Managing Financial Resources & Decisions

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Executive Summery

Here we have been capable of drawing the analyzing sources of finance for selected public company The City UK. The sources are explained completely with relevant to company nature. And then, cash budget and sales budget have been explained with the analysis after bringing required modifications. Then for the purpose of proposals for investment, techniques of capital budgeting such as NPV, payback period etc. is explained. At the ending, some important ratios have been calculated on the data and information of The City UK.  managing financial resources and decisions

Introduction

Any kind of commercial or business organizations are always to deal with Managing Financial Resources & Decisions. It is recognized the difficulty to get the touch of success without a proper management of financial decisions and resources for any business. Decisions makers of finance should play the important role in finding the appropriate source of finance for ensuring lower cost of capital and maximum availability of funds. To fulfill this purpose, a good financial is perfect guidance to financial decision makers involved in financial activities. Moreover, ratio analysis on financial statements is taken as highly crucial because financial statements are considered as mechanism of knowing and estimating the performance and condition of any business. A number of ratios are applied with the analysis of elements of financial statements to evaluate conditions and performance of a business firm.

Sources of Finance Available for a business:

Various sources of finance are used by the larger financial company The City UK to raise fund for their new project. Among such available sources of finance, followings are the most important ones for a public company like The City UK:

Issuance of stock:

Only the larger public companies may use this sources of finance. These sources are the biggest and most notable sources of finance for such public companies as they consider. Through the issuance of stock at different prices these are the good of scope to raise fund to finance in the new projects from public. Company can issue stocks to raise fund from public in two ways viz. common stock and preferred stock. Though there are some preferences available for preferred stockholders, most investors are interested to common stock holders for availing the voting rights and getting the privilege of becoming actual owners of the company(Khan and Jain, 2010-12). This source can make financial statement of a company stronger. Company is not obliged to make any kind of dividend to the investors if it is not able to make sufficient profits and to return the investment on stocks.

Issuance of debenture:

Among many big external sources of finance Debenture is one as most of financial company think. Since the investors prefer to take low risk for the safety of their investment to ensure the guarantee of making fixed return on the invested amount Debenture is considered as attractive source to them (Khan and Jain, 2010-12). Debenture promises to pay a fixed rate of return to the debenture holders periodically. Such debenture is also issued to public or institutional investors containing components of debenture finance. Company is in obligation to repay debenture investment to the investors after promised maturity.

Borrowing from banks:

Each and every financial party usually choose the bank loan as a first source of finance to finance in new or existing projects. Now a days the banks always crowded with the corporations because of their visiting to seek fund for financing their business. Maintaining the relevance to the variety of needs of customers, banks offer different types of credit packages to fulfill these needs. With the compliance of mentor policy drafted by central bank, banks determines rate of interest on the disbursed credit. Corporations like GSK can find bank loan as convenient source of finance to fund in the new projects.

Sources exploration of finance relevant to The City UK:

Due to difference in nature, factors of sources, maturity, cost of investment etc. the mentioned sources of finance can have different extent of relevance to The City UK’s business as a public company of UK.

Two different stocks (common and preferred):

The public companies may use any of them as their choices because both of the sources of finance are absolutely available. Other forms of business are not legal to the UK Monetary Policy to fund through these sources. Financing through issuance of common stock and preferred stock can give the opportunity of financing despite not promising to repay the investment at any maturity date (Stephen and Jordan, 2005). GSK being large company operates larger projects which require it to finance for longer period of time. Besides, company is not obligation to make any dividend in every financial year. From that respect, issuance of stock is a worthy source of finance in terms of cost of capital and availability of funds among other sources.

Potentials and adversities of financing:

It’s not same the benefits and negativity of using different sources. Benefits and adverse consequences of one source differ from that other sources of finance. Along with some adverse disadvantages all the sources have some benefits.

Advantages of Stocking

Stocking is thought as a big and major source of finance. There is nothing to worry as obligation to repay this equity capital unlike many other sources of finance. Public company during liquidation fulfills the claim of stockholder as the last capital provider. But, the whole financing of a project is done through common and preferred stock by GSK, utilization of financial leverage and increasing of EPS will turn into failure (Symansky, 2010).

