Unit 2 Managing Financial Resources Assignment Solution

Unit 2 Managing Financial Resources Assignment Solution

Introduction

The current assignment focuses on the funding requirements of a business or an organizations behavior. The funding need of an organization is a function of various variables. The organization needs to evaluate each and every one these variables very carefully in order to choose the right mix if funds as the same can have adverse effect on the performance and the stability of the organization.

Task 1A

It is often difficult to get bank loan for a start-up business because banks are not interested in unproven business. The process of boot- strapping is the best way to start up business. In this process the entrepreneur finds its own ways to finance the business. In order to expand the business the company has to depend on the external sources of funding. The company raises funds mainly from two sources of finance (a) Equity Share & (b) Debentures.
Equity Share: Equity shares are also termed as ordinary shares which are issued to the owners of the company. The equity capital carries a nominal value or face value. When the equity shares are issued for cash, the issue price must be equal to the face value or nominal value. (Jo?eveer, 2006)
Advantages of Equity Share:
Equity share do not have to be repaid as it do not have any maturity period.
No interest is payable to the equity shareholders. They are only entitled to dividends on profits made by the company.
Disadvantages of Equity share:
As the equity capital is the strongest source of finance there are large number of equity shareholders to whom dividends have to be paid out of profits of the company.
Excessive issue of equity shares can lead to change of ownership in the company.
Debt financing are the common instrument used in line with credit of operational loans in order to finance the company’s working capital. It is also termed as loan stock which is a long term debt capital debt rose by the company. It carries an interest rate which is also termed as Coupon Rate. It is a written acknowledgement of debentures incurred by the company. (Davey, 1982)

Task 1B

1.1 The above information contains information from both the Income Statement of the company and the statement of the financial position. Discuss the purpose of these financial statements.

Income statement or Profit and loss Account:

The income statement shows the historical records of trading account over a specific period of time. It shows the profit or loss achieved by an organization from its operation which is the difference between the organizations total income and total costs. The income statement is important in a number of ways:

• It allows the owners to check whether the company has achieved acceptable profit or not and to see how the company has performed over the accounting period.
• It helps in comparing with other competitor and the industry as a whole.
• It helps the investors to see whether the company able to generate profits in comparison with the cash flow statement. (Gonedes and Dopuch, 1988)

Balance Sheet:

A balance sheet of a company shows the listing of its resources and of its sources of capital for a specified period. The resources in the balance sheet are described as an asset. The sources of capital used to Financial Managing the assets are known as equities. Equities consist of external equities, such as interest of banks and suppliers of goods and services and owners’ equity.
The Accounting Standard Board in its exposure draft on framework for the Preparation and Presentation of financial statement has identified three basic elements of balance sheet. According to it, elements directly related to the measurement of financial position in the balance sheet are assets, liabilities and equities. (Robinson, 1993)

1.2 Analysis of the above information reveals that the company is financed by both debt capital and equity capital. You have been asked by the directors to prepare a short report on the costs of these different sources of finance. You are expected to discuss what factors should be considered by directors when taking decisions regarding the mode of financing.

There are two sources of funds used by a company: riskless debt and ordinary shares. The total earnings are paid out as dividends to the shareholders and there are no retained earnings.

Cost of Debt(k_d) = I/B
Value of the debt (B) =I/K_d
Cost of Debt (Kd) = I/P (1-t)
Where, Kd= cost of debt before tax = I/P0
I= interest,
P0= net proceedsKe = D/PO
Where Ke= Cost of Equity share capital
D= Dividend at the end of year 1
PO= Ex- dividend share price.
The shareholders will always expect dividend value to rise every year. It states that the market price of the share is the present value of discounted cash flow. So the market value is expected to give a constant growth in dividend every year (Pratt, 2002). The formula is given as:
Ke= D0 (1+g)/PO+g
Where Ke= Cost of Equity Capital
D0= Dividend at the beginning of the year
g =growth rate in dividend
PO= market price at the beginning of the year.

1.3 Selecting suitable sources of finance as 1.1 is an example of financial planning. Discuss other instances of financial planning and analyse the importance of financial planning to the company.

Financial Planning is an important tool which helps an organization to manage the long term and short term sources of finance to meet their desired goals. The view point of finance related to the treatment of the funds is based on proper planning by the organization. The revenue is recognized only when actually received in cash and expenses are recognized on actual payments. This is because the finance manager is concerned with maintaining solvency of the firm by providing the cash flows necessary to satisfy its operation. This can be only achieved if a proper planning is implemented in the organization. (Garner, 1999)
Financial planning helps an organization to manage its income and helps to understand how much money is needed for payment of taxes, expenditures and how much to save. Effective financial planning helps to increase the cash flow by continuous monitoring the expenses. Capital can also be increased by an increase in the cash flow. A proper financial plan helps an organization to make proper investment plans. An organization can achieve its goal when a proper financial planning is implemented.

1.4 The above information contains extracts from both the Income Statement and Statement of Financial position. Discuss how these statements meet the information needs of various stakeholders of the company

From the extracts given above it is not clear about the financial position of the company, It has not disclosed a proper financial statement and it is only an extract of the financial statements. No information about the sources of finance i.e. the debt and equity has been given in the question which would help us in determining the financial position of the firm. All information’s are in summarized form and it’s very difficult to judge the financial position of the company. Only the turnover and expenses can be sort out from the given statement. From the given information’s it is only possible to judge the capital employed, turnover ratio, G.P margin, and stock and debtors turnover ratios. (Hung, 2000)

1.5 Discuss how different forms of financing affects the format of the financial statements

The sources of finance put a great impact on the financial statements of a company. The two important sources which have a great impact on the financial statements are equity financing and debt financing. An incorrect proportion of debt and equity can change the ratios of the organization. The ratio between the equity and the other liabilities carrying fixed charges has to be defined. In this process he has to consider the operating and financial leverages of his firm. The operating leverage exist because of operating expenses. The presence of debt funds lead to the existence of financial leverage. If the organization is using debt funds the interest paid impacts the cash flow, the profit and loss statement. The principle paid impacts all the three components of the financial statements. (Kennedy and McMullen, 1973)

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1.6 Calculate the following ratios and comment on the performance of the business over the two years

1. Calculation of Return on Capital Employed (ROCE):

ROCE =     Net operating Profit

                 Capital Employed

Return on Capital Employed

                  For 2003 =      3,825.00 = 8.05% (approx.)

