Business needs finances for implementing business operations and meeting essential payments and expenses. It is not possible to achieve short term and long term goals without efficiently managing the finances. Without finance business will die it is the lifeline of the business (Keller, 2011). The present study is about effective management of financial resources and how these resources are used in successfully executing business activities. It will also identify the resources available for finance in business and at last the study will end in calculating accounting ratios and their measurability.
1.1 Sources of finance that is available to businesses in the UK
Finance refers to source of money for a business to start up, run and then expand. There are mainly two sources of finance – internal & external. Some of the popular sources of finance for business in UK are:
- Banks – These are the most widely used start-ups for the business in UK. Bank offer overdrafts as a form of short term finance and Terms loans are considered to help businesses in buying supplies and equipments such as fixed assets, machinery or office equipments etc (Broadbent and Cullen, 2012).
- Grants – Under grants funding appear from EC and UK government sources, it is better option for businesses seeking finance for specific projects.
- Business Angels – Often high net worth individuals, Business Angels invest in high growth businesses on their own or as part of a syndicate. Besides providing finance angel investors also provide their own ideas, skills and contacts to businesses (Carey, 2001).
- Own finance – One can start its own business by using its own financial resources. This money can be available in form of personal savings or fixed deposits or investments.
- Loans – It’s not just the banks that provide the loans but there are also other business support organization and agencies which provide finance to businesses in UK.
- CDFA – Based in UK, Community Development Finance Association provides loans and support to businesses, charities, social enterprises etc (Collis and Jarvis 2002).
1.2 Implications and costs of the identified sources of finance available to UK businesses
Businesses in UK have many sources of finance available for the business activities. Typically it is not advised to fund the start-up for the business from own funds, loans or credit not necessarily customized to the business requirements and needs. Bank overdrafts and term loans are fine way of covering any instability or fluctuation of funds coming in and out of business (Deakins, Morrison and Galloway, 2002). Grants can be defined as the trustable source of funds as the finance comes from the government sources, businesses can search for grants available in different regions and can find further information on their websites. Angel investors is the growing trend in the business world, apart from arranging finance they also provide their suggestions, skills, talent and experience to the businesses in UK (Dittenhofer, 2001). The National Network Enterprise is a good example of loan for the businesses. Mostly based within the UK’s most disadvantaged communities the Community Development Finance Associations represent a system of regional community fiancé institutions in every local region of UK. (Fairchild, 2002).
1.3 Advantages and disadvantages of the different sources of finance
Own finance makes a great source of capital for the business because possession costs are minimum and business will not be paying any interest or other charges on loans. Drawback is that if the personal savings is plowed into the business, it will lose it all in case if business doesn’t runs (Gloy and LaDue, 2003). Arranging a group of investors can help in raising startup and expansion of capital without inserting the entire risk on the company alone. The disadvantage of bringing in investors is that the company losses a certain element of control over the business (Carey, 2001). Bank loans enables to keep cash on hand which can be use as the operating capital or for personal survival during the decline of the business on the other side the drawback is the interest charged on the loan, bank will ask for interest whether the business is running good or bad.
2.1 Analyse the costs of the different types of finance available to the business
Setting up own business requires suitable source of finance available for its start-up. Presently I want to start a business dealing in producing equipments, tools and machinery for schools, colleges and educational institutes in UK. It will need £500,000 for the business to start and £100,000 out of it will be needed for the premises, staff and marketing (Lam, 2010). Out of the above identified sources of finance three of them are most suitable for the described business.
Bank loans are like the supermarket for debt financing providing short term and long term financing and they arrange funds for all asset needs, including equipment, working capital etc. Unlike other financing terms banks offer some flexibility, the business can pay off the loan early and finish the agreement, (Leung, 2011) VCs and other institutional investors may not be so amenable. Angel investors are also the better medium of raising the funds for the business, if one must sell an ownership to get the company off the ground, start by finding a respected industry executive who is agreeable to spend a reasonable amount and give venture credibility with other investors. The advice and networking without all the heavy handed demands of a VC come in handy too (Li, 2003). Many small business administration offer grants to help new companies to start the business, grants are fundamentally free money and government guaranteed loans come with interest rates that are usually far below what one can get on its own (Dittenhofer, 2001).
2.2 Explain why financial planning is important for the success of any business
Financial planning can be termed as the process of estimating the funds and capital required for the business to develop and expand. It is the process of framing the financial policies and procedures which are essential for administration and investment of funds in effective manner. It is possible to manage income more efficiently with the help of financial planning; it increases the cash flow by cautiously monitoring the spending expenses and prototypes (Keller, 2011). An increase in cash flow results in increase of capital for the business, financial planning acts as a guide in choosing right type of investments policies required for the business. Fine understanding can be achieved when measurable financial objectives are set and hence it can improve the control over budget and financial policies (Broadbent and Cullen, 2012). Process of financial planning reduces the uncertainties which can be hindrance in growth of the business and ensures long term survival of the business by implementing expansion programmes.
2.3 Identify the main users of financial information and assess their information needs
Financial statements provide the information about the financial requirements, operations and wealth of an organization that is intended for use widely by the financial decision makers (Shim, and Siegel, 2008). There are many types of users of financial information such as:
- Investors – These people need the financial information for making the decisions relating to holding, buying and selling of shares and securities of other companies.
- Government – Government agencies need the financial information in command to standardize and authorized the business practises and introduce provisions for the regulation of the firms (Correia and et.all. 2012).
