose an appropriate and cheap source of finance for the smooth operation of the firm. There are important factors to consider when choosing a source of finance. However further work need to be done. The limitedness of time has not allowed for further research and more detail.

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