Sources of Finance Finance is essential for a business's operation, development and expansion. Finance is the core limiting factor for most businesses and therefore it is crucial for businesses to manage their financial resources properly. Finance is available to a business from a variety of sources both internal and external.
Internal sources of finance Funds which are available within the organisation and consist of:
Personal savings Business borrows personal money of a shareholder, partner or owner for a business's financial needs. This source of finance is known as personal savings.
Retained profits Undistributed profits of a company, as not all the profits made by a company are distributed as dividends to its shareholders.
Working capital Working capital is the difference of current assets and current liabilities. Working capital helps any business to fulfil its financing for its short term requirements.
Sale of fixed assets Fixed assets can be sold to raise finance in demanding times for the business. Otherwise businesses may choose to stop offering certain products and sell its fixed assets to raise finance. Selling fixed assets reduces the production capacity of a business affecting a business's return.
External sources of finance External sources of finance are from sources that are outside the business. External sources of finance can either be:
Ownership capital Ownership capital is the money invested in the business by the owners themselves. It can be the capital funding by owners and partners or it can also be share bought by the shareholders of a company. There are mainly two main types of shares. Ordinary shares Preference shares
Ordinary shares Known as a unit of investment in a company, have the privilege of receiving a part of company profits via dividends according to the value of shares held and yearly profit of the company.
Preference shares Preference shareholders receive a fixed rate of dividends before the ordinary shareholders are paid. There are several types of preference shares and company can issue to raise the required capital, provided it is permitted by the By Laws of the company.
Non-ownership capital Unlike ownership capital, non-ownership capital does not allow the lender to participate in profit-sharing or to influence how the business is run. Different types of non-ownership capital: Debentures Bank overdraft Loan Hire-purchase Lease Grant Venture capital
Debentures Debenture holders are not owners but long-term creditors of the company who receive a fixed rate of interest annually whether the company makes a profit or loss.Debentures can be secured, unsecured, fixed or floating.
Bank overdraft A short term credit facility provided by banks for its current account holders allowing businesses to withdraw more money than their bank account balances hold. Bank overdraft is the ideal source of finance for short-term cashflow problems.
Loan Loans are amounts of money borrowed from banks or other financial institutions for large and long-term business projects.
Hire purchase Hire purchase allows a business to use an asset without paying the full amount to purchase the asset rather payment is paid as per pre-agreed instalments in order to acquire the full ownership.
Lease Unlike a hire purchase the ownership of the asset remains with the leasing company, the business pays a rent throughout the leasing period for using the asset in question.
Grant Grants are funding given to businesses for programs or services that benefit the community or public at large. Grants can be given by the government or private firms.
Venture capital The capital contributed at the initial stages of an uncertain business, which is normally a sort of non-ownership arrangement
Factoring A type of source by which credit sales are financed by a bank/financial company for a short time-frame to the business.
. (Ref: http://www.scribd.com/doc/27126810/Sources-of-Finance )
State clearly the implication of each sources of finance identified to the organization.
Following are the implications of sources of finance:
LEASING: Leasing has great effects on business because of leasing the cost is spread over a number of years and there is no need to pay the amount upfront. Leasing helps to maintain the cash flow of the firm. Leasing allows you to use better equipment that would be too expensive. Leasing provides financial security because of leasing companies. Lease rentals are considered as an operating cost, which means that it is often possible to deduct them from taxable profits.
OVERDRAFT: An overdraft is a temporary facility added to bank accounts where you are able to be overdrawn in your bank account by a certain amount. Interest is charged on the overdrawn money. An overdraft is useful when firm is having regular sales and purchases coming out of account and could leave firm in bad cash flow conditions. Overdraft is good for company when it is not sure to pay off its bills. But an overdraft is not supposed to be a permanent source of finance and if the whole business is relying on using an overdraft as a long time source because an overdraft carry interest and fees often much higher rates than loans .
DEBENTURES: Debentures can be a very attractive form of investment, but only should be taken advantage of with companies that have a very high probability of being successful. Large and already successful businesses are smart forms of investments when considering buying corporate debentures
HIRE PURCHASE: Business hires the equipment for a period of time making fixed regular payments. Once payments have finished it then owns the piece of equipment. Hire purchase is different to leasing in that the business owns the equipment when it has finished making payments. With an equipment lease, the
TRADE CREDIT : A business does not always have to pay their bills as soon as they receive them. They are given period of credit, normally around 30-60 days. By trying to extend this period they can improve their short-term finance position. Small businesses now have some protection under law that prevents larger firms exploiting their credit terms. Trade credit is an important source of finance for nearly all businesses - since it is effectively a free source of finance.
