Unit 2 Assignment on Managing Financial Resources and Decisions

Unit 2 Assignment on Managing Financial Resources and Decisions

Unit 2 Assignment on Managing Financial Resources and Decisions

Program

Diploma in Business

Unit Number and Title

Unit 2 Managing Financial Resources and Decisions

QFC Level

Level 5

Introduction

Business require finance for different purposes such as to start new business, expand their existing business activities, running business activities and many more. For this purpose there are various sources available that get discussed in the below report. Business chose the adequate source to raise the funds that fulfil their desire. Flow of funds put adequate impact over their financial statements and impact will get discussed in the below report. Telco get the opportunity to expand their business by taking other business in telecom industry for this purpose they make use of investment appraisal techniques that get discussed below in the report. Telco tends to overtake the Malcom plc. and for its evaluation they will make use of financial reporting ratio analysis.

Task 1 (Scenario part a)

1.1 Identify the sources of finance available to a business (at least 3 long-term and 2short-term). 

The available sources of finance for Telco in order to make expansion of their business are discussed below such as: -

  • Long term sources: These are such sources that get utilised for a longer period of time. Time duration is more than one year.
  • Short term sources: These are such sources that get utilised for a short period of time. time duration is less than one year (Radu, 2013).

Long term sources of finance are as follows such as: -

  • Right issues: - It is the process of issuing new shares and with the issue of shares existing shareholders have effective right to make purchases of new shares. If someone not want to purchase then they are free to transfer or sell their rights to others (Radu, 2013).
  • Retained profits: - It is the process in which Telco make effective savings out of their profits and put into reserves. This is long term source of finance that get utilised for their business expansion motive.
  • Loan stocks: - These are such shares in business that get pledged as collateral for a loan. For lender this type of collateral is most valuable as during the period when shares are publically traded on a stock exchange and didn't get restricted and their shares get sold for cash easily (Radu, 2013).

Short term sources are as follows such as: -

Hire purchase: - It is the process in which Telco make purchases of the required equipment on instalments by paying small amount at the time of purchase. The remaining amount is paid in the small instalments for a specific period of time (Ruckova, 2015).

Debt Factoring: - It is the process of collecting the debt amount from the market related to their business activities. It helps in getting the quick liquid funds for supporting the business activities. It is the short term finance and helps in gathering adequate funds (Ruckova, 2015).

1.2, 1.3 Compare and contrast a rights issue of shares and loan stocks. 

There are effective differences between the rights issue of shares and loan stocks such as: - 

Right issue of shares

Loan stocks

It is the part of the equity capital

It is the part of their debt financing.

It decreases the capital gearing ratio as it increases the equity capital.

It increases the capital gearing ratio as it increases the debt capital.

With the issue of right issue of shares there is effective increase in the dividend payment.

By taking loan stocks business need to pay interest amount over it at a fixed rate of interest.

Amount get utilised till the liquidation of the business organisation.

It must be repaid within the agreed time period.

It make dilution of the ownership.

It didn't make dilution of ownership.

The payment of dividend didn't provide any tax relaxation benefit.

The payment of interest provide tax relaxation benefit.

1.3 Explain which source of finance in (b) above would be more beneficial for the buildings and noncurrent assets. 

Loan stocks are much beneficial source of finance for the purpose of buildings and non-current assets. Loan stock is denoted as the long-term capital that get arranged by the company and agreed to pay interest at adequate rate of interest. Loan stock holders get termed as the long term creditors for them as they get repaid after a long period of time. With the use of it Telco get the tax relaxation benefit as the interest paid over the loan amount get deducted from the taxable amount that reduces their tax liability. It increases their creditability and it also didn't lead to make any control dilution as the loan funds get repaid after a set period of time. It can be arranged again after the repayment of existing loan after its maturity (Morana, 2014).

It is easy to raise funds with the help of the loan stocks as loan holders get their funds after the specific time period and for that period they get adequate level of funds in the form of interest. It is a secured loan amount as it get repaid after a set time period and for that time period they pay fixed rate of interest (Morana, 2014).

