or costs rises unexpectedly.
Trade Credits
Many businesses rely on their creditors as a form of short-term finance. Because
most of the suppliers allows their customers to take somewhere between one and
three months to pay for goods supplied, the debtor company can use what is
effectively an interest free loan of up to 90 days to pay others bills. Creditors will
often give incentives in the form of cash discount if payment is made earlier, but by
delaying payment, the debtor can use money owned to finance other current assets.
According to Watson and et al (2007) (Pg-70), “ Trade credit is an agreement to
take payments for goods and services at later date than that on which the goods
and services are supplied to the consuming company. It is the common to find one,
two or even three months credit being offered on commercial transactions and trade
credit is a major source of short-term finance for major companies.”
Page 10 of 45 Managing Finance Mashukur Rahman Id: 4098
Advantages of Trade Credit
-
Reduced capital requirements: This source is very useful to someone who
has very little amount of money but has a good idea about starting a new
business.
-
Improve cash flow: Trade credit with improves the cash flows and therefore
provides smoother operation for the business.
-
Buy now pay later: This mean that, if the business organisation don't have
sufficient money, at first purchase the product/raw materials by credit. Then after
the sell business makes the payments and profits have been made.
Disadvantage of Trade Credit
-
No discount: If the company finance by using trade credit, then as a debtor
company may does not get any discount on purchase from creditors.
Finance Leases
A lease is an agreement between two parties- one is lessor other is lessee. The
lessor owns a capital asset, but allows the lessee to use it. The lessee makes
payments under the terms of the lease to the lesser, for a specific period of time.
Leasing is, therefore, a form of rental. Leased assets have usually been plant and
machinery, cars and commercial vehicles, but might also be computers and office
equipments.
The business pays a regular amount for a period of time, but the item belongs to the
leasing company. Most owners’ cars are leased to business. The business pays the
monthly fees for using the car.
According to Geoff Black (2005) (Pg-136), “ A finance lease means by which
companies obtain the right to use assets over a period time. The ownership of the
an asset never passes to the actual users of the assets.”
Advantages of Finance Leases:
- Cheaper in the short run investment.
- Cash flow management easier because of regular payments.
Disadvantages of Finance Leases:
- More expensive in the long run, the leasing company charges fees that make
the total cost greater than the original cost.
Hire Purchase
Hire purchase is a form of instalment credit. It is similar to leasing, with the
exception that ownership of the goods passes to the hire purchase customer on
payment of the final credit instalment, whereas a lessee never becomes the owner
of the goods. Hire purchase agreements usually involve a finance house.
Goods bought by businesses on hire purchase include company vehicles, plant and machinery, office equipment and farming machinery.
In hire purchase system buyer gets only physical possession of goods but not gets
the ownership. The price of goods is agreed to be payable in easy instalments with
interest. After finish all instalments of price of goods, and then buyer gets the
ownership of that product.
According to Rao (2005) (Pg-736), “ Hire purchase is a methods of sale under
which the seller undertakes to sale the goods with an agreement to receive cash
price in convenient instalments. The physical possession goods are delivered at the
time of agreement.”
Advantages of Hire Purchase
- A hire purchase agreement allows a consumer to make monthly/quarterly/yearly
repayments over a pre-specified period of time.
- The hire purchase agreement allows a consumer to purchase the goods when
they are not in a position to pay in cash.
- The rate of acceptance on hire purchase agreements is higher than other forms
of unsecured borrowing because the lenders have collateral.
Disadvantage of Hire Purchaser
- In hire purchase agreements, buyer needs paying more money than the original
price of product.
- If buyer miss any instalment, the result is might be lose the product with what he
already paid.
- If the buyer breaks or lost the purchase items, he still has to pay all instalments
of those items as well having to replace the items.
Government Grants
The government provides finance to companies in cash grants and other forms
such as lotteries of direct assistance, as part of its policy of helping to develop the
national economy, especially in production related industries and in areas have a
high unemployment opportunity.
