Unit 2 MFRD Managing Finance Assignment

Unit 2 MFRD Managing Finance Assignment

Introduction:

Unit 2 MFRD Managing Finance Assignment is the driving force for every enterprise to generate revenues. The availability of funding finance in the market makes the owners of the business to choose the best source of finance which suits for the enterprise. The type of finance chosen depends on the nature of the business. As large the organization is, the wider will be the use of finance sources. The use of finance resources not only helps in generating the revenues but also helps in for extension of a business, new product launching, making R and D activities, etc. Tesco is a big brand name, it is considered as one of the leaders in the retail sector in the UK. At present the company is trying to focus towards expansion in South East Asia specially Hong Kong. For the purpose of this expansion the company will require a huge amount of funds for which it is required to employ the various sources of finance. This assignment addresses you the different sources of finance available in the market and also gives an idea to make the decision making regarding the selection of cost effective finance source to the business.

Task 1

1.2 assess the implications of the different sources

Though financial sources are helpful in providing funds to the different organization, but there are some implications involved in the procession. The implications are the set of rules and condition that are made by the financial sources. These are as follows:

Internal sources of finance:

Owner’s capital:

1. It is the most risk free source of finance.
2. It does not create any burden of obligation for the organization.
3. An inclusion of the owner’s capital in the business does not dilute the control of the organization.
4. The only risk lying with this source can be considered as the insolvency of the owner due to loss of his savings if the business faces a huge loss.

Retained Profit:

1. Retained profit is a common source of finance for an organization.
2. Retained profit is the organizations own fund, hence not refundable.
3. Retention of profit does not dilute the control in the organization.
4. Retained profit reduces the value of shares in the market as retention of a huge amount profit will deprive the shareholders from receiving dividend.
5. Retained profit does not create any risk of bankruptcy for the company.

Working capital

1. Working capital is considered as an indispensible source of finance for an organization.
2. It helps in the maintaining the daily operations of the organization.
3. Availing of working capital does not dilute the control of an organization.
4. Recouping of the working capital does not create a risk of bankruptcy.

Sales of the asset

1. The assets of an organization are sold at their book value a fter deducting the accumulated depreciation.
2. Generally obsolete assets are sold that does not add any value to the organization.
3. Generating finance by selling assets does not dilute the organization’s control.
4. Selling of assets reduces the productivity of the organization.
5. It does not create any risk of bankruptcy.

Reducing stock

1. Stocks are sold at a lower rate than that is prevailing in the market.
2. Sale of stock does not dilute the control of the organization.
3. Stocks are sold at a loss.
4. The sale of stock does not create the risk of bankruptcy.

External sources of finance:

Commercial banks

1. Commercial banks provide essential finance for the development of different contract in business the form of loan.
2. The bank is required to be paid interest at a fixed amount till the loan is repaid.
3. Acceptance of loan from a commercial bank does not dilute the control of the organization.
4. A failure in paying the interest can create the risk of bankruptcy (Smart, Megginson and Gitman, 2004).

Debentures

1. Debentures are debt instruments and the investors in the debentures are regarded as creditors of the organization.
2. The debenture holders are paid interest at a fixed percentage.
3. The issuance of debentures does not create any dilution of control within the organization.
4. Failure in timely payment of the debenture interests will lead to bankruptcy.

Issuing shares

1. Shares are capable of raising considerably huge amount of funds.
2. Shareholders are offered the rights of the owners of the organization.
3. An additional amount of issuance of equity will dilute the control of the organization.
4. Equity shares are irredeemable; hence they do not create any bankruptcy risk for the organization.

Venture capital

1. Venture capitalists invest in the shares factors of organizational given the power to control.
2. Venture capitalists are the shareholders hence they are paid dividends at a fixed amount.
3. Raising funds from venture capitalists does not dilute the control of an organization.
4. Venture capitalists invest in the shares of the company; hence receiving venture capital funds does not create the risk of bankruptcy.
5. Raising finance from venture capitalist will dilute the control of the organization substantially.

