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Managing Financial Resources and Decisions

Introduction

In order to successfully manage the financial resources within the organization it is essential for management to proper allocate the resources so that they may engage in proper operational activities. With the proper alignment and allocation of the financial resources corporation can easily accomplishes their goals and objectives. Along with this, it is also assessed that engaging in taking financial decision regarding adequate supply of funds it results in overcoming or minimizing the financial risk (Fischer and Marsh, 2015). For the present report focuses on considering the case scenario of Clariton Antique Ltd. That is started as the an unincorporated business. The company has effective brand image in the field of selling antique items.

Along with this, report will identify the different sources of finance that is available for both unincorporated and incorporated business so that they can easily source the adequate fund for operating the business activities (Zerban, Omar and Al Sibani, 2015). In addition to this, it would also calculate or assess that viability of the undertaking project with the help of different investment appraisals techniques such as IRR, NPV etc.

TASK 1

1.1 Identify the sources of finances for

a) Unincorporated business

Unincorporated are such entities those do not have their separate legal identification. Sole traders or partnership firms come under such type of business. In such firms, owner has to take responsibility of risk and liability of the organization (Dimmock, Gerken and Grahm, 2015). Financial sources available to unincorporated business are as following:

  • Bank loan: It is one of the most suitable source of finance available to the firms. As Clariton Antique Ltd is working as partnership firm, all four partners are responsible for the risk of the organization. With the help of this source, cited firm will be able to increase cash flow in the workplace. Apart from this it can be repaid by borrower easily because schedule of repayment is manageable. Long term funds requirement can be fulfilled with the help of bank loan (Abazieva and et.al, 2015).
  • Third party investors: Venture capitalists is the another source of finance, in this any third party or investor can invest their money in the firm for getting high revenue. This helps in the enhancement of capital of the entity. As high risk is attached with the start up firms like Clariton Antique Ltd so investors look upon the worthiness of the company then they invest amount in it (Abraham, 2015). But cited firm will have share ownership with them that can influence decision making process of the corporation.

b) Incorporated business

These are such firms those which have legal structure, firms have to follow legal guidelines. Owner or partners are no responsible for the debt and risk of the organization. Financial sources for incorporated business are discussed below:

  • Retained earning: It is the cheapest form of source of finance, in which organizations retain own profit for further development of the company (Yildiz, 2014). As per the statistical facts in UK 80% retained profit reinvested by owners for the growth of business. In this entrepreneur needs not to pay interest to any lenders thus, liability remains in control.
  • Share capital: It is the shareholder's money which they invest in the organization for getting higher profit. Shareholders get shares of the company and they enjoy preference rights. It is long term financial source for the company and can help in increasing capital side of the firm. If entity earns profit then they will get dividend on it (Nan and Wen, 2014). 

1.2 Implication for using

Both the sources of finance that is internal and external sources support the business organization in raising adequate funds that assists them to operate their business activities in the market (Aktas and et.al, 2015). There are certain implications of using both the sources that are enumerated as follows-

a) Internal sources of finance

  • Implication of using sale of assets: The key internal source of finance is selling of unwanted assets with the help of this company can easily raise fund for the business. The implication for using sale of assets for raising finance results in adding expenses for the organization (Opitz and Hofmann, 2014). As, for selling the assets such as furniture, building etc company requires monetary fund for opting advertisement. On the contrary to this, while selling the building the company also face legal implication as it may not results in diluting the ownership (Vladimirov, 2015).
  • Implication of using retained earnings: Another internal source of finance include gaining monetary fund through retained earnings these are also termed as the retained profit of the business that is used within the business for engaging in the business activities (Meyskens and Bird, 2015). There are no financial implication associated with this form of internal source of finance. 

b) External sources of finance

Implication of taking bank loans: The key external source of finance that is used by corporation for raising the fund include taking loans from bank. Thus, taking bank loan results in attaining economical implication for the business as in order to meet the bank loan the company need to repay the interest on the loan taken from the bank. Along with this, another implication of taking bank loan is that it also act as the expense for the firm as they have to pay certain amount to bank (Atanassov, 2015). In the situation if company is unable to repay the loan then bank is accountable to cease their operations and activities.

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1.3 Appropriate financial source for Clariton Antique Ltd

Clariton Antique Ltd is aiming to open its second branch and cited firm wants to raise funds so that it can expand its business globally. For achieving this objective Clariton Antique Ltd needs huge amount, so bank loan will be the most suitable source of finance for the organization. Security charges and interest rate of financial institutes are affordable (Florackis, Kanas and Kostakis, 2015). Apart from this cited firm can repay the amount in easy installments. So that risk is limited thus it may give good results to the organization. Though it will increase liability but Clariton Antique Ltd can manage it and will be able to earn good profit by this way.

