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Money is the primarily need of every new as well as established business organization to run their operations successfully. Commercial as well as service rendering entrepreneurs need adequate funds for different purpose i.e. payment of revenue and capital nature expenses, expansion, investment in profitable purpose and managing financial risk to achieve set targets. There are wide ranges of resources available to every entrepreneur through which they can gather sufficient amount of capital resources to meet their financial need. Thus, the present report here emphasizes on identifying variety of capital sources along with its positive as well as negative impact to Sweet Menu Restaurant for its expansion programme. It will enable restaurant to select the best source among all. Moreover, the assignment also aims to evaluating the role and importance of budgetary analysis in effective financial management. Furthermore, the report also shed light on the significance of project evaluation techniques, comprising both discounting and non-discounting methods to test project viability. In the end, operational performance of Sweet Menu Restaurant (SMR) and Blue Island Restaurant (BLR) will be examined through applying ratio analysis technique. It will enable restaurant to take necessary decisions for performing well in future period.
According to the scenario, SMR is a reputable restaurant which is operating in Gants Hill, East London from past 10 year. It built-up a strong reputation in the market by offering various inter-continental food items at an acceptable prices. Now, in order to expand operations, it is planning to begin two branches in Central London and Croydon requiring investment worth £300,000 and £500,000 respectively. In order to finance its proposed expansion plan, it can gather funds through following sources:
Debt fund: In UK and all the other countries, commercial banks and financial institutions provide funding facilities to the corporations to meet their capital need at an interest rate. Thus, one of the options available to SMR to gather funds is to raise capital through external borrowings.
Hire purchase (HP): At the time of beginning branches in Central London and Croydon, SMR can decide to use rented office rather than purchasing it (Berger and Black, 2011). In this, SMR can purchase property on HP system through making some initial down payment and rest in equal periodical instalments.
Retained earnings: Companies distribute some proportion of their net earnings to shareholders and rest of the part is called retained earnings. It is another option available to SMR to meet their capital requirement through ploughing back their available retains profits in the business to support proposed expansion plan.
Trade credit: It is an arrangement between manufacturer and creditors, in which, supplier agrees to deliver material on credit (Brandimarte, 2013). Through this, restaurant can take some time to make payment to the suppliers after gathering sales revenues.
Overdraft: Commercial banks allow their customers to withdraw some extent amount than their available balance in account, called overdraft. It can provide huge help to SMR to meet their urgent short-term capital requirement.
Debt Every commercial bank charges an interest rate on provided debt services on the entities that is its financial implications. It is necessary for the SMR to pay their loan instalments inclusive interest periodically. Mortgage and securities has to be provided to the bank to make lenders relaxed about fund security (Guariglia, Liu and Song, 2011). Lenders have no authority to take participation in business decisions and cannot control operations.
It exists, because if restaurant goes for insolvency than it will have to sale their property for repayment of loan amount.
Instalments which are decided by assets vendors always include some interest charges so as to get some extra return in financial terms (Arrondel, Debbichand Savignac, 2014). Parties have to follow decided terms and conditions and ownership will not be transferred to SMR till the payment of final instalment. Vendors have no power to interfere in business decisions. No bankruptcy implication exists.
Retained earnings No financial cost. Entrepreneur need to transfer some amount in legal reserves. No dilution as it is already the part of owner’s capital (Vernimmen and et.al., 2014). Same as HP.
Trade credit Creditors charge some interest to deliver goods to SMR on credit. Timely payment is necessary for restaurant. It does not transfer or diversify control power to suppliers (Berger and Black, 2011). Same as above.
Overdraft Interest rate on overdraft is comparatively high as compare to bank loan (Brandimarte, 2013). SMR has to repay taken amount on time. Banks have no right to change business decisions. Bankruptcy exists.
After evaluating both the benefits and disadvantages, it can be said that bank loan and retained earnings are considered as best options for meeting of SMR’s financial requirement for proposed expansion plans.
Each and every source of finance has some kind of financial cost like interest, dividend etc. With regards to the selected sources for SMR’s expansion programme, its cost has been described below:
Cost of debt: As stated earlier, that financial institutions provide loans at a lending (interest) rate. Thus, interest payment will be the cost of debt capital for Sweet Menu Restaurant which it has to pay during a fixed interval of time (Horngren, Sundem and Burgstahler, 2013). But still, tax benefits are the benefits of such interest amount.