 Leasing:

1. Leasing helps an organization in saving a huge amount of funds.
2. The lessor is paid lease rentals on a periodical basis by the leasee.
3. Leasing of assets does not dilute the control of an organization.
4. A failure in payment of the lease rentals will lead to the forfeiture of the property or asset by the lessor.

1.3 evaluate appropriate sources of finance for a business project

There are many sources of finance available in the market, but the choice of making appropriate source depends on the nature, size and purpose of the business. Evaluation of source based on business size, if the organization is small then the funds can be raised from banks in the form of over draft or small term loans, funds can be raised from creditors. The suitable form of sources for a small organization is loans from banks as it collects less interest rate comparing to the creditors and money lenders.
            For a large scale organization like Tesco it is important to raise huge amount of funds in order to fuel certain business activity such as expansion of business or conducting R and D activities, etc. There is a requirement of lump sum amount for the expansion of Tesco in Sout6h East Asia, it is estimated that an amount of nearly £ 3 billion will be adequate to support the expansion. So before selecting the source of finance, the management should take proper decision. The decision of using some resources should be made by focusing upon three key elements I.e cost effectiveness, less risky, less restriction,etc. By reviewing all the sources and their key elements, it is clear that the finance that is generated from shareholders in the form of equity is suitable for a large scale organization. Again, acceptance of loan from commercial bank will also work as it is a cheaper source of finance and the interests that will be paid are tax deductible. As the equity share are the sources that composed of less risky and cost effective. The norms regarding payment of dividends also suitable even in critical situations of the business. In order to set up an undertaking land is required and for that purpose leasing will be a suitable source of finance as it will save a huge amount of funds (Smart, Megginson and Gitman, 2007).

Task-2

2.1 Analyze the costs of different sources of finance

After revising the different sources of finance and selecting a suitable one, the next step is to determine the cost of capital. Cost of capital describes the amount of spending done by the company for using the funds. For example: The company raises funds in the form of equity, preference share and spends money by giving dividends. Company spends the amount by paying interests to the creditors, banks, etc. This expenditure is nothing but the cost of capital. In order to maintain financial resources position of the business, the company should decrease the cost of capital.

The cost of the selected sources of finance for Tesco is given below:

• Issuance of shares: The cost of issuing shares is regarded as the dividend paid to the shareholders who has invested in the shares of the company.
• Commercial banks: For accepting loan from commercial banks it is required to pay interest at a certain percentage, which is regarded as the cost of loan.
• Leasing:For leasing an asset the lesee is required to pay lease rentals to the lessor and this is regarded the cost of taking asset on lease (Armitage, 2005).

2.2 Explain the importance of financial planning.

If an organization seeks to earn good revenues on the investment then, the financial manager should prepare an effective financial plan. The financial plan includes the generating funds from different sources and allocating the funds in an appropriate manner. This financial plan helps the organization in making short term and long term goals in order to run a business in a smooth way.
Importance of financial planning:

• Increasing cash flows: An effective financial planning helps in generating the cash inflows by monitoring the spending pattern of the business. It also helps in avoiding unnecessary expenses by controlling the budget. This is directly increase the cash inflows of the business.
• Investment: A proper financial plan considers the organization goals and objectives and risk tolerance of the business, etc. it acts as a guide in choosing the investment proposal which fits for the organization.
• Recovers the losses: As the future of the organization is uncertain so financial planning of the organization helps in taking some useful action by which the losses can be claimed. For example, the insurance coverage replaces the losses caused by the natural calamities.
• Income managing: Proper financial planning helps the organization in managing the incomes by allocating the incomes in different expenses of the business, such as tax payments, monthly expenditure, savings, etc (McKeown, 2012).
• Investment appraisal: Financial planning helps in selecting the most financially viable project for the business where it can invest its funds for generating profits.

