Every business needs four major types of resources classified in two ways: men, money, machine and material or land, labor, capital and enterprise. As it can be seen the financial resources are compulsory, every business having allocated a department that manages this resource (the Finance Department) and a person that is in charge of its activities (the Finance Manager). Financial resources can be provided by a range of sources. This range depends on the type of the business, which can be classified as sole traders, partnerships and companies (private or public).Financial resources are in turn classified considering the period of time when they are available (short, medium and long term), and the origin environment (internal or external). The sources available for a sole trader are personal capital, retained profits, sale of assets, actions of hire purchase, of sale and lease back, loans and credit lanes from banks of informal loans (borrowings) from friends, acquaintances. Additionally, for the other types, finance can come from admission of new partners in the business, bank overdrafts, venture capital and share capital.
For London Woods ltd the financial resources of the private sector company are represented by the sale of the furniture produced (the selling price for a chair in 2013 is 45 pounds, while monthly sales vary between 100 and 120). A long-term loan already borrowed according to the income statement for 2011 and 2012 is another financial source of cash. But in contract with ordinary shares generated for investors, which are the permanent capital of the company, the loan will be integral returned after several years, during which is cost is estimated at a 12% interest rate.
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A recent available source are the 3000 pounds made available for a brand manager in the Latin America, while the production and the revenues from that sales are a potential source of liquidity. 1. 2 Before they are chosen, sources of finance must be evaluated after considering the following aspects relates to the business itself or the source: what amount of money is necessary and in what time, what is the cost of the source (interest rates, dividends etc.), the risk involved, the duration of the contract (between company and supplier of finance), the control of the business over the source or aver the ability to pay back finance received and the gearing ratio of the company (the relationship between what is owns and what is owes).
For example, long-term loans and ordinary shares can generate a greater amount of capital than personal savings or the sale of assets. But while the company must return in time the amount borrowed from a bank it can have as permanent capital the money invested by shareholders.
Also, while the interest rate is fixed and included in every payment, dividends are paid only when the company generates profit. Thus, the company has more control over finance if is source are investments rather than bank loans. 1. 3 The mentioned sources bring simultaneous benefits and disadvantages for the business organization. Personal savings are interest free, do not need to be returned necessarily at a certain time, no collateral part is involved and no paperwork is required, but it cannot provide large amounts and can interfere unexpectedly with cash flow if money is demanded before due time.
Retained profit is the company’s own revenue which does not need to be returned or to pay interest, debt does not increase and its future allocation can remain confidential. On the other hand, retained profits are available for developed, growing business and not for starting or bad-performing businesses. Finance resulted from selling assets is similar: the business finances itself with possible large amounts, only that those assets will not generate profit from the selling point, and it can be expensive later on, if it needs to be purchased.
Ordinary shares are advantageous because they can raise large amounts of permanent capital for which dividends are paid only the company is profitable, but they incur issuing costs and the amount of capital cannot be minimized later. Preference shares do not give the right of decision through vote and they require a fixed profit in return, even if the company makes a smaller profit or even a loss. Similarly debentures do not allow the right to vote, are redeemed when surplus profit is obtained, if not payment of interest rate must be done at a fixed date.
These features apply to loans, bank overdrafts. The hire purchase method has the advantage that the company can make use of the asset before it pays for it but probably will be pay more for it than its value. Venture capital is beneficial because investors are highly interested in the business’s success over a period; investors share profits and may wish to influence strategic decisions. Discounts assure a quick receive of money but debt is collected by the client company itself and thus resources are wasted in debt collection.
2. 1 Being vital for the business’s operations, financial resources (the life blood of business) have attached a certain cost: sometimes a price paid for their availability and most certainly an opportunity cost in the form if the second best way in which they could have been allocated. Personal savings, bank loans, overdrafts, debentures, venture capital, factoring, invoice discounting require the payment of an interest rate, in addition to the amount lend to the business.
Retained profits have attached the opportunity cost: depending on the size of it, profits can be allocated to many departments: they can be invested in research and development, in the extension of fixed assets for the increase of production, in more advertising, can be used in the employed of experts, skilled people. The cost of selling assets is that of the revenue from the goods that would have been produced, but also the difference in the selling price and the purchase price.
Apart from the dividends paid in return, issuing ordinary shares determines administrative costs with the stock exchange listing fee, printing, distribution and advertising fee. The cost in hire purchase actions and leases is the price that the company pays for the item and the cost of ownership over it, since even if the organization paid 90% for the item, it is still owned by the leasing company. Grants are financial resource that does not require any fee.
Planning is usually regarded as one of the first major steps (among generating ideas, assessing feasibility, collecting external information) that needs to be developed in concern with doing a business, a project, presentation etc. As money is a core resource for the business so is financial planning. This stage within a business it used in order to determine over a period of time how will a variety of resources be allocated in order to have both effective and efficient results. Or, it can be used to assess how well the available resources were used in a previous period of time (a quarter, half year, a year).
Financial planning has in addition a few key benefits. It is efficient because it takes in consideration future needs: a business must always be aware of next activities from the “to do” list. Considering next tasks is helpful in being on time: organizations have to prepare now, in advance, what is required later so it do not miss opportunities. This gives assurance to stakeholders that the company is well-managed and creates a pleasant working environment, where lower levels employees know very well what to do.