1.3 Advise the Board of Directors on a source of finance for working capital.

Below sources of finance get utilised for working capital such as: -

Sources

Description

Advantages

Disadvantages

Bank loan

Telco took the loan from the banks in order to support their business expansion.

  • It is easy to get against the securities.
  • It increases the creditability.
  • It provide tax relaxation benefit.
  • It increases the capital gearing ratio.
  • Instalment amount need to be paid on regular basis and failure lead to bankruptcy.

Right issues

Telco make issue of the right shares for raising additional capital to support their business expansion plan.

  • It didn't create any liability over Telco.
  • Additional capital get raised easily.
  • It reduces the capital gearing ratio.
  • It increases the dilution of control.
  • It didn't provide tax relaxation benefit.

Retained profits

Telco make use of the funds they put into their reserves.

  • It didn't create any kind of liability over Telco.
  • It didn't dilute the ownership of Telco.
  • It lower down the capital gearing ratio.
  • It reduces the amount utilised for the giving dividends that make their shareholders sometime unsatisfied.

Task 2 (Scenario part b)

2.1,2.4,4.1 Advise the Board of Directors which of the three financial plans might best benefit the shareholders using Weighted Average Cost of Capital (WACC) and explain how these financial plans will impact on the financial statements. 

Option 1: -

Existing equity capital = £5,000,000

New issue of shares = 2,000,000 * 3 = £6,000,000

Total equity capital = £11,000,000

Cost of capital = Ke * (equity capital/total capital) + Kd * (Debt capital/total capital)

= 14% * 11,000,000/11,000,000 + 0%

Cost of capital = 14% (Barth, et. al., 2013)

Option 2: -

Existing equity capital = £5,000,000

Loan stocks = £6,000,000 at 5% interest rate

total capital = £5,000,000 + £6,000,000 = £11,000,000

Cost of capital = Ke * (equity capital/total capital) + Kd * (Debt capital/total capital)

= 14% * (£5,000,000/11,000,000) + 5% * (6,000,000/11,000,000)

= 6.36% + 2.72% = 9.08%

Cost of capital = 9.08% (Barth, et. al., 2013)

Option 3: -

Existing equity capital = £5,000,000

New issue of shares = £3,000,000

Loan stocks = £3,000,000 at 5% interest rate

total capital = £5,000,000 + £3,000,000 + £3,000,000 = £11,000,000

Cost of capital = Ke * (equity capital/total capital) + Kd * (Debt capital/total capital)

= 14% * (£8,000,000/11,000,000) + 5% * (3,000,000/11,000,000)

= 10.18% + 1.36% = 11.54%

Cost of capital = 11.54% (Barth, et. al., 2013)

Option 2 is preferred for the purpose of raising funds.

The impact of the all three options over the financial statements is discussed below such as: - 

Options

Profit and loss account

Cash flow statement

Balance sheet

Issue of 2,000,000 new shares at £3

The ratio of dividend get increased with this effect that reduces their profit share.

The inflow of funds get recorded under financing activities as it increases the cash balances.

The issue of shares increases the share of their equity capital.

Loan stock of £6,000,000

The ratio of interest get increased and recorded under expenditure section.

The inflow of funds get recorded under financing activities as it increases the cash balances.

The loan stocks get increases the debt balance as it get recorded under liabilities.

Issue of new shares 1,000,000 at £3.

Loan stocks of £3,000,000

The ratio of dividend as well as interest paid get increased and recorded under expenditure.

The inflow of funds in the form of equity shares and loan stocks and get recorded under financing activities. The payment of interest and dividend decreases the cash balance of financial management.

It increases the debt capital and equity capital in effective manner and helps in maintaining adequate balance in their capital gearing ratio.

2.3, 4.3 Given that the Profit before interest and tax (PBIT) of the proposed investment is estimated at £840,000; calculate the company's current earnings per share (EPS).

