The sources of finance indicate about the ways form where the business gets the fund to start the business. A business needs the source of fund for development and expansion of the business. Therefore it is very important to know about the sources of finance before starting the business. Every sources of finance in business has the advantage and disadvantage.
According to Black .G, (2005),
There are two types of sources of finance and they are mentioned below:-
LONG TERM SOURCES SHORT TERM SOURCES
Internal sources External sources internal sources External sources
Retained profit Share Issues Reducing stock Bank overdraft
Bank Loans
Debentures Collecting debt faster Debt factoring
Finance leases Delaying payment to creditors
LONG TERM SOURCES
The source of finance which is for the long period of time is called long term sources of finance. The following are the explanation of the internal sources and its divisions explains the long term sources of finance.
INTERNAL SOURCES
Internal sources are the source which are gained or cycled by the business from the own business. It doesn't require the external partied for involvement but it can be only used for small amount of sources:
RETAINED PROFIT
'Retained profits are those profits which are left after paying all its costs and creditors of the company and kept for the extension of the business or for any other uses'. No any interest is required to give and is invested by the owners of the business. This can be use useful long term sources for the business for future use. (http://www.teachnetuk.org.uk/2007%20Projects/BizGCSE%20Finance/sources/internal.htm)
EXTERNAL SOURCES
This is the sources which are lent by the external parties in the requirement of the interest. It is more useful then the retained profit:-
According to Geoff. B, (2005)
Share Issues
Private business is made of the vast popularity of limited liability enterprises, and is not to sell their shares to the other people except the existing share holders, friends or the persons who are likely known by him. When a company is usually needed to raise the capital of the business then it likely sells the shares of the company by advertising in different networks.
Bank Loans
Bank loans are the finances that are provided by the external source of finance called bank. They are giving in accordance with the interest. Banks are the organization started to provide the finance to the business and get the interest as their profit which makes the running of the bank.
Debentures
Debentures are the long term of secured and unsecured debt taken out by the company and intend to pay in future, for this the company will pay the fix amount of interest every year. If the company is fail to pay the interest then the debenture holders have the right to force the company into liquidation along with creditors in order to get money.
Finance Leases
The finance lease means the money taken from the other financial organization for the fix time with the fix overall interest.
SHORT TIME SOURCES
The short time sources mean the money taken to a business for the short period of time. It can be profitable and non-profitable depending on the types of need. It is not generally used for the project which takes a long time to repay. However it is used for the quick access of the business.
There are some terms of short time sources for finance explained below:
INTERNAL SOURCES
Cox. D and Fardon. M (2003), explains that,
The internal sources refer the sources that company creates itself within it in different strategy.
Reducing Stock
The process of minimizing the stock of the enterprises by selling it at discount prices or the offers is called reducing stock. The company should reduce its stock in order to manage the cash in hand or in bank.
Collecting Debt Faster
Collecting debt faster helps the business to raise the cash level which can help in the payment of salary, for goods, etc.
Delaying Payment to creditors
It is also the means of raising the finance of the business which strengthen the financial position of the business. The long time of payment of creditors may result the advantage of interest free credits but long time can leads to the loss of good will in market.
EXTERNAL SOURCES
The external sources refer to the sources offered by the external means like bank, share holders, debtors, etc. Sources are explained below:
Bank Overdraft
The loan provided by the bank at the moment when there is no balance in bank is called bank overdraft. It is limited because the bank can offer only limited money depending of the credit records but it is little a bit problematic for doing so the bank takes the interest.
Debt Factoring
Debt factoring is a type of short time finance based on selling of trade debt on discount from one party to another. "To buy a discount a debit owed to another, in order to profit by collecting them", (Concise Oxford Dictionary)
1)B)Answers
The implication refers to the advantage or disadvantages of the given sources and plays the important role within it. The implication of different sources of finance of finance in term of legal, financial, dilution of control and bankruptcy are as follows:-
Share capitals
Advantages:
A company has the fixed rules and constitution.
The fund of the business is increased if the large amount of share is sold.
The lower share issues have the lower rate of bankruptcy.
The company can have the different ideas in business and the controls of the business will be diluted in to the other owners also.
Disadvantages:
The preferential share holders are only responsibly for the profit of the business not in loss of the business.
