Friday, December 25, 2015

assignments on finnancial decesions



Introduction

Taking financial decisions is one of the most important parts of any organizations. it includes cash management , analyzing financial decisions and seeking appropriate source for financing. This report aim is to provide with an understanding of where and how to access sources of finance for a business, and the skills to use financial information for decision making. This also deals with how financial information is recorded and how to use this information to make decisions for example in planning and budgeting.

Lo 1 Understand the sources of finance available to a business


1.1    Identify the sources of finance available to a business


Different companies manage the financing from different diversified sources available to them. The sources of finance can be classified into different types like short term and long term or internal and external source. Being a reputable company Sweet Menu Restaurant may manage their finance from these sources:
1.      Share Capital
2.      Retained earnings
3.      Loans and debt
4.      third-party investment
5.      hire purchase and leasing
6.      debtor factoring

Share capital: share capital is the medium of collecting capital from the capital market through issuing new shares.   Funds raised by issuing shares in return for cash or other considerations. The amount of share capital a company has can change over time because each time a business sells new shares to the public in exchange for cash, the amount of share capital will increase. Share capital can be composed of both common and preference shares. (investopedia.com, 2015) Sweet Menu Restaurant can collect share capital trough different way like issuing deferred ordinary shares, Rights share issues, Preference shares issue and so on.
Retained earnings:  The amount of earnings retained within the business is termed as retained earnings.  It has a direct impact on the amount of dividends because this is the amount which is not distributed among the shareholders. This could be turns into great sources of financing for sweet menu as they are continuously making profits over the years.
Loans and debt:  loans and debt is an external source of financing. It could be both short term and long term financing.  Debt financing involves borrowing funds from creditors with the stipulation of repaying the borrowed funds plus interest at a specified future time. For the creditors (those lending the funds to the business), the reward for providing the debt financing is the interest on the amount lent to the borrower. Sweet Menu Restaurant can collect debt and loans from different banks, govt. owned financing companies, private commercial banks or even from near and dear ones.
Third-party investment:  Sweet Menu Restaurant can meet their financial needs by contracting with any third party.  Getting the investment facilities from the third party also cost profit sharing. So, that also has to be kept in mind.
Hire purchase and leasing: Hire purchase is a form of installment credit. Hire purchase is similar to leasing, with the exception that ownership of the goods passes to the hire purchase customer on payment of the final credit installment, whereas a lessee never becomes the owner of the goods. On the other hand, lease is a legal agreement between two parties that specifies the terms and conditions for the rental use of a tangible resource such as a building and equipment. Lease payments are often due annually. [fao.org, 2013]
Debtor factoring: debtor financing is the sale of a business' invoices to a third party. The third party is charged with processing the invoices, and the business lending the invoices is able to receive loans based on the expected payments on the invoices.[J.E. Goodman, 2013]

1.2    Assess the implications of the different sources


Each type of financial source has a set of implications. I could be legal or financial or in terms of dilution of controls.  In terms of debt financing, companies have to pay the interest on the continuous time basis and any failure to pay back the interest and loans may turns into legal action resulting in bankruptcy.
In third party investments, there will be a legal agreement between the buyer and the seller; however, sometimes, these agreements are simply verbal contracts. The implication of not having a written legal contract between both parties can be serious when one side fails to live up to his or her obligations.
Moreover, when a company takes loans from the banks, they have to put some assets to banks as mortgage. This means that the company would not be able to sell the asset without the lender's prior agreement. In addition the lender will take priority over the owners and shareholders if the business should fail and the cost will have to be repaid even if a loss is made.

In terms of share capital, different dividends and amenities have to be provided to the stock holders.  Moreover, share holders have to be entitled with the voting rights in the important decisions of the company. With every share of stock you sell to investors, you dilute, or reduce, your ownership stake in your small business. Because equity investors typically have the right to vote on important company decisions, you can potentially lose control of your business if you sell too much stock.
 

