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)
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Unit 2 Managing Financial Resources and Decisions Assignment Sample
BTEC Higher National Diploma in Business
Unit Number and Title
Unit 2 Managing Financial Resources and Decisions
Present business environment is based on the approach where finance plays important role which is treated as important source to run any organisation. All the activities in the business are executed with the use of finance which is used in different aspects by analysing different attributes. For the purpose to achieve effective use of finance and funds in the organisation there is required to have effective management of finance by adopting strategic management by taking strategic decisions in the organisation.
AC1.1 Identify the sources of finance available to a business.
In a business to run all the activities in effective manner there is required to select most effective source of finance which proved as most effective tool for the organisation. To understand these sources in effective manner we can segregate these sources in internal and external sources of finance (Bach, et. al 2013).
These are the sources which are available in organisation and can make impact on the overall effectiveness of the organisation. Following are the internal sources available in the organisation.
Profits- There is retained profits in every organisation which is generated from the operations of the business and treated as effective internal source of finance with low cost and for long term in organisation.
Revenue- Revenue of business is defined as the sales of the business conducted by its operations that can be sales of products in manufacturing company and in service company services provided by them.
Sale of assets- Finance can be collected in organisation by selling out assets and properties of the company and this is proved as effective source which help in liquidate blocked assets of the company.
Loan from Directors- Directors and members are key people in any business and organisation and organisation can take loan from them on a specified interest rate that is organisation is liable to pay them.
Retained dividends- Organisations can collect finance by stopping the dividends of the shareholders of the company and utilise it in the organisation (Bach, et. al 2013).
Following are the external sources that can be used by organisations that can make impact on the overall effectiveness of the organisation.
Issue of shares and debentures- In present business environment issue of share capital is one of the most effective sources of finance which is for long term. In case of issue of shares there is transferred voting power and ownership of the company to the shareholders of the company. In case of issue of debentures there is increase in the creditors of the company and interest is provided to them on a predefined interest rate.
Loan from bank- organisations can take loan from banks which can be long term and short term on a defined interest rate. This is most effective source for finance for the Entrepreneurs.
Bank overdraft- Bank overdraft is a facility to providing by banks to its customers on their current accounts and based on their goodwill in which they can withdraw amount more than their balance in their account. There is charged interest on that amount which must be repaid in a specified time period and it is effective for short term (Cascio, 2013).
Venture capital- It is source of finance in which there are involved various equities who are investing their money in the organisations having effective ideas for investment for effective profits.
AC1.2 Assess the implications of the different sources.
Sources of finance
Organisation hasproper and effective control over the profits of the company.
There is no risk on the retained profits of business.
Profits are owned by the business so there are no legal implications.
From financial aspects it is effective and support organisation.
Revenue is generated from the day to day activities and there is effective control over them (Cascio, 2013).
There can be generated risk in credit sales of situation of bad debts.
Revenue is generated by activities of the company which make no legal implication.
Revenue of business generates long term finance for the company.
Sale of assets
There is transfer of control with the sale of assets of the company in effective manner.
There exist high risk as in there can be loss on the sales of assets of the company.
There is required to transfer the legal ownership of the assets in the organisation.
There will be increase in the funds of the company.
Loan from Directors
The control dilution is based on the directors and members and organisational policies.
There exist risk as in there can be withdraw of the loan amount by the director in case of termination or resignation.
There is required legal implication for granting loan to the organisation.
Financial position is influenced with this source of finance.
Dividends are effectively controlled by business.
There can be chances to fall in the share price due to dis-satisfied shareholders of the company.
There is legal implication in case of this source of finance.
There will be support to the financial position of the company.
Issue of shares and debentures
Control dilution is transferred with the shareholders of the company as in they have right to vote.
There is huge risk as in there is transferred voting power with the shareholders of the company.
There are various legal implications related to the issue of shares and debentures.
There will be increase in the financial position of the company.
Loan from bank
The control dilution does not exist with bank as in there is charged interest over the funds provided by them.
Risk is higher as in there is chances of bankruptcy in case of non-payment of loan amount.
There are various legal formalities required to be fulfil while taking loan from banks.
There is effective support to the financial system of the company but there is requirement to pay interest on the loan amount.