2.3 Assess the information needs of different decision makers

One of the key elements for decision-making process in an organization is the information system. This information system leads the organization in achieving the objectives of the business by making some structural and functional changes. The information related to business is of two types (1) Financial information (2) Non-financial information. This section provides the knowledge related to the financial data which is essential for decision makers (Fitzgerald, 2002).

From above diagram, it is clear that financial information can be gathered by two ways by obtaining the financial statement like, balance sheet, income statement, cash flows of the business etc. This helps the organization in determining the financial status of the business, cash flows of the business. This financial statement enables the decision maker to decide further business plans.
         The ratio analysis enables the decision maker to know the financial capability of the business by comparing two variables. For example, Debt and equity ratio. By analyzing the above financial data, makes the decision maker to increase business quality.

2.4 Explain the impact of finance on the financial statements

Financial statement is a snap shot of financial position of the business. As the company generates finance from different sources.  It is impossible for a decision maker to understand the exact status of the debt, equity, cash, assets, liability, etc. but the accounting rules and techniques combine all the financial elements in different statements. This helps the management to take different important decision making regarding business.

The impact of the chosen sources of finance upon the financial statements of Tesco Plc is presented below:

• Issuing shares:The shares issued will appear in the liabilities side of the balance sheet of the organization as share capital. Again the cash generated by issuing the shares will appear as cash in the assets side of the balance sheet of the organization. The dividend paid to the shareholders will appear in the statement of change in equity (Palepu, Bernard and Healy, 1996).
• Commercial bank:Loan taken from commercial bank will appear as long term debt in the liabilities side of the balance sheet and the cash generated will be appear as cash in the assets side. The interest paid by the organization will appear in the debit side of the income statement as an expense.
• Leasing:The land or other capital assets taken on lease will be placed at the assets side of the balance sheet as fixed assets while the lease rental paid will appear as an expense in the debit side of the income statement.

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Task 3

3.1 Analyze budgets and make appropriate decisions

The responsibility of the financial manager is to manage the financial issues such as preparing budgets, maintaining accounts and taking effective decision. There are various kind of decisions are there such as, investment decisions, operations decisions and financial decision.  This section enables the reader to know about investment decisions.
Budget is the document that is prepared for evaluating the long term investment of the business. This long term investment is also known as capital budgeting decisions. This capital budgeting always aims to increase the wealth of the share holders that indirectly brings profits to the business (Meriam, Byrns and Winant, 1933).
The decision-making process helps the organization in evaluating the long term investments by which a firm gets maximum profits in a long period. The long term investment involves the decision taken on investing of fixed assets such as land, building, machineries, etc. which brings returns in a long span of time. To make a long term investment the organization should take the help of the financial expert who guides by giving suggestions.

Right decisions while doing budgeting:

• Always try to boost income and cut out expenditure.
• Try to decrease the un-necessary expenditure.
• Try to find out the offer given on investment and utilize it.

The above table indicates that the organization is expected to meet with a situation of cash deficit in all the months apart from the months of January, November and December. This is primarily because of the increase in the purchases and salaries and wages. One can also see that there is not parity between the increase in sales collection and the purchases and salaries payment. In this regards the organization should plan its purchase more carefully and negotiate better credit terms with the providers of the raw materials. The wages and salaries cost be reviewed by the organization and if possible reduced (Donovan, 2006).

3.2 Explain the calculation of unit costs and make pricing decisions using relevant information

Calculation of cost per unit is very necessary to determine the unit price or price of an individual product.  So cost per unit is determined when the company produces large number of identical products. Basically unit cost is derived from two different costs such as the variable cost and fixed cost (Estelami and Maxwell, 2006).

• Variable cost: The cost that varies according to the number of units produced.
• Fixed cost:The cost remains constant event the number of units produced varies.

The cost per unit should decline as the number of units produced increases because as the fixed cost remains constant, and it spread over the large number of units. Thus, the cost per unit is not constant

For example, XYZ Company is producing 10,000 units of widget

Its, Total variable cost = of $50,000

     Total fixed cost = $30,000

Cost per unit = $50,000 + $30,000 / 10,000=$8 cost per unit.