- Competitors – These people need the financial information in order to understand the strategies, strength, weakness and functioning of the other companies.
- Lenders – Many lending institutions like banks and loan giving agencies examine the financial information while making the decision to lend the money including the amount of interests and security (Keller, 2011).
- Customers – They need the financial information for evaluating the performance of the company and its persistence in the market.
2.4 Explain the impact of finance on the financial statements.
Selected sources of finance will have their impact on the financial statements of the business. Arranging finance through bank loans is a form of debt financing, funds coming through bank loan will affect the financial position of the business and will charge all the expenses and interest relating to bank loan in the profit & loss account. Amount of loan will increase the liabilities wall of the balances sheet (Carey, 2001). Generating finance through grants will charge as an expense in the profit & loss account and assets and liabilities side of the balance sheet will increase affecting the liquidity of the business. Funds coming from angel investors will affect the debit side of profit & loss account; hence the profitability will be affected because the profits coming from investments will be shared with the investors. Liabilities side of the balance sheet will be affected because the funds or capital has been generated for the business (Deakins, Morrison and Galloway, 2002).
3.1 Cash Budget
Cash budget indicates whether a business has sufficient amount of cash resources to operate its routine activities, it reflects the total cash outflow and cash inflow from the business activities (Carey, 2001). The above cash budget of Blog’s Books is showing deficit amount at the end of the April 2014. The deficit reflects the excess of spending over income that means amount of expenses are more than the amount of income and it also shows that it becomes difficult for the company to survive in the long run. Company can reduce or eliminate the deficit by increasing sales and reducing expenditures.
3.2 Explain the calculation of unit costs and make pricing decisions using relevant information
Number of units = 1000
Variable cost = £10/unit
Fixed cost = £5/unit
Total Cost = £15/unit
Cost price = 1000 * 15 = 15000 = 15000 + 40% mark up
= 6000 + 15000
= 21000 £ (profit)
Selling price per unit = 21000 / 1000 = 21 £
Additional units to be sold = 600 units
Additional units * cost price * mark up %
600 * 10 * 140/100 = 8400
8400 / 600 = 14 £
Profit = selling price – cost price
8400 – 6000 = 2400 £
The above calculation shows that 21000 £ can be realized from the sale of first 1000 units and selling price per unit will be 21 £. If the company wants to maintain 40% mark-up margin on the additional sale of 600 units the unit price will be 14 £ and company will be getting a profit of 2400 on sale of these additional 600 units (Broadbent and Cullen, 2012).
4.1 Discuss the difference between Gross Profit and Net Profit in the Profit and Loss Account
In the profit & loss account the gross profit margin is a measurement of firm’s manufacturing and distribution efficiency during the production process and it is calculated by subtracting the cost of goods sold from revenue (Shim, K. J. and Siegel, G. J., 2008). A firm boosting higher gross profit margin it shows that its competitors and industry is more efficient. On the other had net profit refers to the amount left over after all deductions are done, once the net value is attained nothing more is subtracted. Net profit is calculated by subtracting expenses such as selling, general and administrative expenses and taxes from gross income (Deakins, Morrison and Galloway, 2002).
Under balance sheets fixed assets such as inventories, cash in hand, debtors are non-moving assets, fixed in nature and are not easy to in cash and current assets such as plant, machinery, land & building etc are flexible in nature, easily convertible in cash and it’s a type of floating money to the company (Keller, 2011).
4.2 Calculate and interpret the relevant financial ratios based on the information given in the financial statements
Current ratio measures the capacity of the firm to pay its short term liabilities also known as liquidity ratio and cash ratio (Leung, 2011) .
Acid test ratio
= 125000 – 800000 / 500000 = .9%
Acid test ratio is the stringent indicator that determines whether a firm has enough short term assets to wrap up its immediate liabilities without selling its inventory (Gloy and LaDue, 2003).
Return on capital employed ratio
= *100 = 350000 / 3400000 * 100 = 10.2 %
Return on capital employed ratio indicates the profitability and efficiency of firm’s capital investments. It should always be higher than the rate at which the company borrows; otherwise any increase in borrowings will reduce shareholder’s earnings.
Gross profit margin
= *100, = 800000 / 1200000 * 100 = 66.6 %
It is a profitability ratio that shows the relationship between gross profit and total sales of the company and it helps in evaluating the operational performance of the business (Fairchild, 2002).
Net profit margin
= *100, = 350000 / 1200000 * 100 = 29.1 %
Net profit is a profitability ratio that shows relationship between net profit after tax and net sales.
Debtors payment period
= *365 = 150000 / 1200000 * 365 = 45.62 %
Debtor’s payments period indicates the debtor collection period and the time taken to collect trade debts; it is the year’s sales which are outstanding at the balance sheet date, express in days.
All of the above ratios help in analysing and evaluating the profitability & liquidity of the business. These ratios are considered important in terms of financial planning and strategies of the business (Fairchild, 2002).
From the above study it has been concluded that managing the financial resources of the company is very significant task for the organization because this state’s about the growth and development of the company. Company should effectively manage its resources in order to accomplish its goals, mission and objectives in an effective manner (Shim and Siegel, 2008). All the tools and techniques are to be used while assessing the feasibility of the products to generate better revenue in future. It can also be concluded that accounting or financial ratios reflects exact and accurate financial position of the business and theses ratios plays an important role in steadiness and sustainability of the business in the market.
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