Assignment

on

Managing Financial Resources & Decisions

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Table of Contents

SI Particulars Page

P1.1

Identify the sources of finance available to the new business you have chosen. 3

P1.2

Assess the implications of different sources of finance for your chosen business. 3

P1.3

Select Appropriate sources of finance for a business project you have chosen e.g. opening new store, developing IT system, buy new machines etc.

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P2.1

Analyse the cost of different sources of finance. 4

P2.2

Explain the importance of financial planning to the business organization you have chosen.

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P2.3

Assess the information needs of different decision makers in your chosen business. 6

P2.4

Explain the impact of finance on the financial Statement of your chosen business. 6

P3.1

Analyse budgets and make appropriate decisions from the given case study. 7

P3.2

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

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P3.3

Assess the viability of project using at least two investment appraisal techniques using the case study provided.

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P4.1

Discuss the main financial statements (the discussion should focus on basic form & purpose of main financial statements)

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P4.2

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

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P4.3

Interpret financial statements using appropriate ratios and comparisons, both internal and external using the given data.

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Reference 16

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Task 1:

LO1 - Understand the sources of finance available to a business.

P1.1 - Identify the sources of finance available to the new business you have chosen.

Answer: Considering the overall economic condition & own financial ability I have decided to start a venture in the form of sole proprietorship. The possible sources of finance of my business are: Personal Funds, Borrowings from Friends and Relatives, Credit Cards, Bank Loans.

P1.2 - Assess the implications of different sources of finance for your chosen business.

Answer:

a) Personal Funds: Personal savings is the key source of finance for sole proprietorship business. The business plans & strategies are made on the basis of personal wealth in such type of business because the owner has the greatest personal and financial stake in the business, so it is natural to use personal funds such as savings to start and build the business.

b) Friends & Relatives: As the sole proprietorship business has less sources of financing available compared to the other forms of business, family & friends are considered as importance source of finance. Friends and relatives are common sources of investment for sole proprietorship businesses. Individuals who know the owner well and believe in owner’s vision are likely sources of funding. Borrowings from friends and relatives tend to have relatively low interest rates because the lender makes the investment out of confidence in the individual and belief in the vision rather than a desire to make money

c) Credit Cards: Credit card is another source of finance in this type of business. It provides fund through cash advances as well as by covering the cost of expenditures. Credit card is a comparatively easy source of business funding to receive but interest rates on credit cards is higher than on the other sources of finance.

d) Bank Loans: Banks also invest in sole proprietorship business. Loans can be taken from bank against collateral, or personal resources that can be pledged as a guarantee against a loan. Bank loans have less-stringent criteria but bears higher interest rates. While providing loan, banks consider the previous track records of credit and the condition of the business which makes it a little difficult for the young businesses to go for bank loan.

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P1.3 - Select Appropriate sources of finance for a business project you have chosen e.g. opening new store, developing IT system, buy new machines etc.

Answer: Now a days bicycle is becoming popular among the people for environment friendliness and easiness as a mean of transport. This has encouraged me to set a bicycle parts store. For purchasing the bicycle parts, I have considered two sources of finance.

a) Personal Savings: For funding the project, I will invest my own savings of £50000. This will prevent me from the burden of paying interest and will allow me to retain full control over the business.

b) Family & Friends: As my own investment is not enough for the project, I will convince my family members to invest £25000 in my business & collect £25000 more from my friends. Financing my project in that way will provide me the advantage of paying less interest than the other sources & enough time to pay the money back.

Task 2:

LO2 - Understand the implication of finance as a resource within the business

Using the same business you have chosen

P2.1 – Analyse the cost of different sources of finance.

Answer:

Cost of different sources of finance has been analysed below:

Cost of Personal Fund: Personal fund is the most important source of finance in a sole proprietorship business. Opportunity cost is associated with personal savings/wealth. That means the owner of the business will be deprived from the income which could be earned from investing the money in anywhere else.

Example: A person a person may purchase share or deposit money to the bank. But without doing so, if he invests own saving to start a sole proprietorship business, he will be deprived from the dividend from share or interest from bank deposit. That is the opportunity cost faced by the owner of a sole proprietorship business.

Cost of borrowings from Friends & Relative: Friends, family members & relatives are another source of finance for sole proprietorship business. They provide capital to the business because of having faith on the owner, not being driven by intention of earning more money. For this reason, cost of borrowing from family and friends is comparatively less than the other sources like bank, credit card.