Cost of HP: Vendor of the assets also charges a interest rate while determining amount of equal instalments. Henceforth, interest obligations will be the cost of hire purchase system.
Cost of retained earnings: It is the business profit that restaurant’s entrepreneur will invest it for the establishment of two new branches to expand the business. It does not includes any cost like interest, but still, opportunity cost exist which means that entity can gain return on these amount by investing it in other profitable purpose.
Cost of trade credit: Suppliers will deliver services at some interest charges which are regarded as the cost of trade credit facilities (Jackson, Keune and Salzsieder, 2013).
Cost of overdraft: Bank charges high rate of interest on overdraft facilities which is its cost. Moreover, SMR also needs to pay the amount of overdraft on right time; otherwise, it will negatively affect business reputation.
SMR is not only required to gather sufficient quantum of funds for expansion, but also, has to manage collected funds appropriately so as to accomplish financial targets. In such respect, restaurant has to prepare best financial plan to commence operations in both the new branches. It is regarded as the process of determining financial need and making policies in relation procurement, allocation, utilization, investment and administration of fund. This planning is of great importance as it enables entities to make business financial strong, best plan assist entrepreneur to manage financial risk and reach success. The significance of financial planning for SMR is outlined below:
Every commercial establishment have wide range of stakeholders, categorized in two parts that are internal and external. They require some valuable information about company’s operations to take qualitative decisions for different purpose, presenting here as under:
Shareholders: They take risk by investing their own money in the business so as to generate more dividends. They require information about current investors return, growth prospectus, and return on capital employed and increase in market price. Investors will only put their money in SMR, if there is a possibility of getting higher return.
Creditors: Companies often purchase some proportion of inventory on credit from the creditors/suppliers (Dhaliwal and et.al., 2014). Thus, they are interested in knowing liquidity position and creditworthiness of the SMR, because they provided credit facilities to corporations that are able to make deferral payments on right time.
Government: Regulatory authorities have some kind of stake in the business success. For instance, taxation department aims in collecting appropriate amount of taxes on net corporate yield. Moreover, regulatory bodies also aim in ensuring legality and ethnicity of SMR’s regular activities and functions.
Lenders: Commercial banks and financial institutions need important information about restaurant’s debt burden capability, solvency, long-term financial risk, cash generating ability and profit position. The main aim to examine this information is to assure loan security.
Employees: They are willing to put their efforts in that organization, in which, there is a greater chance of growth and progress (Horngren, Sundem and Burgstahler, 2013). It is because; workers are mainly aims at getting better hike in salary, appraisal, rewards and other benefits like holidays, more responsibility, club membership etc.
Collection of fund through debt will increase the amount of long-term and loan and cash in balance sheet from £31000 and £11000 respectively. On the other hand, interest payment will be reported in profit and loss account and increase total interest payment from £10000. Its dual impact will be reflecting on closing cash balance which will be decrease by the amount of interest payment. However, instalment payment on hire purchase will be recorded in P&L a/c and also decline total cash and bank balance. Moreover, payment of instalments along with interest will be subtracted from cash position and result in lower return. On the contrary to this, use of retained profit will be recorded in the statement of change in retained earnings only. Buying material on credit will increase accounts payable in balance sheet whereas in P&L a/c, total amount of goods purchase will be recorded resulting less net profit. However, on the other side, overdraft will be the part of short-term liabilities and increase total cash balance under the head current assets. Whereas, interest payment will be recorded as expenditures and at the same time, it will also decline net cash position.
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Commercial entities prepare cash budget through projecting cash inflows and outflows from daily business operations. This budget is considered as useful managerial tool that assist entities to determine their net cash position either surplus or deficit through subtracting total cash spending from generated revenues. With regards to BIR, it can use budgets to evaluate their standard income and expenses with actual results and thereby better decisions can be made to enhance overall performance.