1.3    Evaluate appropriate sources of finance for a business project


Sweet Menu Restaurant needs to assess the different types of finance based on the following criteria:
ü  Amount of money needed
ü  How quickly the money is needed
ü  The cost of financing
ü  Duration of time for finance
ü   risk involved in the financing
Advantages and disadvantages of share capital: the main advantage of share capital is company has no obligation to make interest payments or to repay equity investors’ initial investment. Although you might distribute some of your profits as dividends to equity holders, you can skip these payments if necessary.  On the other hand the main disadvantage of share capital is it typically has higher cost of capital and more time consuming. (Atrill P. 2012)

Advantages and disadvantages of retained earnings:   Though the use of retained earnings does not involve any acquisition cost. The company has no obligation to pay anything in respect of retained earnings, Conservative dividend policy leads to huge accumulation of retained earnings leading to over-capitalization.
Advantages and disadvantages of debt: When a business use debt financing, they have to fully utilize their resources because they will have to pay back the debt and interest to their creditor. Moreover, getting debt financing in these days are quite easy foe existence of different private banks. The main risk involved with the debt financing is failure of paying back loan and interest may turn into bankruptcy. Moreover, the bank interest rates are pretty high in recent times. (Atrill P. 2012)

LO2 Understand the implications of finance as a resource within a business


2.1 analyze the costs of different sources of finance


Different sources of finance are involved with different types cost. Some of them are as follows:
Cost of Debt or loans is the overall average rate an organization pays on all its debts, typically consisting primarily of bonds and bank loans. Cost of debt is expressed as an annual percentage. Costs of debt are basically paid in the form of interest. [Watson,D, 2012]
Cost of Equity shares is a part of a company's capital structure. Cost of equity measures the returns demanded by stock market investors who will bear the risks of ownership. Cost of equity is usually paid in the form of dividends to the share holders.
Cost of retained earnings: cost of retained earnings used as a part of the capital structure of a business firm, is that part of the earnings available to common shareholders not paid out as dividends or the earnings plowed back into the firm for growth. The main cost of retained earnings is that company could have invested this capital in other sectors. [Watson,D, 2012]
Opportunity costs: Opportunity cost is the cost of a foregone alternative. If you chose one alternative over another, then the cost of choosing that alternative is an opportunity cost. Opportunity cost is the benefits you lose by choosing one alternative over another one. The opportunity cost of choosing one investment over another one. [Watson,D, 2012]

2.2 explain the importance of financial planning


Financial Planning is the process of estimating the capital required and determining its competition. It is the process of framing financial policies in relation to procurement, investment and administration of funds of an enterprise. Financial planning denotes taking the future plan regarding which types of financial decisions will be taken for the organizations in the future. It takes great importance in any organizations. The main importance of financial decisions are as follows:

Ø  Financial Planning helps in reducing the uncertainties which can be a hindrance to growth of the company. This helps in ensuring stability an d profitability in concern
Ø  It facilitates the expansion programs of business through proper forecasting of business.
Ø  It facilitates the company to set its goal and helps to achieve it easily
Ø  It helps to maintain a balance between cash inflow and outflow of organizations.
Ø  It help firm to find out best possible alternatives.
Ø  A strong capital base can be built with the help of efficient financial planning
Ø  The financial planning process helps gain an understanding about the current financial position of the market.


2.3 assess the information needs of different decision makers


For taking important decisions, managers have to seek different types of information from different sources. For taking financial decisions, managers have to go through this type of decisions makers:
Government: even though government is not a part of the company, still government needs the information of the company doing business on that particular region.  The basic information needed for government are related to taxation policy, environmental issues, value added to the people life and so on
Stock holders: stockholders or share holders are the owner of the company. For taking different financial decisions, they have to go through important financial information of the company.
Suppliers: suppliers need to know different prospective analysis on the sources of different raw materials and products.
Creditors: Creditors may want to track down the loan they provided to the firm and they also seek information related to capability of the firm.
Employees: the person working within the organization may also seek information for different reasons. 

