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In times of financial turbulence like recession things like negative impact on economy, restricted flow of funds and society getting impacted in form of pay cuts, loss of jobs become common. In a similar circumstance faced by us where we are also forced to quit our job and left barren. To keep up the pace with life we are planning to start our own business. Business to be started up requires an initial investment in form of capital. With the personal saving of £ 50,000 I am looking for an additional funding of £ 1 million to begin my business.
Business is an activity which requires the mobilisation in the form of funds. Success of operations depends upon the quality of management to make available to them the funds and resources necessary to achieve the desired objectives. Thereby, finance becomes a very critical area of resort management evaluation. It requires a wise approach to ensure that the funds are procured from a source and for a tenure that is convenient for the organisation. A critical evaluation of the same is being done underneath.
P1.2 The implications of different types of sources of finance
Sources of Finance/Implications
Issue of Equity Shares has to be as par the legal guidelines set out by the companies act,2006 or any other legal statue in effect thereof
Debentures too are issued only in accordance with the Companies act,2006 and the power of the debenture holders is also defined by the statue
Term Loans are procured from commercial banks and large financial institutions. Thus, there is not set regulation curbing or monitoring the availing of term loan by an organisation
Retained earnings are an internal source of fund generation. Thus organisation specific guidelines only are effective in case of retained earnings and no other legal statue monitors the same
Lease financing is done between the lessor (organisation) and the lessee (lease provider) they may or may not enter into a formal contract for the same. Thus legal implications of the same depend upon the nature of contract entered into.
Hire purchase is a debt undertaking and is obligatory for the organisation
Its an organisation specific measure to generate funds and has no separate legal implication associated.
Equity shares form the core capital base of the organisation and they are also important basis of funding for heavy capital intensive proposals or expansion program’s. Return to equity shareholders is the dividend on net profit earned by the business and is an appropriation of profits
Debenture holders are entitled to a fixed interest on the face value of debentures held by them.
Term loans also are required to be catered with a fixed interest charges as the cost of financing and is an obligation for the organisation to cater periodically
There are no financial implication of retained earning other than reduction in the final profits available for distribution to shareholders
Lease rental is the financial implication created upon entering into lease financing.
The payment of installment which includes the interest is a financial implication of entering into a hire purchase contract.
There are usually no major financial implication of such measure of generating funds.
Dilution of Control
Equity shareholders are owners and they have a say in the management due to the virtue of the voting rights associated with the shares held by them. Issue of equity shares thus leads to dilution of existing control of management
There is no dilution of control
There is no impact on control pattern
There is no dilution of control
There is no dilution of control
There is no dilution of control
There is no dilution of control
Equity shares do not pose any considerable bankruptcy threat as the dividend payable to them is not obligatory but is voluntary.
Default in interest payment on debentures (which is a secured debt) starts to recur it may pose a financial crunch this may force bankruptcy
Non-payment of installments in lieu of loans starts recurring and may pose a financial crunch thus may force to stage of bankruptcy
Retained earnings usually do not have any bankruptcy threat integrated in them
A lessor may not force an organisation to stage of bankruptcy but regular defaults in payment of lease rentals may put entity into financial threat
No direct bankruptcy threat associated with such a financing.
Usually no serious bankruptcy threat associated.
P1.3 Analysis of the appropriate sources of capital
The sources of finance are categorized in two different types, which are:
- Internal sources
- External sources
Internal sources- Internal sources of financing are present intra organisation ex, retained earning etc. the advantage of internal sources of funds is:
- Flexibility: The organisation may use them for whatsoever purpose they deem fit i.e. either short term or long term.
- Cost: The cost of procuring such finance is usually, the cheapest of all
External sources- Financing from external sources is the finance procured form sources external to the organisation. This sources of finance and funding can be availed in the form of issue of shares, debentures, bank loans, hire purchase, lease financing etc. (Hussain, 1989)
The advantages of external sources are:
- Large fund: External sources are a major source of generating large funds. Internal sources are majorly generated by accumulation so immediate huge fund requirement is met only by procuring funds through external sources.
- Process of acquisition of funds:Raising funds via internal sources is comparatively more time taking than generating via external sources.
- Retained earnings: Retained earnings are that portion of profit that is retained by the company for its own use i.e. not apportioned to the shareholders.