Retained earning is another option which can give optimistic results to the cited firm. As Clariton Antique Ltd will use its own profit amount so liability will be in control, it can help in increasing profit of the company. Business can use its own internal amount for further development, by this way owner will not have to share its ownership with third person. Individual will be able to take business decision by own (Acciaro, 2014). It cited firm opt this source then risk will be limited and liability will be in control. It will help in accomplishing the objective of cited firm of raising funds 0.5 million.

TASK 2

2.1 Costs attached with sources of finance

Whenever companies opt any source of finance then it has to bear costs which are associated with them. These costs can increase burden of the entity and can harm its position. For instance bank loan is most preferred source but in this firm has to pay interest and documentation fees to financial institutions. That increases financial burden of the company (Petrakis, Kostis and Kafka, 2016). If Clariton Antique Ltd borrow money from banks then interest cots would be the main cost for the firm. If cited firm opt third party investment or venture capitalists source then owner of the entity will have to pay dividend to the investor. It increases profit and raise funds and on raised capital cite cited firm will have to pay tax. Equity share is another source of fiance but in this ownership cost is attached with it. Two main sources are venture capitalist and financial broker (Winch and Leiringer, 2016). Broker is the person who helps in lending amount to owner from banks.

a) Dividend cost:

It is attached with the venture capitalist, in which Clariton Antique Ltd will have to share its profit in the form of dividend with investors. It reduces profit of the company. “We Finance limited” is the capitalist which has approached to Clariton Antique Ltd. Company is demanding 20% stake in the business against its investment. This source of finance can increase burden of the firm because 20% is very high and entrepreneur will have to share ownership with the investor (Alagathurai, 2014). Dilution of ownership is another cost associated with venture capitalist.

b) Interest cost:

It is attached with the bank loan, Clariton Antique Ltd will have to pay interest if it takes money from financial institutions. Bank will charge 2% annual interest and 1% will be charged by broker as commission so overall cost of capital would be 3%.

c) Tax costs:

Cited firm will have to tax on its surplus amount. For instance; if current tax rate is 20% then it would reduce net profit of the company (El Chami and et.al, 2015).

2.2 Explanation of financial planning and its importance

Economic forecasting is the process which helps to determine future cash requirement and income. Financial plan discuss about resources, activities, equipment which can help in meeting with the common goal of company. It is very important from the business prospective:

  • It helps to determine the future capital requirement (Guerrero-Baena and et.al, 2015).
  • It is essential in framing the financial policies related to cash control, borrowing, lending, investments.
  • Maximum utilization of resources can be done with the help of economic forecasting.
  • Uncertain events and their negative impact can get minimized by proper planning.
  • Effective financial planning helps to make impressive strategies which can reduce the cost of the organization.

Importance of financial planning in the Clariton Antique Ltd, these are as below discussed:

a) Budgeting: It is most essential part of business, economic forecasting assist in reducing the issues such as surplus or shortage. Management of cash flow and outflow can be done with the help of financial planning. Proper financial plan can help in allocation of resource thus, wastage and over used will not take place in the cited firm (Brewster, Mayrhofer and Cooke, 2015).

b) Implication of failure to finance adequately: Failure is the most crucial situation of business, which can harm profit and brand image to great extent. Some time selection of in appropriate source of finance can increase liability. Then difference between profit earning and liability will be higher and cited firm will not be able to meet its obligations on time. By this way Clariton Antique Ltd can not be able to recover such huge loss. With the help of financial planning, entity will be able o forecast the future situations so it would be able to select most appropriate source which can help in minimizing the chances of failure.

c) Over trading: To run business smoothly balance between demand and supply is essential. Over trading can reduce profit and can increase financial burden of the company. By preparing effective financial plan Clariton Antique Ltd will be able to manage its trade well thus, over trading issue will not take place ion the organization (Locatelli and et.al, 2015).

2.3 Information required for making effective decision

Before taking investment decision investor looks upon variety of detail of company. Bank also look upon the economic worthiness of organization before lending amount to the firm. These information helps them in making proper decisions that can help in generating high income and gaining good returns. Various persons will need some information, these are as following:

a) The partner: Four partners have found the Clariton Antique Ltd, they all invested their money in it so that business can run smoothly. Before investing their own money they will need information like liquidity position, assets of the company, solvency ratio, previous profit history etc (Cash Budget, 2017). By this way partners of cited firm will be able to take their own decision whether to invest in the firm or not.

b) Venture capitalist (We Finance limited): We Finance limited has approached to the Clariton Antique Ltd for investment in the company. Before investing amount in the start up business investor will need information like economic position of the company, brand image, solvency ratio, assets, liabilities, dividend policy. Earning capacity etc. These all details will help the capitalist in taking their decisions of investment in the organization.