There is no control diluted with the bank.
There is huge risk of bankruptcy due to non-payment of amount.
There are required to fulfil various legal implications with the organisation.
There is get support to the financial position of the company for short term.
Control is diluted with the equities investing in them.
There is huge risk of the repayment of the amount.
There are required various legal implications and formalities to be fulfilled (Cascio, 2013).
This source of finance makeseffective flow of finance in the financial position of the company.
AC1.3 Evaluate appropriate sources of finance for a business project.
There are various attributes and aspects which influences the selection of the sources of finance which selected by the company must be in accordance with the requirement of the organisation. Decision must be taken by analysing all the important aspects which can influence the decisions.
Loan from bank- For an entrepreneur there is required finance which can be arranged easily. Loan can be taken from bank by providing adequate security and agreed for the terms and conditions of banks (Akhbari, et. al 2015).
Loan from directors- Key people in any organisation can lend their money to the project for effective running and to achieve the objectives in effective manner. In a start-up project it will be effective to collect funds by using this source of finance.
Bank overdraft- There can be taken finance by utilising facility of bank overdraft in which the bank facilitates to collectextract funds more than the balance in the account of the customers. This is short term source of finance for any business which is effective (Akhbari, et. al 2015).
AC2.1 Analyse the costs of different sources of finance.
Following table is showing cost of different sources of finance which can help in analysing their effectiveness.
Source of finance
Cost included in the source
Retained profits is effective as source of finance and not carrying huge cost but there is included opportunity cost which is cost that emerges in case there can be other utilization. This cost shows other utilisations of profits of the company.
In case revenue as source of finance there emerges no other costs as in it is part of the day to day activity of the company (Siano, et. al 2010).
Sale of assets
In case of loss in the sale of assets there can be taken benefit of capital loss from the taxable income of the company.
Loan from Directors
The cost of loan from directors can be defined by the percentage of interest charged on the amount of loan provided by the directors to the business.
The cost of the retained dividends can be loss in the goodwill and there will be increase in the taxable income as in there will be no payments to the shareholders of profits as dividends so it will be taxable as whole.
Issue of shares and debentures
The cost of issuing shares and debentures is defined as the amount of dividend payable to the shareholder and the amount of interest payable to debenture holders of the company.
Loan from bank
Cost of the source of loan from bank is the interest charged by bank which payable on monthly basis and the level of interest defines the level of cost included in this source of finance.
In case of bank overdraft there is charged huge percentage of interest payable by the organisation that can make impact on the overall effectiveness of collection of finance in organisation.
Cost of the source venture capital is the distribution of profits with the capitalist who are investing in the project. This is also defined as the cost of debt in the form of interest amount (Siano, et. al 2010).
AC2.2 Explain the importance of financial planning.
In every organisation there is effective role of financial planning which is makes impact on other activities and their success which leads organisation to the success. Marketing planning is a process to identify various factors analysing them and making the most effective decision. There are included forecasting, comparing, analysing factors and their effective administration. Following are the points showing importance of financial planning in organisation.
- This helps in identifying various factors related to the requirement of finance in organisation. This also helps in analysing the adequacy of funds within organisation.
- This helps in identifying further requirement of funds in organisation to effectively execute all the activities and achieve effective results (Ahrendsen, et. al 2012).
- This financial planning enables to reduce the ratio of uncertainty within organisation and its activities.
- Making budget provides effective control over use of finance in organisation and effective utilisation can be achieved within organisation.
AC2.3 Assess the information needs of different decision makers.
In an organisation there are required participation and consideration of various parties who are treated as decision making and the following are the information required to be assess.
- Shareholders areimportant part of the organisation and must be considered in the decision making process as in they have voting power and they must be provided information related to financial position of the company like profits, revenue, liquidity and earning per share which make them able to take decisions (Ahrendsen, et. al 2012).
- Board of directors must be provided information related to the financial adequacy by which they can take decisions related to frame effective policies and regulations in the organisation.
- Investors of the company must be provided information related to the profitability, flexibility, debt equity ratio and future plans which can help in taking decision to invest or not.
- Government have effective role as in there is requirement to pay taxes and application for any kind of grant which can be done by providing effective information about the organisation (Akkoyun, 2012).