Above table reveals volatile trend of sales as it is fluctuating at -13%, 15.38% and 20% in October, November and December resulted total turnover amounted to £58000. Changing customer attitude, preferences, competition level, pricing pressure and volatility in market demand may be the reasons for this volatility. While, on the other hand, in the first month, total cash spending is very high to £40850 is decreasing to £11630, £13230 and £24280. High capital expenditures to buy furniture and fittings and van total amounted to £30000 is the main reason for excessive spending in the initial month caused shortfall of (£25850). However, salaries and wages, petrol and insurance expenditures remain constant to £7500, £280 and £350 whilst lighting and energy expenditures shows increasing trend from £500 to £600 and £650. Cost of inventory purchase may be increase due to high supplier charges or inflation. Along with this, trade payable budget depicts that 60% of total purchase made on cash while rest is on credit for 1 month.
The sum of money, comprising both direct and indirect expenditures that BIR incurred on preparation of each unit of meal is known as unit cost. Being a restaurant, it incurs expenses on steak, vegetables, ingredients, labour and other overheads (fixed and variable).
Total cost (TC) = Direct cost (DC) + Indirect cost (IC)
Unit cost computation is also necessary to determine the selling price. In the cost-oriented, also called cost-centric approach, BIR can add an appropriate profit mark-up in their total cost and determine net selling price, computed below:
According to the table, it can be seen that cost per unit of meal is £10 and at 40% mark-up and 20% VAT, selling price will be £16. While, on the other hand, its cost percentage on sales price is 62.5%.
Many-times, businesses have to make capital investment in fixed assets such as acquisition of machinery, plant and building and advanced technology etc. Every capital projects is associated with both the risk and return, therefore, it is important for the companies to examine potential return of all the projects and thereby determine the most suitable ones (Dellavigna and Pollet, 2013). According to the scenario, BIR available an empty space in its one branch which it can use to expand the production of ready meals supplied to local supermarkets. In this respect, two projects are available to the restaurant, both are mutually-exclusive but BIR can adopt only one of these. Thus, it becomes essential for the restaurant to determine the best project through applying various investment appraisal techniques, done below:
Payback period: It refers to the length of time which BIR requires to get back initial cash outlay worth £1200 through generating cash flows over the project life. The best benefit of this method is to it helps to identify the time lag in which project cost can be recovered (Bierman and Smidt, 2012). However, on the other side, it does not pay attention to the time value of money and also do not consider cash flows beyond payback period (PP). As per this method, shorter PP is considered suitable and highly preferred by others.
Net present value: This method use discounting to determine the present value of forecasted cash flows over the future period. It is because; NPV believes that having today a sum of money is worth more than receiving the amount in future due to inflation (Grob, 2013). Thus, this capital budgeting technique makes use of an appropriate discounting factor to identify the present value of projected cash flows and subtract the total of it to find out the NPV. As per the method, project that has highest NPV is considered the most viable (Andor, Mohanty and Toth, 2015).
By taking into account derived output, it can be seen that payback period of proposal 1 is comparatively less to 1.67 year whereas NPV is higher in another proposal to £688.0541 which indicates that project B has greater chance of more return in future period. BIR can be advised to accept 2nd proposal because NPV is considered as best technique which provides more realistic results about net project yield. Thus, by investing amount worth £1200 in this proposal, restaurant can gain maximum return of £688.0541.
Every business entity needs to measure their operational success timely so that they can examine their strength and weakness as well. Moreover, financial statements also deliver credible and valuable information to various stakeholders like investors, creditors and lenders.
Statement of comprehensive income (SOCI): It is also called profitability statement, in which, information has been recorded about routine business expenditures and revenues, prepared on accrual accounting concept. The main objective of SOCI is to determine gross profit and net profit of the business, calculated through using following formula:
Gross profit = Turnover – Cost of goods sold
Net profit = Total revenues – Total expenditures
Statement of financial position (SOFP): BIR and SMR needs to prepare balance sheet at the end of every accounting year, in this, entity record their assets as well as liabilities (Deegan, 2013). This statement is of huge importance to determine the financial position or strength by examining solvency and, liquidity position.
Assets = Liabilities + Owner’s capital
Owner’s capital = Assets – Liabilities
Statement of cash flows (SOCF): SOCI records income and spending on accrual concept whereas SOCF take into account only cash inflows and outflows from operating (routine functioning), investing (purchase and disposal of fixed assets) and financial activities (collection and repayment of debt and equity capital) (Edwards, 2013). Restaurant can prepare this statement to determine the reasons for having distinguished cash funds at the end of two different financial years.