Share liabilities are limited because of limited investments by the share owners.
Higher the rate of preferential share holder the business suffers the bankruptcy at loss periods
The capital owed by the share holders is not paid easily, it is paid within the rules of interest of creditors.
Retained profit
Retained profit
Advantages:
It is tax free so that the whole profit is secures to use for the financial purpose.
It helps legally by decreasing the sharing profit between the tax expenses.
More the retained profit less the chance of bankruptcy.
More the profit more the sharing between the shareholders which cause that the original owner gets less profit for that.
Disadvantages:
The low amount of the retained profit shows the actual average profit of the business.
Shareholders cannot provide the security by the charge on goods.
When retained earnings is decreases to least then the chance of a bankruptcy is very high
Every owner of business is responsible to handle this profit for financial use and distribution to the owner.
1)C) answers
Cox. D and Fardon. M (2003),
The constructing of dam in Bangladesh takes 10 years so I will be focusing on the long term of sources of finances because the constructing this dam will not give the profit or earning immediately.
Working capital
The working capital is important point for this type of project. It is for 10 years so I have to start the business with the large amount of the capital for long terms.
Hire Purchase
The are the interest free credits so that it can be used for long time without the interest given and its is comfortable to use because the dam cannot give the immediate earning and it have higher acceptance rate due to collateral security. It is important for the business if I have not past experience in this field.
Grants
It is the government policy to the long term project works. The government help of Bangladesh can be taken in order to complete this project. There are international organizations which help in under-developing countries financially like World Bank. If these grants can be obtained then it is easy to find the public exposure and proper government monetary.
Venture capital
It is important source because it provides the local strategic, functional and financial advice to the work but it has one consequence that is they did not share any sources but they take a large amount of money at the end of the project.
Loans
As it is long term of project we should consider the loans which require the less interest rate because for the 10 years we are going to invest. The international banks can lent the large amount of loans so we should be focusing on these.
Third Party investments
It is the important concept that it increases the capital and the responsibilities so that the new concept can be used. If I have no any previous experience then it should be considered to go the work in the right way.
Retained Earnings
It is important source that can help in the beginning the project in order to purchase the machinery and the necessary equipment. It can be used depending on the amount of retained earnings. However as a hole it is for the whole period of the business
2) A)Answers
According to Dyson J R(2003),
The business usually wants the lowest cost of finance. The finest way to assess the cost of cost of finance is to express the yearly payment to investor or lenders of the amount given. As a whole the business always finds the easiest way to earn profit. Following are the explanation of the cost of different sources of finances:-
Interest
The interest is the fee charged by the investor to the borrowers by the fixed periods of time. The interest is taken in the fixed rate annually called 'interest rate'. There are two types of the interest according to Raman Grewal,
Specific Interest Rate: They are on the specific financial terms, example mortgages, bank deposited certificate, etc. They show the time period for the reason that the money is loaned and the current supply and demand in the market for the money is available.
Administered Interest Rate: They are fixed or established by the certain organizations and includes such as bank prime rate. The bank also charges the different interest rate to their best customers.
Dividends
Dividend is the payment made by the business to its share holders. It is the portion of the business profit paid to the stock holders. According to Grewal. R, there are four types of dividend paid to the share holders:-
Cash dividend: The dividend paid in either cash or cheque is called cash dividend. It is most commonly considered as investments profit and is taxable.
Stock dividend: The dividend which is paid in the form of share to its share holders is called Stock Dividend. This is tax free.
Property dividend: A dividend which paid in the form other than cash is called property dividend. They are taxed at cash dividends at fair market value of whether the property is paid off.
Other types of dividend: The dividend having access to the market price value and warrants is other types of dividends.
Opportunity cost
Opportunity cost is the price of next best choice available within selected multiple choices. Such as if an asset that is capital for one purpose then the opportunity cost is the value of next suitable assets which can be used for.
Cost of retained earnings
The residual profit after paying all the taxes, dividends and all other expenses is called the retained earnings. The cost of these money is always less than the cost of new equity capital due to tax and expenses.
