Managing Financial Resource & Decision Assignment

Managing Financial Resource & Decision Assignment

Managing Financial Resource & Decision Assignment

Program

Diploma in Business 

Unit Number and Title

Managing Financial Resource & Decision 

QFC Level

Level 4

Introduction

For an organization it is of paramount importance to ensure that it is being run profitably. The profit of an organization is what drivers the stakeholders which includes the investors and the prospective investors. It is for this reason a finance manager of an organization has to understand the implications and the importance of procurement of funds and investment of the same. The main objective of this paper is to focus on the various tools and logics a manager takes into account while making such decisions.

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Task 1

P 1.1 Identify the sources of finance available to a business

Every business organization requires funds for its operation. The availability of funds is essential for the commencement of a business. On the commencement of a business adequate funds are required for various purposes and it is mandatory for every business. For the purpose of this discussion it has been decided to start a business that will involve in the manufacturing of paints and the business should be formed as a company. There are certain avenues available in the market that helps in acquisition of funds either in a direct or indirect way those avenues or means through which necessary funds are injected within the business. The various sources of finance available for a business can broadly be divided in two different categories, namely internal and external sources of finance (Groppelli and Nikbakht, 2012). The different sources of finance are stated below:

External sources:

  • Equity shares: Equity shares are regarded as the most popular route of generating funds for companies. Equity shares are the ordinary shares of a company and offer ownership rights to its shareholders. The equity shares are regarded as the only source through which an organization can acquire a substantial amount of funds. The equity share holders are offered dividends which are the regarded as shares of profit that are paid to them for making investment in the company.
  • Debentures: The capital structure of every organization is built with two different components namely owned funds and loan funds. Own funds are funds provided by the owners or the equity shareholders of the company on the other hand the debentures  are debt instruments that help in acquiring funds for the company in the form of debt. The debenture holders on the other hand are treated as the creditors of the company and instead of paying dividend to them they are paid interest for providing debt funds to the company.
  • Bank loan: Bank loan is also a form of debt in the hands of the company. An organization acquires required funds from different commercial banks in the form of debt. The commercial banks allows funds to different organizations in the form of debts and the companies taking debts from different commercial banks also required to pay interest to such banks at affixed percentage.
  • Hire purchase: Hire purchase is a method of acquiring an asset at an installment. Under the hire purchase method there remains two different parties the first one is the hire vendor who is the provider of the asset and the second one is the hire purchaser the company acquiring the asset. For acquiring an asset under hire purchase method it is required for the company acquiring such asset to pay a required amount of fund at different intervals as installments for acquiring the asset and on the payment of the last installment the hire purchaser gets an opportunity to be the owner of the asset.

Internal sources:

  • Owner’s capital: It is regarded as an essential source of finance for every organization and it is also regarded as the first source of funds for every organization. The funds of the owner are stated as the basic source of finance for every organization. This funds are the own funds of the owner that helps the business to grow at the initial phase.
  • Sell of asset: Assets are subject to obsolation, with the development of technology and the change of trend the assets of an organization become obsolete and also due to the natural wear and tear and with the passage of time they lose their value and at that time the company decide to sell those assets it helps in one hand to acquire essential funds for the company and on the other hand provides essential funds for the organization.
  • Release of stock: Stocks are often released at a discount, in the case of January sales as we can see that the stocks are released at a deep discount and that in other hand helps the organization to have essential funds.
  • Retained profits: Generally the profits of a company are distributed among the share holders in the form of dividends and the profits which are not distributed as dividends are retained within the organization and those funds later on are utilized by the company for further investment for the development of the organization (Hubbard and Calomiris, 1995).  

P 1.2 Assess the implications of the different sources

The different sources of finance have their individual implications and they are different from each other in terms of features and implications. The implications of different source of finance are stated below:

Equity shares:

  • The equity shares are ownership shares of a company. The equity shareholders are offered given ownership rights in the company.
  • The equity shareholders are the real owners of the company and the profits of the organization are shared among them.
  • The equity shares are risk free instruments the company is not required to take the risk of debt service obligations for acquiring funds through equity shares.
  • The equity shares are the ownership shares of an organization and dilute the control of the organization.
  • The equity shares are not debt instruments and that is why they do not arise any risk of bankruptcy for an organization.

Debentures:

  • Debentures are debt instruments issued by an organization and the holders of debentures are regarded as creditors of the organization.
  • The debenture holders are provided interest at a fixed rate for providing funds in the form of debt.
  • Debentures do not dilute the control in an organization as they do not offer any kind of ownership rights to the debenture holders.
  • Debentures act as tax shield for different organization as the interest paid by the organization to the debenture holders are tax deductible and as a result of that they help in reducing the tax liability of the concern.
  • The debentures are debt instruments that arises the risk of bankrupt for the organization as the failure in paying off the debenture holders can turn the organization bankrupt.

