Sources of Finance

Questions: Task 1 1. Identify different sources of finance to expand your business. This may include raising funds through a combination of internal and external sources of finance. 2. Assess the implications of different sources of finance and explain the legal and financial implications of your choice. 3. Evaluate suitable sources of finance for your business project and discuss the advantages and disadvantages of your financial choice. Task 2 1.Identify and analyse the cost of finance for your chosen sources. 2. Write a letter to the Manager of Fort Sports Ltd explaining the importance of financial planning and discuss why financial planning is important for the success of the organisation. 3. Evaluate the information needs of different decision makers within an organisation. 4. Explain the impact of finance on the financial statements. Discuss how different types of finance and their costs would appear in the financial statements of your business. Task 3 1. You are required to assess the viability of a project using investment appraisal techniques. Briefly explain which project would you recommend and why? (a) Net present value (NPV) (b) Payback Period (years) Task 4 1. Explain the main financial statements produced by a business. 2. Compare appropriate formats of financial statements (Income statement and balance sheet) for a Sole Trader and a Public Limited Company. 3. Calculate, compare and interpret financial statements using following ratios for the information given above for both businesses: (i) Gross Profit Margin (ii) Net profit Margin (iii) Current Ratio (iv) Quick Ratio (v) Gearing Answers: Task 1: 1. sources of finance: Fort Sports Ltd. is a small company and wanted to expand its business. It can raise its funds through both internal sources and the external sources of funds. The external sources of funds include: Short term funds: Bank overdraft through this facility, the customers of the bank, that is, the individuals or business having account in the bank can overdraw their accounts and the surplus amount would be repaid by the client within a specified period. Trade credit the business people get a grace period for repaying their loan. Debt factoring here the business can sell its bill receivables to debt factoring company at a discounted price. Long-term funds: Owners the fund invested by the shareholders can be invested for the business. Loans Loan can be taken from both bank and family. Debentures loans made to another company (Berrington and Bhandari, 2012). Mortgage this is also a loan, but the monthly payments are distributed to many years. Hire purchase or leasing monthly payment or final payment according to an agreement is also possible. The internal sources include: It includes the funds available within the organization, such as a part of the profit can be used for expansion. 2: Implications Of Various Sources: Fort Sport Limited will face several implications for several sources of finance. The company can implement the internal sources by using a proportion of the profit of the previous year. It can also implement the short-term funds like bank overdraft according to the rule of the bank, and trade credit for the range of 1 week to 90 days (Bulkowski, 2013). Among the long-term funds, the company can implement loan from banks. In case of equity finance, the ownership of the organization Fort Sport Limited will be diluted. On the other hand, in case of debt financing, the debt portion of the firm will increase along with the interest expenses. However, with the help of short-term funds, the organization can meet their working capital requirements. 3: Advantages And Disadvantages Of Sources: Bank overdraft, trade credit and bank loans are suitable sources of fund for the company. Bank overdraft: Advantage Disadvantages Security is not needed. Interest rates are higher than bank loans and variable. Amount can be adjusted according to needs. Cash flow problems may occur. Trade credit: Disadvantage No interest has to be paid. Cash discounts may not be received. Bank loans: Advantage Disadvantage It is a traditional way. Different rules and regulations may cause obstacle. It is recommended that that the organization Fort Sport Limited can opt for both short-term and long-term loans. Short-term trade credit will allow the firm to carry out their working capital cycle efficiently. In addition to this, long-term bank loans is less risky and keep the cost of capital of the firm in check for the management of the firm. The ratio of source of funds for the organization can be 50 percent- trade credit, 30 percent-bank loan and 20 percent-bank overdraft. Task 2: 1: Analysis Of Cost Of Finance: Following are the suitable source of funds for Fort Sports Ltd: Source of Finance Bank overdraft Through this facility, the customers of the bank, that is, the individuals or business having account in the bank can overdraw their accounts and the surplus amount would be repaid by the client within a specified period (Cumming, 2012). The rate of interest, the limit of the overdraft amount differs from bank to bank. Trade credit The business