Unit 2 Financial Decision Making for Managers MGMT 640 Assignment Sample

Financial statement of different organizations (MGMT640 Assignment Sample)

Sole trader prepare profitability statement and balance sheet after ending the financial year. Although, it has not any legal obligations to prepare necessary financial statement. However, partnership prepares profit and loss account, P & L appropriation account, partner's capital account and balance sheet. It prepare all the necessary statements according to the partnership act. However, company is a legal body and legally obliged to prepare profitability statement, balance sheet, cash flow statement, statement of changes in equity and retained earnings. Furthermore, it is legally obliged to.

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(Beth Laurence, J.D Learn About Business Ownership Structures 2015)

Sole Proprietorship
Advantages • All the profits belong to one person only that is owner of the businesses. • Inexpensive in terms of financial cost. • Owner has all the authority of power • Easy to establish		Disadvantages • Owner bears responsibility for all debts • Unlimited liability

Partnership
Advantages • Lower expense of establishment • General partner has a right to monitor all the activities of the company. • Shared ideas of partners • Secured investments are there by consent of all the partners.		Disadvantages • Less preferred business type as it may leads to conflicts as well in the business. • Issue of personal disputes as perception of partners may differ. • Partners depend on each other’s decisions.

Corporation
Advantages • It carries a higher level status. • Limited liability • Opportunity to extend the invested cash • There are certain benefits such as tax allowances that require a certain rate of profits to apply		Disadvantages • It has costly setup fees as it includes huge investment for initiating business along with high legal fees. • The cost is between $500-2,500 (Business and enterprise – Topics – GOV.UK, 2015.)

Financial Statement

Nynfus Corporation was founded in Liverpool, UK, over 10 years ago and since its inception it has been at the forefront of laboratory diagnostics. It develops, manufactures and markets diagnostic instruments. Its biggest markets are the USA and Germany.

5 years ago a private equity fund bought almost all the shares of the company. A few managers and directors own several shares.

Throughout the world, the Nynfus brand name has been established to manufacture high quality and reliable instruments resulting in their products being sold and marketed in more than 100 countries. Today, there are more than 30,000 of their instruments in laboratory use and their customer base continues to grow stronger year after year.

At Nynfus, they do not only pride themselves in the quality of their products but also in the quality of their support through their comprehensive product training programs and their excellent technical support and customer service teams.

Their dedicated sales and marketing team can provide the customers with sales support material and with the advice on how to market the products best in all of the countries. The company also provides the electronic files of brochure artwork allowing their partners to produce their market-specific materials.

All issues related to placement of orders, product availability and deliveries should be addressed to the customer service group, who take great pride in providing excellent service to fulfill their partners' needs.

Following are the financial statements used by Nynfus for business analysis.

• Income statement- It is a statement that provides information about the income and expenses of the firms. This statement shows the profit earned and loss incurred by the firm. It also indicates proportion of expenses in the firm sales. Hence, firm comes to know about the expenses whose proportion is increased in sales.
• Balance sheet- It is a financial statement that indicate the financial position of the firm. There are assets and liability of the firm which indicates that firm financial position is strong or weak. Hence, this statement is widely used by the firms.

 Chart 1: Own chart: Nynfus Corporation Financial Statement 2011-2012

Sole trader

Illustration 6: Income statement of sole trader

(Source: Healy. and Palepu, 2012)

Partnership

Illustration 7: Income statement of partnership

(Source: Ormiston and Fraser, 2013)

Illustration 8: Balance sheet of the partnership

(Source: Humpherys and et.al, 2011)

Companies/corporations and public sector organizations

Illustration 9: Income statement of the company

(Source: Tsalavoutas, André and Evans, 2012)

Illustration 10: Balance sheet of the company

(Spurce: Marques, 2010)

There is a slight difference in the financial statements of sole trader, partnership and companies. This difference is observed because there is difference in size of company operations. Hence, this is the reason due to which minor difference is observed in financial statements of sole trader, partnership and companies.

Proposed action plans:

As per the due or expiry dates of payments and assets, the items of the financial statements have to be considered and an action plan has to be built up. In the list below the items for which the actions are planned are shown:

1. Immediately send a payment reminder, start with discounting or factoring or retortion.
2. Reduce the inventory.
3. Focus on the loans payback, and the payment to the supplier's.
4. Revision of the plant property& equipment, tangible assets.
5. Check the overdue invoices and pay them if it is possible.
6. Collect the refundable VAT from the government.
7. Highly recommended to recheck the credit conditions

Possible areas to invest $50,000

Expenditure and payment point of view: Overdue invoices received from the suppliers must be settled.