AC2.4 Explain the impact of finance on the financial statements.
Following is the impact which is made by different sources of finance on the financial statements of any organisation.
Issue of share capital- In the organisation issue of share capital make impact on the balance sheet of the company which is a financial statement shows the liquidity and effectiveness of any organisation. Share capital is a liability if company as in it is collected from the general public and company is liable to pay dividend on it and repay it latter. So it increases liability of the company (Akkoyun, 2012).
Bank loan- Bank loan can be for long term or short term and this increases liability of the company in its financial statements as well as it increases bank balance which is current asset of the company.
Leasing- Lease will be recorded as long term liability in the financial statements of the company and the equipment will be recorded in the assets of the company. Interest on lease will be treated and recorded as expenses in the financial statements of the company (Grimm, et. al 2016).
AC3.1 Analyse budgets and make appropriate decisions.
A budget is a financial plan for a forthcoming accounting period for a defined purpose which estimates the costs, revenues and resources over a specified period reflecting a reading of future financial conditions and goals and is revaluated on periodic basis. A surplus budget means profits are anticipated while a balanced budget means that revenues are expected to equal expenses. A deficit budget means expenses will exceed revenues (Grimm, et. al 2016).
- It helps the management to make decisions in case of uncontrollable change in conditions.
- It helps in finding the deviation from the budgeted and actual output, analysing and understanding the weak areas and taking corrective measures for improvement.
- It helps in building co-ordination as the plans are made for future considering each of the possible factors.
- It provides an estimate of income and expenses for that particular period and accessing the financial position at the end of the period.
- It guides management in making day to day decisions by providing a basis forecasts (Grimm, et. al 2016).
- A budget enables you to know what you can afford, take advantage of buying and investing opportunities, and plan how to lower your debt.
- 2. It helps to allocate funds, to understand how the money is working, and how far one is towards reaching the financial goals (Hussain, et. al 2015).
- 3. It helps save unexpected costs.
- 4. If one has limited resources it helps in keeping the focus on spending with prudence and meeting the end needs and requirements.
- It helps identify and eliminate unnecessary expenses like penalties, late fees and interests.
- It provides a warning for potential problems.
- It helps making best use of money.
- Helps achieve a financial goal efficiently.
- It helps lighten the debt and solve debt problems.
- 10. Remedial actions can be taken without delay (Hussain, et. al 2015).
AC3.2 Explain the calculation of unit costs and make pricing decisions using relevant information.
Unit cost: It is a summation of all the expenses incurred in the entire process of producing, storing and selling one unit of a product or service. It includes all fixed costs, variable costs, overhead costs, direct material and labour costs and all the other costs incurred in production.
Price: Price is the amount which is paid by one party for purchasing the given goods or services to the other party. In other words price is the cost of obtaining something.
Pricing methods can be broadly classified in two categories:
- Cost oriented pricing method
- Market oriented pricing method
Cost oriented pricing method- cost of production is considered as the base method to calculate price of final product or goods.
- Cost plus pricing
- Mark-up pricing
- Target return pricing
Market oriented pricing method – price is calculated on the basis of market conditions.
- Perceived value pricing
- Value pricing
- Going rate pricing
- Auction type pricing
- English auctions
- Dutch auctions
- Sealed- bid auctions
Differential pricing- It is the strategy of selling the same product at different prices to different customers. It is adopted to maximize the profit of the organization. Differential pricing can be charged considering various basis:
- Customer segment – depending on the segmentation of customer’s different prices can be charged on the same product. For instance, fees in various colleges are different for Indians and NRI’s (Schneider, et. al 2012).
- Image pricing- the image that a product or good has in the market can be the factor for charging different prices. Cosmetics and clothing brand fall in this category.
- Product form pricing- slight variation leads to charging of different prices.For instance the price of iPhone in rose gold is higher than black.
- Location pricing- prices are determined considering the location. For instance, the same bottle of cold drink is sold at a higher price in theatres than usual.
- Time pricing- the same product is sold at a higher price depending upon the time such as off-season.For instance, woollens are sold at high price in winters than in summers (Schneider, et. al 2012).
AC3.3 Assess the viability of a project using investment appraisal techniques.
