A serious disadvantage of operating as a sole trader is that while the proprietor keeps all the profits generated by the business, he or she also has to accept unlimited liability with regard to any losses and in the event of the business becoming insolvent, must bear the loss personally. As a result forming a partnership is one possible, solution to overcome some of the disadvantages associated with running a business as a sole trader, the main one being that it is much easier to raise Finance. Once you start to trade as a partnership business, banks will be keener on loaning out money as they are aware of the fact that all the partners will be providing finance to run the company. Finance will be easily arranged as all the partners will be putting an input to generate the finance required.
The partnership act 1890 states that a partnership comes into being when, ‘between two and twenty people agree to supply capital and work together in a business with the purpose of making a profit,’ in the eyes of the law the partners themselves are the business, in the same way that the sole trader is the business, legally just like a sole trader a partnership business is unincorporated, which means it has unlimited liability.
Partnerships are regulated by the partnership act 1890, however it is sensible for partners to conduct their business in line with the terms of a partnership agreement, a form of contract drawn up by solicitors, this documents sets out details of the capital conducted by each partner, their voting rights, the share of profits and the procedure to be followed in the event of partnership disputes.
Therefore when businesses convert from a sole trader to a partnership, there will be extra capital available due to the input of all the partners
There are several different sources of short term, medium term and long term finance available for Partnerships to develop into Private limited company. Unlike a Partnership a limited company has a separate legal entity (Limited liability) and is recognised as being distinct from its owners and is a legally established business. It is owned by shareholders and managed by directors who run the company in the shareholders interest. Due to the protection given by limited liability, shareholders are not personally liable for the company’s debts. In the event of the business failing, their loss is limited to the amount of money which they invested in the company. This is a big advantage for a private limited company.
As stated by law, share capital may not exceed £50,000 and Ltd must be stated after the company name, this warns those dealing with the business that it is relatively small and has limited liability. By implication, therefore, cheques are not as secure as the ones from an unlimited liability business.
Many small to medium sized company trade as private limited company, this is also a path followed by partnerships that expands and become a private limited company. Private limited company cannot sell their share to the public which limits the firm to raise finance; they can however be transferred and sold to other shareholders within the company, it also means that the company cannot be listed in the stock exchange. The shareholders and directors of private limited companies are invariably the same people. Banks are more willing to lend money as it’s a bigger business then a partnership.
There are several different sources of short term, medium term and long term finance available for Private limited company to develop into Public limited company. The shares of the public limited companies can be floated and then traded on the stock market, to raise finance. Any member of the general public can therefore become apart owner these organisations.
The memorandum of association must clearly state that the business is a public company and it must be registered as such. The term Plc must appear after its name. The principal differences between private and public limited companies are:
- A public company can raise capital from the general public, while a private limited company is prohibited from doing so.
- The minimum capital requirement of a public limited company is £50,000.
- Public limited companies must publish far more detailed accounts than private limited company.
Therefore it can be concluded that, public limited companies are similar to private limited companies, but are much larger. They are able to raise capital by selling their shares on the London stock exchange if they are listed; the shares of some of the largest plc are also traded o the New York and Tokyo stock exchange. This enables plc’s to raise very large sums of money in a way that is much cheaper than borrowing from banks.
Task2
(P2)
Chosen manufacturing company is Coca Cola from the soft drinks manufacturers. The chosen product is ‘Coke’
Above: Simplified Money Cycle
The movement of money in and out of the business as a result of these inflows and outflows is known as the money cycle. If there is no cash in the business, it cannot pay its expenses and buy raw materials to be able to make sales and therefore get more money. The cycle must not be broken. If Coca Cola does not make sales it will have no more money to buy materials and make further sales
Coca Cola manufacturers over 100 different types of products, the most popular and well known is Coke, it is the biggest selling soft drink in history. The product generates a lot of sales, which is the money coming in as shown above on the money cycle. However even though the company generates a large amount of sales, i.e. still needs to pay all its expenses such as cost of electricity for machinery, pay wages to employees and insurance etc, this is the expenses part as shown above on the money cycle. The company continues to make sales and the money cycle goes round and round.
Above: detailed Money cycle for Coca Cola the soft drink manufacturer
The upper portion of the diagram above shows in a simplified form the chain of events at Coca Cola. Each of the boxes in the upper part of the diagram can be seen as a tank through which fund passes.
(M2)
Coca cola must keep control of its working capital. It is vital to know what money is owed, what money is due and what the cash flow position is. It is essential to control this aspect of the business if it is to succeed. The revenue or income received by a firm as a result of trading activities is a critical factor in its success. When commencing trading or introducing a new product, businesses may expect relatively low revenues for many reasons including:
- their product is not well known
- they are unlikely to be able to produce large quantities of output
- It is difficult to charge a high price for a product which is not established in the market.