Investment point of you:

1. Get an ERP system to make the work easier and more systematic, so information can be stored and processed with more convenience. This results in less need of human resources which means reduction in costs
2. Do market research about potential customers along with their payment discipline
3. Developing the fields that support the company in other aspects such as supply chain and marketing as it is observed that the company is efficient with the production.
4. Opening new branches in order to expand business in the UK.

Role of auditor

Auditor play a very important role from company and its stakeholder’s point of view. Auditor by checking company accounts make sure to employer that his employees are not involving in Malpractice Company accounts. Moreover, stakeholders on the basis of certification of authentic accounts given by auditor also believe that company is not cheating them. Hence, this lead to trustworthy relationship between company and its stakeholders. Thus, it can be said that auditor play a very important role in the company.

Published VS internal financial information

Published financial information is an information that is published in the newspaper and other sources of information. Whereas, internal financial information refers to the facts and figures that are top secret and never published in any source of information. 

Ratios

Ratio analysis is done to identify the position of the business for further decision making process. The following ratios are generally considered for analysis: profitability, solvency, liquidity and efficiency. The following two ratios reflect the profitability of the company:

Table 1: Ratio analysis of Tesco

	2014	2015
Gross profit	4010	-2112
Sales	63557	62284
Gross profit ratio	6.31%	-3.39%
Net profit	974	-5741
Sales	63557	62284
Net profit ratio	1.53%	-9.22%
Operating income	2631	-5792
Sales	63557	62284
Operating profit ratio	4.14%	-9.30%
Current assets	15572	11958
Current liability	21399	19810
Current ratio	0.73	0.60
Net income	974	-5741
Outstanding shares	268	270
EPS	3.63	-21.26
Price	246	186
Earning	3.63	-21.26
PE ratio	67.68	-8.74
Sales	63557	62284
Average account receivables	2357	2155
Debtor turnover ratio	26.97	28.90

Interpretation

• Gross profit ratio- Gross profit ratio indicate the portion of sales that is covered by the gross profit. It also indicate the firm cost control capability at the workplace. Gross profit ratio of the firm 6.39% and become negative to -3.39% in FY 2015. Hence, it can be said that firm needs to give good performance in order to maintain position in an industry.
• Net profit ratio- This ratio reflects the firm capacity to control indirect expenses and also indicate the portion of sales that is covered by the net profit. Net profit of the firm was 1.53% only in FY 2014 but in FY 2015 it become negative. This performance comes in existence because expenses of the firm are increasing at a rapid rate and people are preferring to make purchase from discount stores hence, it can be said that firm give worst performance in a year.
• Operating profit ratio- This ratio is giving a same performance like we see in case of gross and net profit. Operating expenses alone have a higher share in the total expenses of the firm. Hence, Tesco needs to control its expenses as much as possible.
• Current ratio- Current ratio indicate the firm liquidity position and standard value of the ratio is 2:1 which means that for every one pound of current liability there must be two pound of current assets. Tesco ratio is below one and this indicate that firm condition is very poor. Thus, Tesco needs to take some steps in order to enhance proportion of current assets in balance sheet relative to current liability.
• EPS- It indicate the earning that each and every share is earning on the profit made by the firm. For FY 2014 EPS is positive and in next fiscal year it is negative because firm book a loss in its business. Hence, it can be said through this ratio negative message is going to the shareholders.
• PE ratio- It is a ratio that check the valuation of the company shares by considering earning of the firm. This share is overvalued or undervalued is determined when firm PE ratio is compared with industry PE ratio.
• Debtor turnover ratio- It is a ratio that reflects the number of times debtor convert in to cash. The value of this ratio increased in case of Tesco which means that firm is quickly recovering debt amount from the debtors. This is a good strategy of the firm especially when proportion of current assets is already very low in the balance-sheet.

Company’s comparison

	Tesco	Sainsbury
Gross profit	-2112	1208
Sales	62284	23775
Gross profit ratio	-3.39%	5.08%
Net profit	-5741	-166
Sales	62284	23775
Net profit ratio	-9.22%	-0.70%
Operating income	-5792	641
Sales	62284	23775
Operating profit ratio	-9.30%	2.70%
Current assets	11958	4421
Current liability	19810	6923
Current ratio	0.60	0.64
Net income	-5741	-166
Outstanding shares	270	191
EPS	-21.26	-0.87
Price	186	264
Earning	-21.26	-0.87
PE ratio	-8.748	-303.759
Sales	62284	23775
Average account receivables	2155	452
Debtor turnover ratio	28.90	52.60

