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Financial resources - the Management Accountant of a Magherafelt based, bread manufacture private limited company, instructed a group of HND business students to investigate the sources of finance available to the business for installing a new production

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Report

From                William Henry

To                Management Accountant

REF                BMcE/ WH

Date                23rd September

1.0        Terms of Reference

On the September 1st 2008 the Management Accountant of a Magherafelt based, bread manufacture private limited company, instructed a group of HND business students to investigate the sources of finance available to the business for installing a new production line in September 2009 at a cost of £500,000.

The purpose of the machine is to increase production of bread for the Northern Ireland market.

As Genesis look gather the finance they need to install a new production line, known as fixed assets, where the amount to be borrowed is large (£500,000) and the repayments are to be spread over a realistically long period of time(asset finance).

 I have discovered that there are two main categories when dealing with this and they fall into categories called internal and external sources of finance.

Finance is the life blood of a business. The main starting and expanding element in any business which may be on industrial or commercial undertaking is the finance. Business finance is mainly developed around three major objectives. Firstly, to obtain an adequate supply of capital for the needs of the business, Secondly, to conserve and increase the capital through better management, Thirdly, to make profit from the use of funds which is an overall objectives of a business enterprise.

The report is to be submitted to the management Accountant for consideration by the Board of Directors on the 8th October 2008.

‘Class notes’

  1.        Procedure

In order to research relevant information the following procedures were adopted to carry to out with effect.

  1. Current textbooks were reviewed – Managing Financial Resources and making decisions – BPP publisher (2004) – Management and cost Accounting – Thomas Learning (2000), GNQU Advanced Business – Heinemann(2000)

Managing financial resources

2.0.2         Internet was used to obtain information on appropriate sources of finance

2.0.3        Bank of Ireland, Market Square, Magherafelt, Alliance and Leicester, Rainey Street, Magherafelt, were contacted to obtain interest rates and terms for borrowing.

3.0        Sources of Finance

There are two areas where finance is required by the business. The first involves the funding from working capital to cover the purchase of raw materials and stock as well as to finance debtors. This type of finance is usually short term. The other type is the financing of assets. This generally requires a long-term finance from lender. All businesses require assets and working capital to operate on a daily basis.

4.0 Fixed Assets

There are many types of finance available to this business each with its own positives and negatives. The duration of the finance matches the life of the assets. Managers need to consider the cost of the finance and the security demanded by the lender. The two main sources to the business are internal and external.

Internal sources are:-

4.0.1Retained Profit

This bread manufacturing company can raise internal finance by retaining profit at the year end. Finance can also be raised by selling surplus fixed assets.

4.0.2Controlling working capital

Reducing costs, delaying outflows and speeding up inflows.

4.0.3        Sale of assets

Assets the company owns can be sold and then leased back which frees up a large amount of capital in the short term.

5.0Terms

Finance can be raised by the company for different periods of time.

Short term 1-3 years

Medium term 3-5 years

Long term 5+ years

6.0 External sources of finance

The company can borrow money from a number of sources

6.0.1Bank overdraft

The business can borrow money from a commercial bank, for example, from their own bank or they can negotiate an overdraft facility from another bank. The bank will allow the company to borrow up to an agreed limit. This will be approximately 1% to 2% above base rate which is 5% (6th October 2008)

6.0.2         Factoring

Genesis can use a different company to collect all debts that they currently are in.

6.0.3        Share issues                  

Genesis can sell new shares in an attempt to raise more finance.

6.0.4        Owner’s savings

If the owner of the company has extra money that he is willing to input into the business then this is known as owner’s capital.

7.0 Long Term Sources

This business can get finance through one to five years. This would be used for the purchase of investment capital such as plant, machinery and equipment. This includes vehicles, computer systems and specialized machinery.

Finance for 5 or more years is used for the purchase of capital assets that are used for long periods of time for example land or buildings.

The sources of finance for these periods of time are the following:

7.0.1        Bank loans                 

Genesis initially does receive an amount of money from the bank, which they pay back, usually but not always in regular instalments. This service is generally provided with interest on the debt.

Legally, a loan is a contractual promise of Genesis to repay a sum of money in exchange for the promise of the bank to give another sum of money.

7.0.2 Hire Purchase

HP is paying off the machinery in payments, and then owning it after a set time. If Genesis were to choose hire-purchasing the machinery, they are still not the legal owners during the term of the contract. If they halt in paying the installments, the owner can re-take the machinery. HP is an advantage to Genesis because it spreads the cost of the machinery over an extended time period.

7.0.3 Leasing

Leasing is just like renting. This is a process by which the company can obtain the use of the machinery needed, for which it must pay a series of contractual, periodic, tax deductible payments. Genesis then receives the machinery under the lease contract and the leaser is still the owner of the machinery.

8.0 Decision making and importance of financial planning

As Genesis is looking to expand their production line, the owners need to think through a thorough plan as to how they will do this and increase profits.

