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.
- 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
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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