Interpretation

• Gross profit ratio- Gross profit ratio of Sainsbury is positive whereas same of Tesco is negative. This reflects that Sainsbury is giving better performance than Tesco and mentioned firm needs to do lots of hard work in order to make gross profit positive.
• Net profit ratio- Net profit of both firms is negative and it means that both companies failed to control indirect expenses. If we compare figures then it can be seen that there is huge decline in the Tesco net profit relative to Sainsbury. Hence, it can be said that Sainsbury is performing well then Tesco.
• Operating profit ratio- Operating profit ratio of Sainsbury is positive and same of Tesco is negative. This means that Sainsbury strongly control its operating expenses but same thing is not observed in case of Tesco. Thus, again former company give a better performance than latter firm.
• Current ratio- Current ratio of Sainsbury is higher than Tesco only by some points and due to this reason it can be said that liquidity position of both firms is almost same. None of the firm can be considered better than other.
• EPS- EPS of both firms is negative but sharp downside is observed in case of Tesco. Hence, Tesco again give poor performance relative to Sainsbury.
• PE ratio – Value of PE ratio of both firms is below industry standard which is 20 and thus it can be said that both company shares are undervalued. PE ratio of both firms is negative and this means that shares of the firms are highly devalued.
• Debtor turnover ratio- This ratio is very high in case of Sainsbury relative to Taco and it means that former firm is recovering debt amount from debtors at a fast pace relative to former firm. Hence, here also Sainsbury is ahead of Tesco.

Entire conclusion is that financial condition and performance of Tesco is very weak relative to Sainsbury.

Industry bench marking:

As per industry standards current ratio must be at least 1.5 but Tesco ratio is below one and this reflects that firm is not performing well in comparison to its competitors. On the other hand, profitability ratios of the firm must be nearby to 26% but actual gross profit of the firm is far from this standard and it can be said that firm is giving poor performance relative to industry. PE ratio of UK retail industry is 20 and name of company is very low. On other hand, firm profit is negative this reflects that firm shares are fairly valued and they are undervalued in terms of low PE ratio. Hence, it can be said that performance of the firm is not good if compared to industry standards and it need to do lot of work in order to improve performance.

Limitations of ratio analysis:

Ratio indicate historical performance while investors are more likely to predict future business performance. Thus, it cannot be used for determining potential business performance which is greatest limitation. Another, different organization follow different accounting policies, rules and regulations. In this case, comparison may not provide any meaningful conclusion and the objectives of comparative analysis may not be fulfill. Furthermore, companies that operates in different market also very much influenced by its market environment which is not considered by the ratios henceforth, it is also its limitation. In addition to it, interpretation of ratios is very difficult as it cannot be said that the identified ratio is good or bad.

Sources of business finance

There are numerous sources of business finance available for businesses: Large financial need ($500,000) might require the use of multiple sources, for example the combination of an amortisation loan and an overdraft. $360K amortisation loan could be taken for 18 months to be repaid in monthly instalment of $20K, along with an overdraft of $140K.Short term loans may also be requested. Although it involves some risk, but it is a cost-effective solution which gives immense time period to the person to make the payment.

Non-refundable loans can also be taken from EU tenders. Investors can be found and convinced to support the company, and this way their share capital can be increased.

Short term working capital:

Every business needs short term working capital to support its all the operational activities. It will be needed for day to day functions.

Importance of working capital for business continuity

Without having adequate amount of working capital, business cannot survive effectively in the market. Firms will not be able to operate and done its daily functioning without sufficient working capital. Each and every organization whether small or large scale need to purchase material, making payment of wages, rent, insurance, electricity, office expenses, marketing and others. Thus, they need adequate availability of funds for this purpose otherwise, it may face operational difficulties and cannot survive in the market.

Difference between long-term and short-term financial needs

Short-term financing	Long-term financing
Short-term financing involves a loan term that is typically less than one year.	Long-term financing is any debt obligation with a loan term that is greater than one year.

The distinction is important for accounting and tax purposes.

Businesses keep a close eye on the money they make and the bills they owe. Anything that is not paid immediately is financed. Financing is a type of credit or loan that allows a business to take possession of an asset in the present but not pay for it until sometime in the future. The financing obligation is carried in the company's accounting system as a liability, or an outstanding amount owed.

As per Shim, 2008, “The evaluation of assets and liabilities allows a person to determine the financial health of a company at any particular time. If a company has more assets than liabilities, it is in relatively good shape; however, if it has more liabilities than assets, it could be in trouble.”