On the basis of duration or period, sources of finance may be three types (Short-Term,
Medium-Term and Long-Term) those are appearing in diagram in following:
Short-term Finance
Short-term finance is finance that uses for a period of less than a year. It is required to
provide working capital for the business. The working capital is needed to purchase of raw
material, payment of wages, salaries, and keeping stocks and meeting day-to-day
expanses of the business.
In short-term period company may use the following sources:
- Retained Profits
- Business Angels
- Bank Overdrafts
- Trade Credits
- Short-term Bank Loan etc.
Finance
Medium-Term Finance
In financial language “medium-term” can be thought as consulting a broad and ill-defined
border between short-term and long-term finance. Medium-term finance is a finance that is
uses for more than one five years. Sources of medium-term finance is include the following
those are can be uses by company:
- Retained profits
- Finance leases
- Government grants
- Hire purchase (HP) etc.
Long-Term Finance
Long-term sources of finance are those that are needed over a longer period of time -
generally over five years. For example, to invest in the new project organisation should be
uses long-term finance.
Company should be takes the long-term finance for investment in the new project
appraisal and their fund may be raises by using following sources:
- Long-term Bank Loan
- Retained Profits
- Owners equity
- Other financial Institutions etc
Factors to be considers before deciding appropriate sources of finance:
Organisation financial planning should be related with organisation's goals and objectives
and then it would be developing ways achieving goals. To be able to do this, financial
manager must have realistic knowledge about finance within the organisation, for example
when need to raise the finance, how much and which sources will be use for the finance
etc.
The company should consider into following factors before deciding how to satisfy its
financial requirements:
- Structure of Organisation
Decision about finance may determine the type of business structure on
organisation takes.
- Length or Period of Finance
Before financing it is very important for Mayor Ltd that for what times fund will be
taken- (short-term / long-term / medium-term).
It is also be considered that the cost of finance before financing in the business. The
company should take the decision that which sources they use for financing. For
example, cost of equity finance is more than high then the debt finance.
Generally, short-term sources of finance are riskier then the long-term sources from
the borrower’s points of view in that they may not be renewed or may be renewed on less favourable terms. Another risk for the short-term borrowers is that interest rate
of short-term loan is not a constant the long-term loan and this risk is
compounded if floating rate short-term debt such as overdrafts is used. So,
company should consider this factor before finance.
If the organisation arranging finance by taking more debt than may affect business
flexibility and also the company might be fall in serious difficulties such as bankrupt.
Usually interest has to be paid on the debt. Debt or loan must be repaid even when
a business looses/decline the profits or costs rises unexpectedly.
TASK 2
Investment appraisal
The investment appraisal is a technique to find out the best investment alternative selection. Investment is applied in business to help to the management to make long term capital investment decision. These decisions are involved in new business projects that the business assist to undertake typically these project will ask for many years and will involve substantial amount of money. There are different tools and techniques of under investment appraisal.
- Payback Period Method (PBP): the pay back method in investment appraisal is used to compare two or more projects can be competing for the available business’s available capital. In this method, when the project can return its initial investment. According to this method which project has less payback period that project can be selected. And the project must get its payback within its life time, otherwise the project should be rejected.
PBP
(Where; PBP = payback Period)
In this method which project the less payback period can be selected. This method does not consider the time value of money and inflation in the future. This method has some advantages and disadvantages.
Advantages
- This is very simple to calculate.
- Useful fur that organization where technology is changing rapidly.
- Useful to manage the cash flow problem, because this technique tries to recover money as possible as quickly.
- It favours the less risky project by selecting the project that recovers the initial investment as possible as quickly.
Disadvantage
- This technique does not consider the time value of money.
- Ignore the earning after payback period.
- It does not consider the real value of money.
- It does not focus the profitability of the project.
()
- Annual or Average Rate of Return (ARR): by this method in investment appraisal finding out annual rate of return and highest annual rate of return can be selected. The reason why different cost of investment, different NCFs, different timing of cash flows etc. The ARR is annual percentage rate of return given by project or investment. Through we can compare two different projects which one is better in easy way. This investment appraisal technique also has some advantages and disadvantages are given below.
