For development, starting up or expansion of any business the funds are needed and to get funds there is a need of various sources of finance. These sources play an important role in growth of any business. The type selection of finance depends on the nature of a business, as small organizations are not able to use a wider variety of sources as compared to large ones.
The sources of finance are:
Internal sources: owner's capital and retained profit.
Working capital: working capital is a firm's investment in short term assets like short term securities, stocks, cash, trade debtors. Working capital is a backbone of any firm, which is used to pay for the everyday activities of the business as staff wages and salaries, rent, payments etc. net working capital is the current assets minus current liabilities.
Net working capital = current assets-current liabilities
Personal savings: business people who use their own money to help in finance their business are comes under personal savings. Personal savings are amount of money which a business person, shareholder or a partner has to use as they wish. Generally personal savings is considered as a source of finance for small businesses.
Retained profit: a profit or a part of profit that an organization saves for its future needs is a retained profit. The retained profit is available for buying new machinery, vehicles etc.
Sale of assets: An organization has several fixed assets that are not used in the production-buildings, land and so on, and in surplus of fixed assets these can be sold to raise finance. Hence, by selling fixed assets, organization can use them as a source of finance.
External sources:
Ordinary shares: ordinary shares also known as equity shares which is a profit (dividends) of an organization shared by owner to ordinary shareholders. Profit of the company can vary from one period of time to other, so as the dividends paid to shareholders. Dividends are not predetermined amount, as in slowdowns dividends may be nothing, on other hand in good years dividends may be high.
Ordinary shareholders are last in queue for receiving business proceeds as they considered unsecured shareholders.
Preference shares: preference shares have preference over ordinary shares. Preference shares are different from ordinary shares, therefore preference shareholder cannot vote at general meeting, and are entitled to a fixed dividend unlike ordinary shareholders. Preference shares may be convertible at some stages into ordinary shares.
Debentures: debentures are loans that are tied to financing of a particular asset such as buildings.
Before any dividend is payable to shareholders, the debenture holders have rights to receive interest payments, even if the company is in loss.
Bank overdrafts: in some circumstances an organization may have small finance problems so these problems do not have any need of long-term loans, so the company arrange on overdraft from its bank to solve the problem. Bank overdrafts are taken on current account and interest is calculated on daily basis.
Loan stock: a loan is a fixed amount of money which has fixed repayment timing schedule and shown on a balance sheet for telling the reader its main details.
Creditors: it refers to a short term credit. A creditor can be a supplier of raw material, allow the organization to buy things in current time and pay for them later.
Grants: there are grants available from local councils and other bodies, so if any company has financial problems can take grants.
Venture capital: venture capital is a high risk scheme but it becomes a well known aspect of finance sources. It is a capital used on early stage in development of a new organization, which has chances of failure and chances of providing above average returns.
Hire purchase: hire purchase means use of assets without buying on full amount. It is very useful for the organizations because they can have the use of immediate assets without to pay large amount for it.
Question 2:
i)
Sales: £
Year1 £15*1.12*10000 = 168000
Year2 £15*1.12*1.12*10000 = 188160
Year3 £15*1.12*1.12*1.12*10000 = 210739.2
Year4 £15*1.12*1.12*1.12*1.12*10000 = 236027.9
Materials: £
Year1 £5*1.05*10000 = 52500
Year2 £5*1.05*1.05*10000 = 55125
Year3 £5*1.05*1.05*1.05*10000 = 57881.25
Year4 £5*1.05*1.05*1.05*1.05*10000 = 60775.31
Labour: £
Year1 £3*1.20*10000 = 36000
Year2 £3*1.20*1.20*10000 = 43200
Year3 £3*1.20*1.20*1.20*10000 = 51840
Year4 £3*1.20*1.20*1.20*1.20*10000 = 62208
Variable overheads:
Year1 2*1.10*10000 = 22000
Year2 2*1.10*1.10*10000 = 24200
Year3 2*1.10*1.10*1.10*10000 = 26620
Year4 2*1.10*1.10*1.10*1.10*10000 = 29282
Years 0 1 2 3 4
£000 £000 £000 £000 £000
(Revenue)
Sales W1 168 188.160 210.739 236.028
(Cost)
Materials
W2 (52.500) (55.125) (57.881) (60.775)
Labour
W3 (36) (43.200) (51.840) (62.208)
Variable
Overheads (22) (24.200) (26.620) (29.282)
Machine (120)
Sales
Proceeds 2
Net cash
Flow (120) 57.5 55.6 74.5 85.92
Cost of
Capital
(R1=15%) 1 .870 .756 .658 .572
Cost of
Capital
(R2=55%) 1 0.645 .416 .268 .173
Present
Value1 (120) 50.02 49.59 49.02 49.14
Present
Value2 (120) 37.08 23.12 19.96 14.86
Net present value (npv) where R1=15%: 197.77-120 =77.77 = £77770
Decision: this project should be accepted because the net present value of this project is positive, and its cash flows would be positive as well.
