Success Ltd is a medium-sized private limited liability company producing furniture for the retail sector and private homes. Currently it employs 50 staff and has been in business in the last 5 years, mainly in a domestic market. The business was set up by 3 young carpenters, Billi kid, Bengazy and Lee Jones. Whilst their ability and enthusiasm to design the furniture is largely undiminished, other business functions such as marketing strategy, administration and sourcing materials at the best prices are not well integrated as neither are particularly interested in the business strategy. This Managing financial resources decisions assignment report has highlighted company’s financial position and identified sources of finance available. In addition, this paper would also help to understand implications of finance as a resource within a business for Success Ltd. Impact of finance in the financial statements would also be detailed.
1.1. Source of Finance Available for Success Ltd
From the case, it is very clear that company has going through a tough financial conditions and facing challenges of quality issues. Product range is very limited and restricted to single market. Moreover, intense completion has also become an important issue for the company as competitors are offering wide range of products using innovative technologies. In order to overcome such issues, Mathew who was appointed as Operations Director has suggested purchasing of 2 new machines for the production department. In order to buy these machines, company needs £4 million pounds but Cecil Jones, the Finance Manager is not comfortable with Mathew’s suggestion as he thinks the company has not got the money to buy those machines. More so, the cost of capital is 10% if they should borrow money to purchase equipment.
Success Ltd is not in the position to use retained earnings as financial resources because cost is very high. Moreover, funding from equity share is also not possible due to down market performance of the company. Now the only option is left to buy machines using debt financing at a cost of 10%.
1.2. Impact of Debt Financing
Borrowing or debt financing would make the company to speed up producing range of products and enhance product quality in short term. This will help Success Ltd to improve customer’s satisfaction towards their product quality and reduce product return percentage. Ultimately, this decision will make company to experience increased profitability. However, it will directly impact on company’s expenses as there would be high interest charges to be paid annually. In addition, company’s liability will be increased. Shareholders of the company will also be affected as high interest rates would result in reduction in Earnings per Share (EPS). Moreover, it will have a negative impact on stock price as well. If in any care, Success ltd come in a situation of not able to repay to such a huge amount and goes bankrupt, stakeholders will be the last to be paid.1
1.3. Evaluation of Debt Financing for Success Ltd
For task 1.3 there is an excel sheet made.
2.1. Cost of Debt Financing
As we know that only option to source of financing is debt financing, we will find out cost of debt financing here.
From the above findings, it is clear that Machine A is more useful and feasible as compared to machine B. Therefore, from Mathew’s suggestion, buying machine A only can be considered. Single machine will cost £2,000. Cost of capital or interest rate is 10%.
Because companies benefit from the tax deductions available on interest paid, the net cost of the debt is actually the interest paid less the tax savings resulting from the tax-deductible interest payment.
Actual Cost of Debt Financing = Interest Rate (1-tax rate)
= 10% (1-0.4447)
= 10 (0.5553)
Therefore, cost of debt financing would be 5.55%.
2.2. Importance of Financial Planning
Financial planning is very important not only for an individual but also for any business. For Success Ltd, good financial business planning can resolve all the issues with their profitability and make them to focus more on improve productivity of wider range of products. Cecil Jones who is the Finance Manager is not comfortable with Mathew’s suggestion to buy machines, but when it comes to enhance producing wider range of products, it can be considered to buy only one machine A. in the short run, success ltd will gear up its customer’s satisfaction by offering good range of products and make market value as well. For this purpose, it becomes important to make effective financial planning so that all resources can be utilized to the optimum level. Following are few importance that company can have from financial planning:
- managing profitability more efficiently
- To monitor operational cost and expenses
- To build a long term capital-base and shape future position of the company
- To cover up future shortcoming or urgencies
- To identify potential investment opportunities
- To improve cash flows of the company
2.3. Information required for decision makers
As per the case, Billy and Bengazy who are the partners in the firm, strongly feel that global expansion of the business would certainly help to increase market value and profitability of the company. However, they being the decision makers are not aware of the technological advancements those should be considered. There are competitors who are offering wider range of products at lower price and with better quality. Most significant reason is the use of technology in production, effective marketing strategyand branding of the product & company. Therefore, first of all, decision makers of the company must look for new technologies to enhance production level and quality of products. In addition, they must also make a market survey of their target market and target audience to find out taste and preference of customers. This will help them to find out exact market requirement and produce accordingly. They must get the information on competitors designs of products in a way that new trend or concept furniture could be offered in the market to attract customers.