(http://www.teachmefinance.com/Scientific_Terms/Cost_of_retained_earnings.html)
There are the methods of calculating the opportunity cost mentioned according to Grewal, R is below:
CAPM Approach: In this firstly we calculate the risk free rate (Rf) which is the 30 day treasury bill rate and the expected rate of returm on the market (Rm). Then estimate the companies beta (Bi) which is the stock risk estimated. Putting these assumption on the CAPM approach equation we get,
Ks = Rf + Bi (Rm - Rf)
Where Ks is the cost of Retained Earnings
And Rf, Bi and Rm have their usual meaning stated above
Bond-Yield-Plus-Premium Approach: To calculate through this method simply take the interest rate of the firm's long term debt and risk premium is added to it (generally 3%-5% points)
Ks = long term bond yield + premium risk
Discounted Cash Flow Approaches: Commonly known as 'dividend yield plus growth approach'
Here,
Ks = D1/ Ko + g
Where,
D1 = next year's dividends
g = firm's constant growth rate
Po = Price
Where,
g = (Retention rate) (Return of Equity)
g = (1-payout rate) (Return of Equity)
2)B) Answers
The financial planning refers to the group of financial statement that show the implication of the resources for making a business decisions. Planning structure may consist of thousands of summaries and calculations. Simply the aim of these calculations is to regulate the profit and loss statement, cash flows and balance sheet.
Cash Budgeting
The estimate of expected cash inflows and cash outflows over a given particular time of a business or individual is called cash budgeting.
Over Trading
If a business tries to trade more than its normal capacity and hence suffers a loss in known as Over Trading.
The importance of the financial planning in relation to cash budgeting and over Trading is given as:-
Financial Planning helps to find the financial position of the business by using the cash outflows and cash inflows of the cash budgeting.
It helps to find the condition of the over trading of the business with the help of the cash flows in accordance with the rules of financial planning.
It helps to find the need of the working capitals, resources of people and net assets which result in the avoiding the over trading.
It stimulates the standard way of the keeping records which ensures the profit and loss of the business.
It help in the prevention of the over trading by the necessary planning and the proper budgeting.
Preparing the cash flows raises the information of the cash available to the business and know the position whether the loan to be taken.
Ratio analysis helps to keep the proper equilibrium in the business and can be checked in all the terms to make the proper strategy for the progress of the business plans.
(http://www.slideshare.net/g0kb3rk/financial-forecasting-financial-planning-and-budgeting-3589355)
2)C ) Answers
In 1975, The Accounting Standard Steering Committee's document The Corporate reported that the equity investor, load creditors, employees, analyst adviser, business contracts, government and public have the right to get the information of the position of the business.
Equity Investors
The decision maker requires information to help share trading decisions so that they can decide to issue the new shares or sell the existing shares. The need the information to assist the issues of new prices of shares in future like dividend payment and management capacity. They need to look the ratio of profitability in order to find the management efficiency.
Business Contacts
It is mostly comprises of the employees, suppliers, trade creditors, costumers, business rivals, loan creditors, etc.
The main theme of the employees is to get the job security by ensuring the long term viability. They also ensure the profitability ratio so that they can get the bonus or the commissions.
Suppliers and trade creditors have the information needs that are as short time. The suppliers and trade creditors believe in the good will of the business in the market and in the qualitative management and analysis.
The costumer always depend upon the good will in the market companies because they need the replacement after the sale there they like to consider the long term viability. As a whole they like to purchase the goods from the companies which are long lasting and qualitative.
Business revels needs to find the ratio of each others in order to compare how well or how worst the business id going. They always require the special offers or the new promotion for the business.
The loan creditors like debenture holder are the parties which provide the short time loans. They also require the information about the financial position of the business and the cash flows of the same business.
The government mainly needs the information regarding to the taxations and also have the role playing in the rules and law of the business world. However the government have to look after the financial wealth of the organizations.
The decision making process should be comprises of the public welfare and needs to give full condition of the business to the general public and helps to promote in the participation.
2)D) Answer
The financial statement means the written records that show the financial wealth of a company. The financial statement comprises the finance related all the data. The financial statement refers to the trial balance, balance sheet, profit and loss statement, cash flows, journals, ledger, etc.
The main purpose of the financial statement is to keep the records of the capitals and liabilities and check the business weather it is in profit or loss. The different financial statement has its own important based on the nature of the finance and their way of keeping records.