If the XYZ Company produces 5,000 units, then the cost per unit will be

Cost per unit = $25,000 + $30,000 / 5000=$11cost per unit.

3.3 Assess the viability of a project using investment appraisal techniques

Investment appraisal techniques are one of the key tools in capital budgeting. This enables the investor to assess the expected returns on the expenditure made by the organization. This technique usually follows time value concept which helps the investor to estimate the value of future returns based on past and present returns. This enables the user to determine cost and benefits of investment of given project.
Various investment appraisal techniques are there but they are divided into two types

Payback period method:

This method helps the investor to evaluate the exact term period in which the project will recoup the initial investment made by the business.
Formula:Initial investment/Annual cash flow
For example:if a project requires Rs 40,000 as the initial investment and will generate 8000 per annum. Then the payback period will calculate calculated
Payback period: initial investment/ annual cash flow
=40,000/8000
=5Years

Net present value (NPV):

This is one of the best methods of evaluating the capital investment proposals. Under this method cash inflows and cash out flows are taken into consideration. These cash flows are converted into present value and then difference between cash inflow and out flow is calculated (Mott, 1997).

Internal Rate of returns (IRR):

This technique enables to the user to calculate the discount rate at which the NPV of the investment will be zero. It also can be denoted as break even cost of capital. Thus, the project with greater IRR than the cost of capital should be accepted. This method follows the money value concept and aims to maximize the wealth of the share holders (List and Zhou, 2007).

The above table indicates that project A has a higher NPV, IRR but a lower ARR. However ARR is less significant than NPV and IRR as these methods take into account the time value of money. As a consequence project A should be chosen over project B

Task 4

4.1 The main financial statement of the business   

Financial statement is a formal record in which all the business activities are been entered. This written report quantifies the financial strength, liquidity, etc. of the business. Basically, it reflects the business transaction and events of the business. A financial statement can be prepared by following types.

Three types of financial statements:

Balance sheet: It is also known as a statement of financial position. This aims to present the image of financial position of the business at a given date. This balance sheet consists of two columns that represent the company’s liabilities at left side and company’s assets at right side.

Performa of Balance Sheet:

Key element of Balance Sheet:

Capital is the money that business owns for running of the business is called capital. This is composed of equity shares, preference shares, etc. This amount is remained after the business assets are used to pay off its outstanding liabilities. Here equity of a business especially represents the difference between the assets and liabilities and creditors are the amount that is borrowed by company from creditors. The loans are also as borrowed money from banks.

Income statement:

Company’s income statement is also known as profit and loss statement. It represents the company’s   financial performance of a specific accounting period. This statement composed of company’s incomes at right-hand side and company’s expenditure at left -hand side. In the result, it shows the company’s loss in right side and profit in the left side of the statement.

Performa of Income statement:

(1) Cash Flow statement:

This statement describes the cash and bank balance movement in a specific period. This movement of cash is categorized in following activities:

• Operation activities:it represents the cash flows of primary activities of the business that includes transaction of cash done during production.
• Investing activities: It represents that the cash flows are made on purchase or sales of the assets other than the inventory. For example, purchase of factory plant and sales of old machinery, etc.
• Financing activities: It represents the transaction of cash made on payment of the cost of capital such as paying interests on debts, paying dividends to share holder, etc.

(2) Notes to accounts

The notes to accounts provide an explanation regarding the preparation of the financial statements. Hence, a person exterior to the organization can easily understand the assumptions and the estimations made by the management. This section is also used to convey any important information about the finance of the organization which is not possible to be disclosed in the financial statements.

(3) Statement of changes in equity

This statement is a must as per the reforms introduced by the IFRS. This statement is mandatorily required to be prepared by a public limited company and shows the equity of the organization, new shares issued, dividends declared by the organization (Gibson and Frishkoff, 1979).