The demand for stock within the shop has overflowed the current standard of expectation.

So the new machinery will help ease the shortage of products and will also increase profits for the private limited company.

To do this, they will need to look at a different range of situations within market researching. Before they set out on buying the new machine they firstly need to find out exactly how it will affect the business.

If it was bought and there was a lack of demand for the products, the company could find themselves in a difficult situation.

They need to go out to the local community in Magherafelt and ask individuals, vital questions about the new products. This will give them a fair assumption of how the products may sell in-store. Questions which need to be addressed to the customers would be for example; how much would you be prepared to pay for new innovative bread being produced in Magherafelt. Customers would also need to explain how much of the stock they would each be prepared to buy. This is very important as it will give figures to be made in the production line. They could also market their new loaves by giving free samples to customers in the shop or at another convenient meeting to help guide them with their problems.

The cost of the machine is important to look at as there are a number of points which need to be adhered to.

Interest of the machinery- The company needs to know the interest rates. leasing is 12.5%, Bank Loan is 8.5%, Hire Purchase is 27% and Mortgage 6.25%.

Time for repayments – The company may want to know the number of years of which the repayments are due and may want to pay it over a set period of time.

Guarantees – can the company take out a maintenance contract?  If the machine breaks down will there be a 24/7 call out support.

Terms of repayment-deposit; monthly repayments: final payment; conditions of repayment (condition of the machinery) is it possible to update equipment during the leasing agreement.

Expected lifespan of machine; the company will want to know how long the machine is expected to last.

Credit history – Dunn and Bradstreet (3 Wellington Park, Belfast) credit reference agency

Length of time in business (new start up; or long established)

Look at accounts of business – profits/sales

Other commitments – debts – mortgage, other HP; leasing.

Contact Details – name, billing address.

Cost – in these circumstances, getting the finance is vital for the company to expand and it is set at £500,000 for the new machinery. The company need to study carefully with regards, to the different types of finance available. They need to look at which of the different options would suit them best.

If they choose leasing, they would avoid the need to pay cash flow. The owner pays with their own cash monthly. This is a good choice as it would avoid the consequences of having to pay interest back on the hire purchasing and bank loans. If things weren’t going to plan, the owner can cut the agreement after a set time so they may not lose as much money compared to HP and the loans. They can also get upgrades on the machines if they want over a space of time.

Choosing the hire purchase source is another existing choice. This, in many ways, is the easiest source of finance for Genesis to deal with. They simply pay instalments over a period of time, with the first payment being 2 as a deposit. If they wish so, the company can, after 3 years, legally own the machinery if they want. This is outstanding compared to leasing, because leasing would result in the company never owning the machinery.

9.0 Costs

Sources

Cost (APR)

Leasing

12.5% (Standard VAT rate applies)

Bank Loan (Long Term)

Rates negotiable but typically base rate (4.5% + 2% = 6.5%) – Alliance and Leister

Hire Purchase

27% (Deposit 1st 2 month’s instalments)

‘Class notes’

10.0 Flow of finance

Genesis can carry out market Research to find out the demand on the products and if they can sell the products at a suitable price to make the company a profit from this information the business will know if they can meet the monthly repayments and make a profit.

11.0 Final Accounts

Final accounts are prepared at the end of the year to give stakeholders an overview of a firm’s financial position. Final accounts contain a Trading and Profit and Less account and a Balance Sheet.

The trading and profit and loss account calculates the firm’s Net profit. This account shows all the income and expenses of the business.

A balance sheet is a statement giving a list of the firm’s assets and liabilities on a specified date.


Leasing

Trading + profit + loss account

Gross profit

Less expenses

Lease repayments (12 monthly repayments)

Hire purchasing

500,000 X 27% for 3years

£375,000

Interest is £133,333/year

Total repayments £424,999.67

‘Class notes’

Bank loan

500,000 X 6.5% x 3years

Annual interest £32,500 (monthly interest £2,708.33)

Total interest over 36 months (97,500)

Monthly payments £16,597.22

Arrangement fee 1% of limit granted (£5,000)

‘Loan information gathered at Alliance Leicester 9 Rainey Street, Magherafelt Co. Londonderry

 By Jonathon Head (Branch Manager)’

12.0 Recommendations

I recommend to the Board of Directors the Bank Loan. I regard HP being not suitable as the machine does not belong to them and will only belong to them at the last payment. Also, I feel a bank loan is suitable because the machinery will belong to the company and they have from 5 years to pay it back to the bank.

13.0 Conclusion

I have come to the conclusion that in order for Genesis to gain a satisfactory source of income they are best looking at three outstanding types to generate funds for the new production line. These types are ‘leasing, hire-purchase and loaning from the bank’. In my opinion i feel that the company should look in the direction of loaning from the bank. This is the most effective as the company being established a long time ago shouldn’t have many concerns getting the loan. It is better loaning money from the bank as the machinery will be yours immediately.

Page                 William Henry                

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