Advantages:
- This method can measure the performance of the project.
- Easy to calculate.
Disadvantages:
- This method includes non-cash flow items but the cash flow is
- important in investment.
- This method does not consider the time value of money.
- This method does not consider the long term risk.
()
- Net Present value NPV or Discounted cash flow: this method is most popular and trustable method in investment appraisal. In this method the cash flows are multiplied by discounted factor, so it is known as discounted cash flow method as well. This method considered the time value of money, so this method is better than other previous two methods. But this method is quite difficult to calculation. In this method which project has positive NPV and highest NPV given project would be selected. The NPV is calculate as deducting present value of all cash flows by present value of all cash inflows (NPV=Present value of cash inflows – present value of cash outflows). To do decision if the NPV is positive the project should be selected, if the NPV is negative the project should be rejected.
Advantages:
- This method considers the time value of money.
- Highly accuracy to the project forecasting.
- Conceder the inflation in future.
Disadvantages:
- Quite difficult to calculate.
- Not easy to forecasting the inflation in future.
- Internal Rate of Return (IRR): Internal rate of return is the discount rate at which the NPV is extremely equal to zero. This method also considers the time value of money. By calculating IRR, if the IRR is greater than Discount factor the project should be accepted and vice versa.
Where; LR= lower rate
LRNPV = NPV at lower rate
HRNPV = NPV at higher rate
HR = higher rate
Advantages:
- This method considers the time value of money.
- Highly accuracy to the project forecasting.
- This method takes only relevant cash flows.
Disadvantages:
- Quite difficult to calculate.
- This method does not compare with other project, only says that breakeven level of the one project.
- The directors of Napoleon plc, a manufacturing company, are considering undertaking a new venture to produce franks, which sell at 50p each. Market research indicates that it should be possible to sell 2.5 million each year over the next 10 years.
The company can produce franks with either a Mark A or a Mark B machine, the operating characteristics of which are as follows:
Notes: The fixed costs include the following:
- $25,000 each year, which is the salary of a supervisor. If the new venture is not taken on, the supervisor will be employed elsewhere in the business at the same salary.
- Straight-line depreciation
- $20,000 of apportioned overheads each year, representing a share of head office costs.
The directors ask their accountant to help them decide whether or not to start manufacturing franks; and, if the answer is yes, which type of machine to buy. The company’s cost of capital (discount rate) is 15% per annum and is not expected to change in the foreseeable future.
Required
- Calculate the net present value (NPV) of each option to the nearest $1,000, explain carefully your treatment of the costs. Use discount factors to three decimal places.
- Calculate the internal rate of return (IRR) of each option to the nearest one per cent.
- Suggest which machine is preferable, explaining the basis of your answer. Include in your answer a brief discussion of whether NPV or IRR should be used to appraise investments.
Calculation of NPV and IRR for Mark A and Mark B
for PVIFA
for PVIV
according to the above analysis the mark is acceptable because it has positive NPV and IRR is greater than the Discount factor, in case of Mark B there is no way to get positive NPV with in the life period and difficult to find out IRR, so the Mark B is rejected.
TASK 3
- Forecast costs from the following cost information;
Variable cost (b) =
=
=
=
=
Total fixed cost (a) =
=
=
=
=
=
=
Where; Y = a + bx
= 200000 + 10x
TASK 4
Ratio Analysis:
Ratio analysis is the calculation and interpretation of financial ratios in order to raw conclusion about the financial solution, position and performance of the business. Financial ratio is a simply relationship between one figure appearing the financial statement other ratio analysis widely used by management, current and prospective investor in auditor. Ratios are use to comment on the financial position and performance to business relation to its past performance, and competitors performance. It will be carried out for different aspects of the business. These are profitability, efficiency, and liquidity bearing and investor performance. There are different types of ratios to analyses.