Bank loan:

  • Appropriate loan agreement is required to be prepared for acquiring bank loans.
  • The bank providing loan is paid an amount in the form of interest at a fixed percentage.
  • Loans are debt funds and do not provide any ownership right and as a result of that they do not dilute the control of the organization.
  • Bank loan creates the risk of bankruptcy as failure to pay back the loan amount can turn the organization as bankrupt.

Hire purchase:

  • A hire purchase agreement is required to be formed between the hire purchaser and the hire vendor.
  • The hire vendor is paid with installment for providing the asset on a hire purchase basis.
  • A hire purchase agreement is an agreement to purchase an asset at an installment and it does not dilute the control of the organization.
  • A hire purchase agreement does not arise any risk of bankruptcy for the organization, however on the failure of the hire purchaser to pay the required installment for the asset; the particular asset will be forfeited by the hire vendor.

Owner’s fund:

  • Owner’s fund is a risk free source of finance for an organization as the owner is not required to fulfill any obligation for utilizing this fund.
  • The owner’s own fund does not dilute the control in the company.
  • The owner’s fund is considered as a risk free source of finance and it does not create the risk of bankruptcy.

Sell of asset:

  • Proper sale deed is required to be formed by an organization while selling its assets.
  • The assets are sold at a lower rate than the normal rate.
  • The sale of asset does not dilute the control of the organization.
  • The sale of asset does not create the risk of bankruptcy as it does not create any debt for the organization.

Release of stock:

  • Stocks are released at a rate lower than the market rate.
  • It helps in providing short term funds for the organization.
  • The sale of stock does not dilute the control of an organization.
  • The release of stock is a mere off loading of stock and it does not create any risk of bankruptcy.

Retained profits:

  • Retained profits are a major source of finance for an organization.
  • The retained earnings are the portion of a company’s own profits and do not arise any kind of obligation for the organization.
  • Retained earnings do not dilute the control of the organization.
  • The retained earnings do not create the risk of bankruptcy for an organization. 

P 1.3 Evaluate appropriate sources of finance for a business project

A business project require funds for its operation and the sources of funds are available there that can be used by the business to fuel the requirement of the project. The different sources of finance have their own advantages and disadvantages. There should be enough planning for choosing the right sources of finance for an organization. The sources of finance are suitable for different business project and the present business is involved in manufacturing of paints. There is fund of £ 50,000, the estimated amount required for the particular project will be £ 500,000. The appropriate sources of finance for this particular business project will be:

  • Equity shares: Equity shares will be helpful for acquiring a considerable amount of fund for the organization. The organization is formed as a company so it will be feasible for it to acquire funds by the issuance of equity shares. An amount of £ 200,000 has been decided to be acquired through the issuance of equity shares.
  • Bank loan: A long term bank will be appropriate for the organization. A bank loan of £ 150,000 will be taken for the purpose of financing the project the bank loan is a debt fund that will not create any dilution in control of the organization.
  • Hire purchase: Hire purchasing is regarded as an indirect source of finance as it helps an organization in saving a huge amount of fund. And in this scenario too machineries worth £ 100,000 will be taken on hire purchase basis it will save a huge amount of money for the company that it had to expend in case of direct purchase.

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Task 3

P 3.1- Analyze budgets and make appropriate decisions

A budget is a statement prepared by different organizations as a scale that helps in forecasting the future expenses and revenues of the company. The objective of budgets is to frame the future steps of actions for a company and it acts as an instrument of control as the organization controls its performance by comparing the budgeted and the actual performance of the organization.

In this case the cash budget of Easy Electronics has been projected for the period a six months period from July to December 2013. The cash budget of the company has projected a that the cash balance of the company for the last three months that is for the months of October , November and December has turned negative which is not a healthy result for the company if the cash balance of the organization is negative that suggests that the company’s liquidity position is worsened (Taylor, 1996). This indicates a chance of bankruptcy of the company in future. The cash flow statement of the organization has projected the cash deficits chat can be regarded as the result of the following reasons:

  • The abnormal increase in the distribution cost of the company.
  • The capital expenditure incurred by the organization in the month of October.
  • A considerable increase in the variable overheads of the company.
  • Numerous expenditures in the form of corporation tax, payment of dividend and interest charges that have been incurred by the organization.

The most appropriate solution for this catastrophe can be the following:

  • The distribution cost should be distributed in every month equally as an average of the total cost.
  • The capital expenditure should have been made in installments instead of making a direct payment.
  • The company should deploy certain control measures in order to control its cost thereby by reducing its overheads.