2.4. Impact of the sources of finance on the financial statements
There are several sources of financing but majorly debt and equity financing is largely used as sources of financing. In equity financing company exchanges the ownership of the business looking for a financial investment. Such kind of financing allows the investor to receive a share in company’s profit. It increases equity capital of the firm that is reflecting in balance sheet.
On the other hand, debt financing is other important source that is used here in this case to achieve organizational goals. Debt financing affects company’s profitability in short run with low net profit. For success ltd., debt financing would make an extra burden of meeting the cost of interest expenses. In addition, it also affects debt equity ratio which is used as the decision making ratio by stakeholders or investors before investing in to the company. High debt cost would increase high debt equity ratio. It means, if success ltd is not able to repay the loan, its assets will be used for repayment and payments to stakeholders would be at the end. It is not a good sign from stakeholder’s point of view.
3.1 Cash Budget
3.2 Cost of Chairs
3.3 Feasibility of Investment in Machines
As per the case, company will use two machines for five year time to enhance the production of wide range of products. In order to find out feasibility of cash flows from these two machines, we will first find out present value of all the cash flows to compare it today’s price of the machine using discounted cash flow method. As cost of financing is 10%, this will be used as discount rate. Net Present Value is used here as the investment appraisal method to find out feasibility of the investment in machines.
= + + + +
= 727.27 + 661.16 + 601.05 + 273.21 + 62.09
NPV = Present Value of Future Cash flows- investment
= £2324.78 - £2000
Now, it is clear that net present value of future cash flows is higher than machine cost of £2,000. Therefore, it is a feasible option to buy machine A.
= + + + +
= 454.55 + 413.22 + 375.66 + 341.51 + 62.09
NPV = Present Value of Future Cash flows- investment
= £1647.03 - £2000
On the other hand, it is also clear that present value of future cash flows is lower than machine cost of £2,000. Therefore, it is not a feasible option to buy machine B.
4.1. Main financial statements of a company
In order to understand company’s position, it is important to evaluate or assess financial position of the company. Especially from investment point of view, it is important to judge company performance of financial statements available. There are basically three main financial statements those are considered at the time of investment or providing financing to the company. First statement is profit & loss statement that gives an idea about overall expenses and profitability of the company. Reviewing profit & loss statement can enable an individual or analyst to find out how company is focusing on improving profitability. Second financial statement is cash flow statements that give an idea about all sources of income of a company. There are three important element of cash flow from where income is generated; one is income from operational activities, second is income from financing activities and third is income from investing activities. These three parts of cash flows helps to understand how a company is managing its resources to the most optimum level to generate income. Third important financial statement is balance sheet that helps us understand the actual position of the company at the end of every year. Balance sheet makes us clear on what are company’s existing liabilities and what are its total assets. All the final position of fixed assets is mentioned in the asset side of balance sheet. In addition, current assets help us to know that how company is going to meet its current urgencies and to manage cash. On the other hand, liabilities side, long term liabilities present an idea of how company has used financing. In addition, these financial statements are very important to evaluate financial ratios of a company to make an investor able to decide before investing into company; make a financer to decide before financing to any project of the company or enables a shareholder to decide before investing into market share of the company.
4.2. Comparison of Financial Statement of a company and sole trader
It is must to prepare financial statement for all type of business whether it is a partnership, private limited company, sole trader or any other business. There are not basically many differences in financial statements of sole trader and company; however usability of final accounts makes difference. Financial statement of a sole trader is just used for its internal accounting purpose and record of financial positions. However, for a company it is must to get its financial statements audited by the external accountants. It gives more transparency in the data provided. Company’s financial statements are used widely for investment purpose whereas for sole traders are not.