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

There are three types of business sector occurred such as service enterprise, merchandise and manufacturing enterprise. Corresponding to these three types of business, three types of business organizations are there. They are as follows:

(1) Sole proprietorship:

This type of organization is run by single owner/ manager. This type of organization can be service oriented business or manufacturing business. However, GAAP principles are followed by all types of business.

• Absence of business entity concept: Here the owner’s capital is treated as a business capital. The concept of business entity that makes the owner’s capital as a liability for the business is followed while maintaining accounts.
• Transfer of owner ship: Here transfer of ownership can’t be done while the owner is live. This is one of the disadvantages of sole property business.

(2) Partnership firm:

When more than one owners of the business runs a business it is called partnership business. This type of organization purely follows the golden rules accounting, GAAP principles, etc.
Business Entity concept is followed by the business, so the owner’s capital is shown in the liability side of the balance sheet.

Profit: Profits of the business are shared on the basis of capital invested by an individual person.
The disadvantage of this type of business is that, more than 20 members in the firm may fail to continue the business.

(3) Public limited companies/Corporations

This type of organization starts with the minimum 7 members and maximum members are unlimited. This type of organization follows all the accounting concepts and conventions as the partnership firm (Guthmann, 1953).

The differences in the format of the same are as follows:

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

Table.2: Ratios Tesco

Every organization generates financial statement to obtain information about the status of their financial and operational health of the business. By analyzing and interpreting the financial statements, the reader enables to know information that helps to identify the key issues and concerns of business. This also helps the industry to encounter the risk involved in the business. There are three methods to analyze the financial statement.

• Horizontal & trend analysis
• Vertical analysis
• Ratio analysis

• Net profit margin: To understand the performance of the organization one has to refer to the net profit ratio. This ratio helps to analyze the performance of the entity throughout the accounting period. For Tesco the net profit has increased to 1.53 from 0.19 hence, the performance of the organization has strengthened in 2014.
• Return on assets: This ratio is used to analyze the efficiency with the assets of the organization have been employed to generate revenue and returns. This ratio calculates the EBIT earned by dollar invested. The return on the assets of Tesco has increased to 1.94 to 0.25 which is a good sign.
• Return on invested capital: Like the above ratio this ratio is used to calculate the efficiency with the capital of the organization has been employed to generate earnings. The same has shown a drastic change and has increased to 5.06 from 1.54.
• Current Ratio: The liquidity of the organization is as important as the profitability. The liquidity is associated with the risk of bankruptcy and hence can’t be ignored. The current is used analyze the same. It is calculated by diving the current assets with the current liabilities which in turn allows to understand the number of times the current liabilities can be covered with the current assets. This ratio has improved for the organization and currently stands at 0.73.
• Quick ratio: The quick ratio’s aim is somewhat similar to the current ratio however it only takes into consideration the quick assets. The quick assets are those assets which can be easily converted into cash and hence, inventories do not form a part of this ratio. The quick ratio however, unlike the current ratio has slightly decreased from 2013 and currently stands at 0.43.
• Interest Coverage Ratio: The interest coverage ratio calculates the number of times the interest costs of the organization can be covered with the current EBIT. Hence, a higher coverage ratio is always desirable. The interest coverage ratio of the organization has increased to 6.05 from 5.4 which is a healthy sign.
• Asset Turnover: The asset turnover ratio is used to understand the efficiency with the assets of the organization have been employed in generating revenue. However, this ratio has experienced a slight reduction from the previous year and currently stands at 1.27 (Palmer, 1983).

Conclusion

Finally, from Unit 2 MFRD Managing Finance Assignment it clear that though, there are plenty of finance sources available in the market but choosing right one is very much essential for the organization. This case gave an idea regarding the financial management such as acquiring finance, allocating them to the best, and managing the sources. This also addressed some important tools of managing financial sources such as financial statements, ratios, etc. It helped the management to analyze and make decisions regarding the most cost effective and less risky finance source. By analyzing and revising the above financial issues, this makes the organization to control the risk and make it into debt free.

Reference

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