OWN CAPITAL: For sole traders and partnerships a common source of finance, especially for start up is money from the individuals who are forming the business. They may also borrow money from family and friends. Own capital is a costless form of finance, but carries the risk of the money being lost.
WORKING CAPITAL: Working capital is the amount of money available for the day to day running of the business. It is the difference between current assets and current liabilities. See below for more details of how working capital can be used.
Using Assignment 3, recommend the appropriate source of finance for the project. Project financing is considered in some way or the other right from the time of project conception. Indeed project financing is intertwined with project planning, analysis and selection. As the project proposal progresses through the stages of planning, analysis and selection, the contours of project financing becomes clearer.
Analyse the implication of finance as a resource within a business.
You are required to assess and compare the cost of different sources of finance. Different sources of Finance for Businesses are available to a small business or a big company. With each source of finance listed the report will assess the implications that can arise and along with this the report will look at the cost to the business to taking a curtain source of finance. All businesses need short-term finance from the very beginning to start up the business and to cover day-to-day running costs. Owners` funds Profits Loans and overdrafts Trade credit Government grants Hiring and leasing Issuing shares Selling assets Venture capital Owners' funds: This is the money that is put business by the owners. When some businesses are first opened owners will provide to pay for the set up costs. If the owners don't have enough money other sources of finance should be obtained to pay for the running costs of the business. Profits: As we have seen from the balance sheet many businesses will use previously earned profit as a source of funds. When profit is used by the business, rather than being given to its owners, it is called retained profit. Loans and overdrafts: There are many different types of loan that a business could take out. When taking out a loan the business must pay back the money borrowed plus interest at regular periods over an agreed period of time.The overdraft means the business is allowed to have a negative figure in its bank account. Trade credit:The business can obtain goods and services from other businesses without having to pay for them at the time. It is common to have one or two months of interest free trade credit. Government grants: Business can receive grants for locating in areas where there are high levels of unemployment and relative poverty, examples are: Hiring and Leasing:Hire purchase is often used to buy equipment. A lease means that the business is simply renting the lorry for an agreed period of time. Issuing Shares: Most shares sold are ordinary shares which entitle the shareholder to receive a share of the business's profits, this is called a dividend. The dividend will vary from year to year depending on the amount of profit the business owns. P5 A financial statement is a formal record of the financial activities of a business, person or other entity. A financial statement is often referred to as account. For business purposes all the financial information is presented in a structured manner to make it understand easy which is known as financial statement. There is great impact of finance on financial statement
Personal savings - Personal savings when lent to the business are considered as loans. The amount lent will appear as Long-term liabilities on the balance sheet. If any interest payments are to be made they will be recorded in the profit and loss account and charged against profits.
Sale of assets - Sale of assets will reduce the value of fixed assets on the balance sheet. The profit or loss made on the sale of asset will be recorded in the profit and loss account for the year. The depreciation of the asset along with its original price will be removed from the balance sheet.
Ordinary shares and preference shares - The issue of ordinary shares and preference shares increase the vale of equity capital in the balance sheet. If the issued shares market price is greater than the nominal value of the share then share premium is also increased in the balance sheet. The number of shares issued is also displayed in the balance sheet and for preference shares the rate of dividend is also shown. The dividends paid to the shareholders are recorded in the appropriation account after tax is deducted from net profit.
Bank overdraft - This appears in the balance sheet as a current liability since it is a short-term debt and has to be paid back within a year. The interest charges and bank overdraft fee if charged are deducted from the profit and loss account before tax is charged.
Loan - Loans are long-term debts and therefore come under long-term liabilities in a balance sheet. The loan when displayed on a balance sheet will usually contain information about the repayment date and the interest charged on the loan. The interest is charged in the profit and loss account.