Requirements of debenture:

The requirements of issuing debenture to the company are paying fixed amount of interest and repaying the capital collected through debenture after maturity date. But this interest payment decreases amount of corporate tax and increased EPS on existing shares through utilization of financial leverage. GSK can select this source to finance the new project planned.

Difference between debenture and bank loan:

Although the bank loan is one kind of external source, there is a great difference and distance from debenture. The maturity of the bank loan is not as long as that of debenture. Bank loan provides special flexibility for larger companies like GSK. On the of extent or relationship, banks approve different kinds of remedy during repayment if in favorable conditions exist.

Cost determining:

In order to ensure the profit besides success and establishment of the company a certain and reasonable profit is added to fix the price covering cost of goods sold and fixed cost at current volume. This method is a simple method. For example, if the variable cost per unit becomes £90 and fixed cost in unit is £10, addition of profit margin at 20% will make the price per unit is £100.

Methods of Pricing:

Among many available pricing methods Following four pricing methods are much common and practiced ones. With proper evaluation these four methods are explained below.

Targeted return:

A targeted rate of return is fixed from past. Price of products is determined in such way that the recovery of that target return can be ensured through pricing of the product (Stevens, 2004).   For example, by estimating investment cost at £20 and the rate or return on investment targeted at 10%, the price is £22.

Value-based pricing:

Product’s prices are determined on the value it created for the customer. The value customers avail is computed through considering the intention of “pay for performance” and pricing is applied on variable scale on the basis of results. For example, widget above service saves cost of energy at £1000, service can easily charge £300, £400 or more for it and customers would gladly pay for it.

Psychology:

An impact raised by the psychological matter of a customer is taken significantly into account to fix the price of the product or service. There is a major and significant role of customers’ perception towards the price of the product in verifying the quality of the product. In case of some products and services, many customers believe that price of high quality products will be expectedly higher than that of low quality products. For example, price of a particular cold drinks above the average price can create perception that it quality is better than average ones (Fritz, Hedger and Lopes, 2011).

Analysis of sales budget and cash budget and completion of sales budget:

Month Monthly Budget Actual Monthly Actual Cumulative Variance
July 240,000 240,000 240000 0
August 230,000 220,000 460,000 -10,000
September 270,000 272,000 7320000 2,000
October 265,000 250,000 957,000 -15,000
November 265,000 255,000 1,212,000 -10000
December 300,000 270,000 1,482,000 -30000

A practical document that show the probable sales amount for a particular period of time may be defined as a sales budget. In line with the change of time, the selected firm increased their sales target. But the firm has not been able to achieve their sales target because of negative variance in actual sales, it can be said that it is less likely to achieve the target of remaining six month unless they can increase their number of customers. There, the firm should adapt a slow technique in increasing sales target with the change of time and business transactions.

A cash budget is the estimation of future cash inflow and outflow in a particular firm. The given cash budget shows the forecast of unfavorable cash condition of the given firm. The ending cash surplus is lower than beginning cash balance. Moreover, the accumulated cash deficit is larger than accumulated cash surplus due to cost of goods sold and other costs. The firm has not been able to target higher cash inflows compared to probable cash outflows(Stevens, 2004).

Activities within the period of cash inflow and outflow:

To improve the position of cash, this firm should take step to increase sales with minimum cost. During beginning months, total expenditure was much higher than total revenue due to cash outflows for buying fixed assets like equipments. To make any business operated with profitability and liquidity, cash inflows must be higher than the cash outflows. This firm’s cash budget represent that the firm is going to face cumulative cash deficit. Moreover, the firm should increase gross profit through buying goods at competitively lower cost which will decrease cash outflows significantly and purchase can be done in credit as well. It should concede effort to make reasonable delay in making payment of expenditure. These discussed recommendations should be adapted by the firm to upgrade the position of cash.