Analyzing a Published financial statement

Nynfus Corporation
	31.12.2012	31.12.2011
in USD	YTD Actual	YTD Actual
Cash	12,441	9,984
Accounts receivable	2,224,236	1,570,623
Inventories	1,990,920	955,153
Raw material	1,486,910	642,965
WIP	365,850	210,521
Finished goods	138,160	101,667
Prepaid expenses	223,111	29,781
Other current assets	15,224	23,395
Current Assets	4,465,932	2,588,936
PP&E	559,402	388,269
Net fixed assets	559,402	388,269
Goodwill	1,464,156	1,792,493
Other intangibles	50,998	52,700
Financial Investments	1,913,636	1,913,636
Other Non-current assets	13,207	13,207
Total assets	8,467,330	6,749,242
Accounts payable	1,664,722	1,312,328
Provisions	10,686	37,285
Accrued Expenses	376,655	279,346
Accrued Taxes	-22,541	-58,374
Other interest	-	-
Other Current Liabilities	617,830	62,745
Current liabilities	2,647,352	1,633,330
Revolving Credit	1,890,168	1,890,168
Senior Term Debt	-	7,881
Capital leases	24,349	41,772
Other short term Loan	864,868	883,964
Total debt	2,779,384	2,823,785
Share Capital	153,000	153,000
Capital Reserves	1,244	1,244
Retained Earnings	2,137,883	2,126,339
Actual P/L	748,467	11,544
Total S/H equity	3,040,594	2,292,127
Total liabilities & equity	8,467,331	6,749,242

Total revenue	12,477,522	10,024,417
Share (pieces) 100$ per share	1,530	1,530
EPS 1	489	8
Net debt 2	2,755,036	2,782,013
Working Capital 3	1,818,579	955,606
Debt equity - liabilities and debt 4	0.64	0.66
Debt equity - S/H equity 5	0.36	0.34
Assets turnover 6	1.47	1.49

1. Earnings per share: If the company pays off all dividends in the current year, then the members may receive an accumulated amount that is five times higher than the principle amount at the time of their initial investment. But banks will not allow this as they will focus on payment of outstanding loans.
2. Net debt: The Company works with huge loans even after considering that the retained earnings are positive. Although the loans are high, neither cash nor any assets are obtained without taking a loan. It increases the total net debt which is the liability that needs to be paid off with the extra expense of the interest.
3. Working Capital doubled: The inventories and the account receivable have increased. The inventories increase nothing warrant, at list the income isn’t growth such an extent. The increase of the account receivable is significant but much more seems as the delays of the customer payment issue, or the expired customer's payment delay versus the volume-based growth. Considering the balance sheet, other current liabilities of the firm increase due to advance payment received from the customer for purchase of any products or services.
4. It has been noted that the ratio of own capital and foreign capital is the opposite of “the theoretically optimal 70%-30%”. The company is running by obtaining loans in a higher proportion instead of using their own capitals.
5. The details of bank accounts and loans from the financial institutions have to be checked in order to make any further conclusions to determine the commercial growth of business.
6. The asset turnover has declined as compared to the previous period.

Assessing implications of different financial sources for the organization

Banks and private investors are the main financial sources. All services have a set of conditions. This is contracted between the different sources of finance (such as banks, private investors, credit unions) as lender and the borrower.

Cost of finance: Retained earning involves opportunity cost to the business. It is the loss of income which can be generated through investing this profits for any alternative purpose. However, on the amount of loans, company has to pay timely interest which is its cost. On contrary, on issued share capital, firms have to make dividend payments to their shareholders. Thus, dividend is the cost of share capital. Along with this, it also diversify business control to the shareholders.

Impact of finance sources on the financial statements

Retained profits used to funding business will be shows under the statement of changing in equity and retained earnings. However, working capital can be improved by negotiating creditors and getting earlier from the debtors. Thus, the amount of debtors will be shows under the current assets head of balance sheet. However, the amount of creditors will be shows under the current liabilities head of balance sheet. Another, the amount of borrowed funds will be shows as long-term liabilities and improve cash balance in assets side. However, the interest payments will be shows under profit and loss account and deducted from cash balance. On contrary, share capital will be shows under the capital assets in liability side and enhance cash balance of the company. However, dividend payments will be shows as expenses in profitability statement and also will be subtracted from cash balance.

Substance over from risk: Firm has to manage their cash flows so that they will be able to discharge their financial obligations effectively. Financial risk is the risk associated with collection of funds. For instance, high borrowings will impose high interest obligations and vice versa. Moreover, rising in interest rates and foreign exchange rates will bring high financial risk to the company.

In the contract, it will be stated how much interest needs to be paid on the principle amount that is taken as loan and the deadlines after which penalties will apply. The interest rate may differ between various financial sources.