Ledger
It is the T-shaped account format on which the left side is known as debit side and right hand side is known as credit. First of all the nature of account is analysed and then the particular is filled with the details and then amount is filled depending upon the nature of the finance is affected and all the data are filled with respect to the date involved. There is always Debit is equal to the Credit.
Trial Balance
After the transaction is posted to the ledger the final outcome is to know the balance system of the finance. Balance means the difference between debit and credit. When there is only one entry on one side then the account is left as it is and when all sides are not balanced then the loan should be added to the other side required the amount. Trial balance is the list of the ledger that is income statement and balance sheet to a certain date.
Balance Sheet
The financial statement of a business or of a enterprises that shows the gathers the assets, capitals and liabilities over a specific period of time is known as balance sheet. It shows that financial statement of a business over a period of time.
Income Statement
The income statement of business is the financial document made up at the end of the year in order to show the profit and loss of the business.
According to Grewal, R
Trading Account: It is the part of income statement that shows that how the operating profit was established through firm's trading activities.
That is,
Gross profit = Sales - Cost of Sales
Profit and Loss Account: It is prepared to show final total profit and total loss over a financial period of time
That is,
Gross profit + other operating income - other operating expenses = Net Profit
Where operating income is interest, rent receivable, discount receive, commission received, profit of sale from fixed assets, etc
And other operating expenses is salary, rent payable, advertisement, travel, depreciation, telephone, etc
In the balance sheet there are two main terms that is assets and liability which interacts each other and plays important role in maintaining the balance sheet functions.
Assets
Any economic value owned by the individual of the business which can be directly converted into cash is called Assets. Securities, accounts receivable, inventory, office equipment, real estate, car, other real properties owned by the business is the assets of the business. On the balance sheet asset is always equal to sum of liabilities, common stock, preferred stock and retained earnings.
Liabilities
A commitment through the legal process that binds the business or enterprises to create a debt is called liabilities. In the case of company, the liabilities is recorded on the balance sheet and can comprises the account payable, taxes, wages, accrued expenses and deferred revenue and has the special function on the balance sheet.
A part of the debt on the company's balance sheet which is not to be paid within one year period of time is called Long Term Liabilities. For example mortgages and bank loans.
The debt commitment which is coming due within one year shown on balance sheet is called short time liabilities. For example trade creditor, expense creditor, etc
3)A) Answers
Cash Budget between the period of Sepember to feburary
Particular
Sep
Oct
Nov
Dec
Jan
Feb
Cash Flows
Sales
2000
3000
Total Cash Inflow
2000
3400
Cash Outflow
Cost of Sales
2000
1418.48
2518.51
333.3
Overhead
2100
2100
2100
2100
2100
2100
Machinery Cost
3000
Total Cash Outflow
2100
2100
4100
6518.48
4318.51
5433.33
Opening Balance
20000
17900
15800
11700
5181.52
2563.09
Total Cash inflow
2100
3400
Total Cash Outflow
(2100)
(2100)
(4100)
(6518.48)
(4618.51)
(5433.33)
Loan Required
Closing Balance
17900
15800
11700
5181.52
2563.09
529.679
3)B) Answers
Solution
Given,
For every silver ring it makes,
It uses 6gm costing £15
And labour cost,
£10 per hour
For polishing department
Cost £8 per hour
And factory indirect cost is £7000 for 500 rings
Now If it takes 2.5 hours for one ring then the costing is
2.5 x 10 = £25
Again,
Polishing for 20 minutes is,
If 60 seconds for £8
Then 20 second is 8/60 x 20 = £2.67
And the total factory indirect cost for one ring = 7000/500 = £14
Therefore the total cost for making one ring is = £15+£25+£2.67+£14 = £56.67
And the total cost for making 50 rings = 56.67 x 50
= £2833.5
Therefore the cost for making 50 rings is £2833.5
C) Answer
Years
1
2
3
4
Units
110000
85000
75000
55000
Sales price
28
25
25
20
Total Sales unit
3080000
2125000
1875000
1100000
Direct Materials
5.5
5.5
5.5
5.5
Total direct material cost
605000
467500
412500
302500
Variable cost
6
6
6
6
Total variable cost
660000
510000
450000
330000
Fixed cost
4
4
4
4
Total fixed cost
440000
340000
300000
220000
Advertisement
600000
150000
Depreciation
200000
200000
200000
200000
Profit before tax
575000
457500
512500
47500
Tax 25%
143750
114375
128125
11875
Profit after tax
431250
343125
384375
35625
Cash flow
631250
543125
584375
235625
Now,
Year
Cash flow
Present value factor
Present value
0
