Finance and Cash Flow Assignment.
Finance and Cash Flow Assignment
For the opening part of this assignment, I am going to be listing the various sources of finance available to Coulla Petrou for both possible business ventures i.e. in the likelihood that she decides to fund expansion on her own within her own premises as a sole trader, or in the event that she decides to take up her brother's offer and form a partnership with him. In the possibility of both case scenarios, I will have to consider the options available to both parties which in this case are Coulla and Andrew, and Coulla who is currently an existing sole trader.
To find out which sources of finance are best suited to fund for expansion to both a sole trader and a partnership, I will crucially have to weigh out all the sources of finance that are open to both forms of business organisations. I will then list the advantages and disadvantages of the sources and finance and then put my knowledge to say which ones would be best suited. Only once after I have done that, will I then go onto evaluate each source of finance by assessing whether they are feasible enough to meet the requirements for the proposed venture plan which is to expand 'The Cutting Shop' by breaking them down into factors such as the time period involved, the cost of how much the expansion itself will cost and the period in which the loan has to be paid back.
Task 1
The sources of finance that are available to Coulla Petrou to fund the expansion of her business both as a sole trader or as a partnership will come from two main areas.
For example if she wants to raise finance, then it can be raised either internally which means that money is obtained from within the heart of the business or externally which is funds raised from out of the business.
The main sources of internal finance that would be available to Coulla as a sole trader or as a partnership are as follows:
> Retained Profits - These are those profits that are put back into the business after the owner or owners have taken out their share of the profits and have paid out their expenses such as running costs of the business - electricity. These are also known as ploughed profits and have the following advantage and disadvantage:
- Retained profits do not have to be repaid unlike, for example a bank loan.
- Interest is therefore not charged
- In Some cases when businesses show a decrease or decline in profits, they
cannot rely on using retained profits as a source of finance because if the
business is not selling, they are then not making any profit and can therefore
not seek finance through it as there isn't any profit which is being retained.
This source of finance in my opinion cannot realistically be an option of raising finance for Coulla for expansion because she has shown 'a net loss over the past two years' which shows that there is not much profit being made and will mean that there will not be enough cash to fund expansion.
> Sale of Existing Assets - These are those assets that are no longer needed by the business, for example surplus equipment i.e. in Coulla's case it could be that she no longer requires her old her machinery and can sell or lease it on because there are more efficient and more reliable machines that dry hair available. This source of finance has the following advantage and disadvantage:
- This makes better use of the capital tied up in the business
- It may take some time to sell those assets
This can again like retained profits cannot possibly be a realistic choice because the business will or does not rather have many assets to sell which in return would give her a large sum of cash. For example, a salon will offer hair gel and scissors which will not have a high enough value.
> Personal Capital - This is all the owner's savings that they have saved up and the money that they wish to contribute into the business. Can be accessed either from their bank account or if they have it lying around in a safe that they have. This has the advantage that
- Money will be available to the firm quickly
- No Interest will have to be paid
- The negative thing is that there may not be enough money saved up by the
owner or owners and it could increase the risk that they spend all of their money for expansion and not having any leftover when a cash flow problem arrives.
> Friends/Family - Another alternative for Coulla Petrou could be to ask her beloved friends or family to borrow cash. Advantages of seeking this form of finance is:
- No interest will be charged
- It is quick and easy to access
Disadvantage of asking her friends or family are:
- They may not have enough cash to fund the expansion
- If Coulla does borrow and cannot pay them back within the agreed time, then it could cause serious tension or falling out..
As well as there being internal sources of finance available to a sole trader or a partnership, there are also external sources of finance available to them. These are:
> HP (Hire Purchase) -
> Leasing
> Bank Loans
> Mortgages -
> Bank Overdrafts -
> Trade Credit -
A Hire Purchase agreement from a finance house enables a business to acquire an asset on the payment of a deposit and to pay back the cost plus interest over a set period, at the end of which the ownership of ...
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As well as there being internal sources of finance available to a sole trader or a partnership, there are also external sources of finance available to them. These are:
> HP (Hire Purchase) -
> Leasing
> Bank Loans
> Mortgages -
> Bank Overdrafts -
> Trade Credit -
A Hire Purchase agreement from a finance house enables a business to acquire an asset on the payment of a deposit and to pay back the cost plus interest over a set period, at the end of which the ownership of the asset passes onto the borrower.
The advantage for Coulla into using a HP agreement is that she can spread her financial costs and not just splash out all of her money on purchasing say for e.g. toning tables.