Venture capital - This is an amount of money invested in the business as equity capital and thus comes under equity capital in the balance sheet. The return for venture capitalists is a share of profits which is recorded in the appropriation account. P6
Explain the importance of financial planning. It is important to plan finances in order to reap long term benefits through the assets in hand. Every decision regarding our finances can be monitored if a proper plan is devised in advance. The following points explain why financial planning is important. Cash Flow: The cash flows increased by undertaking measures such as tax planning, prudent spending and careful budgeting. Capital: A strong capital base can be built with the help of efficient financial planning. Thus, one can think about investments and thereby improve his financial position. Income: It is possible to manage income effectively through planning. Managing income helps in segregating it into tax payments, other monthly expenditures and savings. Family Security: Financial planning is necessary from the point of view of family security. The various policies available in the market serve the purpose of financially securing the family. Investment: A proper financial plan that considers the income and expenditure of a person helps in choosing the right investment policy. Standard of Living: The savings created by through planning come to the rescue in difficult times. Death of the bread winner in a family, affects the standard of living to a great extent. A proper financial plan acts as a guard in such situations and enables the family to survive hard times. Assets: A nice 'cushion' in the form of assets is what many of us desire for. But many assets come with liabilities attached. Thus, it becomes important to determine the true value of an asset. Savings: It is good to have investments with high liquidity. These investments, owing to their liquidity, can be utilized in times of emergency and for educational purposes
Describe the information needs of different decision makers. Decision making can be regarded as the mental processes resulting in the selection of a course of action among several alternatives. Every decision making process produces a final choice. The output can be an action or an opinion of choice. Logical decision making is an important part of all science-based professions, where specialists apply their knowledge in a given area to making informed decisions. For example, medical decision making often involves making a diagnosis and selecting an appropriate treatment.
Good decision making is often a case of pay me now or pay me later. Following are the task to be done during decision making: • Objectives must first be established • Objectives must be classified and placed in order of importance • Alternative actions must be developed • The alternative must be evaluated against all the objectives • The alternative that is able to achieve all the objectives is the tentative decision • The tentative decision is evaluated for more possible consequences • The decisive actions are taken, and additional actions are taken to prevent any adverse consequences from becoming problems and starting both systems (problem analysis and decision making) all over again.
Make financial decisions based on financial information.
Evaluate the usefulness of budgetary system in an organization. Budgetary system is very useful for the companies to manage their financial circumstances as it Compels management to think about the future, which is probably the most important feature of a budgetary planning and control system. Forces management to look ahead, to set out detailed plans for achieving the targets for each department, operation and each manager, to anticipate and give the organization purpose and direction. USEFULNESS: It Promotes coordination and communication. It clearly defines areas of responsibility. Requires managers of budget centers to be made responsible for the achievement of budget targets for the operations under their personal control. Provides a basis for performance appraisal .A budget is basically a yardstick against which actual performance is measured and assessed. Control is provided by comparisons of actual results against budget plan. Departures from budget can then be investigated and the reasons for the differences can be divided into controllable and non-controllable factors. It enables remedial action to be taken as variances emerge. â‚¬Â it Motivates employees by participating in the setting of budgets. ·it improves the allocation of scarce resources. It Economizes management time by using the management by exception principle. P9 Describe how unit cost is determined and how it can aid pricing decisions. THe unit cost of a product is the cost per standard unit supplied, which may be a single sample or a container of a given number. When purchasing more than a single unit, the total cost will increase with the number of units, but it is common for the unit cost to decrease as quantity is increased, as there are discounts etc. This reduction in long run unit costs which arise from an increase in production/purchasing is due to the fixed costs being spread out over more products and is called economies of scale. All business decisions depend upon unit cost. Cost of producing one unit of product or service, usually based on averages. For example, if total manufacturing costs are $100,000 and the production volume for a given period is 10,000 units, the unit production cost is $10 per unit ($100,000/10,000 