Profit Before interest and tax = £840,000

Less interest = 0

Less Tax = £252,000

Earnings after tax = £588,000

Less dividend = £150,000

Earning for shareholder = £438,000

Number of shares = 5,000,000

Earnings Per Share = Earning for shareholder/Number of shares

= £438,000/5,000,000

Earnings per share = 0.0876

(Blanco, et. al., 2015)

Task 3 (Scenario part c)

3.3 Explain the benefits of net present value (NPV) method of appraisal.

NPV or Net Present Value: - It is the investment appraisal technique that get utilised for evaluating the profitability of the project by comparing the net present value of their cash inflows and their initial investment. Higher the positive difference higher the profitability and lower the difference lower the profitability. It the amount is negative or lower than the initial investment it renders only loss to the organisation (Abazari, et. al., 2013).

Benefits of the NPV are as follows such as: -

  • While calculating it gives importance to the time value of money.
  • In the calculation procedure it makes effective inclusion of time period whether it is before cash flow or after cash flow.
  • It renders high priority to the factors related to project such as profitability and risk.
  • It helps in maximising the firm's value.
  • It helps in decision making related to the projects and investments as negative NPV get rejected immediately (Abazari, et. al., 2013).

(b) Use the following investment appraisal techniques to calculate for the Brunei’s investment opportunity:

3.3  The payback period. 

Pay-back period: The time period in which the amount of initial investment is recovered in the form of cash inflows termed as pay-back period. Pay-back period is utilised to measure the associated risk with the investment or project as lower time period shows that investment is less risky whereas higher time period shows that investment is high risky (Hall & Westerman, 2013).

Below is the calculation of the pay-back period such as: -

= 3 + [(24,412,500 - 20,000,000) / 6,750,000]

= 3 + [4,412,500 / 6,750,000]

= 3 + 0.65

= 3.65 years (Hall & Westerman, 2013)

Payback period is 3. 65 years or 3 years and 7 months

3.3 The net present value.

NPV: - It is the difference amount among the investment made and the net discounted cash flows. When the amount of discounted cash inflows are higher than initial investment amount then it get termed as positive NPV or profitability of project and if the amount of initial investment is higher than discounted cash inflow then it get termed as negative NPV or loss. Positive NPV investment or projects get preferred (Mukherjee & Al Rahahleh, 2013).

Year

Revenue

C.I.(10% of revenues)

P.V. @ 8%

Discounted C.I

0

0

-20,000,000

1

-20000000

1

45,000,000

4,500,000

0.926

4167000

2

54,000,000

5,400,000

0.857

4627800

3

67,500,000

6,750,000

0.794

5359500

4

77,625,000

7,762,500

0.735

5705437.5

4

0

2,000,000

0.735

1470000

 

 

 

NPV

1329737.5

(There is an amount of £2,000,000 shown as C.I. in fourth year is residual value)

Formula of NPV = Total of Discounted cash inflow - Initial investment

Total of discounted cash inflow = 21,329,737.50

Initial investment = 20,000,000

= 21,329,737.50 - 20,000,000

NPV = 1,329,737.50 (Mendes-da-Silva & Saito, 2014)

3.1,3.3 Using your answers to part (b) evaluate each investment opportunity and make your recommendation to the Board of Directors. (LO 3.1, 3.3)

Telco attain some share of information in context to the investment opportunity such as: - 

Basis

Talk mobile in Indonesia

Vocal-phone in Brunei

Initial investment

£27,500,000

£20,000,000

Pay-back period

2.45 years

3.65 years

NPV

£4,275,000

£1,329,737.50

NPV %

15.55%

6.65%

As per the attained results over the two investment opportunities it is concluded that investment opportunity of takeover Talk mobile in Indonesia is preferred over Vocal-phone in Brunei. The reason behind this decision is that firstly the investment made in Talk mobile in Indonesia is less risky as compare to the vocal-phone in Brunei on the other hand it is also highly profitable as compare to the vocal-phone in Brunei.