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Example: If the owner borrows £10000 from his friend with a commitment of paying 2% interest, then at the time of paying back, the owner needs to pay only £200 as interest which is much less than the other financial institutions.

Cost of Loan: A sole proprietor can take loan from bank or other financial institution to arrange capital. In that case he will have to pay interest at a higher rate. Compound interest rate is another factor to be considered. It may increase the interest if the payment of installment is delayed. Tax rate is also a factor in calculating the cost of loan.

Cost of financing with Credit Card: Credit card also carries similar cost like bank loans. But along with the interest, it extra charges an additional amount of money.

P2.2 – Explain the importance of financial planning to the business organization you have chosen.

Answer:

For a sole proprietorship business financial planning is very much important. The purpose of financial planning is elucidated below:

Arranging capital

The scope of obtaining capital being limited in sole proprietorship, how the funds will be collected is to be planned carefully. This decision will make a significant impact on the business. If equity is considered as the only source of finance, business may suffer from paucity of capital and many business opportunities might be lost. Again if the base of the business is not strong enough and major portion of funding is done through debt financing, it might be difficult for the business to bear the burden of interest. So, a good combination must be made between different sources of finance while designing the capital mix for which financial planning is very necessary.

Proper utilization of fund

After obtaining necessary capital, how to use it is to be planned carefully. The amount of capital is limited in a sole proprietorship business and a business might need money for many different purposes. That is why, to meet which need how much money is to be allocated is to be planned to ensure the proper utilization of available funds.

Project Appraisal

For a business it is needed to determine from different projects, which business project is to be undertaken. Before undertaking a project if it is feasible enough to invest should be evaluated carefully.

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Dealing with Changes

Nothing but the change is constant. To deal with the future changes financial planning is a must. What changes the business may face in future is to be predicted by assessing the current trends and plans should be prepared in order to manage them. How much capital might be needed in future under different conditions and how those needs will be met is required to be forecasted by the financial manager.

P2.3 – Assess the information needs of different decision makers in your chosen business.

Answer: Information is needed to the different parties involved with the business for making financial decisions. The decision makers in sole proprietorship business and their information needs are explained below:

Owner: Owner is the main user of business information. He prepares plans and formulates strategies according to the business information. To analyse the viability and profitability of the investment and to determining the future course of action, information is required by an owner.

Investors: The investors analyze the feasibility of investing in the business at first. They look forward to ensure a reasonable return on their investment before they commit any financial resources to the business. For that investors require relevant information.

Creditors: To determine if the organization is credit worthy, the creditors require business information. Terms of credit are set by creditors according to the assessment of the financial health of the business. Creditors include suppliers as well as lenders of finance.

Tax Authorities: Tax authorities are another user of business information. To determine the credibility of the tax returns filed on behalf of the business, authority requires financial information.

P2.4 – Explain the impact of finance on the financial Statement of your chosen business

Answer: The sources used to finance the business have significant impact in its financial statement. If the business is financed mostly with equity, less interest will have to be paid. This will allow the owner to make more profit. The amount which would be required for paying interest of debts can be used in other purposes. Again a debt based financing will provide more capital to the business. Asset base of the business can be extended with the additional capital. Along with such advantages, debt financing will increase the interest amount to be paid. This may cut profit.

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Task 3

LO3 Be able to make financial decision based on financial information.

P3.1 Analyse budgets and make appropriate decisions from the given case study.

Answer:

Analysing the budgeted profit and loss account, it is observed that things are going well for Easy Electronics ltd. Their sales revenue is good enough to make a gross profit of £16, 952. Again, meeting other expenses and paying the tax, the company still makes a good amount of profit which eliminates all doubts about its profitability.

From its cash budget, it is seen that the company has made surplus cash flows in June, July and August constantly. But because of paying corporation tax and making capital expenditure, the company failed to earn a positive cash flow. As these costs are unavoidable, management does not have many things to do with it. Even though is causes a deficit in cash flow, it is better for long term. It is also observed that revenue earning is increasing steadily but the expenses and distribution cost is also increasing. Management must pay attention to that in order to increase revenue an cutting the cost.

P3.2 Explain the calculation of unit costs and make pricing decisions using relevant information given below:

You are required to use budgeted profit and loss account to explain how unit costs are calculated. It is estimated that Easy Electronics Ltd. will manufacture and sell 650,036 mother boards for the six months period ending on 31st December 2013. The finance director of Easy Electronics ltd. has asked you to evaluate a proposal to reduce the selling price by 10% from the current price of £55.12 per unit and as results sales are expected to increase by 20%. Cost of sales will also increase by 20%. All other costs will remain constant. You are required to make pricing decision based on the above information.