- Retained earnings helps the organisation to become self-sustained and enables it to be saved from any unforeseen astringencies in financing. It helps in strengthening the liquidity position of the organisation.
- Implications: Continuous retention would hamper the funds available to the shareholders and thus impact there earnings, this might become negative to the shareholders sentiments.
- Equity shares- Equity shares are regarded as common stock of the business. The holders of equity enjoy exclusive rights like voting, sharing of profits etc.
- The company need not pay any financial accounting charges like interest for procuring funds via equity shares.
- It market capitalisation of the company and hence enhancing its overall credit worthiness
- These are a permanent source of finance as they are redeemable only at the time of liquidation.
- A huge base of equity shares affects the overall control of the company.
- They are not liquid in nature.
- Debentures are a loan stock which are issued by a company for a fixed tenure and requires a payment of fixed monthly interest thereon.
- The flotation cost of issuing debentures is cheaper than any other mode of public subscription.
- The interest payment on debentures helps in saving tax as it is tax deductible.
- Debt financing does not impact the control pattern of the organisation.
- Huge financing by debt creates a heavy financial obligation on the organisation and this may cause a financial distress.
- Procuring them is the simplest of all.
- It helps in saving tax as the interest paid on them is tax deductible.
- Sometimes it becomes very complicated to procure a bank loan.
- The rate of interest payable on a bank loan is comparatively higher.
P3.1 Analysis of budget
Easy Electronics ltd Budgeted Profit and Loss Account for the six month period ending 31December 2013.
Less: Cost of sales
Profit from disposal of equipment
Administration cost (£2400 + £675)
Profit before interest and tax
Profit before tax
Less: Corporation tax @ 23%
Profit after tax
The analysis of Income statement of Easy Electronics Limited has given us the following observations, It may be seen that Easy electronics limited is having a gross profit ratio of 47.3%. This is a satisfactory margin. Howsoever it might be able to benefit a lot if it considers the option of volume sales rather than margin sales. The operational expenses of the business strategy are howsoever a matter of concern with a net profit ratio of 21% it shows that company may be able to retain more of its profit if it could manage its operational expenses to an extent.
Easy Electronics ltd Cash Flow Forecast for July to December 2013
Receipts (in flows)
Receipts from cash sales
Receipts from Debtors
Receipt from disposal of fixed asset
Total receipts (A)
Payments (out flows)
Payments to trade creditors
Salaries and wages
Administrative cost (excludes monthly depreciation £100,000 for July - Sept and £125,000 for Oct - Dec )
Interest and other finance charges
Total payments (B)
Net cash flow (surplus or (deficit)) C = (A-B)
Opening cash balance (D)
Closing cash balance (C+D)
The cash budget of Easy Electronics Limited has given us several observations that are helpful in decision making and analysis as mentioned underneath, It may be seen that ABC limited is experiencing a positive rise in the cash generated from business activities i.e. the revenues. A rise in the cash flow is a positive signage for the operational management.
The expenses for the period also show a sheer rise. The matter of concern here is that the rise in expenses is at a greater rate than the rise in income, which has ultimately created a situation of negative or very less returns in the month of October, November & December. Circumstances like these call for a management attention as if these if not fixed may move on to pose a threat on over all organisational sustainability because the rise in expenses would ultimately drive away all the vale addition made by sales and other sources of revenue.
P3.2 Calculation of Unit Cost and Pricing Decision
The analysis of the proposal of Easy electronics limited to effectuate a price cut is being analysed below Under Existing Situation,
Less: Cost of sales
Revenue Per Unit
In the current situation where the company is selling its products at a market price of 55.12 the company is decision making net revenue of 16 per unit. If the proposal to effectuate a price cut of 10% per unit is being effectuated,
(55.12*90%) * (650,036*120%)
Less: Cost of sales
Revenue Per Unit
If the management decides to reduce the price per unit by 10% to 49.6 is expected to increase the sales by 20%. Howsoever due to the rise in costs by 20% the overall sales increase appears to be nullified and hence the revenue per unit is reduced to 12. Thus, it is not advisable to implement the proposal.
P3.3 Project Appraisal
Statement showing analysis of the proposal
Cash out flow
PV of cash flow
Overall NPV of The Project
Internal Rate of Return
The investment appraisal techniques used for the analysis of aforesaid investment proposal are Net Present Value (NPV): The NPV technique is the most tested and accepted investment appraisal technique it denotes the present value of benefits a proposal is expected to generate.
