In this given case study, a prospective businessman is highlighted. Through the document suggestion in different sides are presented. Finding sources of finance, effects and choosing a right form have discussed here. This document will be helpful for those who are looking for opening a new business, but don’t know about the financing of the business. Hope you guys will be helpful reading this document.
In a trade there is a variety of sources of finance available. Without having accurate awareness on these, the cost of finance would be needlessly huge. Here we will discover the different sources of finance for John. First of all John should know the initiatives and legal steps to start any forms of business (Task A).
Sole trader- It is with single leadership and the proprietor of the trade takes the full account of profit or loss that gains. It is very simple to begin one, with no such legal limits (in specific); however they are allowed to pay income tax on profits. Problem is that sole traders are more likely to face shortages of capital than any other forms of businesses, sole proprietors are held fully liable to pay their debt either through selling their personal properties etc. Partnerships- the general requirement to begin is with two to twenty compared to sole trader; however profits as well as losses will be shared by the partners. For these, Partnership Act 1890 has been established. Each may also sign the Deed of Agreement. Other than these exceptions to sole-trader they are almost similar (i.e. partners are liable for debts also for the income taxes from the share of their profits etc). Limited Companies- There is mainly two types of limited companies; one is public limited company and is private limited company. These both require ‘Memorandum of Associations’ and Articles of Associations as from the legislation of Act 1985 (as mended by the companies Act 1989). Government imposes a much higher rate tax (on profits) which is corporation tax. As by now John should have some ideas on the types businesses and some tips on the legal procedures and how to start one. He should now know that the finance can be avail in three terms- short, mid and long term. Hence below his estimates classified according to what type of financial period it requires (short, mid or long term) (Task B) –
Building and fixtures Long term Office Vehicle Mid term Security System Mid term Payroll Expense (year 1) Short term Marketing expense Short/Mid term (can vary) Office Stationary Short term Printing and Publications Short term Table no: A- Shows the terms of finance which are required to satisfy the expenditures (efficiently and effectively). Now as John Caird is planning to begin a business, there, finance cost will also be a big kind of cost like the operational and administrative costs. So there are variety sources of finances and as a business man, he should know these sources fall under which category, debt or equity. Hence below some of the sources are classified according to debt or equity category (Task C).
Debt- these are cost where interest forms of payment is paid for instance- Bank Loan, Trade Credit, Hire-Purchase, Mortgage Loan, Leasing, and Bonds & Debentures (from the given information). Equity- these cost are paid from the part of profit or income for instance-Invoice Factoring, Share Capital and Retained Earnings (from the given information). Conclusion- Some different sources of finances are recognized particularly in this chapter; also they fall under which categories. We also learnt in what terms (short, mid or long term these sources of finances are categorized into. The most important point of this chapter is that not all the sources of finance are used to pay all kinds of expenditures. Without knowing this properly, the finance cost will be unnecessarily much higher
Previously from this chapter we have learnt some different sources of finance. Like about bonds, leasing, bank loans etc, which are usually available in the business. Different sources of finance have different implications. Each are different from one another. As they are so each has their own advantages and disadvantages over the other, hence it is up to the business to choose and select what type and sources of finances they require. As we go ahead we will see some various sources of finance as suggested to John Caird. As suggested by Sandy in the case, to take the leasing contract for buying the building and fixtures instead of buying it at one shot. Therefore the risks and other implications of leasing are discussed (below) (Task D).
First of all, the leasing is generally provided by the finance houses or particularly specialized leasing companies. This ‘leasing’ is a kind of borrowing instead of acquiring an asset. From this John can save a huge amount of money, and instead he will only have to pay a monthly or an annual fee. This will also reduce the burden of maintenance cost will be greatly can enjoy the tax advantages. From this perspective leasing is actually cheaper than direct purchase. By this John will have the flexibility to change and take better product instead of holding the leasing one when the leasing period expires. However certain risks also involves kind such leasing. As there is no ownership of property; as a result the leasing company has the right to switch the contract to another party- when the leasing period is over. If the asset is to be used for a very long period of time like the building and fixtures, then my personal opinion will be not for the leasing but rather going for a long term bank loan. Though leasing is much better for shorter or lesser durable assets like security systems etc, however even building and fixtures it is also good. Now John wants to know and distinguish between the usage and implications of factoring and discounting. How they are been used is explained below (Task E).