(800000)
1
(800000)
1
631250
0.917
578856
2
543125
0.841
456768
3
584375
0.772
451138
4
235625
0.708
166823
Total Net Present Value
853585
4)A) Answers
Profit and Loss Account
The financial statement which shows the profit or loss of the business over one year period of time is known as Profit and Loss Account. The main aim of this statement is to provide the financial position of the business in the market so that the business makes the further plan for improvement of the business in the managed way. By using this statement the business loss or profit can be checked and toward the progress of that. It is also profitable for the decision makers of the business. The typical format of the profit and loss account is given below:
Balance Sheet
The quantitative details of the business finance at the certain point of time comprising the assets, liabilities and net worth is called Balance sheet. The first part of balance sheet shows the productive aspect like company's assets while second part shows all the financing methods such as shareholder's equity and liabilities. It can be judged by the following assumed valued structures:
Cash Flow Statement
"A financial statement that reflects the inflow of revenue vs. the outflow of expenses resulting from operating, investing and financing activities during a specific time period"
(http://www.entrepreneur.com/encyclopedia/term/82038.html)
The main theme of cash flow statement is to find out the cash coming in and the cash going out of the business. It helps us to determine the actual aviability of cash in order to determine whether the business needs the more investment or anything else. It also helps us to finalise the position of the share so that a company can get more advantage. By knowing the presence of the cash, the business can make the decision that it should increase the shares or take the loans so that business can enjoy the more profit.
4)B) Answers
There are three types of business and they are mentioned as follows:
A company form of Business
It is the business which has to publics the accounts to the member of general public. There are no drawings and compulsory to follow all the financial statement i.e. profit & loss statement, cash flows and balance sheet.
Partnership Business
It is the business which has been invested by two or more than two people or organizations. They can follow any format compulsory unless they can do that.
Sole Traders
This is the types of business which do not need any types of financial statement to be followed. They can make any types according to their needs and have the capacity for drawings.
There are three types of financial statement valid in London (profit & loss statement, cash flows and balance sheet) and their difference between the formats of financial statements are as follows:
Balance sheet
(http://www.thetimes100.co.uk/theory/theory--company--125.php)
It is like a snapshot taken at a particular point of time which shows the financial condition of the business. Business needs assets in order to produce the capital.
The assets comes from two sources which increase the finance of the business.
Internal: Rises from owners of the business like shareholders in case of business.
External: the repayable form like loan which will be paid after.
Internal sources are owed to shareholders while external sources are owed to the people outside the business (liability) and so the balance sheet is balanced. This balance sheet starts with the listing the assets, coming liability and owners capital in order to balance sheet. This is how the balance sheet looks like.
Particular
Amount (£)
Fixed Assets
XX
Current Assets (XX)
Current Liabilities (XX)
XX
XX
Long term liabilities
XX
Owner's equity
XX
XX
Profit and loss statement
(http://www.thetimes100.co.uk/theory/theory--company--125.php)
This account can be made regularly to look weather the business is in profit or in loss and the quantity of profit or loss. The top part of the profit and loss account is known as the trading account of the business. The deduction of cost of sales turn over will give the gross profit. Sometime turn over refers to the sales revenue and it is calculated y multiplying by number items sold by their average price. Overheard are usually considered as the expenses in profit and loss account.
Particular
Amount (£)
Sales
XX
Less cost of goods sold
(XX)
GROSS PROFIT
XX
Add all other incomes
XX
Less all other expenses
(XX)
NET PROFIT
XX
Cash flow Statement
(http://www.moneyinstructor.com/doc/formatcashflow.asp)
The format of cash flows is very simply and show only the information of the period considered and does not refer to complete statement shown in profit and loss statement and balance sheet. It shows the avaibility of cash with the business by comparing the opening balance and closing balance of the cash flows. The closing balance of the last month will be the opening balance of this month. By comparing this diagram we can know that weather the business require the loan or not.