P 3.2 Explain the calculation of unit costs and make pricing decisions

Particulars 

£'000

£'000

£'000

Sales

 

35,830

38,696.38

Less: Cost of sales

 

(18,878)

(22,653.60)

Gross profit

 

16,952

16,042.78

Profit from disposal of equipment

 

100

100.00

 

 

17,052

16,142.78

Less: Expenses

 

 

-

Administration cost (£2400 + £675)

3075

 

-

Distribution cost

3,481

(6,556)

(6,556.00)

Profit before interest and tax

 

10,496

9,586.78

Loan interest

 

(500)

(500.00)

Profit before tax

 

9,996

9,086.78

Less: Corporation tax @ 23%

 

(2,299)

(2,089.96)

Profit after tax

 

7,697

6,996.82

As per the new policy adopted by the company of reduction of the sales price by 10% the sales of the company has projected a hike of 20% which has increased the revenue of the organization but at the same time the reduction of sales price have also increased the cost of sales of the organization by 20%. That has actually reduced the overall profit after tax of the company from £ 7,697 to £ 6,996.82. This fall in the profit of the company cannot be regarded as a financially viable step for the organization and hence cannot be regarded adoptable for the company. Therefore the company should stay with its existing plan.

Every company whether manufacturing products or providing services is required to price its products. Pricing decision is a decision making that is framed with proper care and considering different factors. It is a vital function for an organization and tit should be done in an efficient way otherwise it would cause great trouble to the organization.

The unit price of a product is calculated by dividing the total of the direct and indirect cost incurred by the same with the number of units produced by the organization. in tjis case the unit costs will be calculated as:

Unit cost = 18,878,000+6,556,000/650,036

                = £ 39.12706/ unit

P 3.3 Assess the viability of a project using at least two investment appraisal techniques

Project A

         

Year

 

cash inflow

DCF - 10%

PV at 10%

0

 

-8000

 

1

-8000

1

 

2000

 

0.909091

1818.182

2

 

2800

 

0.826446

2314.05

3

 

3200

 

0.751315

2404.207

4

 

1200

 

0.683013

819.6161

5

 

800

 

0.620921

496.7371

6

 

500

 

0.564474

282.237

6

 

400

 

0.564474

225.7896

NPV

       

360.8185

           

Year

 

cash inflow

DCF - 15%

PV @15%

0

 

-8000

 

1

-8000

1

 

2000

 

0.869565

1739.13

2

 

2800

 

0.756144

2117.202

3

 

3200

 

0.657516

2104.052

4

 

1200

 

0.571753

686.1039

5

 

800

 

0.497177

397.7414

6

 

500

 

0.432328

216.1638

6

 

400

 

0.432328

172.9312

NPV

       

-566.675

By calculating the NPV of the cash inflows of the organization by discounting the same with its existing coast of capital i.e. 10% the organization has received a positive balance of £ 360,818 while discounting the same inflows by the 15% as the discounting factor the balance was a negative NPV of £ - 566,675. So it is quite visible to us that discounting the cash inflows with 10% seems to be a financially viable idea while taking the same as 15% is not as viable as the first one as the NPV is negative when the discounting factor is 15%.

Another investment appraisal technique can be regarded as the Accounting Rate of Return technique that efficiently finds out the average rate of return of an investment idea (Langdon, 2002). The ARR has been calculated below:

Year

CFAT(000)

0

(8,000.00)

1

2,000.00

2

2,800.00

3

3,200.00

4

1,200.00

5

800.00

6

500.00

Total CFAT

10,500.00

ARR

21.88%

It is found that the ARR of the cash inflow of the company is 21.88% which is higher than the cost of capital of the company which is 10%. Hence, the proposal can be accepted.

Task 4

P 4.1 Discuss the main financial statements

There are various financial statements that are prepared by different organizations as the results of their financial performance. The main financial statements that are required to be prepared by various organizations are mentioned below:

  • The statement of financial position: It is commonly known as balance sheet. It is prepared by different organization in order to project the financial position of the organization. Financial position of an organization is regarded as the position of assets and liabilities of the organization.
  • The income statement: The income statement clearly states the profit or loss of an organization in a particular financial year. The financial performance of the organization is projected through the income statement of such organization.
  • The statement of cash flow: The cash flow statement shows the cash flow of an organization it simply states the amount of cash inflows of an organization and at the same time the cash outflows of the organization from various activities which are segregated in three different types, namely, operating, financing and investing activities.
  • The statement of change in equity: The change of equity is regarded as a statement that projects the changes in the equity shareholding of an organization and at the same time it projects the retained earnings of an organization and the amount of dividend by the organization in a particular financial year.