Financial Sources	Legal aspects	Financial aspects	Chance for bankruptcy	Dilution of control
Retained profit	Amount reserved for further investment	No financial implications	Nil	Dilution remains same as the part of company
Working capital	Amount belonging to operations of firm	NA	NA	NA
Share capital	Dividend has to be paid to legal shareholders of the firm	Generation of huge funds from public	Nil	Partial ownership of shareholders
Loan	Interest and principle to be paid for the loan amount	Timely payment of interest has to be done.	If interest and principle amount not paid	Collateral security taken by bank

Table 2: Implication of sources of finance

From the above table, it is observed that there are diverse aspects of consideration for various financial sources. There are certain costs that are associated with direct or indirect source. Every type of finance has some legal implication that has been presented.

External and internal sources: External finance sources are generated from outside while internal finance sources can be generated from the inside the organization. For instance, retained profits and working capital are internal sources whereas loan and share capital are external finance sources.

 

External sources of finance

Equity: - This is one of the most commonly used source of finance. In order to raise the capital through this source company is required to follow a legal procedure which is laid down by the regulatory authority. This source can be used by the organisation who are capable of listing in primary market.

Advantages

This source is adjustable in nature. Company can issue shares as per there requirement.

Disadvantage

Power of the existing shareholders dilutes when new shareholders arrive.

Venture capital: - In order to avail this source company is not required to be listed on the primary market. This can be said as the variable of the equity.

Advantages

Main advantage of venture capital is that it help the private firms to easily invest in the client company and in return they are able to get the shareholding in the client company.

Disadvantage

One of the major disadvantage of this source is that control of the existing shareholders reduces due to the entry of new shareholders.

Debentures: - It is the acceptance of debt in written taken by the company from the general people. In lieu of which company is liable to pay the fixed rate of interest to the public from who they have raised the capital. In addition to this they are also required to repay the principle amount after the completion of a specific time period. On the other hand if company does not repay to them on time than in that case debenture holder has the right to the sue the firm.

Advantages

While availing this facility power of the existing shareholders does not dilute. In addition to this rate of interest paid is less as compared to the dividend paid to the equity shareholders.

Disadvantage

Debt burden of the company increases.

Retained profit:- It is the part of profit that is kept by the company as a reserve. No cost is incurred by the company at the time of using this source.

Advantages

Main advantage of this source is that company is not at all required to bear any cost while availing this source. They can use this source as and when required.

Disadvantage

There is no disadvantage of the using this source.

Recommendations for financial sources for business projects

A company could choose from various sources of finance depending on the amount of capital required and the purpose fro need. Sources of finance can be divided into three categories, namely traditional sources, ownership capital and non-ownership capital (Four Basic Types of Financial Ratios Used to Measure a Company's Performance, 2015). Firms can take long term asset backed loan which is secured for banks. By keeping asset with banks firm can easily get a loan from the bank. In case of short term loan also some of the banks took a security of asset. Firm can approach to those banks who are giving a loan without taking any asset. Hence by following this strategy or recommendation by pledging less assets firm can raise good amount of funds.

1. Traditional Sources of Finance

Internal sources could be a company’s assets, factoring or invoice discounting, personal savings and profits that have not been reinvested or distributed among shareholders. Working capital is a short term source of finance and is the money used for a company’s day-to-day activities, including salaries, rent, payments for raw materials and electricity bills. Hence, traditional source of finance must be used to meet working capital requirements of the firms.

1. Ownership Capital

Ownership capital is the capital owned by the shareholders of a company. A company can raise substantial funds through an IPO (Initial Public Offering). These funds are usually used for large expenses, such as new product development, expansion into a new market and setting up a new plant. The various types of shares are:

1. Ordinary shares: These are also known as equity shares and give the owner the right to share the company’s profits and vote at the firm’s general meetings (Mariotti, 2010).
2. Preference shares: The owners of these shares may be entitled to a fixed dividend, but usually do not have the right to vote (Mariotti, 2010).

Companies that are already listed on a stock exchange can opt for a rights issue, which seeks additional investment from existing shareholders. They could also opt for deferred ordinary shares, wherein the issuing company is not required to pay dividends until a specified date or before the profits reach a certain level.

Unquoted companies (those not listed on stock exchanges) can also issue and trade their shares in over-the-counter (OTC) markets.

III. Non-Ownership Capital

Non-ownership capital includes funds raised from lenders, such as banks and creditors. Companies typically borrow a fixed amount from a bank, at a predetermined interest rate and with a fixed repayment schedule. Certain bank accounts offer overdraft facilities. This is used by companies to meet their short-term fund requirements, as they usually come at a very high interest rate.

