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Managing Financial Resources and Decision Making

Introduction

The Financial management is the base of an organizational growth, survival and sustainability. The decisions taken in an organization are directly affected by the financial management. With the help of financial statements the current position of the company can be analyzed, and the resources available can be evaluated with the company's performance. Financial management is a broad term which includes financial resources such as balance sheet, profit and loss statement, cash flow statement and budgetary control statement. The financial statement is prepared at the end of every year so that the financial position of the company during the year can be analysed and the new plans to improve them can be made.

Task 1

A company needs various sources to finance its new business or existing business or for the expansion of the existing one. The sources of finance for different types of organisation are different. Presenting here sources of finance for different businesses.

New Business: A company for starting up a new business needs some sources of finance, so that it can establish its business in the market. The company while starting a new business can use its own saving (Booker, 2006). Other option is to have an equity finance and debt finance.

Equity Finance: TheCompany can finance its business with equity. The company can make an initial public offer (IPO). It can sell its share to the public at large and to the major market holders.

Debt Finance: TheCompany can take loan from banks to finance its business. The loan can be short or long term and can be secured or unsecured.

Existing Business:  The Company also take on lease or hire purchase, the assets which are used in the business, for recovering the amount due from the creditors it can take the services of factor (Broadbent and Cullen, 2012). Retained earnings can also be used as this option will be available easily for the existing business.

Expansion of an existing business: The Company needs external and internal sources of finance in case of expansion. It depends on the area in which the company is expanding its business. Internal sources of funds will include options such as retained earnings, dividends, sale of assets. On the other side external sources of funds will include sources such as bank, investors, venture capitalist etc.  

Large Business: To finance its business the company can take help of international financing by way of euro issue, foreign currency loan, ADR and GDR etc.

Small business: To Finance small and medium sized business the company can take bank loans, issue equity shares and retained earnings etc. (Goldman and Carrier, 2010).

SOURCES OF FINANCE

ADVANTAGES

DISADVANTAGES

1. Share Capital

The company can finance by using its own capital without any cost to be paid by it. It can obtain large amount of funds by issuing its own shares to the public and other investors (Keller, 2013).

The company has a burden of repaying the amount taken for issuance of shares to the shareholders in the case of liquidation. The company has to share its profits and losses with the shareholders and give them control power in the company.

2. Retained Earnings

The company can use its own profits earned in current as well as past years to finance.

The company uses its profits to finance its business, the company lefts with less balance of profits which can be useful in the case company suffers heavy losses (Kitchen and Confetto, 2010).  

3. Bank Loans

Banks gives loans to the company without taking any controlling position in it.

Banks charges huge interest as per their convenience and the rules made by Banking Regulatory Act, 1949, which imposes burden on the company.

4. Debt Finance

With the help of debt finance funds can be obtained at lesser costs than the interest chargeable by the banks.

The debts can be secured or unsecured. In case of unsecured debts the c collateral security is not taken by the lender which places the company in a less secured position.

5. Government Grants

Government of UK provides a huge amount of funds to finance the specific business of the company (Drake and Fabozzi, 2012).

The company needs to refund the grand in case the conditions attached to it are not fulfilled.

6.Lease and Hire purchase

A company can take assets on lease and H.P. By paying the lease rentals during a fixed interval.

The company has to return the asset back to the lessor on expiry of lease term. In case of hire purchase the purchaser will get the ownership on the day when all the installments have been paid.

Case study examples for three different businesses are as follows:

Small business start-up

A person named Ryan having interest in making food products, planned to set up a proprietary business with a low budget. The name he chose for the business is Ryan Enterprises (Gibson, 2012). The business was settled up by investing owner’s capital. The proprietor took bank loan to finance the business. The business was also financed by the relatives of the owner.    

A large business expansion

A company named Wrist & Watch is formed at a large level by issue of equity shares to the public. The company also issued preference shares and debentures to finance the business. The company was provided government grant by the government of UK. The said company also expanded in various countries other than UK. The creditors of the company are also an external source of finance (Nobes, 2014).

Existing medium sized company

A group of people having expertise in making crockery started a new venture by contributing their own capital and by bank loans. They bought an existing medium sized company named Marc-hell Crockery working in a same business of crockery. The company took assets on lease for a fixed time period.

Task 2

The company in the seminar will discuss the different aspects of financial management relevant to the business which is presented below:

Share capital: If the company is new in the market issues its shares by way of initial public offer and if it is an existing can issue via FPO. The company has to transfer the control of the shares acquired by the shareholders; this is cost to the company (Vickerstaff and Johal, 2014).

Bank loan: The Company gets finance from bank by way of loans but it has to pay interest along with the installment at fixed intervals. The bank does not get any control for the loan provided to the company. It only charges interest at the prevailing bank rate.  