- Profitability Ratio:
- Liquidity Ratio
- Gearing Ratio
- Investment Valuation Ratio
- Profitability Ratio: The profitability indicator ratio deals with the analysis of profit margin, effective tax rate, return on assets, return on equity, return on capital employed etc. This ratio consist the following ratios:
- Net profit margin ratio: Net profit margin should be higher to the organization. Higher the net profit margin higher the company’s stabilities. To maintain the high profit margin.
- Need to utilize the available resources efficiently.
- Cut down the cost.
Net profit Margin is calculate as
Net profit margin =
- Gross profit margin: Gross profit margin is calculated as the gross profit dividing by its sales revenue. Where gross profit comes from cost of goods sold deducting by sales revenue.
Gross profit margin =
- Return on capital employed: To calculate we take profit before interest and tax, because those interest and tax are beyond the control. So we have to try judging our efficiency where it is controllable.
Return on capital employed
=
(Where, capital employed = Shareholders equity+ Long term liability+ Reserve)
- Liquidity Ratio: Liquidity Ratio is the firm’s ability to come up to meet the current liquidity of the company. The liquidity ratio shows the liquidity capacity of the organization. In which :
- Current assets ratio: The current assets ratio is calculate as current assets divided by current liabilities which shown as follows:
Current assets ratio = ......:1
- Acid test ratio: The acid test ratio is known as quick ratio. The acid test ratio is:
Acid test ratio = .........: 1
- Gearing Ratio: In this ratio can be analysis debt ratio to equity and capital employed. If more debt the situation is highly geared, but this situation become more risky and vice versa, because the organization need to pay interest and need to return back when they become matured.
- Debt to Equity Ratio: If the long liabilities divided by the sum of capital and revenue the debt to equity ratio can be find out.
Debt to Equity Ratio =
- Debt to capital employed: The debt to capital employed ratio can be find out as the long term liabilities divided by capital employed. Where the capital employed would be sum of shareholders equity, long term liabilities and reserve.
Debt to capital employed =
- Investment valuation ratio:
- Earnings per Share=
- Dividend Per Share=
- Dividend Cover=
- Stock holding period=
- Debtors collection Period=
Credit collection Period =
Task four
Ratio Analysis:
Ratio analysis is the calculation and interpretation of financial ratios in order to raw conclusion about the financial solution, position and performance of the business. Financial ratio is a simply relationship between one figure appearing the financial statement other ratio analysis widely used by management, current and prospective investor in auditor. Ratios are use to comment on the financial position and performance to business relation to its past performance, and competitors performance. It will be carried out for different aspects of the business. These are profitability, efficiency, and liquidity bearing and investor performance. There are different types of ratios to analyses.
- Profitability Ratio:
- Liquidity Ratio
- Gearing Ratio
- Investment Valuation Ratio
- Profitability Ratio: The profitability indicator ratio deals with the analysis of profit margin, effective tax rate, return on assets, return on equity, return on capital employed etc. This ratio consist the following ratios:
- Net profit margin ratio: Net profit margin should be higher to the organization. Higher the net profit margin higher the company’s stabilities. To maintain the high profit margin.
- Need to utilize the available resources efficiently.
- Cut down the cost.
Net profit Margin is calculate as
Net profit margin =
- Gross profit margin: Gross profit margin is calculated as the gross profit dividing by its sales revenue. Where gross profit comes from cost of goods sold deducting by sales revenue.
Gross profit margin =
- Return on capital employed: To calculate we take profit before interest and tax, because those interest and tax are beyond the control. So we have to try judging our efficiency where it is controllable.
Return on capital employed
=
(Where, capital employed = Shareholders equity+ Long term liability+ Reserve)
- Liquidity Ratio: Liquidity Ratio is the firm’s ability to come up to meet the current liquidity of the company. The liquidity ratio shows the liquidity capacity of the organization. In which :
- Current assets ratio: The current assets ratio is calculate as current assets divided by current liabilities which shown as follows:
Current assets ratio = ......:1
- Acid test ratio: The acid test ratio is known as quick ratio. The acid test ratio is:
Acid test ratio = .........: 1
- Gearing Ratio: In this ratio can be analysis debt ratio to equity and capital employed. If more debt the situation is highly geared, but this situation become more risky and vice versa, because the organization need to pay interest and need to return back when they become matured.
