There are different types of sources of finance.
Categorizing according to time they can be:
1. Short term sources of finance
2. Long term sources of finance
Overdraft facilities are provided by banks where a pre arranged limit is first set and then the customer if he exceeds the limit, he has to pay the fee on the exceeded amount and this varies from one bank to another.
When different businesses combine and share finance and make use of finance for meeting common pre decided business objectives the money shared is called Trade Credit.
The process of using assets for certain period of time by paying rent without actually purchasing or owing them is called leasing. The party who uses the assets is called LESSEE and the party who actually owns these assets is called LESSER and the time period of this contract is called the Term of LEASE.
Loan is money borrowed from the lender which the borrower is made to pay back in installments and also the returned amount total is more than the money borrowed. The initial amount borrowed is known as Principal and the additional amount of money paid back is called Interest which is a fixed proportion of the Principal.
The concept involved is same as Bank Overdraft except the borrower receives a smart card which he can use to buy products and services. The limit of a card is pre-determined like in the overdraft and the borrower is charged additional fee if limit is exceeded.
As discussed above bank loans can also vary in time and accordingly can be a short or long term source of finance.
When a particular sector of the company needs investment the company can issue shares in the market and use the capital earned to invest for the task. It can be authorized that is the total amount a company can issue to shareholders or Issued which is the actual amount paid by the share holders.
Debentures is a debt or may be known as borrowed money and is similar to Share except for the fact that the money gained by issuing debentures is not an earning but only a debt which the company has to pay back or at least pay the interest on the amount received per debenture. Debenture holders unlike share holders do not have a right to vote but can encash the money lended at any time since the profit margins are almost fixed.
The company assets which are not in use anymore can be sold to get money in turn, which can be used since it comes into circulation and the assets not in use are dead value.
This is the money invested by a bigger company in smaller company to assist and make more profits. When after a study the giant company notices the trend of growth for a small rapidly developing company, it plans to invest money and get good returns benefitting from the rate of growth for a smaller company which could be more than the rate at which the giant company is progressing.
It is a part of company’s earnings for the previous year which can be used as an investment for further developing the company rather than paying it as dividends. So the figure keeps on cumulating year after year when the company is in profit.
It is the total capital money which is owned by the share holders of a company. At launch the company can issue IPO Initial public offering at a fixed price and there after depending upon the growth of the company the value changes.
Grants are issued by a Government to small units for helping them to develop their business. The money may be lended at a very low interest or given as a Non return value.
The financial resources discussed above have different implications in an Odd situation of dilution or bankruptcy. Bank loans or Overdrafts are always given against a security which may be a property or asset owned by the company. In case of Failure to pay back the loan if the company is bankrupt the bank acquires the assets against which the loan was issued and can sell them to get the amount issued back to the account. Trade credit taken from other business may go into dilution if the company goes bankrupt and is a sure loss. So the risk involved in trade credit is quite high and the terms of sharing the money should be predefined including actions to be taken in case of bankruptcy.
Leasing is a safe play as the assets always belong to the Lesser and if the lessee is unable to return the amount committed as a part of rent or installment the contract can be abolished and the assets are acquired back by the lesser. Credit cards can again be a loss to the issuer in case of a failure to pay back the balance amount pending. A legal action can be taken against the defaulter as per the terms and conditions decided at the time of issue of the card. In case of share capital the position of a company in the market is not always the same. A share holder has to be up to date for the current situation and future trends of the company whose shares he buys. In case the company is expected to go in loss the shares can be sold at a reducing price. Debentures are also subjected to terms and conditions stated by the company at the time of purchase. If the company goes bankrupt the investment goes for a toss. Venture capital is a risk involved investment and the lender has to have a positive forecast for the company where it invests money.
In regards to the upcoming Sudan Highway Project, I will like to choose amongst the few available options we can choose to finance our project with the option best suiting our needs. As the elapse time of the project is 7 years we can choose over long term financial sources the best amongst which is getting a Venture Capital from any other existing construction company as the project assures good returns for sure in the long run and any company with market experience and knowledge will accept the offer to finance on ratio based system for profit which also covers us from any risks involved since the initial expenses will be high and we expect low returns during first 2 to 3 years. Just in case we are unable to find a Venture interested in investing the capital we can also opt for Bank Loan since that also covers us from the initial risks involved and even if the turnover is below than what is expected for initial years we will have enough margin to switch our needs going ahead with time.