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Answer:

Easy Electronics Ltd.

Estimated Sales (650,036 units × £55.12) £35829984

New Sales (780043 units× £49.608) £38696373.1

Increase in sales revenue £2866389.1 or 7% (approx.)

It is observed from the above calculation that with the increase in sale by 20% & reducing price per unit by 10%, the overall sales revenue increases by 7%. So, despite of the increase in the selling expense the new pricing strategy can be taken because of its profitability.

P3.3 Assess the viability of project using at least two investment appraisal techniques using the case study provided below:

Easy Electronics ltd. is considering diversifying into manufacturing Aluminium computer cases or housing from October 2014. The companies cost of capital is 10%. The net cash flows are given below:

Year Project A: Aluminium Housing(£000)

0 (8000)1 20002 28003 32004 12005 8006 500

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Answer:

Viability of the project can be assessed by using NPV method.

NPV = [ A 1 + A 2 + A 3 + A 4 + A 5 + A 6 ] - C (1+K)1 (1+K)2 (1+K)3 (1+K)4 (1+K)5 ( 1+K)6

= [ 2000 + 2800 + 3200 + 1200 + 800 + 500 ] - 8000 (1.10)1 (1.10)2 (1.10)3 (1.10)4 (1.10)5 (1.10)6 = 135.028

Viability of the project can also be assessed by using IRR method.

NPV at 10%

NPV = [ A 1 + A 2 + A 3 + A 4 + A 5 + A 6 ] - C (1+K)1 (1+K)2 (1+K)3 (1+K)4 (1+K)5 ( 1+K)6

= [ 2000 + 2800 + 3200 + 1200 + 800 + 500 ] - 8000 (1.10)1 (1.10)2 (1.10)3 (1.10)4 (1.10)5 (1.10)6 = 135.028

NPV at 15%

NPV = [ A 1 + A 2 + A 3 + A 4 + A 5 + A 6 ] - C (1+K)1 (1+K)2 (1+K)3 (1+K)4 (1+K)5 ( 1+K)6

= [ 2000 + 2800 + 3200 + 1200 + 800 + 500 ] - 8000 (1.15)1 (1.15)2 (1.15)3 (1.15)4 (1.15)5 (1.15)6 = -739.60

Now IRR have to be calculated using Trial & Error Method

Here,

A= Lower Discount Rate = 10

B= Higher Discount Rate = 15

C= NPV of Lower Discount Rate = 135.028

D= NPV of Higher Discount Rate = -739.60

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Therefore IRR = A+ C × (B-A)

C-D

= 10+ 135.028 × (15-10)

135.028-(-739.60)

=10+0.1544×5 =10.772

Using NPV & IRR technique, it is found the Net Present Value of the project is positive, and internal rate of return is more than the cost of capital. Hence the project is viable enough.

Task 4

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

P4.1 Discuss the main financial statements (the discussion should focus on basic form & purpose of main financial statements)

Answer: There are four main financial statements used by the business organization. These are, balance sheet, income statement, owners’ equity statement & cash flow statement.

The four basic statements summarize the financial activities of the business. They can be prepared at any point in time (such as the end of the year, quarter, or month) and can apply to any time span (such as one year, one quarter, or one month).

The Balance Sheet

The purpose of the balance sheet is to report the financial position (amount of assets, liabilities, and stockholders' equity) of an organization at a particular point in time. Balance sheet allows someone—like a creditor—to see what a company owns as well as what it owes to other parties as of the date indicated in the heading. This also provides information to the banker who wants to determine whether or not a business deserves additional credit. Others users of balance sheet include current investors, potential investors, company management, suppliers, some customers, competitors, government agencies, and labor unions. Basic elements of a balance sheet are,

1) Assets

Economic resources owned by the company can be termed as asset. Assets also include costs paid in advance that have not yet expired, such as prepaid advertising, prepaid insurance, prepaid legal fees, and prepaid rent.

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Examples of asset accounts that are reported on a company's balance sheet are Cash, Petty Cash, Temporary Investments, Accounts Receivable, Inventory, Supplies, Prepaid Insurance, Land, Land Improvements, Buildings, Equipment, Goodwill, Bond Issue Costs etc. Every asset on the balance sheet is initially measured at the total cost incurred to acquire it. Balance sheets do not generally show the amounts for which the assets could currently be sold.

