Managing Financial Resources and Decisions - Assignment Example

Task You are a recent finance graduate from of London and you have just been appointed as a junior consultant for a Financial Consulting Firm in the city. Your immediate manager has asked you to write a report on the sources of finance highlighting the three key sources in Short term, Medium term and Long term. The sources of finance available to a business There are many various sources of finance available to a business, which can come either from internal or external sources. Internal sources are the sources, which can be gained without an agreement of anyone except the Board of Directors and management of the business (Atrill & McLaney, 2006). External sources require involvement of other parties, such as creditors, potential shareholders, etc. Sources of finance can be divided into three categories based on the timeframe characteristic and include the following: short-term, medium-term and long-term financing. Below is provided a brief overview of each type of finance sources. Internal sources of finance The main source of long-term internal source of finance is retained profit of the company. It is a profit generated by the company and not (fully) distributed to the shareholders but used for satisfying company’s needs (Atrill & McLaney, 2006). The retaining of profits has no issue costs, and the amount generated is certain as it is based on the profit of the company. Also, there will be no effect on the control of the business, as no outside investors are involved (Atrill & McLaney, 2006). However, this method might be not sufficient enough for the company willing to grow and expand its business because of limited funds. Short-term sources of internal financing include increasing the level of payables (creditors) and reducing the level of inventories (stocks) and receivables (debtors) (Atrill & McLaney, 2006). The company can delay payment to trade payables in a short-term period and thus retain funds within a company. However, this method is quite risky as failure to pay out the funds within an agreed period might incur significant costs to the business. Reduction of inventories (stock levels) the company may make funds used for inventory available for business. However, it is critical to ensure that appropriate levels of inventory necessary for business activity (Atrill & McLaney, 2006). Tighter control over receivables will lead to reduced proportion of assets, however, sales and customer goodwill can be lost in result (Atrill & McLaney, 2006). External sources of finance External sources of finance also can be divided into short-term, medium-term, and long-term sources. Long-term sources of finance include the following key sources: ordinary and preferences shares, rights issues, loans, bank borrowing, venture capital, leases, and others. New issue of share (as a source of finance) might be appropriate when the company needs to raise more cash. The company can issue ordinary (equity) shares with the approximate nominal of face value varying between $0.50-1 (Food and Agriculture Organization of the United Nations, n.d.). By offering newly issued shares to the existing shareholders, the company generate new source of finance – rights issues. Loan stock (debentures) is another long-term debt capital, where a company has an obligation to pay interest for the loan (coupon yield) on a regular basis during a certain period of time. Long-term bank borrowing is another type of source of finance, which is normally available for the purchase of capital assets such as property (mortgage loan) (Food and Agriculture Organization of the United Nations, n.d.). Venture capital is a capital provided to small and medium-sized businesses seeking for grown and business expansion opportunities but with no access to stock market (Atrill & McLaney, 2006). This type of source of finance is in the form of loan finance and share (depends on business case). Medium-term sources of finance include bank loans issued for the period from 3 to 10 years. The interest rate on such a type of bank lending can be either fixed or variable (can be adjusted every three, six, nine or twelve months) (Food and Agriculture Organization of the United Nations, n.d Short-term sources of finance include: bank overdraft, debt factoring, and invoice discounting (Atrill & McLaney, 2006). Bank lending is another type of source of finance, which can be in the form of bank overdraft or a short-term loan for not more than three years (Food and Agriculture Organization of the United Nations, n.d.). Appropriate sources of finance for a business project Based on the information given about a firm and the objectives identified, it is possible to suggest that the most appropriate source of finance for a business project is to issue shares and to make the company public. If the company does not have sufficient funds for going to the stock market, it might choose venture capital as the most appropriate source of finance. In such a way the company will gain an opportunity to achieve its objectives stated in the case study. Task 2  a) You are required to analyse the impact the key sources mentioned above will have on the company’s financial statements (Income statement and the Balance Sheet) The impact of the key sources of finance A firm which generates a new source of finance should reflect these changes in its financial statements, including the Income Statement and Balance Sheet. Each source of finance is more likely to have different impact on the financial statements of the firm. Below is presented a brief overview of how some key sources of finance affect the records in financial statements. Bank overdraft Bank overdraft is a short-term source of finance and is reflected in the balance sheet in the current liabilities section. Ordinary shares and preference shares As a result of issuing ordinary and/preference share the value of equity capital in the balance sheet of the firm is increased. In the balance sheet