Factoring is taken when there is a huge amount of sales is done on credit. Then the company mainly faces a money shortage (i.e. short of working capital) and so it falls under debt by it’s current liabilities ex- creditors, bank interests etc. so to avoid such circumstances the company sells it’s debt to a financial factor (ex: commercial bank) and gets the money instantly with less service and interest charge. Through this the company can pay out it’s liabilities and can buy more stocks to run the business. A copy invoice is sent to the factoring company. When it receives the invoice, the factoring company will pay 80% of the invoice value to the selling company immediately. Discounting is quite different. As by this process he will be able to collect money from the debtors at a much faster, pace than usual. Through these debtors will be more willing to pay it earlier, than without this discounting because earlier they will pay it they will be able to enjoy higher discounts. This system is also comparatively much cheaper than the previous proposal and it is particularly helpful in reducing the ‘bad debt’. Practicing this system requires hiring more employees, which is a more troublesome issue. Further more when there is a question of quality and safety standard then, invoice factoring is the better option. As such finance houses are much more specialized in dealing of taking such issues. From the case we could see Sally pointing out importance of the trade credit (Task F is discussed).
In running a business this source is one of the most frequently used and it is also one of the most useful sources of finance. This is to done for trying to find ways to delay payments to suppliers. As this allows the buyer on credit to pay on a later dates than paying it immediately, hence it is also an informal way borrowing where paper work is not mandatory while acquiring the bank loan. The main advantage of this is in it’s fastness to acquire. However the paying period of this is much shorter than the bank loans and it’s costs are relatively higher too. So from trade credit John buy several things such as security system, office stationary, printing and publications. (Task G is discussed below)
Now John wants to issue share capital and bonds/debenture to raise more capital for his business. He should know that not all forms of business can issue share capital or raise funds from bonds and debentures. For this in particular, only public limited company is able to all these. There is also a much higher complexity level of forming such business. As lot of paper works and regulations are needed to be maintained. For this ‘Associations of Memorandum and Articles of Associations from the legislation of 1985 Act is to be followed thoroughly. There is a big difference between the share capital and with bonds and debentures. As one falls under equity and another on debt and so theirs risks and costs varies. It is shown in the table-
High Relatively much lower
Low or no risks High
Generally it is wiser to issue share in times of low profitability and issue more bonds or debenture in times of higher profitability.
From this chapter some of the most basic, important and useful implication of finance were noticed. How they were used and with their usefulness and also some drawbacks were realized. As in this case various sources of finance like leasing, discounting, factoring, shares and debentures, their implications were
Here we will see and discuss some issues about how they affect the business and in it’s performance. Here the implications will go more in depth. Now we could see that John is interested in sole-proprietorship business. From the available sources of finance suggestions are made according to the requirement of John to start his business (Task H).
Building and Fixtures- Better to obtain on mortgage loan, by this he can have a full and permanent ownership of the property. Office Vehicle- In general it is wiser to buy on mid term loan, as means of paying it by instalments. Security System- It is better to take it on lease than any other forms like hire-purchase. It is because in each and every year new and better security systems are arriving Payroll Expense- For this one short term bank loan or personal savings can be used Marketing Expenses- Short term bank loan will be particularly good for this. Office Stationary- Buying on hire purchase can be a good one, as by buying on credit he can use the product immediately. Printing and Publications- It can be managed through trade credit, as it can be easily payable during the business years. As John finally got settled by being a sole-trader, he is still very much curious on the financial statements of different public limited company and among which he mostly got attracted on the statements of Cairn Energy. Now to clear some of his confusions, these followings are given below (Task I).
Cairn Energy stated that their “Property, Plant & Equipment- Development/Producing Assets has increased from $1,119.6m in 2008 to $1,828.6m. In fact their claim is proven to be true, as it can be seen from the balance sheet that their long term liabilities and capital has increased. For instance their loans and borrowings, retained earnings and share premium have increased significantly. Now there are other things which John likes to know from public limited company, that are- Deferred tax liability- This is the tax liability which can be shifted to the next year from the current year. Called up share capital- It is  “the money required to be paid by the share holders immediately”. Share premium- It is the value which is set above the face value (-the increased amount). John Caird now goes to further investigations as he has found diluted EPS, in the income statement part (Task J explained below).
EPS stands for ‘Earnings per share’. This is the income distributed to the shareholders, according to the number of shares they possess and dilution occurs, when the number of share increases the earnings per share and dividend per share also declines. Hence diluted EPS stands for, when EPS declines due to the result of dilution. Cairn’s long term cost of debt finance is approx $781.8m. However from the overall Cairn’s business performance, it is not so satisfactory.
From the overall perspective some of the important implications of finance were noticed, also on how they affect they affect the businesses. Further more by this John Caird hopefully will now have sufficient knowledge on running the business and managing the financial decisions.
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