The decision making criteria of NPV Technique is = Accept a proposal if it has a positive NPV, more specifically choose a project which yields the maximum NPV. (Kapil, 2013)
The formula for its computation is,
NPV= PV of Cash Inflows – PV of Cash Outflows The NPV for the aforesaid proposal is 358,000 since it is observed that the proposal is generating a positive cash flow hence the proposal may be accepted.
Internal Rate of Return (IRR): This technique is another most tested investment appraisal technique. The IRR technique gives the rate at which the net cash inflows equal the net cash outflows. In other words IRR is the discounting factor at which the Net Present Value becomes 0. The decision making criteria for IRR is to accept a proposal if the IRR is greater than the discount rate, if less than the discount rate than reject the proposal.The IRR for this project is 11.83% which is greater than the discount rate of 10%. Hence, the proposal may be accepted.
P4.1. The main financial statements
Financial statements for a company are a mirror image for the operations undertook by it in a given fiscal, the financial statements depict the monetary effects of the managerial operations & activities undertaken thereof, the financial statements of a company constitute of:
- The balance sheet: The balance sheet is a statement representing the status of the assets and liabilities held by an organisation. The balance sheet contains the status of fixed and current assets and long & short term liabilities and the shareholders fund.
- The Profit and Loss account: The profit and loss account is a statement representing the revenues, cost and expenses incurred by a business during a period. It’s a statement showing the cost of running the operations less the revenues. (Fraser and Ormiston, 2001)
- Cash flow statement: The cash flow statement represents the effect of on the cash flows of a business due to its operations. It should be known that profits levels do not directly impact cash flows. As in, a company may be profitable but a cash crunch may force it into the stage of bankruptcy. The cash flow statement depicts the following vital information.
- Cash from operating activities: It depicts the cash generated from business operations.
- Cash from investing activities: It depicts the cash generated from the investing activities like buying or selling of assets.
- Cash from financing activities: The cash generated from activities like issue and redemption of shares and debentures, repayment of long term etc. are depicted under this head.
P4.2 Formats of Financial statements for different types of business
Financial statements are the mirror to any organisations operations. The financial statements depict the degree of efficiency of operational performance. The preparation of financial statements is governed by different statues and regulation in different parts of the world. A listed company for instance needs to prepare its financial statements in the format prescribed by the UK financial accounting standards or GAAP’s and the Companies act, 2006.For the purpose of our discussion we shall divide the types of organisation that are expected to prepare their financial statements and see what are the type of statements they are expected to prepare, the types of organisation are,
Listed Company: A listed company is expected to prepare the following records as its financial statements,
- Balance sheet
- Income statement
- Statement of changes in equity
- Cash flow statement
- Accounting policies and disclosure notes
Partnership Firms: the format of preparation of financial statements by a partnership firms is not governed by any specific statue as such. In case of a partnership firm the addition or depreciation of profit and losses are made from the partner’s capital. (Fraser and Ormiston, 2010)
Partnership firms also tend to practice to maintain a fixed and a fluctuating capital balance system where the fixed capital usually remains fixed in the operational course of business and fluctuating capital is the capital from where all capital adjustments like drawings, salary to partners etc are usually made.
3. Sole Proprietorship Firms: A sole proprietorship firm is also not covered under any specific statue guiding the preparation of their financial statements. They may choose to prepare a trading account which depicts the revenues/income on one side and expenses on the other, to reach to the profit/loss earned during a fiscal under consideration.
P4.3 Ratio based Financial Analysis
WM Morrison Supermarkets
J Sainsbury Plc
Liquidity or Short term Solvency Ratio
Average Collection Period
Creditors Payment Period
Asset Management Ratio
Stock Turnover Ratio
Gross Profit Margin Ratio (%)
Net Profit margin Ratio (%)
Return On Assets (%)
Berry Ratio (%)
Return on Capital Employed (%)
Debt Management Ratio
Gearing Ratio (%)
Interest Coverage Ratio
Current Ratio: It represents the capability of the organisation to cater to its debt payments. It is computed by the formula,
Current Ratio= Total Current assets / Total current liabilities
None of the organisation is seen to have the ideal ratio moreover the current ratio for WM Morrison and J Sainsbury have almost been similar. Howsoever J Sainsbury is observed to have a better debt management system overall as its current ratio is slightly better than WM Morrison
Liquidity Ratio: Liquidity ratio depict the capability of the organisation to pay its short term debts as and when they fall due. It is computed by the formula,
Liquidity Ratio = (Total current assets- inventory) / (Total current liability – Bank Overdraft)
The absolute liquidity ratio for J Sainsbury has been higher than WM Morrison. A better liquidity ratio signifies a better liquidity risk management of J Sainsbury in comparison to WM Morrison.