With regards to preparation of financial statements, there is not high level of legal compulsion on sole trader and partnership organizations. Sole trader contributed their own capital, do business himself/herself and gained profit or loss through operations. They prepare SOCI, SOFP and SOCF by taking into account UK Generally Accepted Accounted Principles (GAAP) and conventions. While, on the other hand, in partnership, all partner’s contributed their money and run operations by putting their combined efforts. Moreover, they receive interest on capital (IOC) as a return for their money invested. These organizations prepare profit and loss appropriation account to share total business profit among all in decided ratio whilst capital account is prepared to determine the capital contribution of each partner (Deegan, 2013). They follow UK GAAP, accounting concepts and principles along with partnership act legislations. Besides this, large sized companies do operations at wider scale and also have number of internal as well as external stakeholders. They are legally liable to comply with Company Act, 2006, UK GAAP, International Accounting Standard (IAS) and International Financial Reporting Standard (IFRS) (Pratt, 2013). Through complying with all the laws and regulations, it can deliver credible and authentic information to the users. Along with this, CA, 2006 also impose legal obligations to the companies to verify their accuracy of financial statements through an independent auditor to communicate information about their financial position to bank, investors and taxation authority.
In the actual market place, companies not only need to prepare their annual accounts but also require evaluating and comparing their own performance with that of competitors so that more qualitative decisions can be taken. Ratio analysis is an effectual way to compare financial strength and operational results both internally and externally, done here as under:
Gross margin: This ratio indicates restaurant’s ability to generate over total sales. SMR and BIR has GM to 63.57% and 66.22% respectively, thus, it is higher in BIR demonstrating that this restaurant is generating more return on their total turnover. Greater turnover to £225,000 and less cost to £85000 is the main reason behind high profitability in BIR.
Net margin: It indicates overall profit generating capacity on total turnover (Kumbirai and Webb, 2013). BIR has high NM to 31.71% than SMR’s ratio of 24.29%. Ratio reflects that BIR is performing much well in the market because it is generating larger return on their total sales. Effective control over indirect expenditures is the main reason behind this.
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Current ratio: It indicates relationship between current assets and current liabilities helps to measure business ability to pay short-term liabilities (Karande and Chakraborty, 2012). It is higher in SMR to
Quick ratio: This ratio measure liquidity position without considering closing inventory balance. Greater ratio in SMR to 0.63:1 reveal that it is able to meet their short-term liabilities timely, but still, it is far away to standard ratio of 1:1, henceforth, it can be advised to enhance their CA and pay off some creditors to reach idle level.
Assets turnover ratio: It measures management capability to use corporate assets to generate more sales (Karande and Chakraborty, 2012). High ratio in BIR to 1.59 reflects that managers are effectively and optimally utilize their assets to generate larger revenues.
Receivable turnover ratio: It measure business ability to generate cash from debtors. BIR’s ratio is almost 2 times of SMR to 59.80 which is a sign of excellent management efficiency to generate revenues quickly from accounts receivable.
Debt-equity ratio: It indicates the ratio of long-term debt and shareholder’s capital in total capital employed, high ratio depicts more risk or vice-versa. SMR and BIR have D/E ratio of 0.19:1 and 0.04:1 indicates that SMR has managed its capital structure through the composition of both debt and equity. But still, it should be reached to the level of 0.5:1 that is considered as idle.
Interest coverage ratio: It indicates debt burden capacity of the firm so as to meet their capital requirement through collection of long-term borrowings. It is comparatively greater in BIR to 42.27 that demonstrate that it is highly able to take external borrowings through bank and thereby meet their capital need.
After evaluating the report, it can be concluded that debt fund and retained profit are identified the most suitable and appropriate source for funding SMR’s expansion plan. Moreover, report identified the fact that budgeting is of huge importance for the financial planners to administrate and effectively manage their money-related activities. While, application of project evaluation methods identified 2nd proposed more viable, hence, BIR must invest funds in this project. At the end, comparative evaluation of financial performance of SMR and BIR examined that BIR is performing much well in the market whereas liquidity and solvency position of SMR is much better reflected that it is able to pay their creditors and lenders on right time.
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