2.4 Explain the impact of finance on the financial statements for your chosen business


The amount of debt a company takes on has an impact on its balance sheet. In particular, it affects the relationships between several components of the balance sheet. Analysts, investors and bankers all rely to a certain extent on the balance sheet to determine the risk profile of the business. An increase in debt could signal that a company is moving toward shakier financial ground.
When Sweet Menu Restaurant Company raises funds through equity financing, there is a positive item in the cash flows from financing activities section and a positive increase of common stock on the balance sheet.

On the other hand, If Sweet Menu Restaurant raises funds through debt financing; there is a positive item in the financing section of the cash flow statement as well as an increase in liabilities on the balance sheet.

So a change in the financing substantially changes both income statement and the balance sheet of the Sweet Menu Restaurant.

LO3: Be able to make financial decisions based on financial information


3.1 analyze budgets and make appropriate decisions


The cash budget contains an itemization of the projected sources and uses of cash in a future period. This budget is used to ascertain whether company operations and other activities will provide a sufficient amount of cash to meet projected cash requirements. If not, management must find additional funding sources.
If we look at the cash budget of the Blue Island Restaurant, notice except October and November, we have to go through a negative balance of cash. And that is not a very good sign for any firm. Moreover, we also notice Blue Island Restaurant have to expense a lot of money in the inventory which also leads to a negative balance of cash.
The basic reason behind negative cash balance is because Blue Island Restaurant expenses more money in variable and fixed cost. On the other hand the net sale of the firm is not very satisfactory comparing with the variable and fixed cost shown n the cash budgets.
To rectify this faulty cash budgets we could follow two approaches:
1.      Increasing the net sales
2.      Decreasing the costs
If we could take measures to increase the net sales in this 4 month, it can hope that the net cash balance will show positive results. For example if we can change first month net sales into $60000. We can expect a positive balance of $19150. On the other hand, we can also reach our desired goal through cutting down unnecessary variable and fixed cost. For example we can turn down first month cost into $10000 we can expect a profit of $5000.

3.2 Explain the calculation of unit costs and make pricing decisions using relevant information


If we look at the meal cost of the firm, we notice the company have to expense $8 as fixed cost and $2 as variable cost. So the total cost of per meal stands at $10. The firm wants to make 40 % profit per meal that makes $4 per meal. And the firm also has to pay value added tax for 20 % per meal which stands $2 per meal. So the net sale value of the per meal stands at $16

To analyze the pricing strategy, we will follow the breakeven point analysis:
We know Breakeven Point = Fixed Costs/ (Unit Selling Price - Variable Costs)
So in terms of Blue Island Restaurant we have,
Fixes cost =$8
Variable cost = $2
Unit selling price = $16
So breakeven point of Blue Island Restaurant will be 8/ (16-2) = $0.5714
That also means to achieve a net sale of $15000; the firm also has to sell about 938 meals per day.


3.3 Assess the viability of the two projects using investment appraisal techniques


For proposal A
Year
Cash flow
Cumulative cash flow
0
-£1200
-1200
1
800
-400
2
600
200
3
400
600
4
200
800
5
50
850




So payback for proposal A = 1 + 400/600 = 1.667
For proposal B
Year
Cash flow
Cumulative cash flow
0
-£1200
-1200
1
300
-800
2
400
-400
3
500
100
4
600
700
5
550
1250

So payback for proposal B = 3 years.
So comparatively proposal A seems better cause it gains investment earlier than the proposal B.
NPV for proposal A = -1200+ 800/1.1+ 600/1.21+ 400/1.33 +200/1.46+ 50/1.61
                            =$ 491.1934
NPV for proposal B = -1200+ 300/1.1+ 400/1.21+ 500/1.33 +600/1.46+ 550/1.61
=$ 530.28
So , if we consider net present value of two options proposal A seems batter cause it have invest less amount of money to achieve more profit

LO4: Be able to evaluate the financial performance of a business.


4.1 Discuss the main financial statements


The main elements of financial statements are discussed below:
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. Net profit or loss can be obtained by deducting expenses from income. The basic components of an income statement are revenues, expenses and profits.
Balance Sheet: balance sheet presents the financial position of an entity at a given date. It is comprised of assets, liabilities and owner's equity.