                                           47,505.00

                   For 2002 =      5,925.00 = 16.97% (approx.)

                                           34,912.00

Calculation of Gross Profit Ratio:

       G/P Ratio =     G/P *100

                                 Sales   
G/P Ratio:-

  For 2003 = 33,092.00/2,05,157.00 *100 = 16.13
 For 2002 = 28,800.00/1,82,530.00 *100 = 15.78%
Calculation of Stock Turnover Ratio (STR):-

STR =    Net Sales – G/P

                     Stock

         = Cost of Goods Sold

                     Stock
 For 2003 = 1,72,065.00 =14 times (approx.)

                                    12,482.00
 For 2002 = 1, 53,730.00 = 13 times (approx.)

                                      11,862.00

Debtors Collection Period ( Debtors Days):-

Average Collection Period =Debtors

 For 2003 =32,287.00 *360 = 57 days (approximately)

For 2002 =28,410.00 *360 =56 Days (approximately)

Creditors Payment Period:

Total Purchases = Sales + Closing Stock – Gross Profit

Average Payment Period =Total Creditor* 360

Credit Purchase

For 2003 = 17048.00 + 13388.00 *360

         = 30436.00 *360

              184547.00

        = 59 Days (approx.)
For 2003 = 13585.00 + 6870.00 *36
 165592.00
 44 Days (approx.)

Inference:-

There has been a disproportionate growth between the sales the expenses. The sales have increased by approximately 12% whereas the expenses for the period have gone up by 23%. This is the main reason of the loss suffered by the organization. The company should take initiative to control the outflow.  The interest expense of the organization has gone up by 58% as the organization has relied heavily on debt funds. This has led to an increase in the organizations interest expense and have led to an adverse time interest coverage ratio. In order to maximize profitability the company should take initiative to work on the financial performance. (Horrigan, 1967)

Task 2A

Statement of cash flow shows the changes in the cash and cash equivalents positions in a business management. Cash and demand deposits together with short term investment comprise the cash and cash equivalents of a business. The statement of cash flow is presented under three different heads namely operating, investing and financing.

 There is a drastic change in the volume of sales during the period as a result the conversion cost is too low. There is a dramatic fall in the gross profit of the company. As all other information’s in the question are given in a summarized form and it is only the extract of the financial statement, from the point of view of the investor it is very difficult to judge the financial performance of the organization. (Coyle, 2000)

Recommendations

It is highly recommended to the management that they should try to cut down the conversion cost in order to maximize the gross profit of the company. They should also try to minimize all other indirect expenses such as sundry expenses, wage expense etc. in order to get higher profitability.

Task 2B:

Project A concentrates introducing a high tech machinery into its main processing facility. By introducing such machinery the company would achieve a substantial increase in its output.

Project B deals with introduction of a marketing activity by which the activities of business will substantially increase without any necessary updates in the production facility.

Analysis:-

Both the projects has an initial investment of ? 450,000, however the net cash inflows are different for each year. The cost of capital is assumed to be 6%. Based on the above calculation the Net Present Value of Project A comes to £254170 and that of Project B is £121010. Based on the Net Present Value Project A is more preferable than that of Project B as the NPV is higher in case of Project A i.e. by £133160.

Task 2C

Cost per Puppet = 2,85,000.00= £ 14.25
                                  40,000.00

Calculation of Selling Price of each puppet:

Cost of each Puppet              = £ 14.25
Add: 15% Mark-up Profit      = £   2.15

  Selling Price of each Puppet: £ 16.40

Conclusion

The main of a financial manager is to maximize the wealth of an organization and not just profit maximization. Wealth maximization is a wider term than profit maximization as the latter does not take into account the time value of money and various other elements. In order to maximize the wealth of the organization the managers have to choose the sources of capital very carefully and look into the proper rationing of the same.

References

Coyle, B. (2000). Cash flow forecasting and liquidity. 1st ed. Chicago: Glenlake Pub. Co.
Davey, P. (1982). Debt financing. 1st Ed. New York, N.Y. (845 Third Ave., New York 10022): Conference Board.
Garner, R. (1999). Ernst & Young's financial planning essentials. 1st Ed. New York: J. Wiley.
Gonedes, N. and Dopuch, N. (1988). Analysis of financial statements. 1st ed. [Sarasota, Fla.]: American Accounting Association.
Horrigan, J. (1967). An evaluation of financial ratio analysis. 1st ed. Chicago: University of Chicago.
Hung, M. (2000). Accounting standards and value relevance of financial statements: An international analysis. Journal of accounting and economics, 30(3), pp.401--420.
Jo~eveer, K. (2006). Sources of capital structure. 1st ed. [Tallinn]: Eesti Pank.
Kennedy, R. and McMullen, S. (1973). Financial statements; form, analysis, and interpretation. 1st ed. Homewood, Ill.: R.D. Irwin.
Pratt, S. (2002). Cost of capital. 1st ed. Hoboken, N.J.: John Wiley & Sons.
Robinson, K. (1993). Balance sheet. 1st Ed. New York: Roof Books.