Factoring

Factoring enables a company to raise funds using its outstanding invoices. The company typically receives about 85% of the value of the invoice from the factor. Remaining amount remains with the bank that is providing factoring services to the firm. There are different factoring schemes and companies can opt any scheme as per their convenience. This method is more appropriate for overcoming short-term cash-flow issues (Statement, 2009).

Hire purchase

Hire purchase allows a company to use an asset without immediately paying the complete purchasing price. After paying installments when value of same in aggregate become equal to the asset value then it is assume to be purchased by the firm Trade credit enables a company to obtain products and services from another firm and pay the bill later.

Venture Capital

Firms in the early stages of development can opt for venture capital. This option gives the financing company some ownership as well as influence over the management of the enterprise.

Under this there is a venture capital firm that makes an investment in the company. In return they get shareholding in the firm in which they make an investment. Venture capital firm also get a share in the profit earned by the client firm. Moreover, they have right to participate in the board meetings to take day to day business decisions.

Duration

Depending on the date of maturity, sources of finance can be grouped into various types (Maynard, 2013). They are as follows:

Sources of funds	Application		Advantage	Disadvantage
Long terms sources
Share capital or equity share	Issue of shares to public for raising funds		Able to raise huge amount through public	Have to pay dividend out of the profits
Preference shares	Raising amount through selected people who are given preference		1. Absence of voting rights 2. Fixed return to shareholders	1. High rates of dividend 2. Tax disadvantages are there
Retained earnings	Part of revenue that is kept as reserve		No dividend to be paid that increases cost	Reduces capital of the firm
Debentures/Bonds of different types	Creditors of the firm carrying fixed rate of interest		Interest over debenture is tax deductible that saves income tax of firm	Compulsory payment of interest after a fixed period that is burden for the company
Loans from financial institutions	Amount borrowed from financial institution against collateral security		Easy to apply and quick grant of loan	Interest has to be paid that increases expenses of the firm.
Loans from commercial banks	Loan obtained from banks against financial security		Easy to obtain funds for managing financial tasks	Getting loan is more expensive than traditional banks.
Asset securitization	Creates portfolio of assets and issue them as interest bearing security		It provides high credit ratings and low borrowing cost	Very complex structure to be created and followed
Venture capital funding	Fund is raised through investment of other firms that is profitable to investor and issuer		Creates advantageous industrial connections that are beneficial for future	The accounting and legal cost makes the securing deal to be a difficult process
Medium-term sources
Preference shares	Raising amount through selected people who are given preference by board		Fixed return to shareholders	High rates of dividend
Debentures/bonds	Creditors of the firm carrying fixed rate of interest		Interest over debenture is tax deductible that saves income tax of firm	Compulsory payment of interest after a fixed period that is burden for the company
Public deposits for duration of three years	Amount invested by public for 3 years and interest will be paid		Easy source of fund with very less legal formalities	There are legal restrictions over limits of raising funds
Commercial banks	Loan obtained from banks against financial security		Easy to obtain funds for managing financial tasks	Getting loan is more expensive than traditional banks.
Financial institutions	Amount borrowed from financial institution against collateral security		Easy to apply and quick grant of loan	Interest has to be paid that increases expenses of the firm.
State financial corporations	Fund is raised through government approved loans where lender are not intended to make profits		They are secured as board of managers are appointed by government	They are difficult to manage and control
Lease financing / hire purchase financing	Using the asset by paying installments that is owned when total cost of asset is paid		Limited outflow of cash, hence company can manage funds easily for installments	Ownership is not transferred till all the installments are paid
External commercial borrowings	Commercial loans taken from non-resident lenders		Fluctuating interest rate in global market that may give benefit to loan taking firm	The fluctuating interest rates include huge risks of changing market conditions that may prove negative as well
Euro-issues	It is the type of foreign currency bank loan		It gives companies a wider access to international market.	It may face foreign exchange risk if total foreign debts are not matched against foreign currency asset
Foreign currency bonds	Allowing non-resident people to invest in the company by issue of bonds		The changing interest rates may provide advantage to issuing company	It gets easily affected by inflation in the market.
Short term sources
Trade credit	Credit is given to the buyers while purchases		It enhances sales of the firm	No cash is obtained on immediate basis
Commercial banks	Loan obtained from banks against financial security		Easy to obtain funds for managing financial tasks	Getting loan is more expensive than traditional banks.
Interest over Fixed deposits for a period of 1 year or less	Earnings can be kept deposited in financial institution for getting interest		Non-taxable up to a certain limit	Opportunity cost of other investment can be borne
Advances received from customers	Amount is received from people for the purchase of goods in advance		No interest is paid to the customers	Liability of the firm increases for particular time period
Various short-term provision	They are provisions made out of current profits to meet tax obligations		It is cheap source of finance without any cost	Excess provisions may be created that leads to misuse of funds

Table 3: Sources of funds

Task 2

a) Budget and Cash Flow

Cash flow forecast: It can be forecasted through estimating potential cash revenues and expenditures. Revenues has been identified through anticipating future sales while spendings have been determined through estimating electricity charges, wages, require investment and loan repayment.