Bank loans will give us flexibility for the funds and the areas of investment and apart from this it also enables us to take independent decisions without being pressurized by a third party investor in the project. Rest about the assets we will need for initial start up can be done on lease basis since investing in assets initially will be highly spending and will not yield expected profit.
The cost of various sources of finance varies and makes one source preferable over other depending upon the business needs. Discussing a few preferred sources: Leasing In case of leasing the cost is less if the deal is for a short duration as it cuts down the original cost of actually purchasing the equipment and also there is no depreciation since the goods are only rented and now owned. But in long run it can prove costly as the rent paid could be equal to or more than the actual cost of asset. Hire Purchase This is different from leasing as the asset used is actually purchased and owned by the company and a fixed amount is paid in installments.
The total amount paid is always more than the actual cost but since the payment is made in installments the burden of big investment is reduced.The equipment used also undergoes depreciation so the loss is tolerated by the owning company. Debt Factoring If the customers fail to pay back the money,the company can actually sell the accounts to a third party which pays the company 80 to 90% of the original amount and the third party in turn does collection on original company’s behalf. Government Finance is a free of cost money offered by Govt. for development of a company. The interest charged is either nil or very low so that the company in loss can withstand the situation. Trade Credit is mostly considered as a free source of finance.
The supplier can supply goods without receiving the return payment immediately and the payment can be made after a fixed period which is generally 30-90 days. Retained Profits This is the cheapest source of finance since the money is owned and not borrowed. Own Capital this is also a costless source of finance but there is risk factor involved for the money could be lost. Working Capital is the wealth owned by the company on day to day basis.It is the difference between the current assets owned and the current liabilities of the company.
Financial planning is important for cash budgeting and also for avoiding overtrading.The following points are the benefits of Proper Financial Planning:
Overtrading is an absurd source of loss in trading. Overtrading happens when a business undertakes task and attempts to complete it, but later finds itself short of resources (labour, working capital or net assets).The major cause is improper or no planning to foresee things like manufactured quantity, time involved etc. If things are planned and followed in the right order each trade can be looked as a separate transaction. Planning beforehand always helps to avoid a situation of chaos which may end up shutting down the complete business. Some small units have a false belief that they do not need planning since the money involved is less but the amount is not relevant when it comes to planning. Planning will always help a business to grow in the long run.
Different types of information is needed by decision makers depending upon the stage of operation they are in. The decision involved can be Quantitative or qualitative. Equity Investors- The share holders require information for making share trading decisions so they can decide on buying new issues or sell existing shares. They want to make judgments regarding movements in future share prices, likely future dividend payments and management efficiency. This helps them take voting decisions in Annual general meetings. They can compare profitability ratios to determine management efficiency.
They should have the previous data to compare the market trend and future estimates. Customers (especially buyers of fixed assets) need to know information which will help them understand the long term viability of the business. They should know the warranty terms and service offered after sales from the manufacturer. The customers get info from market surveys or from the current users who promote or detract a product. Suppliers and trade creditors’ information needs are similar to those of the short term suppliers. They should be aware of the business position of their trade partners and the future plans of the trading company. If the company still stays in the same line of business only then it is worth to go ahead with a trade credit or else the money should be recovered if there is a doubt that the company may change their LOB. Business Rivals – To keep in competition it is important to know the financial ratios of the Rivalry Company.
This helps them understand where they stand in terms of profit making and also plan their next moves to stay at par or over par to their rivals. The other business my plan to launch a new attractive offer or scheme for promoting a product. This information is critical so that they can withstand a different relevant offer to counter it. Managers – Managers need all financial data for the market share progress, profitability, loss sectors, employee attendance, work inputs, current plans, forecasting etc. Information needed is related to employees along with the short term viability of the organization. Investors – Need to know about the current position (profit or loss) in the market and the long term viability of the company including the cash flow to ensure interest. Employees-Need to know the available options in the job market and also the position of their company to ensure job security. Loan creditors -Need information about cash flows and priority of repayment. Long term creditors look at the overall strength of business and estimate future position of the business.