A disadvantage of using HP is that instalment credit or interest will be charged and would mean that Coulla will have to pay extra money on the basis of the charge and she will lose additional money through paying the interest charge.
Another advantage of using HP is that it is a medium term funding facility which cannot be withdrawn provided that the business makes the payments as they fall due.
Furthermore it should be kept borne in mind to Coulla that they are medium term agreements. It may not be possible say for instance or could prove costly if the agreement is terminated which is another disadvantage. Moreover under HP, the fiancé company retains legal ownership of the equipment, at least until the last instalment that has to be paid by the lendee.
This normally gives the finance company better security then lenders of other types of loans or overdraft facilities. As a result, the finance company may be able to offer better terms to the business which is another advantage to Coulla.
Another good thing about an HP agreement is that for example say in the case of Coulla's business she has shown a net loss in the past two years and if she decided to take up a HP agreement in which to pay her suppliers - 'Superflex', she will have to put down a deposit or to make advance payings. It may then be possible for the business to trade in other assets that they own such as hair style machines as a means of raising finance.
Leasing is where a business buys an asset and then hires or leases it to another business (the lessee) for a fee in terms of rent over a fixed period of time. I feel that Leasing would also be a beneficial alternative or method to 'The Cutting Shop' because as mentioned earlier, the business has shown a net loss over the past couple of years which means that not much profit has been made.
Furthermore, Ms Petrou also specifically stated that she wanted to cut her costs and by leasing for example, the toning tables from 'Superflex UK', not only will she pay for what she has borrowed, but also more importantly cut her costs dramatically because she will not be buying the toning tables, but paying for what she has borrowed.
Another advantage apart from that leasing reduces the financial outlay of costs is that within the agreement between the leaser and the lessee, is that service maintenance is all usually all inclusive as part of the deal.
This means that say for example, Ms Petrou buys £1000 worth of toning tables and after two or three years new radically enhanced toning tables are created, she cannot just exchange the machines because she purchased the machines herself. Overall, this means that depreciation costs which is the wear and tear of machinery due to time can be avoided because Coulla can exchange her toning tables and could result in the rise of sales and profit due to the better quality of toning tables at her shop.
Looking at this method of finance as a whole, I strongly advocate that Coulla uses leasing instead of borrowing a bank loan because the financial outlay of costs are reduced and service maintenance is normally included so that if there is a problem with her toning tables, she can exchange them or if better ones are out she can get them instead. Also with bank loans the owner's personal possessions can be taken by the lender as a form of security which in leasing almost is unlikely to happen and Coulla does not have to worry about paying a large sum of money back because with leasing, small amounts of money is paid back at a fixed rate.
Moreover, on some leasing agreements such as those which are more long term, the finance company offers the option of variable interest rates. In such cases could be a disadvantage for Coulla because it may be more difficult for her to budget for the level of payment demanded by the lender and could cause a cash flow problem as she may not for instance be able to fork out if the interest rates inflate. Also the decision to provide finance to the 'Cutting Shop' depends on their current credit standings and potential because Superflex's finance company has security on the toning tables, it could be tip in the balance of the finance company as Coulla may not have enough funds to pay Superflex for the usage of the equipment. In such cases Superflex could sue and get money back and will get back their toning tables. It could also swing as a favour for Coulla as she will know where she stands.
Bank Loans are medium term loans which are obtained from banks. The obvious advantage for Coulla to exercise upon this alternative is that she can borrow thousands of pounds which could easily fund the expansion for her shop. In relation, she will have around seven years to pay back the borrowed money which means that she can fully utilize or make best use of the cash by spreading the costs over a long time - she can hold onto the cash for as long as possible which means that if she incurs a cash flow crisis, she can use it to pay of her debts.
A negative factor about using a loan is that the finance house usually has assets secured to them from the business as a form of security and interest is charged which will add to the list of expenses of Coulla. Moving on, the business and the bank both know precisely what the repayments of the loan will be and how much is interest is payable and by when. This makes cash flow more predictable for both parties but for the business especially because they will have a good idea as to how much money to borrow is business wise before they go into the red.
Commercial Mortgages are like bank loans except the time period as to when the cash has to be paid back is of a greater length and the sum of money is larger which is an advantage for Coulla as she can borrow enough money to fund the expansion of her business. A disadvantage of taking up a mortgage is that interest is charged which means that Coulla will be adding to her expenses even further.