The comparison among both investment is not made fairly as the investment amount is not similar but then also by comparing the NPV percentage it is clearly observed that NPV earned by the talk mobile in Indonesia is 15.55% which is more than double to the NPV earned by the vocal-phone in Brunei is 6.65%. With this investment opportunity in Talk mobile in Indonesia is less risky as funds get recovered in 2.45 years whereas they took around 3.65 years which shows that they are bit riskier as compare to them (Baker & English, 2013).

Now it is recommended that management of Telco make investment in order to take over the Talk Mobile in Indonesia (Baker & English, 2013).

3.2 Define the concept of unit cost and explain briefly how they can be calculated. 

Unit cost: - The cost that get incurred during the manufacturing process of the one unit product in the form of direct and indirect cost is termed as the unit cost. Direct costs make inclusion of the cost of material, cost of labour and other direct costs and indirect costs make inclusion of fixed costs.

In order to calculate the unit cost there are two effective methods are available that follows different techniques to make calculation of the unit costs such as: -

  • Marginal costing: As per this costing method the unit cost is calculated by adding all the available direct costs and overheads. It doesn't make inclusion of indirect costs or overheads in the calculation part (Puri, 2014).
  • Absorption costing: As per this costing method the unit cost is calculated by adding all the available direct costs and overheads along with all indirect costs and overheads. It include all the costs incurred over the manufacturing process in order to produce a single unit. This provide effective base for setting profit margin and fixing final price (Puri, 2014).

For example: -

Direct labour cost = £10
Direct material cost = £15
Direct overheads = £5
Fixed costs = £15
Fixed overheads = £5

Particulars

Marginal costing

Absorption costing

Direct labour cost

£10

£10

Direct material cost

£15

£15

Direct overheads

£5

£5

Fixed costs

0

£15

Fixed overheads

0

£5

Unit cost

£30

£50

3.2 Discuss what factors should be taken into account by an organisation such as Telco when setting prices for their output.

Telco follow the cost plus pricing method in their pricing decision making as they add up all available costs whether they are direct or indirect (variable costs and fixed costs) along with a mark-up amount of profit. There are various factors that get considered at the time of pricing by the management of Telco such as: -

Understand the customers value: - During setting prices there is effective need of understanding the customers value as they need to set the reasonable prices for their products so that huge number of customers make purchases of their products and helps in attaining high revenues (Schmidlin, 2014).

Understand your costs: - During pricing there is effective need of understanding the cost as it helps in analysing that the cost incurred over their product is high or low. If they attain high cost then they need to minimise their profit margin to make their price competitive in market. And if they attain low then they set such price that helps in getting high profits and competitive enough in comparison to their competitors.

Understand your competitors price: - In pricing decision making it is necessary to understand the price of competitors as it helps in setting adequate level of price due to which they are not in the situation of losing their customers. If price is set much higher as compare to their competitors price then customer's doesn't prefer to purchase their product. And if the put low prices then they face problems in recovering their unit cost incurred (Schmidlin, 2014).

Consider transparency: - Telco management have to provide adequate level of transparency in setting their prices so that their customers get attracted towards their products and prefer them over their competitors in effective manner. It helps in making effective comparison among the products such as discount rates, different packaging and many more (Robinson, et. al., 2012).

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Task 4 (scenario part d)

2.2, 2.3 Comment on the main trends and messages contained within the cash flow. 