units). Unit costs may be stated in terms of gallons, feet, tons, individual units, and so on. Unit costs must be available for comparison of varying volumes and amount and for the purpose of establishing unit sales price of the product or service. If volume of activity increases, the variable cost per unit remains the same but the fixed cost per unit drops. P10 Postal project is for 5 years Initial investment in the project. Investments in services Cost of each new van = £8,000 100 new vans will cost = 100x8000 = 800000. Cost of each truck= £ 18000 20 new trucks will cost= £ 20x18000 = £360000 Total investment = 800000+360000= 1160000. There are 5 working days in a week 1 week= 5 days 1year= 52 weeks RREVENUE FOR 1st YEAR: Market research untaken forecast that demand will average 15,000 letters and 500 parcels per working day during first year . 15,000x5x52x.53= 2067000 (letters) 500x 5x 52x 5.25= 682500 (parcels) Total revenue for the first year= 2067000+682500= 2749500 EXPENDITURE FOR 1st YEAR OF THE PROJECT: Wages of 180 new workers 13000£ costing each= 180x 13000= £2340000 Expenditure on maintenance of 100 vans costing 2000£ each= 100x2000= £200000 Expenditure on maintenance of 20 new trucks costing 4000£ each= 20 x 4000= £80000 Depreciation in 1st year= 1160,000 divided by 5 = 232000 Expenditure on advertising during 1st year= 50,000 Expenditure on premises= 150,000 TOTAL EXPENDITURE = 3052000 Revenue - expenditure= loss 2749500- 3052000= 302500 302500 is net loss during 1st year. Less taxation= nil Therefore in year 1 there is loss of 302500. 2ND YEAR Revenue for 2nd year In 2nd year there is estimate of 20000 letters and 750 parcels per working day during whole year 20000x5x52x.53= 2756000 750x5x52x5.25= 1023750 Total revenue during 1st year= 2756000+ 1023750= 3779750 Revenue is same for the remaining years that is 3779750 EXPENDITURE DURING 2ND YEAR OF THE PROJECT Wages = 2340000x1.05=2457000 Expenditure in maintenance of vans= 200000x1.20x1.05 = 214200 Expenditure in maintenance of trucks= 80000x 1.20x 1.05= 100800 Depreciation= 232000 Expenditure on premises=165375x1.05=173644 Total expenditure during 2nd year= 3177644 Expenditure - revenue is net loss=3177644-3779750=602106 3RD YEAR Wages during 3rd year= 2457000x1.05=2579950 Maintenance of vans= 214200x1.20x1.05=229408.2 Maintenance of trucks= 100800x1.20x1.05=127008 Depreciation=232000 Expenditure on premises= 165375x1.05=173644 TOTAL EXPENDITURE=3342010.2 Profit=3342010.2-3779750= 437739.8 4TH YEAR EXPENDITURE FOR 4TH YEAR Wages = 2579850x1.05=2708842.5 Maintenance of vans= 229408.2 x1.05x1.20= 289051.812 Maintenance of trucks= 127008x1.20x1.05=160030.08 Depreciation=232000 Expenditure on premises= 173644x1.05=182326.2 Profit= 3779750-182326.2= 3597423.8 5TH YEAR Wages = 2708842.54x1.05=2844284.667 Maintenance of van= 245695.96x1.05x1.20=263140.36 Maintenance of truck=160030.08x1.05x1.20=201637.89 Depreciation=232000 Exp on premises= 182326.2x 1.05=191442.51 Total expenditure=3732505.427 Loss= 3732505.427- 3779750=47244.57 TASK FOUR Analyses and evaluate the financial performance of a business. P11
Explain the main objectives of financial statement. Financial statements are means through which companies present their financial situation to shareholders, creditors and general public. Financial statements are supposed to accomplish. The intent of financial statements is to provide information useful in economic decision making. In particular, the data should be useful in making investment and credit decisions. Financial statements should provide a reliable indication of a company's financial position, operating results, and changes in financial position.
Objectives: 1. Provide reliable financial information. 2. Provide other needed information about changes in economic resources and obligation. 3. Provide reliable information about changes in net resources. 4. Providing financial information that assess in estimating the earnings of a business. 5. To disclose other information according to the needs of the users. P12
Describe the difference between the presentation formats of financial statements of different types of business. The financial statement presentation project is a joint project between the IASB and the FASB (the Boards). Since April 2006, the Boards have been discussing fundamental issues related to the presentation and display of information in each of the basic financial statements (Phase B). The Boards' goal is to issue an initial discussion document on those issues in the fourth quarter of 2007.
Statement of Comprehensive Income
Statement of Cash Flows
Business Ã´â‚¬â€šÅ Operating assets and liabilities Ã´â‚¬â€šÅ Investing assets and liabilities
Business Ã´â‚¬â€šÅ Operating income Ã´â‚¬â€šÅ Investment income
Business Ã´â‚¬â€šÅ Operating cash flows Ã´â‚¬â€šÅ Investing cash flows
Financing Ã´â‚¬â€šÅ Financing assets Ã´â‚¬â€šÅ Financing liabilities
Financing Ã´â‚¬â€šÅ Financing income Ã´â‚¬â€šÅ Financing expenses
Financing Ã´â‚¬â€šÅ Financing asset cash flows Ã´â‚¬â€šÅ Financing liability cash flows
Statement of Changes in Equity
What are financial ratios? Financial ratios are useful indicators of a firm's performance and financial situation. Most ratios' can be calculated from information provided by financial statement. Financial ratios can be used to analyze trends and to compare firm's to those of other firms.
Financial ratios can ge classified according to information they provide: Liquidity ratio. Asset turnover ratio. Financial leverage ratios. Profitability ratios. Dividend policy ratio.