c) Finance broker: Broker is the mediator between borrower and lender. They arrange loan for the organization, they need information regarding previous liabilities of Clariton Antique Ltd, repay capacity, interest bearing capacity, solvency ratio, inventory turn over ratio etc. These all details will support banks in taking decision of lending. (Gearing Ratio, 2017)

2.4 Impact of financial sources on accounting statements

Selection of sources of fiance is very important part of business functions, it can enhance profit or can increase burden of the company. If Clariton Antique Ltd chooses to go with venture capitalist then it will raise capital of the cited firm. That will impact on the balance sheet of the organization. But entity will have to pay dividend to investors and also it will have to include the person in all important board meetings.

They will impact on the income statement of the company, as dividend paid will reflect in the expenses side and will reduce overall profit of the company. As it will increase cash inflow thus, impact on the cash flow statement of the Clariton Antique Ltd (Locatelli and et.al, 2015).

Finance broker is another source of finance that impact on the financial statement of the company. As Clariton Antique Ltd will have to give 1% brokerage to the person that will count as expenses of the corporation thus, impact on the profit and loss account of the cited firm. Bank loan will increase assets side and will enhance cash inflow of the organization. On other hand organization will have o pay interest for longer period to banks. That will enhance liability of the company thus, will impact on the balance sheet of the organization. Interest (2% annual), documentation fees, brokerage (1%) etc. are expenditure of the company so it will reflect into the profit and loss account in the expenses side (Guerrero-Baena and et.al, 2015). best assignment help

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Task 3

3.1 Cash budget

Cash budget is the plan that assists firms in evaluating the cash flow during particular financial year. It is the projection of cash inflow and outflow through which an enterprise can measure its earning over expenses. For instance if there would be shortage of funds in near future then organization can make changes in its credit policy.  For running business activities smoothly, it is essential to have cash budget so that unnecessary expenditures can get reduced to great extent. It adds all income such as from cash sales, credit sales etc. and deduct it from expenditures for getting the net cash balance (El Chami and et.al, 2015).

Particulars

January

February

March

April

May

June

 

 £

 £

 £

 £

 £

 £

Cash inflow

 

 

 

 

 

 

Sales on cash

 

15000

 

22500

 

300000

 

15000

 

15000

 

3750

 

Credit collection

142500

262500

405000

547500

330000

285000

Total cash revenue

157500

285000

435000

562500

345000

288750

Cash outflow

 

 

 

 

 

 

Total payments

807250

137250

119750

437250

227250

219750

Total cash outflow

807250

137250

119750

437250

227250

219750

Net cash (Total cash income- total payments)

-649750

147750

315250

125250

117750

69000

Opening cash balance

110000

-539750

-392000

-76750

48500

166250

Closing cash balance

-539750

-392000

-76750

48500

166250

235250

From the above cash budget it is analyzed that in the month of January total expenditures of  Clariton Antique Ltd was very high as compare to its ash inflow. Which means cited firm was not able to meet its obligations and its cash management strategies was not appropriate. But after that it as managed its expenses and in February to June cited firm has make effective control over its spending that has given benefit of positive cash balance (Cash Budget, 2017).  For improving liquidity in the entity, Clariton Antique Ltd will have to focus on enhancing its sales figures, which is possible if cited firm gives cash discounts to its customers. Trade discounts will attract more consumers and they will buy the antiques that will increase cash inflow in the company.

3.2 Calculation of Unit cost

Clariton Antique Ltd is not engaged in the production of goods, but it has to bear fixed and variable expenditures. Fixed expenses of the cited firm are building rent, salaries etc. Whereas variable costs of the Clariton Antique Ltd are transportation cost, utility bills, purchasing of final goods etc. Both these cost increases burden of the company and that is why profit of the firm can get reduced (Acciaro, 2014). Formula of unit cost calculation is as below described:

Total fixed cost + variable costs / total number of unit produces by the firm

For instance: Fixed cost of Clariton Antique Ltd is £30000, variable cost is £40000 and cited firm wants to produce 10000 units then calculation of unit cost will be as :

 = £30000+ £40000 / 10000

= £70000 /10000

= £7 unit

By identifying the per unit cost, cited firm can take its pricing decisions easily. If Clariton wants to earn profit of 25% till the end of 2017 then calculation of pricing will be as following:

= Unit cost + Uni cost * desired profit percentage

= £7 + £7*25%

= £8.75

So it can be said that if Clariton wants to earn 25% profit then it will have to keep per unit selling price £8.75.