Cash budget is as follows such as: - 

Particulars

Jan

Feb

March

April

May

June

'000

'000

'000

'000

'000

'000

Sales

4,000

4,500

4,980

7,200

7,800

3,900

Payments

 

 

 

 

 

 

Wages & salaries

2,800

2,800

2,800

3,900

3,900

3,900

Supplies

1,240

1,520

2,150

2,360

2,830

3,890

Rent and rates

280

280

280

280

280

280

Advertising

200

200

200

200

200

200

Miscellaneous

30

30

30

30

30

30

Total payments

4,550

4,830

5,460

6,770

7,240

8,300

Net receipts/ (Payments)

-550

-330

-480

430

560

-4,400

Balance B/F

2,000

1,450

1,120

640

1,070

1,630

Balance C/F

1,450

1,120

640

1,070

1,630

-2,770

Trend: - By analysing above prepared cash budget it get realised that revenues and payments both shows increasing trend as there is adequate level of increment is noted down in both sections. By looking at the revenues it is analysed that there is inconsistent increase is noted down. There is no significant increase is observed in revenues along with this in the month of June there is huge fall is noted down in their sales revenues. The fall is 50% of their last month's sales revenues.

On the other hand there is consistent increase is noted down in their expenditure as it keeps on increasing. The consistent increase in payments sections lead towards increase in deficit amount. The rate of increment in payments is also increasing. They are facing problems in maintaining surplus balance but due to huge fall in revenues as well as consistent increase in payments results into huge deficit balance (Robinson, et. al., 2012).

Message contained: The above prepared cash flow statement passes the message that Telco need to improve their operational activities in order to minimise their expenditure so that they get surplus amount in the end of their month. They also need to improve their sales revenues so that they easily meet out their monthly expenditure and attain surplus balance at the end of month (Robinson, et. al., 2012).

2.2 Explain why a company may be profitable but run into problems with its liquidity (financial planning).

It is stated that company may be profitable but run into problems with its liquidity or company may face problems with its profitability but run with effective liquid funds. The main reason behind company running profitable but attaining poor liquidity funds is the operational inefficiency. It can be observed that with the effect of the poor operational efficiency there is adequate decrease in the liquidity. With the increase in the profitability there is effective chances that organisation make more credit sales that increases their debtors and risk the business in the form of the bad debts. It shows that there is effective relation among the profitability and liquidity. there is adverse relationship between them as with the increase in profitability there is decrease in liquidity and with the decrease in profitability there is increase in liquidity. In order to increase profitability management make credit sales and in order to pay routinely expenditure they utilise available liquid funds with this effect there is decrease in the liquidity (Grimm & Blazovich, 2016). On the other hand in order to increase the liquidity factor they focus over making cash sales due to which their profitability get decreased as they are not able to get effective revenues with the effect of it (Grimm & Blazovich, 2016).

2.3 The needs of different users of the financial statements are very specific. You are required to list 7 users of accounts and clearly assess their needs.

There are various different users of the financial statements that require different set of information. Some of them are discussed below such as: -

Management: They access the information for the purpose of effective decision making. They utilise information related to the profitability, liquidity, overall performance, financial position and many more. They also set effective objectives with the use of it and allocate resources accordingly (Grimm & Blazovich, 2016).

Employees: They access the information related to the profitability and financial position as they make evaluation whether they get bonus or appraisal or not. They also evaluate the information in order to measure their growth opportunities and make decisions to continue with the organisation or not (Grimm & Blazovich, 2016).

Suppliers: They shows their interest in their liquidity and financial position information as they make evaluation that when they get their payments. They also utilise this information in deciding whether they render them more credit supplies or not on the basis of their liquidity and financial strength.

Creditors: They make demand for the information related to the liquidity as they evaluate the possibility of getting their debts cleared by them. They measure the factors whether they attain their debts or not. On this basis they decide whether they increase their credit ratio with them or not (Longinidis & Georgiadis, 2011).

Investors: They have their interest in their profit related information as they evaluate their overall efficiency in getting profits with the help of their sales revenues and operational activities. With the help of evaluation they make decision whether they can invest money in their business or not.

Shareholders: They are the owners of the business and they review the information related to the financial position and profitability. By evaluating profitability information they evaluate the chances of getting dividends. They also evaluate the financial position of the business and take decision whether they continue with the organisation or selling their shares (Longinidis & Georgiadis, 2011).