Retained earnings: The Company earns profits and out of them some profits are distributed to the shareholders by way of dividend and some are retained by the company to meet its future requirements (Zoan, 2014). If the company utilizes the earnings there remains no balance for future. It is the cost the company has to bear.

Government Grants: The Company has to fulfill all the conditions attached to the grants. The grants should be recognized only when there is a certainty to receive the grants.

Presenting here the reasons why financial planning is important for an organization.

Cash flow: Cash flows reflect the earnings and expenditures of the company. The company has operating, financing and investing activities. The cash flows are the evidence of company's growth and profits. The company can take tax advantages on the basis of cash flows (White, 2006).

Capital: The Company can evaluate its financial position by capital as well. If the cash flows are increasing that means the capital is also increasing. The company can make investments with high capital.

Income: The Company is running business only to earn more than its investments. The financial planning helps earn profits by incurring expenditure. Earnings should be managed in such a way that tax benefits can be obtained by the company.

Investment: The Company makes its financial plan in such manner that it can take right decisions on investments (Ball, Jayaraman and Shivakumar, 2012). The investment in the industry where possibility of earning income is high then suffering from losses, benefits the company.

Assets: The main source of income for a company is its asset. Assets and liabilities goes together. The company makes plan to settle up the liabilities in the manner that it does not affect the assets. The assets are managed in such a way that they can last for many years.

Different types of information are required for the decision making. These includes as follows:

Costing - This information is produced from different types of costing within the business (Bhowmik and Saha, 2013). It is related with different types of costs which include variable costs, fixed costs, overhead etc.

Balance sheet – This reflects information about the assets and liabilities of the company. It shows the position of the business in terms of liquidity, solvency, profitability etc.

Cash flow statement – It reflects the management of cash inflow and cash outflow. The cash flow is shown from operating, investing and financing activities.

Income statement – It shows the position of income and expenses at the end of the financial period (Brigham and Ehrhardt, 2011). The information is used to take decision related to profitability.

Following stakeholders requires the financial information:

Employees – These people require information for the purpose of taking decisions related to their career and opportunities.

Customers – These stakeholders always expect better products and services from the company.

Shareholders – They will require financial information for the purpose of taking decisions related to investment in the shares of the firm.

Government – Government require financial information to make sure that company has not indulged into any kind of wrong practices.

Creditors – These people expects that business must make timely payments to the creditors.

Tax authorities – These authorities also expect that firm is making timely payment of different taxes.

Sales Budget Forecast: The sales budget of ABC Manufacturing Ltd. For the period of six months beginning from July 2007 to December 2007 and the first six months of which includes actual sales and variances between the budgeted and actual sales. The major issues are selling strategy, pricing strategy of the company (Efendi and Swanson, 2007).

After Analyzing the budget various issues have been noticed which are as  follows :

The actual and budgeted sales are higher in December so the variance is more in December. The reason being selling strategy of the company is not appropriate.

  • Analysis of the budget concludes that the pricing strategy of the company is not as per the requirements of the company structure.
  • The estimation of sales in the past six months is not correct.

Solution to the issues addressed: The Company should adopt the selling strategy in which the actual sales do not deviate much from the budgeted sales. The company should adopt the appropriate pricing policy for the products which will lead to favorable variances. The estimation of budgeted figures should be based on past year figures and should not be hypothetical (Evans and Porter, 2010).

Cash flow Forecast: The aforesaid company has presented the cash flow forecast for the new business for the year ending 2008. The analysis of forecast draws the following conclusion:

  • The sales in August and December declined because of which the earned less or no surplus.
  • The purchases in the whole year are fluctuating which results in imbalance in the production of the goods.
  • Expenses are more than revenue in few months (Booker,  2006)
  • Deficits represent non utilization of resources in few months.

Selling Price

120

(Variable cost)

 

- Material

52.5

- Lab our

35.75

- Var. Overheads

10.2

 

 

contribution per unit

21.55

 No. Of units

 

Total contribution

161625

(Fixed Cost)

120000

 

 

Profit

41625

Contribution Per Unit : Selling Price – Variable Cost = 21.55

Break Even point (In Units): Fixed Cost / Contribution Per Unit

120000/21.55= 5568 units (approx.)

Break Even point (In value): Fixed cost/ pv ratio

 120000/17.96= 668213 pounds (approx.)

Profit volume ratio : Contribution/ Sales

21.55/120*100 = 17.96

Margin of safety (In value) : Total Sales – Break even Sale

900000-668213 = 231787 pounds

Margin of safety (In units) :  Total sales (in units) – Break even sales (In units)

7500 – 5568 = 1932 units

Calculation of profits at various sales levels

Sales level(In units)

5000

8000

10000

Total Contribution

107750

172400

215500

Fixed cost

120000

120000

120000

Profit/ (Loss)

-12250

52400

95500

 Calculation of Break Even Point :

When Selling price is increased by 5 pounds

Contribution per unit = 125-98.45=26.55 pounds per unit

Break Even Point = 120000/26.55 = 4520 units

When Fixed cost is increased by 5000 pounds

BEP = 125000/21.55 = 5800 units

When Material Cost is Increased by 5 pounds

Contribution per unit = 16.55 pounds per unit

Break Even Point = 120000/16.55 = 7251 Units

Comparison of profits of the two customers for Machine X

CUSTOMERS

South wood Electrical

Westbrook Engineering

Total Contribution

1755

-

Profit/ (Loss)

1755

-8450

Recommendation: Since the West Brook Engineering is showing loss and the South wood Electrical is showing Profit therefore the company is recommended to give order for Machine X to South wood Electrical.