Investment appraisal techniques
The techniques applied to evaluate the best proposal for an organization or company amongst the given set of proposals using methods for calculation like internal rate of return, average rate of return, payback period, net present value (Uechi, et. al 2015).
Net Present value- NPV is the technique of capital budgeting in which there are analysed invested amount with the returns generated in the present value.
The formula of NPV calculation is as follows: -
= Amount of total discounted cash flows - Amount of initially invested
Payback period- This is the period in which the total amount invested is recovered in a project. This time period defines the risk factor in a project. So there must be less payback period for effectiveness of the project (Uechi, et. al 2015).
AC 4.1 Discuss the main financial statements.
Financial statements are a formal record of the financial position of a business, entity or an enterprise.
Financial information is thus represented by :
- Balance sheet – it represents the statement of assets, liabilities, and capital of a business at a given point of time,
- Income statement- It provides a report of the company’s financial performance over a specific accounting period. It takes into consideration all the operating and non-operating activities thus helps in assessing the financial position of the company. It provides the details of incomes and expenses over the preceding period.
Income statement is divided into two parts; operating and no- operating. The operating portion discloses the incomes and expenses that are earned or incurred from regular business operations (Pompian, 2012).
Income statement is used to calculate ratios as return of equity, return on assets, gross profit, operating profit, earnings before interest and tax and earnings after interest and tax.
Therefore it provides two to three year data for historical comparison.
- Cash flow statement- it is a financial statement that affects cash and cash equivalents due to changes in balance sheet and income statement. Cash flow statement comprises of three parts:
- Operating activities- it includes activities that are conducted in the operations of the business (Johnson, 2014).
- Investing activities- it includes activities that are conducted for making investments.
- Financial activities- it includes a summary of financial activities such as inflow from banks, investors and customers and outflow in the form of distribution of dividends.
AC 4.2 Compare appropriate formats of financial statements for different types of business.
J. Sainsbury (Company)
Owner is the individual who runs the business
In a company owner is defined as the shareholders of the company who are having voting power in the decisions made in organization.
The partners are the owner of the partnership firm and can be two or more than two. They invest money in the ratio.
Share of liability
Whole liability is on the sole trader who own the business.
In company there is limited liability of the owners and shareholders.
In partnership firm partners have unlimited liability.
In the sole proprietor there is prepared balance sheet in the horizontal format.
Balance sheet of a company is prepared in vertical format as per IFRS guidelines.
Partnership firm follow horizontal or vertical format as per choice for preparing balance sheet.
There is no need to prepare the income statement in sole proprietor.
There is prepared income statement in company in which there are shown al the incomes and expenses incurred in specified year.
Profit and loss appropriation account is prepared in partnership firm in which all the income and expenses are recorded.
Cash flow statement
No need to prepare cash flow statement in sole proprietor.
This is prepared by the company to manage all the transactions related to cash in organization to have effective control.
There is no requirement to prepare cash flow statement in partnership firm.
AC 4.3 Interpret financial statements using appropriate ratios and comparisons, both internal and external.
-The capital turnover ratio is showing the effectiveness of the capital that makes impact on overall effectiveness.Tesco is having effective capital turnover ratio comparing to Sainsbury.
Gross profit margin
Gross profit/revenue- Sainsbury is having effective gross profit margin and more profitability.
Operating profit margin
Operating profit/revenue- Sainsbury is having effective operating profit margin.
PBT or LBT/revenue
Operating cash flow
Cash flow/operating profit- Tesco is having appropriate management of cash flow rather than Sainsbury which is making it more profitable.
Current assets/current liabilities- Current ratio shows the ability to pay liability over assets of the company which is effective in the company Tesco.
Total debt ratio
Long term + Short term debt/ Equity- Sainsbury is effectively managing its debts rather than Tesco.
This report is showing all the available sources of finance which can be used in organisations that can make impact on various activities. There are defined effectiveness of the sources with their different attributes and advantages and disadvantages. There are various tools and techniques which can manage financial resources in effective manner and can achieve most profitable results (Nilakant, et. al 2012). This report will explain various aspects related to the sources of finance, financial statements and their evaluation by analysing cost of sources of finance and selection of most effective source of finance.
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