A Bank Overdraft is short term borrowing on bank current account. It is relatively cheap and for existing sole trading or partnership businesses, the Base Rate is somewhere between the region of 2.5% and 5%. This is an advantage because Coulla can save money. Interest is also charged quarterly, but you only pay interest on what you have borrowed.
This again is an advantage because the business does not get charged on whatever the bank says. Although having said this, if the bank becomes weary about the ability of a business to repay, it can ask for the overdraft to be repaid on demand. This can have a catastrophic effect on a business position because if they have security on the business i.e. the owner's car they can sell it. I think that Coulla using a Bank Overdraft to fund the costs of her business's expansion cannot be an option because firstly it is a short term source of finance that has to be paid back quickly. Secondly the sum of money borrowed is a small amount - normally a couple of thousand pounds and is used to rectify cash flow problems
Instead Coulla could use a bank overdraft to counter the deficit of funding expansion as the bank has the flexibility to review and adjust the level of the overdraft facility, perhaps in the short-term. Also being part of a short-term debt, the overdraft balance is not normally included in the calculations of the business's financial gearings
Trade Credit is a short term agreement where a company purchases things and pays for them at a later date, typically 30 days or in some circumstances, 60 days. This can be employed by 'The Cutting Shop' for day to day activities such as buying shampoo and hair gel, but will not fund for expansion.
Task 2
NB: As some of the sources of finance that have been mentioned previously in task 1 and apply to a Ltd. Company such as Superflex, they won't be mentioned.
Apart from the earlier quoted sources of finance that can be used to fund expansion, limited companies are also open to:
> Venture Capital Firms or Business Angels
> Government Assistance
> Debt Factoring
> Commercial Mortgages
> Rights Issue
When a company is growing like Superflex Ltd., for example, when contemplating investment in capital equipment such as their toning tables or an acquisition, its current financial resources may be inadequate (scarce). Few growing Ltd Co's are able to finance their expansion plans from cash flow alone. So they will therefore need to consider raising finance from other external sources some of which have been stated earlier in question for 'The Cutting Shop' still apply to larger companies.
A key consideration in choosing the source of new business finance is to strike the balance between equity and debt to ensure the funding structure suits the business, in this case expansion for Superflex Ltd. The main differences between borrowed money (debt) and equity are that bankers request interest payments and capital repayments, and the borrowed money is usually secured on business assets or the personal assets of shareholders and or/directors. A bank also has the power to place a business into administration or insolvency if it defaults on debt interest or repayments or its prospects decline.
In contrast, equity investors take the risk of failure like all other shareholders, whilst they will benefit from participation in increasing levels of profit and on the eventual sale of their stake. However, in most circumstances Venture Capitalists will also require more complex investments such as preference shares and loan stock in addition to their equity stake. So the overall objective in raising finance for a company is to avoid exposing the business to excessive and continuous use of high borrowings, but without unnecessarily diluting the share capital. This will ensure that the financial risk of the company is kept at an optimal level.
Venture Capital Companies and Capital involves the sale of equity or a share in the business to some form of a venture capital fund. This is usually another company that is wealthy or a rich business individual - 'A business Angel'. The venture capitalist company buys and equity stake in an unquoted company with growth potential.
Venture Capital from the Perspective of the Company
Venture Capital is a possible source of finance for Superflex as it is a limited company that wants to grow even further. The sale of equity has the following advantages:
> The Venture Capitalist will provide management advice to strengthen the business
> Lower Gearing will in turn make it easier to raise debt finance
> The business is not committed to meet regular interest payments
> The equity will reduce the gearing of the firm
I feel that this would be an extremely wise and suitable business decision providing that on the basis that Superflex increase their profitability levels so that a Venture Capitalist will want to buy into the company and expand.
Government Assistance can also help a company such as Superflex grow because they help to facilitate/aid the growth of businesses. This would be suitable as it is cheap but could take time for the money to be passed onto the business
Debt Factoring could be used by Superflex to fund expansion if the amount of money owed is large. For example, if the debt owed to them is high - £20,000 they can seek a debt factoring firm that will say to them 'we'll take your debts and make sure we get back what is owed to you'. But the disadvantage of a debt factoring firm is that out of that £20,000 they will take 20% of the value of the sum of money as they are larger and more powerful than Superflex are. However, having said that, Superflex will still make a £16000 gain and could subsequently put this forward for expansion.