Particulars
Oct
Nov
Dec
Jan
Feb
Mar
Cash Inflows
Sales
Total Cash Inflows
Cash Outflows
Cost of Sales
Rents
Drawings
Total Cash Out Flows
Opening Balance
Total Cash Inflows
Total Cash Outflows
Loan Required
Closing Balance
However all the formats of the financial statement are different then each other but the similarities are that all the three statements shows the financial statement of the business directly or indirectly.
4)C) Answers
Profitability Ratio
Gross Profit Ratio for 2008 Gross profit for 2007
Gross Profit Ratio = Gross profit / sales *100
We have, gross profit =354000 We have, gross profit = 340000
Sales = 654000 sales = 740000
Therefore, therefore,
Gross profit ratio = 354000/654000 *100 Gross Profit ratio = 340000/740000 *100
= 54.13 = 46
Net profit margin for 2008 Net profit margin for 2007
Net profit margin = Net profit/ sales revenue *100
We have, Net profit = 171000 Net profit = 132000
Sales revenue = 654000 sales revenue = 740000
Therefore,
Net profit margin = 171000/654000 *100 Net profit margin =132000/740000 *100
= 26.15 = 17.84
From looking above profitability ratio we can say that the ratio has increase over a year of time.
The gross profit ratio has increased from 46% in 2007 to 54.13% in 2008. Then main reason of this increase is although the both sales of goods and cost of goods have been fallen over one year, yet the sales profit was smaller than the sales from 2007 to 2008.
Then new profit margin has increased from 17.84% in 2007 to 26.15% in 2008, it is because decrease in sales from 740000 in 2007 to 654000 in 2008
Liquidity Ratio
Current ratio = current assets/ current liabilities
Current ratio for 2008 current ratio for 2007
We have, Current assets =124000 We have, current assets =134000
Current liabilities =94000 current liabilities =62000
Therefore, current ratio= 124000/94000 Therefore, current ratio= 134000/62000
=1.32 = 2.16
Quick Ratio
Quick ratio = current assets- stock / current liabilities
Quick ratio for 2008 Quick ratio for 2007
We have, stock = 124000 stock = 94000
Quick ratio = 124000-124000/94000 quick ratio = 134000-94000/62000
= 0 = 0.65
The current ratio was good in 2.16:1 in 2007 but it has fallen to 1.32:1 in 2008. The main reason behind this is the bank draft of £4000 taken in 2008 and simultaneous fall in the cash from $40000 in 2007 to zero in 2008.
Similarly, the acid test ratio has fallen from 0.65% in 2007 to zero in 2008. the liquidity position of this company is in a very bad stage and the management should pay the special attentions to increase the liquid assets of the company so that it can have a healthy ratio of 2:1 (current ratio) and 1:1 (Quick ratio).
Efficiency Ratio
Fixed Assets Turnover Ratio for 2007 Fixed Assets Turnover Ratio for 2007
Fixed Assets Turnover Ratio = sales revenue/ Net book value of Fixed Assets
We have, sales revenue = 654000 sales revenue =740000
Net book value of fixed assets =120000 net book value of fixed assets =100000
Therefore,
Fixed assets turnover ratio = 654000/120000 Fixed assets turnover ratio= 740000/100000
= 5.45 = 7.4
Stock Turnover Ratio (in days) of 2008 Stock Turnover Ratio (in days) of 2007
Stock Turnover Ratio (in days) = Stock / Cost of sales *365
We have, cost of sales = 300000 cost of sales = 400000
Stock= 124000 Stock= 94000
Therefore, Stock Turnover Ratio (in days), Therefore, Stock Turnover Ratio (in days),
= 124000/300000 *365 = 94000/400000 *365
= 0.41*365 = 0.235 *365
= 149.65 = 85.775
The fixed assets turnover ratio has fallen over the period of one year. This shows that the company's efficiency has fallen and the sales revenue has fallen by 84000 from 2007 to 2008.
The stock turnover days also increases showing that the company's sales have gone slow.