Presenting here the detailed analysis of the projects for investment appraisal by the company.

Accounting Rate of Return: Average return during the period/ Initial Investment

Table 1: Calculation of ARR

 

Project A

Project B

Initial investment

450000

450000

1

180000

60000

2

230000

120000

3

280000

250000

4

120000

250000

Total

810000

680000

Average

202500

170000

ARR

45

37.08

 Table 2 Calculation of Net Present Value

 

Project A

Pv @6%

Present value

Project B

PV @10%

Present value

Initial investment

450000

 

 

450000

 

 

1

180000

0.943

169740

60000

0.943

56580

2

230000

0.889

204470

120000

0.889

106680

3

280000

0.839

234920

250000

0.839

209750.0

4

120000

0.792

95040

250000

0.792

198000.0

Total

 

 

704170

 

 

571010

NPV

 

 

254170

 

 

121010

Payback Period: Initial Investment/ Cash flow per period

Table 3 Calculation of Payback Period

Year

Project A

 

Project B

 

 

Cash flow  (£)

Cumulativ e value

Cash flow  (£)

Cumulative value

Initial Cost

450000

 

450000

 

1

180000

180000

60000

60000

2

230000

410000

120000

180000

3

280000

690000

250000

430000

4

120000

810000

250000

680000

 For uneven cash flows,

A = last year value with a negative cumulative cash flow

B = absolute value of cumulative cash flow at the end of the period A

C = total cash flow while the period after A

 For project A = 2+

= 2.05 years

For project B = 3+

= 3.02 years

Internal Rate of Return

Table 4 Calculation of IRR

 

Project A

Project B

Initial investment

-450000

-450000

1

180000

60000

2

230000

120000

3

280000

250000

4

120000

250000

IRR

29.20%

15.02%

Recommendation: As per the calculations shown above the following should be recommended to the company:

  • Payback Period: The payback period of project B is more than project A, so project A is recommended on the basis of Payback period.
  • Internal Rate of return: IRR of project B is more than project A so Project B is more Viable.
  • Accounting rate of return: Since the ARR of project A is more so project A should be accepted (Broadbent and Cullen, 2012)
  • Net Present Value: On the basis of NPV method, NPV of project A is more, so Project A should be accepted by the company.

The three financial statements are as follows:

  • Income statement – It shows the income and expenses for the business at the end of the accounting period (Drake and Fabozzi, 2012).
  • Cash flow statement – It shows the management of cash inflow and cash outflow within the business (Statement of Cash Flows,2000).
  • Balance sheet – It shows the position of assets and liabilities at the end of the financial period.

Ratio analysis

Liquidity Ratios – The liquid ratios are reflecting a declining trend. From this it can be interpreted that company is facing issues in meeting its short term liabilities.

Activity Ratios – These ratios are showing a positive trend into the business. It reflects that firm is capable of effectively utilizing its assets for profitability and returns

Profitability Ratios – The ratios are showing a declining trend. Gross profit ratio has decreased which shows that company is not been able to manage its operational affairs. Net profit ratio has also decreased which reflects that there is a need to focus on improving the sales and profitability.

Conclusion 

From the above study it can be concluded that finance is the backbone of the business. The sources of finance are to be selected on the basis of size and scale of the business. The Company is running business only to earn more than its investments

 References 

  • Ball, R., Jayaraman, S. and Shivakumar, L., 2012. Audited financial reporting and voluntary disclosure as complements: A test of the confirmation hypothesis. Journal of Accounting and Economics. 
  • Bhowmik, K. S. and Saha, D., 2013. Sources of Finance. Financial Institution of the Marginalized India Studies in Business and Economics.
  • Booker, J., 2006. Financial Planning Fundamentals. CCH Canadian Limited.
  • Brigham, F. E. and Ehrhardt, C. M., 2011. Financial Management: Theory and Practice. 8th Cengage Learning.
  • Broadbent, M. and Cullen, J., 2012. Managing Financial Resources. Routledge.
  • Drake, P. and Fabozzi, F.J., 2012. Analysis of Financial Statements. John Wiley & Sons.
  • Efendi, J. and Swanson, E. P., 2007. Why do corporate managers misstate financial statements? The role of option compensation and other factors.Journal of Financial Economics.
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