Sources of finance
Definitions:
Share Capital – is money invested in the firm, this is not repaid to the investors in the normal course of business. It represents the risk capital staked by the owners through purchase of the firm’s common stock (Ordinary shares). On the balance sheet of the firm, share capital is listed as stockholders’ equity or owners’ equity.
Bank loan – is a long term loan and will often be for large amount of money for starting up a business or to expanding. Business will agree with the bank to pay installment monthly fees with interest charge.
Start up fees – Non-recurring costs associated with setting up a business, such as accountant’s fees, legal fees, registration charges.
Retained earnings – Profit generated by a firm that are not distributed to stockholders as dividends but are either reinvested in the business or kept as a reserve for specific objectives. Balance sheet figure are shown under the heading retained earnings in the sum of all the profits retained since the firms inception.
Joint venture – also called “Issue shares” two or more parities join together to start up a business; hoping it will grow, make a profit and will be a going concern business. The joined parties will share revenue, expenses and control of the business.
There are different cost of sources of finance available, they are:
Cost of long term finance
- Consultant fees, stockbrokers and on who advises on how to invest wisely
- Fees and commission will be paid institution chosen to invest the money with
- Fees paid to tax advisors
- Share Capital or Owners savings – the amount to be paid is up to cost management, within legal constraints
- Scrip dividend – the company pays in form of new shares
- Cost of providing shareholders with information about the performance of the business
- Cost of investing i.e. bank charges, commission, advisers fees
- Borrowed funds- interest costs and administrative costs
- Repayment of loan
- Government grant- opportunity and administrative cost
- Earnings – business has to pay tax on their earnings
Users of the Financial Information
Main users of the financial information are:
- shareholders / investors
- employees
- lender
- suppliers and customers
- government
- the public
The above are grouped into internal and external users. Internal users consist of managers and employees while the rest of the above list. The above parties demands financial statement information:
- To facilitate decision making
- For monitoring of management
- To interpret contracts or agreements that include provisions based on such information
Shareholders/ Investors – Investors group would comprise both existing and potential shareholders. They would consider whether to invest in the business or sell current investments. Equity investors consider two elements in their investment:
Incomes are in the form of dividends and gain in the share price. If the investor takes a short-term view then current dividends are of interest; whereas longer-term view would concern future earnings.
Employees
Employees and their representatives require information on business performance for two principal reasons:
- wage and salary negotiation;
- assessment of current and forward opportunity in terms of employment.
They would be interested in both the current financial stability and the longer-term financial viability of the business. Employees need information in a clear, simple and understandable form. Some employee reports include a value-added approach rather than a profit and loss account view of performance.
Lenders
This is often referred to as the loan creditor group. It would include the long, medium and short term lenders of money. The concern of the existing or potential loan creditor is ‘will they get their money back?’
The banks make up much of this grouping and would also have an interest in the net realisable value (NRV) of the assets. Medium and long-term creditor groups will review the future cash flow potential of the business.
Suppliers
This comprises the trade creditors – an important element in the supply of a business’s working capital. Suppliers would be interested in the financial stability of the business in terms of cash flow and the firm’s ability to meet its short-term liabilities. They would consider current and future cash flow together with current and future profitability. An interest in the company’s future strategy is also likely as they would need to consider how they, as suppliers, fit with the strategy.
Customers
This group will be interested in the business’s short and longer-term financial stability and its potential to supply high quality goods and services with, where appropriate, sound after- sales service. They may also have interest in the environmental policy of the business.
Government
The government departments require published financial information for the purposes of taxation – company taxation and VAT. The government are decision makers and their forward economic plans are influenced by the performance of all businesses within various sectors in the economy. The current financial reports will be used as a base in their economic models for assessing future performance.
The Public
The public are often referred to as ‘stakeholders’ and businesses do not exist solely in isolation. Businesses are part of society at large and as such generate much public interest. At local and national levels factors such as employment and the environment are often key interests. Some of these issues are included in their financial information and longer-term strategy.
Task A – ACB Training limited with an annual turnover of £25 million are looking to re-locate to help meet clients’ needs more effectively; two different locations are available and will see which will be the best location to re-locate to, putting in consideration the cost, payback and the returned earnings.
Location A – this given location is in the heart of the city centre with an estimated increase of 25% that requires £10 million for an investment move. Having the annual turnover and the estimated increase percentage this should help with the comparison with Location B.
Estimated increase £25,000,000 x 0.25 = £6,250,000
Plus annual turnover £25,000,000
Total estimated annual turnover £31,250,000
The payback period time taken to recover the initial investments of £10 million will be a period of 1.6 years (£10,000,000 / £6,250,000); this calculation will help determine which of the two locations will be worth the return.