Government: They have their interest in their various set of information such as profitability, liquidity, financial position and more. They make overall analysis of the organisation in order to evaluate that they are following the set standards or not in order to perform their functioning, in preparing their financial statements and many more (Longinidis & Georgiadis, 2011).

Task 5 (scenario part e)

4.1, 4.3 Using a maximum of four financial ratios analyse the profitability and liquidity performance 2014 /15 based upon the financial statements in scenario part e advising Telco whether the takeover for Dot should be considered on a preliminary level before engaging in a costlier appraisal. 

Ratio

Calculations

2015

Calculations

2014

Analysis

Gross profit = G.P./Net sales * 100

1,000/2,200 * 100

45.45%

650/1,800 * 100

36.11%

There is increment is noted down in their revenue earning capacity.

Net profit = N.P. /net sales * 100

204/ 2,200 * 100

9.27%

128/1,800 * 100

7.11%

There is effective enhancement is noted down in operational efficiency to utilise their revenues.

Current ratio = Current assets/ current liabilities

200/178

1.12

130/140

0.93

The ratio analysis shows that there is effective enhancement in activities that help in maintaining adequate funds to meet their liabilities.

Quick asset ratio = quick assets/current assets

100/178

0.56

55/140

0.39

There is adequate increase in their efficiency as their liquid funds get increased effectively.

Analysis: - On the basis of the analysis and the ratio calculation it is concluded that Telco must take over Dot as there is effective increase in their efficiency whether to earn profits and maintain adequate level of funds (El-Dalabeeh, 2013).

4.2 Telco is a medium size company. What are the main differences in the financial statements of sole traders, partnerships and limited companies? 

  • Financial statements: There are various activities performed by the Telco and these activities get recorded under various statements. Different activities get recorded under specific financial statement. These financial statements get prepared for the purpose of extracting the various information to measure profitability, liquidity, financial position and many more (Moehrle, et. al., 2010). There are three statements that get prepared commonly such as: -
  • Balance sheet: - Telco utilise this statement for the purpose of recording their assets and liabilities. This statement provide summarised over-view of the statements. Assets are of two types such as current assets and fixed assets. On the other hand liabilities segregated into three parts such as current liabilities, long term liabilities and equity capital.
  • Cash flow statement: - Telco utilise this statement in order to record their transactions related to their cash and cash equivalents. They segregate their cash and cash equivalents transactions into three different segments such as operating activities, financing activities and investing activities. This statement get utilised for extracting information related to their liquidity (Moehrle, et. al., 2010).
  • Income statement: - Telco utilise this statement for the purpose of recoding transactions related to their revenues and expenditure. Under revenue sections they record the information such as sales income, interest received and others. On the other hand expenditure section make inclusion of rent paid, salaries and wages paid and many more (Moehrle, et. al., 2010).

Comparison between Sole proprietorship, companies and partnership such as: - 

Sole proprietorship

Partnership

Companies

They prepare balance sheet to maintain simple record of their activities.

They prepare balance sheet to show partner's capital account.

They prepare balance sheet to show their equity capital.

They prepare profit and loss account for evaluating their profitability.

They prepare profit and loss account for the purpose of evaluating profits and distribute among partners.

They prepare profit and loss account to evaluate their profitability and helps in getting detailed information.

They didn't prepare cash flow statement.

They didn't prepare cash flow statement.

They prepare cash flow statement for the purpose of evaluating the liquidity information.

They didn't follow the IFRS and GAAP guidelines.

They didn't follow the set standards or guidelines by the IFRS and GAAP.

They follow the set standards and guidelines rendered by the IFRS and GAAP for the purpose of preparing their financial statements.

Statutory audit is not required.

It is not mandate to conduct statutory audit.

It is compulsory to conduct statutory audit.

Conclusion

In the end it get concluded that Telco chose the sources of finance in the form of loan stocks, ordinary shares and retained earnings. With the help of these they raise adequate funds in order to support their business expansion plan. In order to take over business opportunities they make use of the investment appraisal techniques as well as financial ratio analysis to evaluate the profitability.

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