Average collection period: It represents the number of days taken by company to recover cash from its debtors. The formula for computing it is,
Average collection period = (Receivable*365) / Sales
Lower is preferable because inability to collect funds from debtors is an opportunity cost to the organisation. WM Morrison has funds locked in with debtors for comparatively greater number of days than J Sainsbury this signifies that J Sainsbury has better debt collection system.
Creditor payment period ratio: Account receivable ratio measures the company’s efficiency in paying its trade creditors. It is computed by the formula,
Creditors Payment Period Ratio = (Accounts Payable* Number of Working Days)/Net Credit Purchases Both the organisation take a lot of time to pay its creditors this is not advisable as this may result in loss of suppliers trust & overall marketing strategy goodwill.
Asset Management Ratio:
Stock turnover ratio: It depicts how many times a company’s inventory is sold over and replaced, generally computed by,
Stock turnover ratio = Sales/ Inventory
The inventory turnover ratio for both of the companies has been almost similar with a slight difference existing. A low ratio implies poor sales and thus excess inventory. A high ratio signifies strong sales or ineffective buying.
- Gross profit margin ratio: This ratio tells the gross profit generated out of every pound of revenue. Formula for computing this is,
- Gross profit margin ratio = (Gross profit/Total sales) *100 WM Morrison has a better gross profit ratio than WM Morrison in both years. The gross profit ratio of J Sainsbury fell by 0.075 than 2010 whereas the gross profit ratio for WM Morrison decreased by 0.09 % in comparison to 2010.Higher ratio signifies a better expense management.
- Net profit margin ratio: This ratio signifies the net profit generated out of every unit of pounds earned. The formula for its computation is,
- Net profit margin ratio = (Net profit/Total sales) *100 It may be seen that Profit margin for WM Morrison is higher than J Sainsbury for all of the years. A lower net profit denotes lower margin of safety.
- Return on assets: This ratio depict the return generated on every unit of assets held by the organisation. It represents the management’s efficiency in using its asset to generate profits. (Horrigan, 1978) It may be seen that ROA for WM Morrison is higher than J Sainsbury for 2011 as well as 2010.
- Berry Ratio: It is the ratio between the gross profit earned and the operating expenses. A higher ratio means the firm is more profitable. The formula for its computation is,
- Berry Ratio =Gross Profit/ Operating Expenses The berry ratio of WM Morrison has been better than J Sainsbury which depicts its better profitability status than J Sainsbury.
- Return on Capital Employed: This ratio measures a company’s profitability and the efficiency with which capital is employed. It is computed by the formula,
ROCE = EBIT/ Capital Employed A stable ROCE is assumed to be the basis of analysis and decision making the ROCE for WM Morrison has increased by 0.11 % in comparison to 2010 whereas, J Sainsbury’s ROCE went down by 0.9 % than 2010.
Debt management ratio
- Gearing Ratio: Gearing ratio is a financial ratio that compares some form of Capital to borrowed funds. It is a measure of financial leverage. Higher the gearing ratio higher is the risk of financial distress. J Sainsbury has a very high gearing ratio in comparison to WM Morrison for both of the years this is a symbol of possible liquidity threat that J Sainsbury might have to face in case of a financial astringencies.
- Interest Coverage: This denotes the ability of the organisation to pay the interest on its outstanding debt. It is computed by,
- Interest Coverage = EBIT/ Interest Charges for the period Ideally it should be over 1.5.Interest Coverage ratio of WM Morrison has seen a sheer decline in 2011, J Sainsbury’s interest coverage ability also may be seen to have reduced over the period.
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Adams, C. (1977). Appraising information needs of decision makers. 1st ed. San Francisco: Jossey-Bass.
Cousins, D. and Piper, A. (1970). Costing. 1st ed. London (St Paul's House, Warwick La., and E.C.4): Teach Yourself Books.
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