people get a grace period for repaying their loan. It is specially formulated for the business that deals with a supplier. The range of the grace period is between 1 week to 90 days. This range of period varies depending on the type of business and the industry in which the specified company belongs to (Shim, Siegel and Shim, 2012). Bank loans When the company receives a certain amount of money from the bank and in return the company has to pay the interest along with the principle amount is called bank loan. It is recommended that that the organization Fort Sport Limited can opt for both short-term and long-term loans. Short-term trade credit will allow the firm to carry out their working capital cycle efficiently. In addition to this, long-term bank loans is less risky and keep the cost of capital of the firm in check for the management of the firm. The ratio of source of funds for the organization can be 50 percent- trade credit, 30 percent-bank loan and 20 percent-bank overdraft. 2: Letter To A Manager: The Manager, Fort Sports Ltd. Respected Sir, The objective of the company is to grow and expand. Thus the main aim of the management is to increase the capacity of the production and to implement the various financing options appropriately. Thus financial planning is mandatory for the betterment of the firm. As without proper planning, the management could not invest the proper proportion of fund at various sectors. Therefore an estimated budget should be prepared. Please take remedial measures as early as possible for the growth of the company. Thanking You, Finance Manager, Head offices, Fort Sports Ltd. Date 27. 07. 2015 3: Needs Of Information: Information about the financial condition of the company is mandatory for the various decision makers of the organization. As the decision makers analyze the budget, annual report for the betterment of the company and also find out the ways to recover the negativities of the company (Drury, 2012). According to the availability of the information, even the share holders invest in the stock market. Thus, all types of financial information are necessary for making a plan and taking a decision. The different types of information needs can be in the form of liquidity, profitability and cost structure of the firm. If the operational costs of the organization are on the higher side, then, the organization is exposed to higher operational risk. Another form of information can be in the form of cash budget and variances budget of the organization. These are the various types of information that are required in case of decision making for the organization. 4: Impact Of Finance On Financial Statements: The different types of finance, which would appear in the financial statements of the company, are sales revenue, shareholders equity capital, issue of shares, purchase of treasury, payment of dividend, cost, expenses, borrowings, and collections of money. Firstly, sales should be mentioned in transaction as it increases the revenue in income statement. Profit is affected by sales revenue (Groppelli and Nikbakht, 2012). But sales decrease the merchandised goods in balance sheet and increase account receivable. Secondly, collection of money decreases the account receivable and increase cash. Thus capital of the company is increased. Thirdly, increases in the shareholders equity increase the total assets and equity in balance sheet. Lastly, issue of new shares would increase the interest. Task 3a: 1 (a) Cash Budget: CASH BUDGET OF BRENTWOOD STORE For 4 months, 2015 JUNE JULY AUGUST SEPTEMBER Opening balance 90000 213000 206000 200000 Sales 300000 312000 370000 410000 Total Receivables (A) 390000 525000 576000 610000 Cash purchase 110000 180000 210000 250000 suppliers credit 56000 72000 86000 rent 5000 - - 5000 other expenses 42000 63000 74000 81000 Loan 20000 20000 20000 Total Payables (B) 177000 319000 376000 422000 A-B 213000 206000 200000 188000 Surplus means when the income of the company exceeds the expenditure in a specific time period. Deficit means when the expenditure of the company exceeds the income of the company in a specific time period (Horngren and Horngren, 2012). Here, according to the cash budget, the total receivables exceeds the total payables of the company, thus, it is surplus for the company for all the four months. The cash budget should always be positive, and for positive opening balance, the receivables should be higher than the payables. This positivity is the sign of healthy financial condition of the company. Several recommendation s can be given regarding their cash budget of the firm. The above cash budget reflects that cash balance was the lowest in case of August and September. Therefore, it is important for the firm BRENTWOOD STORE to minimize the cost of operations and cost of purchase by a considerable percentage. In addition to this, the organization may also curtail other variable expenses to cut down the respective costs. Task 3 b: cost analysis: 3.2 (a): i) Selling price per unit = Total sales / Number of Units = 61600/200 = 308 ii) Total profit earned = Total sales Total costs = (61600 - 44000) = 