- Debt to Equity Ratio: If the long liabilities divided by the sum of capital and revenue the debt to equity ratio can be find out.
Debt to Equity Ratio =
- Debt to capital employed: The debt to capital employed ratio can be find out as the long term liabilities divided by capital employed. Where the capital employed would be sum of shareholders equity, long term liabilities and reserve.
Debt to capital employed =
- Investment valuation ratio:
- Earnings per Share=
- Dividend Per Share=
- Dividend Cover=
- Stock holding period=
- Debtors collection Period=
Credit collection Period =
To analysis an organizational financial situation of the selected financial statement of the organization has presented as bellow. The Ratio analysis of Sainsbury for year 2009 and 2010 the income statement and balance sheet are as follows:
The Ratio analysis of Sainsbury for year 2009 and 2010.
Source:
- Profit Margin Ratio
A)Net profit Margin:
COMMENT AND SUGGESTION:-
In the year 2010 the net profit margin is go down compare to the year 2009, due the the cost of sale, so to increase the npm company should cut down the purchase cost, buy in bulk to reduce the buying cost, increase the sales price without effecting the sales.
-
Gross Profit Margin:
COMMENT AND SUGGESTION:-
In the year 2010 the gross profit margin is go up compare to the year 2009, but it is marginally goes up , so to increase more gpm company should take measure to cut down the purchase cost, buy in bulk to reduce the buying cost, increase the sales price without effecting the sales.
- Return on Capital Employed:
COMMENT AND SUGGESTION:-
In the year 2010 the ROCE is decrease compare to the year 2009.
- Liquidity Ratio
- Current assets ratio:
COMMENT AND SUGGESTION:-
In the year 2010 current asset ratio is go down compare to the year 2009, to improve current asset ratio improve your cash sales, better terms with your creditor, collect money from your debtor introduce better payment method.
- Acid test Ratio :
COMMENT AND SUGGESTION:-
In the year 2010 acid test ratio is decrease compare to the year 2009, to improve acid test ratio organisation do not stock access it incurred the extra cost like storage, theft, damage etc.
- Efficiency ratio
- Inventory turnover Ratio:
COMMENT AND SUGGESTION:-
In the year 2010 inventory turnover ratio is decrease compare to the year 2009, it5 is due to decrease in sales of goods. To increase the inventory turnover ratio organisation should take measure to cut down the purchase cost, buy in bulk to reduce the buying cost, increase the sales price without effecting the sales.
- Stock Holding Period:
COMMENT AND SUGGESTION:-
In the year 2010 stock holding period is increase marginally compare to the year 2009. To improve this organisation should introduce the better payment method.
- Debtors collection Period
COMMENT AND SUGGESTION:-
In the year 2010 and 2009 debtor period is same. To improve this organisation should introduce the better payment method, reminder letter, penalty for late payment.
- Creditors payout Period
COMMENT AND SUGGESTION:-
In the year 2010 Creditor payout period go up compare to the year 2009, it will effect the organisation profit because we have to pay more interest or penalty decided buy our creditors. To improve this organisation should introduce the better payment method.
- Gearing Ratio
- Debt to equity ratio:
COMMENT AND SUGGESTION:-
In the year 2010 debt to equity ratio go up marginally compare to the year 2009.
- Debt to capital employed:
COMMENT AND SUGGESTION:-
In the year 2010 debt to capital employee ratio go up marginally compare to the year 2009.
To improve the same organisation should take care about access staff and reduce it so that it cannot effect the organisation.
- Investor Ratio:
- Earnings per share
$0.999/ share $1.019/share
COMMENT AND SUGGESTION:-
In the year 2010 earning per shares is increase compare to the year 2009, it will help organisation to rise the fund when needed, because when organisation gives more return to the share holder confident of the share holder increase in the organisation.
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