Breakeven point calculating:

Breakeven point is a stage of revenue at which the revenue gets equal to expenditure incurred. From that respect, if amount of revenue stays below the breakeven point, volume of production is in loss and if it is above the breakeven point, this volume is in profit. For the calculation of profit of firm, determination of breakeven point is important.

Here is a fluctuation in selling price level which may influence the volume of sales. If the selling price of product increased to £330 by increment of 10% from the given price, breakeven points in volume would be 2636 units approximately. Moreover, sales volume will decrease because of higher price which will discourage some customers not to buy the product. In other case, getting down of product’s price to £270 will take breakeven point at 5800 units. But the sales volume will increase as customers will buy the product in cheap price. Hence, it is a cost-plus method which was followed by West field Company for taking pricing decision for product A.

Significance of capital budgeting:

A number of techniques are used for evaluating investment proposal in long term projects. Among those techniques, the following discussed three methods are the most practiced ones:

Accounting rate of return (ARR):

The amount of profit or margin that an investor expects from an investment in projects is defined as accounting rate of return. It calculates the return which is generated from net income of the proposed capital investments. Accounting rate of return divides the average profit by initial investment to estimate the return as expected (Foster, 2012-13). This method helps an investor make comparison the profit potential of proposed projects.

Payback Period:

The duration required by the investors to recover the investment amount in a particular project is defined as Payback Period. It is considered as important determinant for taking decision of making investment by assessing the length of time for the recovery of initial investment. The shorter the recovery time, the more attractive the investment. The longer the required time, the riskier the investment.

Net Present Value (NPV):

The amount of difference between the discounted cash flows from project and cost of initial investment is defined as net present value. It is the most popular and practiced method of capital budgeting technique used to assess investment proposals (Diamond and Khemani, 2005). Net present value always requires the discounted cash flows to be larger than initial cost of investment for making the proposed project acceptable. Net present value with considering the time value of money can give accurate value which can be gained from investment proposals with greater discounted cash flows.

A prescription on investment proposals:

Comparison of Project A and Project B with Net Present Value and payback period
Projects A   Project B
year Cash Discounting DCF(£) Cumulative year cash Discounting DCF(£) Cumulative
inflows (£) Factor cash inflow inflows (£) Factor cash inflow (£)
1 80000 0.862 68960 80000 1 30000 0.862 25860 30000
2 80000 0.743 59440 160000 2 50000 0.743 37150 80000
3 40000 0.641 25640 200000 3 90000 0.641 57690 170000
4 20000 0.552 11040 220000 4 120000 0.552 66240 290000
4 40000 0.552 22080 240000 4 40000 0.552 22080 330000
PV of total inflows 187160   PV of total inflows 209020
Initial cost 200000 Initial cost 200000
NPV of project A -12840   NPV of project B 9020

 

calculation of Accounting Rate of Return    project A    project B
particulars   £   £
cost of investment 200000 200000
expected profit        
year 1 80000 30000
year 2 80000 50000
year 3 40000 90000
year 4 20000 120000
220000 290000
average income of project A 220000/4
55000
Average Income of project B     290000/4
      72500
Average investment 40000+1/2(200000-40000)
120000
ARR for project A 55000/200000 0.275
ARR for project B 72500/200000 0.3625

 

From the above calculation of given data and information, different techniques advice different proposals for taking investment decisions.

According to the advice of NPV, project B should be selected for investment as this project has positive NPV of £9020. But NPV of project A is negative with (£12840).

On the other hand, payback period prefers project A as this one much profitable than project B due to early investment recovery. Project A needs exactly 3 years for investment cost recovery whereas project B requires more than 3 years to do so.

In terms of ARR, project B as investment proposal for new projects should be selected. This project will generate higher average income than project A. the ARR (0.3625) of project B is greater than that (0.275) of project A.

Ratios for interpretation of financial statements:

In order to interpret the financial statements the following ratios are used:

Profitability:

To calculate the profit making ability of an organization this ratio is an important one. This ratio indicates the profit rate of a firm for a given year. Profitability indicates the extent of return of a company on the sales made (Foster, 2012-13). The higher the profitability of a company, the stonger the financial condition of that company. Higher profitability makes a business viable and frequent in taking financial decisions for initiating new projects.