should also be reflected the number of shares issued and the rate of dividend (for preferred shares). Venture capital Venture capital can be in the form of share or loan finance. If it is issued in the form of share it should be reflected in the balance sheet as equity capital (Atrill & McLaney, 2006). Loan stock (Debentures) The value of loan stock, along with the repayment date and interest rate should be displayed in the company’s balance sheet (the equity and non-current liabilities section) (Atrill & McLaney, 2006). Loan Loan is a long-term source of finance, and should be reflected in the balance sheet as long-term liability. b) Financial planning is an important aspect of financial planning for any business, discuss Financial planning and its importance for any business In order to do any business there should be developed a plan for the future. Whatever are the goals and strategic objectives of the company, the plan of its achievement should be mapped out in a systematic way in order to make a project successful. Planning proces enables an organization to state clearly the aims and objectives of the project/business, to identify and evaluate available options and opportunities, to make a decision of which option to choose and based on it, to develop a long-term plan followed by a detailed short-term plan (Atrill, 2012). Financial planning helps an organization to coordinate its business objective with financial performance and to develop projected financial statements. Thus, financial forecast helps any business to evaluate whether its plans and objectives are achievable and financially viable. Moreover, financial planning helps the firm to better assess its resources and allocate them with greater efficiency. The information needs of different decision makers In order to ensure that financial information is useful, accountants and senior executives need to be clear for whom and for what purpose the information will be used. There can be identified several major categories of /decision makers who have information needs in order to make decisions (Atrill & McLaney, 2011). These user groups include the following: Customers: decide whether to continue business with the company (especially relates to B2B models); Employees: decide whether to continue work in the company based on the declared strategic goals, financial performance, risks of bankruptcy, etc.; Investment analysts: decide whether to advise customers to invest in the company and other advisory/consulting needs (reports publications, etc.); Owners/shareholders: decide whether to invest more to the company or to sell the shares they currently held; Suppliers: decide whether to continue to supply on credit goods/materials/services the company based on its financial capability to pay its liabilities; Managers: to decide what areas could be improved and benchmark the plans and results; Lenders: to assess the potential business risks and to decide whether it is worth to lend money to the company or to require repayment of existing loans if the company’s business is under the threat of bankruptcy; Government: decide whether the enterprise is subject to taxation benefits, and to assess whether financial support is needed (Atrill & McLaney, 2011). Task 3 a) Identify and discuss the objectives of a budget and assess its importance generally with special emphasis in the small and medium size enterprise Budget is an integral element of the financial planning process, as it identifies the way/path how the firm should be managed during a year. Thus, the budget can be viewed as a business plan of the company for a short-term period (usually a year). Budgeting is recognized to be one of the most crucial activities for managers, as it enables them to convert the long-term plan into clearly identified set of actions (Atrill and McLaney, 2006). By developing a budget, the top management of the company sets financial goals and targets for the next year, covering all aspects of the business. The budget as a financial instrument helps to define clear financial targets for the following categories of the firm’s business activity: sales revenues and expenses; short-term credit to be taken or given; cash receipts and payments; personnel requirements and inventories requirements (Atrill and McLaney, 2006). There are identified five key areas of using the budgets. First of all, budgets help to identify possible short-term problems and to promote forward thinking approach. Secondly, its can be used for improving coordination among different sections of the business, whereas the activities of various business departments are dovetail into one another (Atrill and McLaney, 2006; Jones, Atkinson and Lorenz, 2012). Thirdly, budget can serve as a great motivator for managers for better performance, as the levels of required achievements are clearly reflected in the budget. Fourthly, budgets can be used as a basis for a system of monitoring and control, whereas actual performance is compared against the planned performance. And finally, budgets can provide a system of authorization for management, as there is set financial limits on each business activity (Atrill and McLaney, 2006). b) Net Present Value is a capital investment appraisal tool, you are required to discuss how management can use it to determine the viability of a capital investment Net Present Value is recognized to be a better tool for determining the viability of a capital investment. There are few arguments for this statement. First of all, this method takes into account the time value of money. Secondly, Net Present Value enables to include into calculation all relevant cash flows despite the date of expected/planned occurrence (Atrill and McLaney, 2008:529). Thirdly, net Present Value is the only method of appraisal the viability of a capital investment which provides an understanding of the impact on the wealth of the investors/owners of the business. Negative Net Present Value (below zero) will indicate on reduced