The revenue and the Cost of Goods Sold will be postponed one month based on the 30 days payment term. The different types of expenses that will be included in the formation of budget includes:

• Electricity bills on quarterly basis
• Wages and other overheads
• Investment for the truck in September
• Loan repayment in November

Budgetary control system: Budget is an effective tool which can be used by the corporation as control mechanism. Through using this tools, management can monitor business payments on a continuous basis. They can control business spending so that actual spending will not cross the budgeted expenses. Thus, it can maximize revenues and control spending.

Budget formation: It can be constructed through determining potential future revenues and spending. Thereafter, net cash flow in terms of surplus or deficit can be determined through identifying the difference between cash revenues and payments. However, closing balance can be determined through adding opening cash balance to the net cash flow. Under the zero base budgeting, it can be prepared through identifying future operational activities. However, incremental budgeting method will increase all the previous cash incomes and payments without considering its importance for future period.

• Table 4: Budget and cash flow for the firm

	July	August	September	October	November
Opening balance	5000	11000	16000	11000	15700
Sales	10000	8000	9000	10000	9000
	15000	19000	25000	21000	24700
Expenses
Electricity bills	1000			1300
Wages	3000	3000	4000	4000	5000
Investment on truck			10000
Loan repayment					5000
Total expenses	4000	3000	14000	5300	10000
Closing balance	11000	16000	11000	15700	14700

Analysis:

Because of the financial position profits and losses are not that strong, the timing on loan payback is not good. The company can deal with it, but my suggestion is the company should request more instalments from the bank. This has to be discussed with the Bank.

They have credit to purchase a truck. But this is mainly credit, which needs to be paid back in November. So leasing the truck would be more appropriate.

If they have other unplanned expenses or CAPEX income in January (December invoice 92Ł) then there will not be enough money for the operation of the company.

Based on the forecast, the upcoming year seems to be very weak for the company which will also affect the cash flow.

As I mentioned the CAPEX (lease) and postponing, the instalment will be a strategically smart decision. The actual picture shows how they could handle those expenses without any other sources of funds, but considering that the profit and loss is just a forecast, and if they are not able to keep it then it will destroy the cash flows as well.

Because the depreciation isn’t part of the cash flows until the incomes are higher than costs reduced by the depreciation, the operations are financed.

On top of that they will have other expenses as CAPEX, loan, repayment, credit, and they won't be able to cover those if the company continues its weakening activities.

Managing cash flows: On the basis of above budget, it can be seen that sales shows a fluctuating trend as it got improved or decreased over the period. Thus, it can be suggested that firm has to increase its cash inflow through higher sales. It has to construct policies for growth in sales. However, for cost reduction, business has to control its electricity and wages payments through saving energy and hiring staff at lower wages rate. It will lead to reduce cash outflows so that company can enhance its positive cash flow and ending cash balance. This in turn, organizations can operate successfully in the market.

b) Recommendation for managing disadvantages of each sourcusiness finance and expenditure

Based on the criteria of Net Present Value, the NPV2 is better due to the smaller loss.

Profitability Index is also better, only the half of the investments is recoverable. Both projects are negative.

Personally I would keep it in the Bank, even without interest. The figures are the following:

	NPV of Project I	NPV of Project II
Cost reduction after 3 years	-49.7	-24.9
Immediate outlay	£200	£100
Loss	-£133	-£44

• NPV1 Project -49.7 cost reduction after 3 year's Cost (immediate outlay) 200 pounds
• NPV2 Project -24.9 cost reduction after 3 year's Cost (immediate outlay) 100 pounds
• If I made a decision I would choose the project NPV2. Tie up less money, and smaller loss (-£44) compared with the first project where the loss is (-£133).

Since the NPV in both cases are negative; this case, the IRR will be negative as well as per the basic economic context.

Based on the sample provided: advantages, disadvantages of each source

Reduce the inventory amount, speed up the stock rotation, decrease the days of rotation. So our money will not stick in the ITO.