Net present value 2 (npv2) where R2=55%: 95.02-120 = -24.98= -£24980
ii)
Internal rate of return (IRR) : R1+ [npv
Npv1-npv2] * (R2-R1)
=15%+ [ 77770
77770-(-24980)] *(55%-15%)
= 15%+ 77770
102750 *40%
= 0.15+0.76*0.40=.453
iii)
Years 0 1 2 3 4
£000 £000 £000 £000 £000
(Revenue)
Sales W1 168 188.160 210.739 236.028
(Cost)
Materials
W2 (52.500) (55.125) (57.881) (60.775)
Labour
W3 (36) (43.200) (51.840) (62.208)
Variable
Overheads (22) (24.200) (26.620) (29.282)
Machine (100)
Sales
Proceeds 2
Net cash
Flow (100) 57.5 55.6 74.5 85.92
Cost of
Capital
(R=15%) 1 .870 .756 .658 .572
Present
Value (100) 50.02 49.59 49.02 49.14
Net present value: 197.77 - 100 = 97.77 = £97770
Conclusion: as a result the company is getting more return when the cost of machine decreased, and in contrast the company was getting less return when the cost was high. So company can decrease its cost, and can do better.
Question 3
3. a)
i.
Current ratio : current assets
Current liabilities
For (Ali plc) = 1700 = 3.4:1
500
For (Baba plc) = 1100 = 0.85:1
1300
Comment: As the current ratio increases, the company is more capable of paying its obligations. Current ratio gives the idea of an organization's ability to payback its short-term liabilities with its short term assets.
So Ali plc has a good financial health as compared to Baba plc.
ii.
Acid test ratio: current asset - stock
Current liabilities
For (Ali plc) = 853.0-592.0
422.4
= 0.617:1
For (Baba plc) = 816.5-403.0
293.1
= 1.410:1
Comment: acid test ratio is almost same as current ratio. Companies with fewer ratios have difficulties to pay current liabilities. So Ali plc has low ratio, in contrast of Baba plc. It means current assets of Ali plc are much dependent on inventory than Baba plc.
iii.
Gearing ratio :
Long term loans + preference shares *100
Capital employment
For Ali plc = 320+190
447+877.6 *100
= 510
1324 *100
= 38.50 %
For Baba plc = 250+250 *100
601.2+1124.6
= 500
1725.8 *100
= 28.97 %
Comment: a gearing ratio compares owner's capital to borrowed funds. Gearing is an important factor for calculating risk of an organization, more the gearing ratio more the company considered risky.
So Ali plc is on more risk situation than Baba plc.
iv.
Interest cover ratio: profit before interest and tax
Interest
For (Ali plc) = 151.3
19.4
= 7.798 times
For (Baba plc) = 166.9
2705
= 6.069 times
Comment: interest cover ratio determines the interest payable. The higher the ratio, the less the company burdened by debt expenses.
So Baba plc is not generating sufficient revenues to satisfy interest expenses, as compared to Ali plc.
v.
Dividend payout ratio:
Profit available for ordinary shareholders
Annual dividend
For (Ali plc) = 99.9
135
= 0.74 times
For (Baba plc) = 104.6
95
= 1.10 times
Comment: dividend payout ratio is same as dividend cover ratio. It relates to percentage of earnings paid to shareholders in dividends. Higher payout ratio means company is doing well.
So Baba plc is a mature company in contrast of Ali plc.
vi.
Price earnings ratio: market price per share
Earning per share
Earning per share = profit available to ordinary people
Number of shares in issue
For Ali = 99.9
320
= 0.31
For Baba = 104.6
403
= 0.26
Price earning ratio for Ali = 6.5
0.31
= 20.96
For Baba = 8.20
0.26
= 31.53
Comment: price earning ratio is a measure to calculate how expensive a stock is. A high price earning ratio means that investors are expecting high earning growth in future. Baba plc has high price earning ratio than Ali plc so earning growth of Baba would be high as expectation of investors.
3. b)
Performance audit of the organization:
Gross profit percentage: the gross profit percentage is a measurement of financial performance of a company, and it is a profit before operating expenses. It helps in calculating profit after costs of a company.