Different types of finance impacts financial statements in various ways. Assets-Assets have an impact on the balance sheet. A balance sheet shows company’s assets, liabilities and owner’s equity. If the assets are owned and not financed the company is in advantage. In balance sheet assets equal to liabilities added to owner’s equity. Financed assets increase liabilities and owned assets increase equity. Liabilities-Liabilities also impact balance sheet. More liabilities mean less money owned by the company. If assets are constant and liabilities increase the equity decreases. So if assets are constant and liabilities decrease the owner’s equity increases. Equity- Owner’s equity is calculated as the difference between current assets and current liabilities.
Whenever the asset or liability accounts changes the equity is changed along depending upon increase or decrease of either an asset or a liability. Revenue-Revenue has an impact on income statement. Revenue is the money business earns in any form. Net income or loss is given by income statement. Net income or loss is calculated as the difference between revenue and expenses. If revenue is more than expenses the company has a net income and f the expenses exceed revenue then the company suffers loss. Expenses-Expenses also impact the income statement. For a business to progress expenses need to be controlled. If expenses are in excess they harm the finances of a business. If expenses are more tan revenue it means the business spent more than what it earned and is encountering loss. A balance sheet is marked based upon the following equation:
So a balance sheet consists of 2 parts and each part balances the other. It means that the assets which are means used to perform an operation in the company are balanced by liabilities, equity investment brought into the company and the company’s retained profits. Liabilities and Equity are two sources which support the assets used for company’s operation. Equity stands for the amount of money which was initially invested in the company and also includes retained earnings which combined together forms a source of funding for the business. So at any point of time balance sheet can be regarded as a snapshot of company’s financial position.
Forecasted Cash Sales starting from Nov till Feb = £ 3000+ £ 4000 + £ 4500 +£ 4500 = £ 16000 Selling Price = Cost price +30% Therefore Cost price + 30%= £ 16000 Cost Price = £ 16000 X 10/13 = £ 12307 Monthly Overhead = £ 2200 Total overhead for the Budget period = £ 13200
Cash Sales Collections of Credit Sales Bank Loans
Payment to Suppliers Payments of Operating and Other Expenses Payments of Equipment Vehicle Expenses Payments of Bank Loan and Interest Inventory Purchases Investment in Short-Term Securities Estimated Cash Balance at the End of the Period £ 9493
Weight of the RING = 8 g Cost of Silver (per gram) = £ 15 Cost of Ring material = 8 X £ 15 = £ 120 Manufacturing labor cost = £ 20 per hour Time to make 1 Ring =2.5 hours Total cost of labor for 1 Ring = £ 20 X 2.5 = £ 50 Service labor cost = £ 8 per hour. Service time for 1 Ring = 40 mins (2/3 hours) Service cost for 1 Ring = £ 8 X 2/3 = £ 5.33 Total factory indirect costs = £ 10,000 1 Ring cost = £ 120 + £ 50 + £ 5.33 = £ 175.33 500 rings cost = £ 175.33 X 500= £ 87665 Adding Total factory indirect costs = £ 87665 + £10000 = £ 97665 Final price per Ring =£ 97665 / 500= £195.33
To calculate the BEP Total Fixed cost= £4.50 X 100000= £ 450000 Cost of machinery to be added for first year = (£ 750,000) X 100000 (100000+80000+70000+55000) = £ 245901.64 Overhead on advertisement = £ 550000 So TOTAL FIXED COST= £450000+ £245901+£550000= £ 1245901 BEP = Total fixed cost / (Selling Price – Variable cost) = £ 1245901 / £ 30 – (£ 5.75 + £ 5.00) =£ 1245901/ £ 19.25 = 64722 So the total number of units to be sold before the company starts getting profits is 64722. So the company should be able to make profits after selling 64722 pieces.