2012 rotation speed in days 58.24 days

In 2013 with 10-% business growth with the ITO 33-% decreases these days can reduce by 35.26 days this will create a lot of free cash. Control the customer debt. Select the future strategic partners. Maybe this will decrease our income but this is still better position. We don't need to redact the final net income.

Financial statements help the business to identify their financial status that demonstrate its working. It is required to be assessed so that appropriate decisions regarding further business practices can be taken by stakeholders of the entity. The budgeted income statements for six months of Green Limited which is a wholesaler are as follows:

Item	Jul £’000	Aug £’000	Sept £’000	Oct £’000	Nov £’000	Dec £’000
Sales Revenue	114	118	124	104	96	92
Cost of goods sold	(64)	(66)	(70)	(59)	(54)	(52)
Salaries and wages	(20)	(20)	(20)	(20)	(20)	(20)
Electricity	(6)	(6)	(8)	(10)	(12)	(12)
Depreciation	(6)	(6)	(6)	(6)	(6)	(6)
Other overheads	(4)	(4)	(4)	(4)	(4)	(4)
Total expenses	(100)	(102)	(108)	(99)	(96)	(94)
Profit/loss for the month	14	16	16	5	0	(2)

 

Analysis:

From the above presented figures, the following results are obtained:

• It is observed that the net income will not be high by the end of the year, and therefore, the repayment of the loan for November may be a difficult task as well under which company has to manage funds to repay the amount of loan.
• The company has some funds though which they should try to repay from the part of their liquidity to pay the amount of loan.
• The company has cash for the CAPEX of van, but it is preferable if they purchase with Capital lease.
• The capital lease and the repayment of the loan in more frequent installments would affect the cash flow.
• If other costs of business will increase in January or February, it could be very risky for the Company, especially when they have generated lower sales and profit of last months. The business will observe lower profit at the end of year as a result of which the cash flow will be weak as well.
• The van CAPEX and the multi-part repayment will a good strategy for the save of cash flow.
• Although the forecast shows that the net income and the cash-flow will not be very bad, however this is "only" a forecast. We must be careful.
• Depreciation is not the part of cash flow. If the earnings before interest, dividend and tax is over 0, then the cash flow will be safe.
• If the sales continue to decrease, the EBIDTA will decrease as well, and the cash-flow will decrease too. The company does not need a new loan or credit if the following can be achieved: decrease of the sales must be stopped and reversed, the payment schedule and the "non P/L" payment (CAPEX, loan repayment, interest, etc.) Must be modified.

Task 3

a) Project assessment

Investment appraisal is the technique that is performed to identify the best project which should be selected by the company out of the list of various projects. It is performed by determining Net Present Value of the project. Moreover, it identifies the payback period and Average Rate of Return. It is performed to observe the feasibility of the project alternative regarding the selection of better choice for greater profitability.

Hanley Manufacturing Limited has two potential projects. They can only invest in one project. The following information is available on the projects.

	Project 1 £’000	Project 2 £’000
Cost (immediate outlay)	200	100
Expected annual operating profit (loss):
Year 1	58	36
Year 2	(2)	(4)
Year 3	4	8
Estimated residual value of machinery	7	12

The business has an estimated cost of capital of 10% and uses the straight line method of depreciation for non-current assets. The business has sufficient funding to meet capital expenditure requirements for either project.

Project 1)

Net Present Value = -200 + (58/1.1 - 2/1.1² + 4*1.1³ + 7*1.1³) = -141

Profitability Index = (200 - 141)/200 = 0.297

Project 2)

Net Present Value = -100 + (36/1.1 - 4/1.1² + 8/1.1³ + 12/1.1³) = -56

Profitability Index = (100 - 56)/100 = 0.444

b) Recommendation based on calculations

Observing the figures that have been derived, it is found that both projects are not a good investment, because the NPV (net present value) showed negative results. Simultaneously, it is found that the PI (Profitability indexes) are less than 1 as well. This clearly demonstrates that it is difficult to get the money back from this investment, because the PI<1 and the NPV<0.

NPV P1 (cushion) = - 200+200/1.1³ = -49.7

NPV P2 (cushion) = - 100 + 100/1.1³ = -24.9

If I do not invest, I will have more money…

If I must choose one of these versions of investments, the second will be my choice.

I will have to deposit less money and observe less loss than the first project.

Because the NPVIRR (internal rate of return) will be negative as well, this is an economic axiom.

Control:

The Internal Rate of Return that has been obtained from both the projects:

Internal Rate of Return
Project 1	Project 2
(58-2+4+7)/200-1 = -0.67	(36-4+8+12)/100-1 = -0.48

This shows that the investments will not be able to generate profit as expected by the firm because as per the principle, if IRR<0, the investment will make a loss for the business.

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