4.3. Ration Analysis and Interpretation
Net profit margin (NPM)
= Net Profit/Turnover
= 110,000 / 2,217,000
NPM ratio is used to find out margin of profit on sales. Industry NPM is 10 % whereas Success ltd has very low at 4.6% only. It means other competitors are performing excellent and making higher profit as camper to this company.
Gross profit margin (GPM)
= Gross Profit/Sales
GPM represents trade profit margin of the company.For Success Ltd. it is almost equal to industry ratio so it can be said that almost all the companies has similar percentage of direct expenses to their sales.
= Current Assets/ Current Liabilities
= 966,240/ 427,270
Current ratio represents company’s position of how current assets are able to meet current liabilities of the company. If this ratio is higher than 1, it is considered that company is in good position to meet out its urgent pay-outs. Here, for Success ltd current ratio is 2.26 which is even higher than industry’s current ratio. It means, success ltd has good stability to pay-out its current or urgent liabilities if required.
Quick ratio (1)
= Current Assets-Inventories/ Current Liabilities
= (966,240-496,240)/ 427,270
Quick ratio states that how a firm is able to meet out urgent requirement of cash liabilities or cash payable. It represents how quickly company can convert current assets into cash to make urgent cash payments. For Success Ltd. Quick ratio is 1.1 which is higher than industry’s quick ratio of 1. It means, this company is in good position to convert current assets into cash.
Return on Capital Employed (ROCE)
= Earnings before Interest and Tax (EBIT) / Capital Employed
= 284,500/ 21,74,080
A higher ROCE indicates more efficient use of capital. ROCE should be higher than the company’s capital cost; otherwise it indicates that the company is not employing its capital effectively and is not generating shareholder value. For Success Ltd. ROCE is positive and near to industrial ratio. It means company is quite likely using its capital in accordance to generate profit.
= Debt/ Equity
= 1,146,280/ 1,027,800
D/E ratio for Success ltd is 1.11 which is lower than that of industry average. It means company has lower debt ratio as a source of finance and funding as compared to equity financing which is a good sign. Company’s equity capital can be used to repay the debt part if needed at the time of any urgency.
Contact usGet assignment help from full time dedicated experts of BTEC HND & HNC assignments.
Call us: +44 - 7497 786 317
Unit 2 Managing Financial Resources and Decisions Assignment
1.1 Why business needs finance and what are the available sources of finance to a business
Every business be it small or large needs funds for various activities such as expansion, working capital or start-up. The quantum of funds required depends on the activity of the business for example the funds required in the case of working capital would be less than that required in the case of expansion of the business. A business help can procure funds from various sources such as equity, debt, retained earnings, venture capital and seed funds. However, the choice of source depends on the purpose of utilization of those funds. The main role of a finance manager of an organization is to maximize the wealth of its shareholders; this is a much broader concept than profit maximization and the choice of source of finance can sizeable contribute to this objective. As a consequence it is immensely important that the right mix of finances struck. There are a number of ways by which the sources of finance can be categorized however, primarily sources of finance can be categorized as own funds and loan funds. (Atkinson, 2005)
Own funds: These are the sources that primarily belong to the organisation in the broader perspective. The primary examples of such sources are equity and retained earnings. When a business opts for equity capital it has to issue shares our stocks to shareholders in exchange of the money. Though this money belongs to the shareholders the business is not required to pay it back till it has been liquidated by the order of the court. A business is considered to be a perpetual entity hence; it is assumed that the business will go on forever regardless of the change in its ownership. As a consequence it is considered that the business would not have to pay back the money of the shareholders. Retained earnings also form part of own funds. Read 10 earnings of those earnings which have been ploughed back by the organization over the years.
Loan Funds: as the name suggests loan funds are the funds that have been borrowed by the organization from the market. An organization has to pay interest on these types of funds. Examples of loan funds are debentures, term loans and bonds to name a few.