Location B - is very close to city centre with the investment of £8 million required for the move and it’s estimated that business will increase by 10% if this option is selected.
Estimated increase £25,000,000 x 0.10 = £2,500,000
Plus annual turnover £25,000,000
Total estimated annual turnover £27,500,000
The payback period time for location B to recover the initial investments of £8 million will be a period of 3.2 years (£8,000,000 / £2,500,000). Location B will take 3.2 years to payback £8 million to make a return. In this case, for 3.2 years ACB Training ltd to make a profit in 3.2 years, it is a long time for a company to run to make ends meet and a long wait to get a return. So therefore, location A will be worth the move as it will take 1.6 years to payback the amount and give a good return.
The source of finance available with ACB Training:
- Issuing 1 million new shares of £10 each- this will give amount of £ 10,000,000. This depends on the number shares will be bought and plus the fees that will occur i.e. administration fees etc
- The bank that ACB Training ltd are dealing with gave a quote to provide a loan needed with the interest rate of 7% per annum with a maximum loan period up to 10 years – this will give an interest of £700,000; payable over 10 years. This can be avoidable and opt for another source of finance as it will reduce the cost for ACB Training to pay out.
- Annual retained earnings brought forward from the previous year is £25 million; with this amount the £10,000,000 required for the re-location can be paid from the £25 million; the remaining will be £15,000,000. This will be the best option for ACB Training as no extra cost with incur i.e. administration fees, interest fees etc. On the other hand, there are disadvantages and they are:
- Less amount in paying out dividends to shareholders
- Less amount of cash float
- One of the competitor companies offered to help with the project, the investors are expecting 80% share of profit in future venture. Competitors expecting 80% share of the profit is quite high, and also there are chances that the competitor will try to take over the decision making and it’s a risk for ACB Training reputation. All of these are the disadvantage for ACB Training ltd but on the other hand there are also advantages as the risk will be spread to all and not just one company will be affected.
Task 2 - Importance of financial planning
Definition of financial plan:
A financial plan consists of sets of financial statements that forecast the resource implications of making business decisions. Financial plan will need to take into account sources of finance, cost of finance, and costs of developing the project, as well as the revenues and likely profits to justify the expansion programme.
A financial plan can be a budget, a plan for spending and saving future income. This plan allocates future income to various types of expenses, and reserves some income for short-term and long-term savings. A financial plan refer to financial statements (balance sheet, income statement and cash flow statement) created within a business plan. A financial plan is also an estimation of future income, expenses and assets. A financing plan or finance plan usually refers to the means by which cash will be acquired to cover future expenses through earnings, borrowing or using saved cash.
Financial planning has important aspects for the organization; this allocates the recourses to help achieve its objectives. Financial plan is plan that helps the management to assess the company’s position financial i.e. cash flows, retained earnings, shareholders wealth etc. Managers become aware of the financial situation, company’s activity, its investment and how to meet customers’ needs.
Long term and short term budget are crucial for all organization, this works as a guideline for the financial plans for future success. Short term plans are usually are less than a year, its referred to operational budgeting and is a guide plan for the long term budget which can be up to five years. These two are budgeting process that will help make current and future decision regarding capital budgeting, working capital and capital structure and increase shareholders wealth.
Long term plans are for major strategic decisions made, such as:
-merger activity
-expansion of capacity
-development of new products
-overseas expansion
Short term plans provide targets for management, it’s a measure against which actual performance can be monitored and controlled.
Financial planning is the task determining how a business will afford to achieve its strategic goals and objectives. The financial plan is created after the vision and objectives have been set. The financial plan describes all activities, resources, equipment and material that are needed to achieve the set objectives.
The financial planning activity involves the following tasks:
- Asses the business environment
- Confirm the business vision and objectives
- Identify the types of resources needed to achieve these objectives
- Quantify the amount of resource (labor, equipment, materials)
- Calculate the total cost of each type of resource
- Summarize the costs to create a budget
- Identify any risks and issues with the budget set
The role of financial planning includes three categories:
1. Strategic role of financial management
2. Objectives of financial management
3. The planning cycle
Conclusion
After researching different type of cost of sources of finance available for ACB Training, the best location for the move was chosen in associate with different type of financing option available and how the financial planning help to achieve ACB Trainings objectives. The importance of the financial planning taking into account the costs and the importance of the long and short term plans for organization.
Reference and Bibliography
http://www.accaglobal.com/students/student_accountant/archive/2002/25/404835
http://en.wikipedia.org
Finance as a resources - Finance lecture notes
Colin Drury, Management and Cost Accounting, sixth edition, 2004