Sensitivity analyses:    There are various components those affect the over all pricing decisions such as sales, costs, net income etc. This analyses shows changes in CVP if variables get changed. For instance if variable cost of the company get increased to 50000 then unit cost would be: 30000+50000/10000= 8 then, pricing for getting 25% profit would be; 8+8*25% =  £10. This difference is reflected by sensitivity analyses.

3.3 Investment appraisal techniques

To invest amount in the high return and less risky project is very important. That can help in generating good income in the organization. Investment appraisals techniques assist in identifying the viable projects so that company can earn good earning. ARR, NPV, PBP etc. are many methods that can help in taking appropriate decision of investment.

Pay back period (PBP):

It is the method which defines the time duration in which entity can get return its money. It focuses on risk and timing factors.

PBP = Initial investment / annual cash flow

  • Advantage: It is very simple technique and favor to quick return project so that liquidity of the company can get maximized.
  • Disadvantage: it ignores the profit side of the projects and do not give any definitive investment signal.

 

Investment 1

 £m

Investment 2

 £m

Initial investment

 

-8.6

 

-4.4

1

1.6

-7

0.8

-3.6

2

2.8

-4.2

1.4

-2.2

3

3.4

-0.8

2

-0.2

4

3.6

2.8

2.4

2.2

5

4

6.8

2.3

4.5

6

4.2

11

2.6

7.1

Pay back period

 

3.22

 

3.08

Clariton Antiques Ltd has decided to meet the criteria of 3.5 year PBP. In both projects PBP value is less than its expectation. Thus, both investments are less risky and in both cited firm can recover its invested amount soon. So it can be said that both investments are viable for the Clariton Antiques Ltd, but if it has to select one then it should go with project 2 because in this cited firm will be able to pay back its money within 3.08 years.

Average rate of return (ARR):

It is another technique which concentrates on returns over investment. Formula:

ARR = Total net profit / No. of year / Initial cost *100

  • Strength: As it gives result is percentage so company can compare it easily. Profitability is the major concern of this method.
  • Weakness: Terminal value and time factor completely ignored by the ARR (Winch and Leiringer, 2016).

 

Investment 1

Investment 2

 

 £m

 £m

Initial investment

8.6

4.4

1

1.6

0.8

2

2.8

1.4

3

3.4

2

4

3.6

2.4

5

4

2.3

6

4.2

2.6

Total

19.6

11.5

Average

3.26

1.9166

ARR

37.98%

43.56%

From the above calculation it can be said that Clariton Antique Ltd should invest in project 2. As it was assuming value of ARR is 35% and both investments are giving results more than its expectation. But Investment in project 2 would give high return to the cited firm.

Net present value (NPV):

It is good tool that focuses on the difference between present cash outflow value and future cash inflow. Formula:   

  • Strength: It helps to select such project in which company can generate income soon.
  • Weakness: It avoids unforeseen costs that is why results do not matched with the expectations.

 

Investment 1

PV @ 14%

Present value

Investment 2

PV @ 14%

Present value

 

 £m

 

 £m

 £m

 

 £m

Initial investment

8.6

 

 

4.4

 

 

1

1.6

0.877

1

0.8

0.877

1

2

2.8

0.769

2

1.4

0.769

1

3

3.4

0.675

2

2

0.675

1

4

3.6

0.592

2

2.4

0.592

1

5

4

0.519

2

2.3

0.519

1

6

4.2

0.456

2

2.6

0.456

1

Total

 

 

12

 

 

7

NPV

 

 

3.38

 

 

2.53

It can be said that project 2 would be viable as in his value of NPV is less than project 1. In this it will be able to generate good income soon (Atanassov,  2015).

Task 4

4.1 key components of financial statements

  • Income statement: it has two main elements ; profit and loss. It includes earnings and expenses in it and then calculate net profit or loss of the company.
  • Statement of cash flow: Two major components of cash flow statement in the Clariton Antique Ltd are cash inflow and outflow (Alagathurai, 2014).
  • Statements of change in equity and gain: Shareholder equity is one on the main elements and retained earning is another component of financial statement.
  • Statement of financial position: It has three components; assets, liability and equity. Assets has two parts current and non current, liability has another two parts current and non current.
  • Notes to the financial statements: These footnotes provide additional information about operation and position of the company.

4.2 Formats of financial statements

Sole trader:

Such type of business do not follow international accounting standards. They include expenses and income in the profit and loss account, not necessary to include corporate tax in it. Balance sheet consists of two components assets and liability.

Partnership firm:

It is necessary to include profit of all partners in the income statements. Dividend is necessary to pay to all stakeholders that will show in the balance sheet of the company (Winch and Leiringer, 2016). Tax is necessary to pay by partnership firms so that net profit can be calculated by them it shows in the income statement.

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