Coca cola must keep control of how much money is coming in and going out of its accounts. The company must make sure it has enough money to pay its outflows, if it doesn’t the company can become insolvent.
Uses for surplus cash:
If the cash flow forecasts predict a shortage for coca cola then the company can take actions to avoid the problem. It can do this in several ways including:
Speeding up Cash inflows:
Negotiating shorter credit for customers, the average producer in the UK has to wait 75 days to be paid. If customers agree to pay for the goods earlier, cash is received earlier. In a very competitive market the length of credit may be a competitive issue. Large companies like coca cola often insist on longer credit. Some companies offer discounts to encourage early payments of bills, for example.
Credit management:
Coca cola can improve cash flow by ensuring that payment is received on time. This can involve writing reminder letters and making phone calls to persuade customers to pay promptly.
Factoring:
It may be possible to factor the debt. By factoring the company is able to receive 80% of the amount due within 24 hours of an invoice being presented. The factor then collects the money from the customer when the credit period is over and pay the seller the remaining 20% less the factoring fees. These depend on the length of time before the payment is due, the credit rating of the creditor and current rates of interest. The fees are usually no more than 5% of the total value of the sale.
Task3
Working
W1)
25% mark - up
1divided by 4 X 28,000 = 7,000 (profit)
S - C = P
S - 28,000 = 7,000
S = 7,000 + 28,000
S = 35,000
W2)
Opening stock
30,000 Sales 35,000
Add purchases 35,000
18,000
48,000
Less closing stock 20,000
Cost of goods 28,000
7,000
35,000
The cash flow forecast for Fixit Ltd shows negative figures in some months and this might be because of some problems but particularly in the cash flow.
Problems associated with cash flow
In the month of April, Fixit payed some fixed assets (plant) and payments were made and this has caused the outflows of this month to increase. Because of this increase, the payments exceeded the inflows and that has created a negative figure which means he has made a loss
Collection period
Debtors x 365 = 70,000 x365
Sales 210,000
= 121days
Creditors payment days
Creditors x 365 = 28,000 x 365
Cost of sales 168,000
= 60days
These calculations above show that Fixit Ltd has taken a risk like all business and the risk is very bad as they have accorded more days to their debtors than the creditors. So it basically means that they had to pay the creditors before receiving any money from the people who owed them.
One of the problems arising from this casflow was maybe the time taken for the consumers to receive the goods they have ordered because a delayed delivery means late payment. Without cash afloat, Fixit Ltd will have in the day-to-day running of the business. Meeting liabilities when there is a shortage of cash might prove to be difficult to sustain regular supply of the goods and can even pressurise the future of the company.
How to manage cash flow problems
Prepare cash flow projections for next year, next quarter and, if you're on shaky ground, next week. An accurate cash flow projection can alert you to trouble well before it strikes.
Understand that cash flow plans are not glimpses into the future. They're educated guesses that balance a number of factors, including your customers' payment histories, your own thoroughness at identifying upcoming expenditures, and your vendors' patience. Watch out for assuming without justification that receivables will continue coming in at the same rate they have recently, that payables can be extended as far as they have in the past, that you have included expenses such as capital improvements, loan interest and principal payments, and that you have accounted for seasonal sales fluctuations.
- If you got paid for sales the instant you made them, you would never have a cash flow problem. Unfortunately, that doesn't happen, but you can still improve your cash flow by managing your receivables. The basic idea is to improve the speed with which you turn materials and supplies into products, inventory into receivables, and receivables into cash. Here are specific techniques for doing this:
- Offer discounts to customers who pay their bills rapidly.
- Ask customers to make deposit payments at the time orders are taken.
- Require credit checks on all new non cash customers.
- Get rid of old, outdated inventory for whatever you can get.
- Issue invoices promptly and follows up immediately if payments are slow in coming.
You may be able to raise cash by selling and leasing back assets such as machinery, equipment, computers, phone systems and even office furniture. Leasing companies may be willing to perform the transactions. It's not cheap, however, and you could lose your assets if you miss lease payments.
Solvency ratios are used to evaluate and determine the financial strength of an organisation. They show the extent to which a business is leveraged and designate the business's ability to survive risk and stay solvent.
Current Ratio
The current ratio is the standard measure of any business' financial health. It will tell you whether your business is able to meet its current obligations by measuring if it has enough assets to cover its liabilities. The standard current ratio for a healthy business is two, meaning it has twice as many assets as liabilities. But for Fixit Ltd, the ratio is 1.7:1, which means that the company can just about pay its liabilities and still have 0.7:1 left. If the ratio were below one, it would have meant that the company the liabilities were more than the current assets and the company would have been in trouble.
Acid test or quick test ratio