2) Liabilities

Organization's debts or obligations can be called its liability. Liabilities include amounts received in advance for future services. The amount received which has not yet been earned, the company defers the reporting of revenues and instead reports a liability. It also includes the amounts owed to creditors for a past transaction and they usually have the word "payable" in their account title.

Examples of liability accounts reported on a company's balance sheet: Notes Payable, Accounts Payable, Salaries Payable, Wages Payable, Interest Payable, Other Accrued Expenses Payable, Income Taxes Payable, Customer Deposits, Warranty Liability. Lawsuits Payable, Unearned Revenues, Bonds Payable, Etc.

3) Stockholders' Equity

It indicates the amount of financing provided by owners of the business and earnings. The investment made by the owners is called contributed capital. The amount of earnings reinvested in the business is called retained earnings. "Owner's Equity" are the words used on the balance sheet when the business is a sole proprietorship. If the business is a corporation, the words Stockholders' Equity are used instead of Owner's Equity. An example of an owner's equity account is Mary Smith, Capital (where Mary Smith is the owner of the sole proprietorship). Examples of stockholders' equity accounts, Common Stock, Preferred Stock, Paid-in Capital in Excess of Par Value, Paid-in Capital from Treasury Stock, Retained Earnings etc.

Income Statement

Income statement is one of the financial statements of a business which shows the income and expenses of a business at a particular time. It highlights different sources of earning revenue & sources of expenditure. The income statement provides the investor/manager a view of whether the organization is making profit or loss throughout a particular period.

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Elements in their income statements:

A. Revenues and Gains1. Revenues from primary activities2. Revenues or income from secondary activities 3. Gains (e.g., gain on the sale of long-term assets, gain on lawsuits)

B. Expenses and Losses 1. Expenses involved in primary activities2. Expenses from secondary activities 3. Losses (e.g., loss on the sale of long-term assets, loss on lawsuits)

Cash flow statement

Cash flow statement shows how changes in balance sheet accounts and income affect cash and cash equivalents. It deals with the flow of cash in and out of the business. The statement captures current operating results and the accompanying changes in the balance sheet. As an analytical tool, cash flows statement determines the short-term viability of a company, particularly its ability to pay bills.

People and groups interested in cash flow statements include:

a. Accounting personnel, who need to know whether the organization will be able to cover payroll and other immediate expenses

b. Potential lenders or creditors, who want a clear picture of a company's ability to repayc. Potential investors, who need to judge whether the company is financially soundd. Potential employees or contractors, who need to know whether the company will be able to

afford compensatione. Shareholders of the business.

Statement of Owners' Equity

The owner’s equity statement highlights the changes in retained earnings. Retained earnings appear on the balance sheet and most commonly are influenced by income and dividends. The Statement of Retained Earnings therefore uses information from the Income Statement and provides information to the Balance Sheet.

The following equation describes the equity statement for a sole proprietorship:

Ending Equity  =  Beginning Equity  +  Investments  -  Withdrawals  +  Income

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For a corporation, substitute "Dividends Paid" for "Withdrawals". The stockholders' equity in a corporation is calculated as follows:

    Common Stock (recorded at par value) +  Premium on Common Stock (issue price minus par value) +  Preferred Stock (recorded at par value) +  Premium on Preferred Stock (issue price minus par value) +  Retained Earnings ---------------------------------------------------------------- =  Stockholders' Equity

P4.2 – Compare appropriate formats of financial statements for different types of business.

Answer:

Formats of financial statements for different types of business such as sole proprietorship, partnership and limited company are different from each other.

Each business has different economic sectors. That is why different financial statements with different format are used to satisfy those sectors.

Sole Proprietorship

Financial statements for sole proprietorship traders are simple. It may not have the balance sheet and income statement. The report just needs to show the profit and loss account compared to a public limited liability company which requires being prepared based on international financial reporting standard (IFRS) and generally accepted accounting principle (GAAP).

Partnership

The financial statements are prepared to show the profit, income, outcome and the loss of the business. The income statement is prepared first because the net income or loss becomes a part of the statement of partners’ capital. The statement of partners’ capital is prepared second because the ending partners’ capital balances become part of the balance sheet. The statement focuses on analyzing the capital and profits of the company that are is circulated inside the company. 