P 4.2 Compare appropriate formats of financial statements for different types of business

Different business prepares their financial statements in different ways. For instance, the companies follow the rules prescribed by the IFRS and GAAP for the preparation of financial statements while a sole proprietor is not required to form his financial statements by adhering to the guidelines of those regulatory bodies. While a partnership firm is also free to prepare their financial statements in the way they wish but the adherence of the rules of IFRS and GAAP will be recommended in case the firm is intended in borrowing money from a bank, as the bank will require those statements and they should be formed as per the prescribed rules of different bodies (Mirza and Nandakumar, 2013).

In case of the a sole proprietor ship the balance sheet provides the information relating to the capital of the owner, while in case of  partnership firm the balance sheet will project the partners capital and the same for a company will show the balance of the capital provided by the shareholders. Moreover, in case of the partnership firm it is required to prepare the partner’s capital account that will provide information relating to the drwing and interst on capital of each partner.

P 4.3 Interpret financial statements using appropriate ratios and comparisons, both internal and external

Financial ratios help an organization in obtaining various ideas regarding the performance of the organization. The ratios helps in projecting the performance of the organization in various ways say, for example, the position of solvency, the position of liquidity, the operating ratios etc. In this part of the discussion the comparison of the financial ratio between the two most renowned supermarkets in the UK namely, J Sainsbury and W.M. Morrison will be conducted.

The comparison of the different financial ratios of the two different companies is presented below:

NetAssets Turnover

2011

2010

Change

WM Morrison PLC

2.34

2.35

-0.42%

J Sainsbury PLC

2.42

2.5

-3.20%

Ratio analysis as a tool enables to conduct the performance analysis of different businesses or a single business over time. The various stakeholders of an organization are not always aware of the various finance jargons. Hence, ratio analysis helps to analyze the performance of the organization in a summarized form. The tool of ratio analysis has been used in this context to analyze the performance of Sainsbury and WM Morrison.

  • Current Ratio: The current ratio shows or indicates the liquidity condition of the organization. It shows the number of times the current liabilities can be paid off with the help of the current assets at the disposal of the organization. The current ratio J Sainsbury is better than WM Morrison.
  • Liquidity ratio: Also known as the quick ratio helps to understand the quick debt paying ability of the organization. The quick ratio only takes into account the quick assets of the organization for the purpose of paying off the current liabilities. The quick assets are those assets which are readily convertible to cash and hence inventories don’t form a part of this ratio. The quick ratio of J Sainsbury is better than Morrison.
  • Gross profit: The gross profit ratio of an organization indicates the operational efficiency. It takes into account the sales, purchases and the market labour cost or in other words the cost of conversion. It does not take into consideration the indirect costs. The gross profit ratio of Morrison is better than that of J Sainsbury. Though the organization’s GP ratio has fallen from 6.97 to 6.89 it is better off than that of Sainsbury who’s GP Ratio as of 2011 was 5.43.
  • Net Profit: The net profit ratio of Morrison has increased by 0.06 as compared to the year 2010. The same has decreased in the case of Sainsbury. Sainsbury’s ratio has decreased by 0.34 which indicates the increasing cost of sales.
  • Interest Coverage Ratio: The interest coverage ratio indicates the debt paying capacity of the organization. The interest coverage ratio takes into EBIT of the organization and the interest obligations. A higher Interest Coverage Ratio is favorable. In case of Morrison the ratio has fallen from 21.33 to 6.09 and lesser than Sainsbury’s ratio.

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Conclusion

As is evident to operate a business a manager needs to take into account all the facets of the organization starting from procurement of funds, investing the same till the presentation of the financial results to the various stakeholders of the organization. Hence, a finance manager has to understand the various tools available at his disposal in order to make informed decisions. 

References

Clayman, M., Fridson, M. and Troughton, G. (2012). Corporate finance. Hoboken, N.J.: John Wiley & Sons.
Dorval, D. (2004). Financial success for the rest of us. Lincoln, Neb.: IUniverse, Inc.
Gil-Lafuente, A. (2013). Decision making systems in business administration. Singapore: World Scientific.
Groppelli, A. and Nikbakht, E. (2012). Finance. Hauppauge, N.Y.: Barron's.
Hubbard, R. and Calomiris, C. (1995). Internal Finance and Investment. Cambridge, Mass.: National Bureau of Economic Research.
Johnstone, S. (2010). Labour and management co-operation. Burlington, Vt.: Gower Pub.
Langdon, K. (2002). Investment appraisal. Oxford, England: Capstone Pub.
Mirza, A. and Nandakumar, A. (2013). Wiley international trends in financial reporting under IFRS. Hoboken, N.J.: Wiley.

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