It helps businesses to compare the different alternatives between resource allocation in order to perform activities in which they have a smaller opportunity cost. Planning constantly also provides the opportunity to monitor, control activities and be financially sustainable for the organization and its stakeholders. 2. 3 The decision making process is represented by information needs required by decision makers. The decision makers or the organization are the stakeholders that have an interest in respect with the activity of the organization. They are divided between internal and external parties.
The internal parties are the shareholders and their information need is to know the risk implied by their investment or the return that can generate in order to sell shares or to buy and if the company is able to pay dividends. Employees, another important category wants to know is the business is well-performing in order to deduce the stability, the prospective, and any remuneration and benefits that their current vacancy within the company offers. Suppliers are interested to know if in short term the business as able to pay for the goods supplied.
Lenders, an important category of external stakeholders, need the same information, but for the long term. Continuation of operations is also a concern of customers, especially if they have a dependence on the company’s activities. Governments and regulators are interest in how the business is caring operations in order to compare it with regulation and law, so that the organization is operating legally. The public, a general external category of stakeholders is interested in the performance of the business for the need of economic stability and available jobs.
2. 4 In the study case of London Woods there are several sources of finance with impact in the financial statements (the profit and loss account, the balance sheet, and the cash flow statement). A major source of the finance is the firm’s production of furniture which if it is sold is incurred in the profit and loss account, while the remaining stock is stated as a current asset on the balance sheet. Another source of finance proposed for the business, as Mathew claims, is two machines that will generate more revenue but are going to cost 4 million pounds.
The prices paid will be incurred in the expenses section in the income statement and the value of the two machines will be included under the asset’s column in the balance sheet. The machines would have to be bought by first taking a loan with an interest rate of 12%, which will have to be stated under expenses in the income statement, while the loan must be declared in the long-term liabilities section in the balance sheet. According to the profit and loss account a current source of finance is the shareholders capital, a current loan which costs the business 550 (interest rate) and the debtors, which are customers of the organization.
The company does not have to buy the machine B, as the results are negative and the company does not have enough money. 4. 1. Finance is used to create before or at the end of time periods financial statements that help in planning activities, in recording performance and in assessing the current state of the business. Finance is used to create three types of financial statements. The profit and loss account assesses if past activity used effectively the allocated resources. The balance sheet is a summary about the assets, liabilities and liquidities of a business at the end of a business term.
Finance also generates information about sales, purchases and labor costs. All this information can be further used in setting budgets for next business terms. Budgets can be used to determine future quantity and price of sales, production, materials, labor, manufacturing overhead, selling and administrative costs and in the end the final cash budget. Based on previous information, when they are creating budgets managers can take measures that reduce costs, increase profits, improve work efficiency or increase productivity and can find information like when to make new purchases of machinery, materials etc. 4. 2.
Financial statements do not differ substantially of those of a sole trader as they rely on the same accounting principles. Both balance sheets of both companies will be calculated using the simple formula according which equity equals assets minus liabilities. The financial statements of the fictional sole trader Olivia Boulton1 and those of The Coca-Cola Company2, registered in the USA are relevant in this way. Although they use the same principles, the statements of the two operators are slightly different in content. Olivia Boulton, as a sole trader runs a small business (she sells cookware goods designed in Italy).
Profits are usually small and re-invested in the business, but the possibilities for expansion are limited. Sole traders are the owners of the business who can run it independently and do not involve other in decision making. A sole trader takes the risk of compensating liabilities with his own goods. In comparison, The Coca-Cola Company a public limited company owned by anonymous shareholders, which generated large profits and pays dividends and caries operations globally. The financial statements of Olivia Boulton contain the traditional elements of a profit and loss account and of a balance sheet.
The profit and loss account which states the net profit incurred in the period, calculated by eliminating expenses from income or gross profit, starts with the estimation of sales, purchases and stock in order to determine the gross profit. The expenses include liabilities regarding the interest rate of a loan, wages plus other administrative expenses (rent, travelling). The balance sheet has a simple format too. The fixed assets are only represented by the premises and the shop fittings, current assets include stock, debtors, bank and cash, while on the liability column the only type of tax incurred is the VAT (value added tax).
In the case of Coca-Cola the statements look different. The cost of goods sold is directly stated as well are the selling, general and administrative expenses. The major difference is the emphasis of the tax incurred and the dividends paid (basic net income per share, diluted net income per share, and dividend per share). The balance sheet contains other elements too. A great amount of the company’s assets are represented by investments, trademark with indefinite lives, goodwill, intangible assets, bottler’s franchise rights with indefinite lives. Under the liability column the amount owned for loans long-term debts are much higher.
After taking liabilities, the company’s equity is much more elaborated and allocated to multiple purposes: a part is reinvested, a part is allocated to shareowners, another one to non controlling interests, while other incurred as capital surplus. 4. 3 a) Net profit margin: Op * 100 : sales revenue: 370*100/4990 =7. 4 b) Current ratio current assets/current liabilities: 1540/790 = 1. 9 c) Quick ratio current assets – current stock/current liabilities: 1540-680/790 =860/790=1. 08 d) ROCE for year 2012: 370*100/1850=20% ROCE for year 2011: 510*100/1900=26. 8% e) Assets turnover ratio: 4990/1850=2. 69; f) Debt/Equity ratio: 550/1850=0. 29
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