In year 2007 organization's gross profit percentage was higher than year 2008, and in year 2007 the percentage was above and in 2008 is below from the average percentage. As a result company's financial performance is going down.
Quick ratio: quick ratio is better known liquidity measure because it excludes inventory from current assets. In year 2008 the company's position is better than year 2007, but in both years ratio is below the average ratio. So company's position is not good, but performance is improving.
Return on equity: a company's profitability is measured by return on equity. It is a measure of profit on investment of shareholders in percentage. In year 2007 the company's return on equity percentage was higher than year 2008, and in both years percentage is below the average percentage. So the company is not able to generate internal cash, and performance is decreasing as well.
Return on capital employment: this indicates profitability and efficiency of a company's investment. It should be higher than the rate of borrowing. In year 2007 is was on high than year 2008, but it is below from the average of company in both years. So the company's efficiency is going low, so as performance.
Earning per share: earning per share is an indicator of company's profitability, and is important in determining a share's price. In year 2007 the earning per share of the company is higher and in year 2008 it goes lower than the average of company. As a result company is not performing well.
Debtor collection period: it is a average time taken to collect trade debts, in other words the time which a business takes to collect owed to it by trade debtors. In year 2007 company takes less days than year 2008, but takes more days in both years than average days of company. So the efficiency of the company is decreasing and the performance as well.
Overall performance: as a result the company's performance is decreasing.
3 .c)
Ways to improve the ratios:
Overheads: evaluate the overhead costs of organization, and see if any decrease in overheads can be made; because low overheads make a positive impact on profitability. Overheads include advertising, indirect Labour, rent etc.
Increase in profitability: assess profitability on services and products of the organization, and monitor where prices can be increased to increase profitability.
Assets: if organization has assets which are unproductive or idle and the organization stored it then the organization can give away them and can generate money.
Money in non-business purposes: review the money that is held by non business purposes, because with this money the cash of company can be increased.
Expand sales: by expanding sales the organization can improve the gross profit. This can be done by controlling direct costs.
Current assets: current ratio can be increased by increasing current assets, and current assets can be increased by increasing by borrow additional long term debt, increase in profit, by selling additional capital stock.
Current liabilities: current ratio can also be increased by decreasing current liabilities.
Labour cost: sales can be improved by decreasing Labour costs, and Labour cost can be decreased by decreasing employees, decreasing hours, decreasing salary.
3. d)
Balanced scorecard: balanced scorecard developed by Kaplan and Norton, this scorecard has four perspective financial performance, internal process, learning & growth and customers. These perspectives provide feedback about the performance of the organization. This scorecard used to improve external and internal communication, to measure performance towards goals.
Balance scorecard of Norton and Kaplan
Balance scorecard of McDonalds
This balance scorecard has four perspectives customer, finance, internal and innovation & learning. Which are given below:
Customer: CSF (customer satisfaction factor)
Price - McDonalds see customer service as an
investment, not a cost. So prices of products
are so reasonable.
Quality- McDonalds keeps brand promises with
Customers and provides good quality, the . quality is depends on customer feedback.
Time - McDonalds knows the importance of
Customer's time, so they promise to give
Quick service.
KPI (key performance indicator)
Customer survey - McDonalds provides 100%
Customer satisfaction, and
Customers give positive
Responses.
McDonalds always ready for
Customer suggestions.
Finance: CSF
Cost reduction or growth- McDonalds is dealing with financial
problems so they make reductions
in costs.
KPI
Retain on investment or cost bench marketing- the cost of
Production of
McDonalds is
good as
compared to other
competitive
organizations.
Internal: CFS
Employees- McDonalds has 47,500 employees, in which 57%
Staffs are males and 43% are females. They provide
employees free meals, paid holidays, and employee
discount card.
Sale process- McDonalds set their objectives for sales, and then
decides how objectives can be achieved, then these
Objectives are delivered to customers.
KPI
Staff turnover- McDonalds have low level of turnover.
The leaving rate of employees at
McDonalds is low as compared to other
Companies.
Innovation and learning: CSF
Innovation: the McDonalds have innovation like
'Start small, think big and scale fast'
Today McDonalds is growing day by
day.
Internal learning: McDonalds provides training to
Its employees. McDonalds have
Hamburger universities to
Provide the training to
employees.
KPI
Suggestions: customers give positive responses
to McDonalds for its quality and
service. McDonalds learn from the
feedback of the customers and
try their best for improvements.