17600 3.2 (b): i) Selling price per unit = Total sales/ Number of Units = 123200/400 = 308 ii) Total Profit earned = Total sales Total costs = (123200 - 74000) = 49200 Task 3c: 3 (a) Net Present Value: NPV of Project A = [20000/(1+0.10) + 28500/(1+0.10)2 + 36000/(1+0.10)3 + 40500/(1+0.10)4 ] - 80000 = 18181.81 + 23553.71 + 27047.33 + 27662.04 = 96444.89 80000 = 16444.89 NPV of Project B = [34000/(1+0.10) + 34000/(1+0.10)2 + 34000/(1+0.10)3 + 34000/(1+0.10)4 ] - 95000 = 30909.09 + 28099.17 + 25544.70 + 23222.45 = 107775.41 95000 = 12775.41 NPV of Project C = [20000/(1+0.10) + 30000/(1+0.10)2 + 42000/(1+0.10)3 + 42000/(1+0.10)4 ] 90000 = 18181.81 + 24793.38 + 31555.22 + 28686.56 = 103216.97 90000 = 13216.97 As the Project A has the highest positive NPV value, thus Project A should be suggested. 3 (b): Payback Period: Payback period for Project A: Cash flow () Cumulative cash flow () Outflow 80000 (80000) Year 1 20000 (60000) Year 2 28500 (31500) Year 3 36000 4500 Year 4 40500 36000 Payback period (when inflow amount varies) = A + (B/C) Where, A = last period with negative cumulative cash flow B = absolute cumulative cash flow value at end of period A C = total cash flow during period after A Payback period = 2 + (31500/36000) = 2.8 years Payback period for Project B: Payback period (when cash inflows are ideal) = Initial investment/ Cash flow per period = 95000/ 34000 = 2.8 years Payback period for Project C: Cash flow () Cumulative cash flow () Outflow 90000 (90000) Year 1 20000 (70000) Year 2 30000 (40000) Year 3 42000 2000 Year 4 42000 40000 Payback period = 2 + (40000/ 42000) = 2.9 years Though both the projects A and B have the same payback period, since the positive value of NPV is greater in project A, the recommended project should be project A. Task 4: financial performance of a business: 1: Main Financial Statements Produced By Business: There are three financial statements which are commonly produced by business are as follows: Income statement: Expenses, revenues and profits are the major components of income statement. Income statement displays two matters - the revenue and the net income or loss. The key elements of income statement are sales, non operating expenses and operating expenses (Horngren, Harrison and Oliver, 2012). Balance sheet: It includes assets, liabilities and shareholders equity (O'Hare, 2012). Assets are three types current assets, fixed assets and cash and inventory. Liabilities include both short-term and long-term. Cash flow statement: It includes three types of activities operating activities, financial activities and investing activities (Peterson Drake and Fabozzi, 2012). 2: Comparison Between Financial Statements Of Sole Trader And Public Limited Company: Sole trader does not have to make a balance sheet. But it is mandatory for the public limited companies (Robinson, 2012). Sole Trade Company has to pay 50% tax, whereas, limited companies have to pay only 20% of the corporate tax. Thus limited companies have to pay lesser tax (Seal, Garrison and Noreen, 2012). 3: Ratio Analysis: i) Gross profit margin ratio = (Gross profit/ Net Sales) * 100 For Manufacturing: = (10400/ 40870) * 100 = 25.44 For Wholesale: = (12430/26540) * 100 = 46.83 The wholesale is in better position as the ratio is higher. ii) Net profit margin = (Net profit/ Net sales) * 100 For Manufacturing: = (5850/ 40870) * 100 = 14.31 For Wholesale: = (2950/ 26540) * 100 = 11.11 The manufacturing is in better position as the ratio is higher. iii) Current ratio = Current assets/ Current liabilities For Distribution: = 2510/ 1950 = 1.28 For Retail: = 5070/ 2950 = 1.71 Retail is in better position as the ratio is higher. iv) Quick ratio: = (Current assets - Inventories)/ Current liabilities For Distribution: = (2510 - 2420)/ 1950 =0.04 For Retail: = (5070 - 2370)/ 2950 = 0.91 Retail is in better position as the ratio is higher. v) Gearing ratio = Total debt/ Total Equity For Distribution: = 3950/ 6950 = 0.56 For Retail: = 6120/ 11620 = 0.52 The above ratios reflect that retail segment has a higher liquidity ratio than the segment of distribution. The working capital cycle of the firm is also effective in retail segment than in distribution segment. References Berrington, M. and Bhandari, V. (2012).Pinnacle financial statements. [Sydney]: IFRS System. Bulkowski, T. (2013).Fundamental analysis and position trading. Hoboken: WILEY. Cumming, D. (2012).The Oxford handbook of entrepreneurial finance. New York: Oxford University Press. Drury, C. (2012).Management and cost accounting. Andover: Cengage Learning. Groppelli, A. and Nikbakht, E. (2012).Finance. Hauppauge, N.Y.: Barron's. Horngren, C. and Horngren, C. (2012).Management accounting. Toronto: Pearson Canada. Horngren, C., Harrison, W. and Oliver, M. (2012).Accounting. Upper Saddle River, N.J.: Pearson Prentice Hall. O'Hare, J. (2012).Analyzing Financial Statements for Non-Specialists. Hoboken: Taylor and Francis. Peterson Drake, P. and Fabozzi, F. (2012).Analysis of financial statements. Hoboken, N.J.: Wiley. Robinson, T. (2012).International financial statement analysis. 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