Commercial Mortgages could also be used by Superflex if they wanted to expand by opening up more premises as these type of loans can allow high concentrations of money to be borrowed and the time period by which it has to be repaid is usually between 10 0 15 years.
Rights Issue is where existing shareholders are given the premium to buy additional shares at favourable prices or to sell the shares onto a third party. If Superflex became a plc, it could persuade its shareholders to sell its shares and gain extra finance which could fund expansion for them.
Share Capital could be used if Superflex became a plc as they could generate additional finance from the selling of shares. But the values of shares have to be high if they are used for expansion.
Advantages of Becoming a Public Limited Company
> Access to Capital -Emerging and growing companies often have limited access to capital. The fact that their assets walk out the door at the end of every working day makes it very difficult to obtain financing from banks or other traditional sources. However, companies on the threshold of growing such as Superflex UK often need significant amounts of capital to maximize the development and/or marketing of their technology through an invariably limited window of opportunity. As a result, it is very difficult to build a technology company through cash flow - it is just too limited. The public markets allow companies with strong growth potential to raise the capital necessary to develop full speed ahead. Further, the principals of such companies will usually retain voting control subsequent to the initial public offering. Once the company is public, subsequent financings are easier as the company has a track record with investors and the securities regulators.
> Liquidity - A shareholder of a company that has gone public and listed its securities on a stock exchange or over-the-counter system) can sell his or her shares through the public market.
This is called liquidity. Prior to a company going public it is very difficult, if not impossible, for the shareholders to sell their shares. Being able to provide shareholders with liquidity makes it much easier to attract investment into the company, as the investors have a built-in exit strategy. Liquidity also gives the principals of the company the ability to cash out their equity position in the company.
> Public Company Multiples - Public company shares are usually valued at a higher price than a comparative private company. This is because of the fact that there is an organized market through which the shares may be sold. This is usually referred to as the "public company multiple".
> Incentive Stock Options - High tax rates and cost of living, a de-valued dollar, and intense competition make it very difficult for Private Limited Companies to attract and retain experienced management and technical personnel. One partial solution to this problem is the granting of incentive stock options. Public emerging growth companies are often able to attract the people they need by providing them with a reasonable salary coupled with a substantial number of incentive stock options.
These options grant the employee or consultant the right to buy a certain number of shares of the company at the market price of the shares at the date of the grant for a specified period. As the market price of the shares of the company (hopefully) climbs towards the heavens, the stock options become worth a significant amount of money.
> Acquisitions - In today's rapidly changing world, technology companies often have to grow quickly in order to survive. One method of achieving rapid growth is to grow by acquisition. Often the most expeditious way to deal with a competitor, or potential competitor, is to buy it. Public companies can use their stock, instead of their cash, to make acquisitions. This is sometimes referred to as using your stock as "currency". Furthermore, the markets provide public companies with a ready valuation for their stock.
> Profile - There is no question that taking a Ltd company to public increases its profile. The increased profile assists the company in attracting investors, strategic partners, and customers. As people come to understand the company's product they will be much more likely to purchase its stock. People buy what they understand. Furthermore, people often presume that public companies are more substantial than private companies.
> Finance -As a company gets larger, from being a Private Limited Company to a Public Limited Company, additional capital can be generated much more easily from the public on the Stock Exchange. It could also mean that banks could become more lenient in lending money to the business as they will have more money and could fund expansion more easily too.
> Being a limited company means that the shareholders as individuals have limited liability. This means that them as members of the company are only liable financially to the value of the shares that they have invested in the company if the company incurs debts. The company on the other hand is deemed a legal body by the Companies act and is viewed as unlimited. If the company fails and incurs debts then the company must pay the debts if funds are available. Even if the company is wound up, the members only have to pay the full value of their shares initially invested and any premium that may be due on them; they cannot be asked to pay anymore even if the company does not have enough funds to cover the debts.
Disadvantages of Becoming a Public Limited Company
> The legal requirements which have to be met before you can operate the business are quite complex and lengthy
> The company cannot make contracts, e.g. take an order for goods or services, until it has been incorporated, i.e. the date on the certificate of incorporation of your company if the registrar of companies passes your application.
> Annual accounts must be audited by Companies House. This could be costly and time consuming to prepare.
> The public would also have access to financial statements
Task 3
The Money Cycle
The money cycle is a diagram that shows the inflows - where the source of cash comes from and outflows of cash - where it ends up or goes to in a Business.
Money Cycle for
'The Cutting Shop':
Amish Patel
Peter Eskesen