Task 4(a) Profit and Loss account Profit and loss account is prepared to monitor a business’s progress. This includes monitoring sales and costs. If the company shows its going in profits it is good enough but if it is going in loss then relevant action needs to be taken to remedy the situation in future. To start with it takes into account the Trading entries i.e. income from sales and direct cost associated in making those sales. It also takes into account the other expenses in the business along with the balance of stocks at the start and end of the financial year. Balance Sheet Balance sheet is a statement of assets, liabilities and owner’s equity. The main purpose is to find profits or losses incurred by business. Assets equal the sum of liabilities and equity. It helps to identify financial liquidity problems and identifies company’s potential to meet the financial obligations. It gives an account of the working capital and the indebt situation of a company. It gives an estimate if the company can meet its short term liabilities and as to where a company stands if compared to its competitors. Cash Flow Statement The main purpose of this statement is to calculate the cash balance at the end of a period. It consists of cash flows from Operating, investing and financing activities. It gives information about previous sources of cash and enables to predict even cash flows in future. It also gives the potential of a company to meets its financial obligations. Helps identify the main source of cash which is preferably cash from operating activity. It also explains the effects of financing and investment activities on business operations.
Task 4(b) Different Formats of financial statements by business entities: Government financial statements: Government statements either use Accrual accounting or Cash accounting. They can even use a combination of these two accounting methods. They use a complete set of Chart of Accounts which is totally different from the normally used Chart of profit oriented business. Non-profit organizations: For a nonprofit organization a statement generated is simple as compared to a for-profit organization. The statements just include a balanced sheet marked with statement of different activities (indicating income and expenses) which is just like a Profit and loss statement generally made for a for-profit organization. Personal financial statements: Personal financial statements are generally required when applying for a loan or aid. The organization which supplies loan makes filling a form as a formality to access the candidate’s financial position. This is generally a single form for reporting personal income and expenses. Inclusion in annual reports: For share holders interest the annual reports are generated by the parent company to indicate the progress and assure them their investment is going on a good side. This generally contains letter from company’s CEO which describes company’s performance and financial achievements throughout the year. To attract new investors pleasing graphics and photos are added to annual report.
Starting the analysis by calculating simple Profitability Ratios: Gross Margin: Gross Profit X 100 Net sales = £ 300000 X 100 = 50% ( For 2008) £ 600000 = £ 250000 X 100 = 38.46% ( For 2007) £ 650000 Gross Margin increased as compared to last year indicating business has expanded overall in size. Profit Margin: Net Profit Net Sales = £ 111000 = 0.185 ( For 2008) £ 600000 =£ 70000 = 0.107 ( For 2007) £ 650000 Even the profit margin shows an increase since the Net Profit stood out to be more than previous year. Return on Sales: Operating Income Net Sales = £ 86000 = 0.143 ( For 2008) £ 600000 == £ 136000 = 0.209 ( For 2007) £ 650000 Return on Sales dropped as compared to last year as the retained earnings were less due to more investment done and also the paid dividends were more. Return of Investment: Net Income Avg Owners Equity = £ 86000 = 0.506 ( For 2008) £ 170000 = £ 136000 = 0.618 ( For 2007) £ 220000 RoI is dropped since the net income was less as compared to Previous Year ,Even the Equity showed a decrease but overall impact shows business is dipping in terms of returns generated.
Current Ratio: Current Assets Current Liabilities = £ 125000 = 1.25 ( For 2008) £ 100000 = £ 140000 = 2.00 ( For 2007) £ 70000 Current Ratio has decreased indicating business needs to plan and manage more assets and try to cut down on liabilities as for a business to grow CR > 1 and also the trend should be rising. Mark Up Ratio: Gross Profit X 100 COGS ( Cost of Goods Sold) = £ 300000 X 100 = 100% ( For 2008) £ 300000 =£ 250000 X 100 = 62.5% ( For 2007) £ 400000 Acid Test Ratio: Current Assets -( Inventories + Prepays) Current Liabilities = £ 25000 = 0.25 ( For 2008) £ 100000 = £ 70000 = 1.00 ( For 2007) £ 70000 Debt Ratio: Total Liabilities Total Assets = £ ( 40,000 +36,000+25,000+50,000+18,000+20,000 ) + £100000 £ 125000 + £ 150000 =£189000 + £ 100000 =1.05 For (2008) £ 125000 + £ 150000 = £(36,000+34,000+24,000+50,000+16,000+20,000 ) +£ 70000 £ 140000 + £ 150000 = £ 180000+ £ 70000 = 0.86 For (2007) £ 140000 + £ 150000 Since the Debt Ratio which was under 1 last year and has exceeded to greater than 1 now, so clearly the business is not going in Profit.
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