Statement of Cash Flow:  statement of cash flow shows net cash came in the firm and net cash outflow from the firm, it deals with different cash related transactions.
Statement of Owner's Equity: The statement of owner's equity reports changes in owner's or partners' equity between accounting periods. The key components are the beginning equity balance, additions and subtractions during the period, plus an ending balance

4.2 Compare appropriate formats of financial statements for different types of business


Format for income statement: The basic format for an income statement states revenues first, followed by expenses. The expenses are subtracted from the revenue to calculate the net income of the business. This is the most simplified version of an income statement that would be used by most service providers and others that do not have a cost of goods sold for the services they use to create a profit. If there is a cost of goods sold, the income statement is a more involved statement.
Format for balance sheet: For a small company, the organization may have a very simple balance sheet as described above. For a larger company, the business often will break it down to current and long-term assets and current and long-term liabilities. Current assets refer to any assets that can quickly be converted to cash, such as short-term investments or checking accounts. Long-term assets are those things that would take longer to convert to cash, such as equipment or real estate.
Current liabilities are those debts that are due within the next year. Long-term liabilities are those due more than one year from the date of the balance sheet.

Format for cash flow statement: it shows the actual flow of cash in and out of the business. It helps investors and others to determine if the business is having difficulty managing its cash flow. It starts with the cash flow from operations, followed by cash flow from investing and cash flow from operations. Each category shows incoming and outgoing cash from the business. The ending cash flow should be equal to the amount of cash the business has on hand

4.3 Analyses financial statements using appropriate rations and comparisons, both internal and external.



1.      Current Ratio :
   Formula for current ratio = current assets/ current liability
              For Sweet Menu Restaurant C.R = 68000/3800 = 1.78
           For Blue Island Restaurant= 41000/65000 = 0.63
         Usually A ideal current ratio is 2:1. So, Sweet Menu Restaurant is not in satisfactory stage.
  1. INTEREST COVERAGE RATIO:
 The ratio between EBIT and Interest is known as interest cover
   For Sweet Menu Restaurant INTEREST COVERAGE RATIO =116000/10000 =11.6              

   For Blue Island Restaurant INTEREST COVERAGE RATIO= 71200/3000=23.37
Interest coverage ratio is better if it is higher. So Blue Island is in sound position.
3.      DEBT EQUITY RATIO:
Debt equity ratio = long term debt / Shareholder’s funds
   For Sweet Menu Restaurant: 31000/ 164000=0.18
For Blue Island Restaurant: 5000/118000=0.042

4.      PROPRIETARY RATIO:
The ratio between shareholders equity and entire assets is known as proprietary ratio.
Proprietary ratio = Shareholders Equity/ Total Assets
   For Sweet Menu Restaurant: 164000/171800=0.954
  For Blue Island Restaurant: 118000/106000=1.11

5.      Net  profit ratio
Net profit ratio = (Net profit / Net sales) x 100
For Sweet Menu Restaurant: 85000/350000 =24.28%
For Blue Island Restaurant: 94800/199000 =47.63%
So, Blue Island is in sound position

Conclusions

Financial decision is important function which a financial manger must perform. It is important to make wise decisions about when, where and how should a business acquire funds. Funds can be acquired through many ways and channels. A sound financial structure is said to be one which aims at maximizing shareholders return with minimum risk. In such a scenario the market value of the firm will maximize and hence an optimum capital structure would be achieved. Other than equity and debt there are several other tools which are used in deciding a firm capital structure.

References

2.      http://www.fao.org/docrep/w4343e/w4343e08.htm accessed at 19. 12. 2015
3.      J. Downes, J.E. Goodman, "Dictionary of Finance & Investment Terms", Baron's Financial Guides, 2003
4.      Atrill P. (2012), Financial Management for Decision Makers.  6th Edition, Harlow: Pearson Financial Times/Prentice Hall.
5.      Watson,D. and Head, A. (2012), Corporate Finance Principles and Practice. 6th edition, Harlow: Pearson
7.      Anthony, L. (2012), Formant of a financial statement [online


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