1.2 Access and compare the implication of the different sources of finance
There are various sources of finance that can be availed by a small business or a big firm. With each source of finance given below, the implications for the business that can possibly crop up will be assessed. Sources which provide short term funds can only be used to cover working capital necessities. They cannot be used to finance fixed assets to meet the margin money for working capital loans. (Newlyn, 1968)
The credit given out by the supplier of goods or services to the customer in the regular course of business is known as trade credit. Due to competition, it forms a major portion of short term financing in a business. Trade credit is an unstructured source of finance which facilitates the regular course of business.
An accrued expense is an accounting expense which the company owes to a person or organization, but is already noted in the firm’s balance sheets. Accrued expenses are required to be paid sometime in the future. It is a liability that the company has to pay for the goods or services that it has already received.
When a firm has a fairly high credit rating, it can issue short term unsecured promissory notes called Commercial papers. First introduced in USA, it was a significant money market apparatus.
Inter-Corporate Deposits (ICDs):-
Inter-corporate deposit or ICDs are deposits made by one firm with another firm. The usual time period for such deposits is 6 months.
Long term finance permits a business to grow and expand by creating more assets and infrastructure. Some long term financial instruments are discussed below:-
Equity Share Capital:-
It is the fundamental resource of finance for any business. An ownership interest of the business is sold to generate funds to finance the enterprise. Equity shareholders enjoy voting rights in all the affairs of the company. There is no maturity period for equity shares or any obligation to pay dividend on it. (Newlyn, 1968)
Preference Share Capital:-
Preference share capital stands for the preference with regard to payment of dividend and the return of capital in case of liquidation of the business. It also confers ownership interest but with a maturity period. Preference shareholders have the right to collect dividends before equity shareholders.
The borrowing firm can issue debentures as a debt instrument. A debenture is an unsecured bond. The debenture holder is paid an interest, the rate and period of which is specified and promised by the borrowing firm at the time of issue.
Lease & Hire Purchase:-
A firm can obtain asset on lease from the lessor, instead of garnering funds to purchase the required equipment. Hire purchase is the condition when asset is purchased on credit and terms and condition are laid in the Hire Purchase agreement with regard to the payment. (Mason, 2007)
Loan given out by a bank with a repayment schedule and a floating interest rate is called a term loan. Its maturity period varies between 1 to 10 years.
1.3 Critically evaluate the appropriate the sources of finance for the above mention businesses
Case 1: in this scenario the business needs to install building of £ 150,000 and equipment worth £ 400,000. In this case the business can finance the equipment through hire purchase and the building through debt-financed. The advantage of debt financing is that the interest paid on such loans is tax-deductible expenses which would allow the organization to save taxes. Purchasing machinery on hire purchase will allow the organization to save interest costs had the organization purchased the machinery out of its own retained earnings. (Faulkender and Petersen, 2006)
Case 2: in this case the individual can use the £ 70,000 received as redundancy payment and the rest can be financed through term loans. This would allow the individual to save interests on the £ 70,000 whereas the interest on the rest of £ 110,000 would be tax-deductible expense.
Case 3: considering the fact that the organization is a public limited company it can go for equity financing. This way the organization would not have to spend money as interest expenses.
Case 4: in this particular case the organization can ask the creditors to extend the credit period by three months. This would allow the organization to pay its bills on time. Trade credit is the most commonly used source of finance.
Case 5: as the club is in the process of being promoted to Zurich premiership the club can consider listing its shares as an option. This would allow the organization to have a solid capital base and above all it would not have to pay interest on the same.
M1: Critically evaluate each available sources of finance to that particular firm. Evaluation should include the pros and cons, and legal aspects of each source
Debt financing: the advantages of debt financing are that the interest paid on the same is tax-deductible. Hence, the real cost of debt is lower than the actual cost. However, too much of debt might have a negative impact on the liquidity position of the organization.
Equity financing:the biggest advantage of this source is that it does not have to be repaid during the lifetime of the organization however; issue of too many shares can dilute the capital base of the organization. (Rossi, 1928)
For complete copy of this solution, order for HND Assignment Help