Limited Company

The financial statement requires reflecting the current, non-current assets, liabilities, sales, profits, cost of income tax payable and earning per share. On the basis of those information decisions are made by the manager about future management strategies. Investors make the investment decision by analyzing these information.

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P4.3 Interpret financial statements using appropriate ratios and comparisons, both internal and external using the given data.

Answer:

Particulars WM Morrisons J Sainsbury PLC Supermarkets PLC2011 2010 Change 2011 2010 Change

Turnover (£ Mill) 17663 16479 1184 22294 21102 1192Profit (Loss) before Taxation 947 874 73 799 827 -28Return on Shareholder’s Funds % 17.55 16.13 1.42 14.19 15.25 -1.06Gross Margin % 6.89 6.97 -0.08 5.43 5.5 -0.07EBIT Margin % 5.51 5.49 0.02 3.92 4.03 -0.11Profit Margin % 5.36 5.3 0.06 3.58 3.92 -0.34Barry Ratio 3.95 3.79 0.16 3.09 3.04 0.05Return on Capital Employed % 12.53 12.44 0.09 8.68 9.78 -1.1Return on Total Asset % 9.61 9.59 0.02 6.47 7.26 -0.79Net Asset Turnover (x) 2.34 2.35 -0.01 2.42 2.5 -0.08Current Ratio (x) 0.57 0.55 0.02 0.65 0.58 0.07Liquidity Ratio (x) 0.24 0.24 0 0.35 0.31 0.04Stock Turnover (x) 23.27 25.83 -2.56 23.77 25.99 -2.22Debtor Collection Days 3.95 4.36 -0.41 1.8 1.61 0.19Creditors Payment Days 29.12 31.31 -2.19 31.16 31.76 -0.6Gearing % 42.02 29.61 12.41 66.18 57.28 8.9Interest Cover (x) 6.09 21.33 -15.24 6.79 8.13 -1.34Earnings Per Share (£) 0.27 0.24 0.03 0.32 0.34 -0.02Dividend Per Share (£) 0.12 0.08 0.04 0.15 0.14 0.01Market Capitalization (£ Mill) 7236 7083 153 5846 6257 -411Total Assets (£ Mill) 9859 9111 748 12340 11399 941Working Capital -981 -948 -33 -1104 -1221 117Shareholders Fund (£ Mill) 5397 5420 -23 5629 5424 205

From the current ratio and liquidity ratios of WM Morrisons we can see that its current ratio has been increased by 0.02% and liquidity ratio is same as 2010. From the profitability ratio we see that its profit margin has been increased by 0.06% from 2010. Asset turnover has been decreased a bit but return on asset is increased by some percentage. Return on shareholders fund is also increased. Earnings per share has also increased. So it can be said that WM Morrisons has made a better profit in 2011 than 2010. Its interest covering has decreased a lot that means the company has to pay some attention to their debt. Debtor collection has become lower which means it is going well in this collection terms. This is a good sign. Dividend per share is

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increased, so the shareholders will think well about the firm too. Considering these factors it can be concluded that WM Morrisons co has performed better than 2010 in 2011.

From the current & liquidity ratio J Sainsbury PLC we can say that the firm has earned more abilities to pay its short term debts. From the profitability ratio, it is observed that the profit margin has decreased significantly. Asset turnover and return on asset has also been decreased. As the return on shareholders fund & EPS are decreased, it can be said that J Sainsbury PLC has made worse performance in recent year regarding its profit. Its interest covering has decreased which means the company needs to pay more attention in their debt management. An increase in debtors collection days suggests that it is not making good performance in collecting from debtors. Dividend has raised but without making good profit raising dividend is not a good sign. Company should pay more attention in raising profit. So, we can conclude that, J Sainsbury PLC has failed to perform better than 2010 in 2011

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Reference

http://yourbusiness.azcentral.com/sources-investment-sole-proprietorship-12432.html

http://www.ehow.com/list_6799727_sources-finance-sole-trader.html

http://www.fao.org/

http://accounting-simplified.com/financial/

http://www.is4profit.com/business-advice/finance-and-money/

http://www.entrepreneur.com/article/41520

http://www.accountingcoach.com/

http://www.bayt.com/

‘Accounting Principles’ by Weygandt, Kieso, Kiemel

‘Fundamentals of Financial Management’ by Eugene F. Brigham & Joel F. Houston

‘Entrepreneurship Strategies and Resources’ by Marc J. Dollinger

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