wealth, while positive Net Present Value (greater than zero) – on enhanced wealth (Atrill and McLaney, 2008). Task 4 You are required to download 2012-13 financial statements of British Airways and assess and comment on its performance for the year using appropriate ratios for profitability, liquidity and efficiency. There are two main financial statements of the company, including the Balance Sheet and Income Statement. Both these statements can be helpful instruments for analyzing, interpreting, and evaluating the company’s financial performance and profitability. Ration analysis is one the methods used in order to evaluate the financial performance of the business. Some of the key ratios which are calculated based on the case study of British Airways are divided into three major categories: profitability, liquidity, and efficiency (detailed calculation of these ratios is presented in the Table 1). Profitability ratios For evaluating the profitability of the business there were calculated the following ratios: Operating profit margin [operating profit/sales revenue]*100 Gross profit margin [gross profit/sales revenue]*100 Liquidity ratios For evaluating the liquidity of the business there were calculated the following ratios: - Current ratio [current assets/current liabilities] - Quick ratio [current assets excl.inventories)/current liabilities] Efficiency ratios For evaluating the efficiency of the business there were calculated the following ratios: - Receivables Turnover - Inventory Turnover [sales/inventory] (Fuhrmann, 2014). - Asset Turnover [net sales/average total assets] British Airways - Financial ratios Dec 31, 2013 Dec 31, 2012 Profitability ratios Operating profit margin 8% 7.72% Gross profit margin 15% 15.98% Liquidity ratios Current ratio 1.26 1.27 Quick ratio 0.43 0.43 Efficiency ratios Receivables Turnover 14.25 14.33 Inventory Turnover 2.02 2.16 Asset Turnover 0.95 0.97 Table 1. British Airways - Financial ratios (Source: Financial Statements, Marketwatch.com, n.d.). Discussion Profitability Operating profit margin ratio calculated for the BA for FY 2012 and FY 2013 has shown that operational performance in 2013 was stronger than in 2012 (8% versus 7,72%). Thus, if in 2012 for every £ 1 of sales revenue an average of 7,72 p. was left as operational profit after covering all costs and other expenses of operating business, by 2013 it has declined to 8 p. for every £ 1 of sales revenue (Atrill and McLaney, 2010). Gross Profit margin ratio in 2013 was weaker than in 2012 (15. 98% versus 15%). Decline in this ratio indicates that gross profit of the company was lower relative to sales revenue in 2012 (Atrill and McLaney, 2010: 198). Liquidity Current ratio enables to compare the “liquidity” of assets, or in other words capability of the firm to convert its assets into cash and cash availability (Atrill and McLaney, 2010). Current ratio for the BA is quite stable with minor increase in 2013 comparing with the FY 2012. The higher the ratio the better it is at it indicated the company can easily convert its assets into cash. Taking into consideration an assumption that an “ideal” ratio is 2:1 (Atrill and McLaney, 2010), BA’s current ration is comparatively low. However, it is also worth to take into consideration the industry in which the company operates. Quick ratio, also known as, the acid test ratio also helps to evaluate liquidity of the organization, but in more stringent way as it excludes inventories in calculations (Atrill and McLaney, 2010). Quick ratio calculated for BA for both FY 2012 and FY 2013 indicates that the company doesn’t have enough liquid current assets in order to cover its current liabilities (Atrill and McLaney, 2010). Efficiency Receivables turnover is a ratio, which helps to evaluate whether its collection of accounts receivable is sufficient enough (Investopedia.com, 2003). The ratio for BA during the FY 2012 and FY2013 remained practically the same, and as a result this data doesn’t provide useful information for analysis. Inventory Turnover is a ratio, which helps to identify how effectively the company manages its inventory/stocks. Inventory turnover for BA for the period from FY 2012 to FY 2013 has slightly decreased. Comparing inventory ratio of BA to average industry ratio (0.51), it is obvious the BA’s inventory is much higher (Csimarket.com, 2015). Asset turnover for BA for the period from FY 2012 to FY 2013 has slightly increased, but the different is not significant and sufficient enough for comparative analysis. Taking into considerationt that the average asset turnover for Airline industry is equal to 0.81 (as of 2013), BA’s asset turnover (2.02) is much higher (Csimarket.com, 2015). References: Artrill, P. (2012). Financial management for decision makers. Harlow: Financial Times Prentice Hall Atrill, P. and McLaney, E. (2006). Accounting and finance for non-specialists. Harlow: Financial Times Prentice Hall Atrill, P. and McLaney, E. (2008). Accounting. Harlow: Financial Times Prentice Hall Atrill, P. and McLaney, E. (2008). Accounting and finance for non-specialists. Harlow: Financial Times Prentice Hall Atrill, P. and McLaney, E. (2010). Accounting and finance for non-specialists. Harlow: Financial Times Prentice Hall British Airways Annual Report (2013). Annual Report. Csimarket.com (2015). Airline Industry Efficiency. Available at http://csimarket.com/Industry/industry_Efficiency.php?ind=1102 Fuhrmann, R. (2014). How do I calculate the inventory turnover ratio? Investopedia. Available at: http://www.investopedia.com/ask/answers/070914/how-do-i-calculate-inventory-turnover-ratio.asp Jones, T., Atkinson H., and Lorenz, A. (2012). Strategic managerial accounting. Oxford: Goodfellow Publishers. Investopedia (2003). Receivables Turnover Ratio Definition, Investopedia.com. Available at: http://www.investopedia.com/terms/r/receivableturnoverratio.asp Marketwatch.com, (n.d.). Boeing Co. Available at: http://www.marketwatch.com/investing/stock/ba/financials/balance-sheet Read More