Financial Risk:

As a result of inability in paying financial obligations this risk can arise. A company financing through credit and other external sources needs to pay interest every year or at other intervals besides repaying procured credit at maturity date (Brooke, 2007). If the company cannot pay the interest and repay procured loan on due date, the company will face financial risk.

Working Capital:

The amount of difference between current assets and current liabilities of a firm is known as working capital. Current assets become higher than current liabilities. Working capital always needs to be in positive figure for continual of the business.

Liquidity:

The ability of a company to meet its current obligation computed by this ratio. Liquidity should be maintained at a minimum level for the safety. It should be maintained in such a way that cash is not kept idol and cash is insufficient to meet obligations (Diamond and Khemani, 2005). Inability to meet current obligations can hamper current operation of the company with insufficient supplies of required materials. Better liquidity can be assisting to a business to avail credit facility offered by different types of creditors like bank.

Performance from investors’ point of view:

Investor is the supplier of life blood of an organization. Through supplying finance in different ways, they make company run in full motion. Investors expect return from the company for their investment. As factors of their return, they assess earning per share, price earnings ratio, net profit margin, dividend rate and bonus share (Foster, 2012-13).

Formulations of comment on movement in ratios:

Following ratios are used on the financial statement of The City UK:

Profitability:

2013                                     2012

Gross profit margin:                                           =

=67.6099%                       =70.0163%

Net profit margin: =                     =                              =

= 21.2337%                   = 17.69895%

 

Liquidity:        =                     =

=1.113                     =0.991067

Working Capital= current assets – current liabilities

2013                                                2012

=

=                                     =

Financial risk= Profit before interest- interest

2013                                               2012

=£7,028m-£767m                    = £7300m-£799m

=£6261m                                  =£6501m

Performance from investors’ point of view:

2013                                                    2012

Basic Earning per share:       = 112.5p                                                 =91.6p

Diluted Earning per share:       = 110.5p                                                =90.2p

 

Here it is noticed that the ratios deffer from one period to another period. So it may be commented that financial performance of 2013 is better than 2012. Result of, net profit margin, current ratio, earning per share indicates that in this year there has been improvement in financial conditions and performance.

Affecting factors towards unreliable conclusions:

There are some factors which can distort the result of ratios leading to unreliable conclusions. Depreciation is one such factor which can have influence in varying ratios. Credit can also make the ratio distorting as unpaid sales amount shown as revenue may show huge profit than actual one. Interest amount can be hided in EPS calculations. Therefore this factor can make results of ratio conflicting.

Conclusions:

Financial decisions play an important and significant role on the operation and growth of the company. Financial resources are properly managed with selecting good sources of finance considering cost of finance and maturity of finance. For managing financial decisions perfectly, proper formats of financial statements should be selected. Through the application of ratios and their comparison, performance and conditions of firm are assessed.

References:

  1. George Foster (2012-13), Financial Statement Analysis, Stanford, UK.
  2. Khan and Jain (2010-12), Financial Management, Delhi, India.
  3. Stephen and Jordan (2005), Fundamentals of Corporate Finance, New York, USA.
  4. Symansky, S. (2010), ‘Donor Funding and Public Financial Management (PFM) Reform in Post-conflict Countries: Recommendations Delivered from Personal Observations’. Discussion Paper, London.
  5. Fritz, V., Hedger, E. and Lopes, A. (2011) ‘Strengthening Public Financial Management in Postconflict Countries.
  6. Stevens, M. (2004) ‘Institutional and Incentive Issues in Public Financial Management Reform in Poor Countries’. Report to the PEFA.
  7. Diamond, J. and Khemani, P. (2005) ‘Introducing Integrated Financial Management Systems in Developing Countries’.
  8. Brooke, P. (2007) ‘Study of Measures Used to Address Weaknesses in Public Financial Management Systems in the Context of Policy-based Support’. Bannock Consulting for PEFA.

Allen, R., Shiavo-Campo, S. and Garrity, T.H. (2006), Assessing and Reforming Public Financial Management: A New Approach.