FINANCIAL RATIO ANALYSIS OF TESCO: The purpose of this report is to analyze Tesco financial performance using the analysis of ratios as a financial tool. This information will be taken from the annual reports of 2008 and 2009.
. Ratio analysis: Profitabiliy Ratios 2009 2008 Return on Capital Employed 8.13% 9.09% Return on Equity 7.64% 8.95% Gross Profit Margin 8.65% 7.13% Net Profit Margin 3.91% 4.25% Tesco's profitability ratios show a moderately deterioration in profit from 2008 to 2009 in a margin of 6%. This downward trend is due to several changes the company had such as, (1) the sell of JS Development and Shaw's supermarket, this has an impact on the company's current assets and profit, in one hand it brings in cash for the sell but on the other hand it stops the daily cash input, consequently there were a decline in profit in 2.6%; (2) the purchase of Swan Infrastructure Holdings Limited, which consist of a whole modern IT system and it is part of a Business Transformation Program me, therefore, there was a rise in 6% of the capital employed , and also a significantly fall in cash in 27%. Because of all these reasons, there was a drop in profit, but as it is a long-term investment it is estimated to be an income generation in the future. Efficiency and Effectiveness Ratios These ratios are used to try and identify the strengths and weaknesses of a business using a variety of different ratios (Giles et al., 1994, p. 371). The following table illustrates the efficiency ratios used in tesco's case. Efficiency and Effectiveness 2009 2008 Fixed Asset Turnover 2 times 2.07 times Debtor Collection Period 1.51 days 2.38 days Creditor Payment Period 28.8 days 28.78 days Stock Holding Period 17.21 days 18.67 days
Liquidity Ratios As Maclaney and Atrill (2002, p. 197) said, Certain ratios may be calculated that examine the relationship between liquid resources held and creditors due for payment in the near future. These ratios in Sainsbury's company are as follow. Liquidity Ratios 2009 2008 Current Ratio 0.83:1 0.87:1 Acid Test (Quick Ratio) 0.67:1 0.70:1 Table 3. Liquidity Ratios (Base on data contained in Appendix B) The current ratio has a slightly fall, due to the current liabilities rising faster than the current assets. Looking at the current liabilities it can be seen that the company is using bank loans to finance the acquisition of the IT systems by the group, which increased in 63%. The current assets have also been affected by a decreased in 27% of cash account since a 10% of the purchase was made in cash. Similar situation happened with the acid test ratio with a slight fall in the rate. These ratios show a low rate, due to the fast stock rotation which produces cash sales. Although, it seems like the current assets do not cover the current liabilities, the liquid assets are used as productively by the growing of the business to make it more effective, thus profitable. Capital Gearing Ratios This is the relationship between the amount financed by the owners of the business and the amount contributed by outsiders (Maclaney and Atrill 2002, p. 197). For instance, Sainsbury's capital gearing ratios are: Capital Gearing Ratios 2009 2008 Gearing Ratio 28.54% 25.97% Times Interest Covered 5.91 times 5.31 times The gearing ratio has increased by 9% due to the long-term debts rising faster than the capital employed during the period from 2008 to 2009. The long term debts went up by 14%, which is because the purchase of IT fixed assets and also the company resort to operations in the capital market and by operating subsidiaries to deal with the interest rate and current risk these finance involves. On the other hand, the times interest covered stayed constant and even though is a low rate, the company still can cover its interest with their profit. Investor Ratios Certain ratios are concerned with assessing the returns and performance of shares held in a particular business (McLaney et al., 2002, p. 197). The investor ratios for Sainsbury's are the followings: Investor Ratios 2009 2008 Earnings per Share 0.20 0.23 Price Earnings Ratio 12.63 times 9.54 times Dividend Yield 6 6.89 Dividend Cover 1.32 1.52
REFRENCES: http://www.scribd.com/doc/27126810/Sources-Of Finance http://www.ukessays.com/essays/accounting/sainsburys-ratio-analysis.php http://www.scribd.com/doc/27126810/Sources-of-Finance http://wikitextbooks.co.uk www.buzzle.com/articles/importance-of-financial-planning.html ByShashankNakate http://www.ehow.com/list_5770990_advantage-disadvantages-financial-statement-analysis.html http://www.economics-dictionary.com/definition/planning-programming-budgeting-system.html http://www.iasb.org/ Financial Statement Presentation http://www.thewholesaleforums.co.uk/features/startup/sole-trader-ltd-company-partnership-or-llp/