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Managing Financial Resources and Decisions

INTRODUCTION

The report has discussed the key factors of managing financial resources and decision making. Also the importance of managing cash inflows and cash outflows for a business has been highlighted. The key factors to be considered in preparing cash budgets and the process of preparing budgets has been discussed. On the other hand the purposes of the main financial statements produced by any business and how the format of these financial statements can vary with the size of the businesses have been evaluated. Also information needs of different users of financial statements have been assessed.

Different sources of finance available for a business have been discussed by considering different debt and equity financing options. The implication of the different sources of finance is explained using different examples. In addition the impacts on financial statements due to obtaining these sources of finance are further evaluated.

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TASK 1

L01: Be able to make financial decisions based on financial information

PREPARATION OF A CASH BUDGET

According to the view by Anderson (2000), a cash budget is a financial plan that summarizes all estimated receipts and payments within a specific time frame. The cash budget for Yardley wood store can be calculated as follows based on the given case study.

             
  1 2 3 4 5 6
Sales 500,000 500,000 640,000 640,000
Cash inflows     500,000 500,000 640,000 640,000
             
Less            
Rental (5,000) (5,000) (5,000) (5,000) (5,000) (5,000)
Plant & machinery cost (780,000)          
Additional equip cost (350,000) (160,000) (105,000) (105,000)    
Running cost   (62,000) (62,000) (62,000) (62,000) (62,000)
Cash outflows (1,135,000) (227,000) (172,000) (172,000) (67,000) (67,000)
             
Net cash flows (1,135,000) (227,000) 328,000 328,000 573,000 573,000
opening cash balance   (1,135,000) (1,362,000) (1,034,000) (706,000) (133,000)
Closing cash balance (1,135,000) (1,362,000) (1,034,000) (706,000) (133,000) 440,000
             
FINANCIAL INFORMATION

When considering the amount of finance required in first six months of the operation, it is clear that at the beginning of the first few months there will be a serious requirement of cash requirement. As for an example in the 2nd month there is a cash requirement of 1,362,000 and then there after the cash position is turning a positive cash balance at the end of the 6 months. Therefore after 6 months the cash position would become positive and thus there won’t be any additional cash requirement.

OTHER FACTORS TO BE CONSIDERED IN CASH BUDGET

According to the view by Bryson (2000, pp.l4-3-62), cash budget could be defined as an estimation of the cash inflows and outflows for a business or individual within a specific time frame. One of the main factors to be considered when preparing a cash budget is the changes in economic factors in foreseeable future. If there is any possibility of a financial crisis, then it would have a major negative effect on the cash flow predictions. Another main factor to be concerned is the sales forecasts where predictions about margins are equally important. Also generally businesses have their assumptions on various economic factors such as interest rates, exchange rates, economic growth rates, market share growth etc. where all cash flow planning would be based on those. As a result it is important to have more realistic assumptions which can be arrived using the advices given by business analysts.

Based on the view by Shen (2002, pp. 251-253), first important factor in preparing a budget is the income level of the organisation. He has further stated that when preparing a budget it is essential to focus on the net income, but not the gross income. On the other hand it is advisable to take every expense into the cash budget preparation. All monthly expenses which are expected to be spent on each month needs to be budgeted carefully. Another important factor in preparing a budget is achieving the cash balance. If there would be more income than expenses it will reflect a cash rich situation where as if there are more expenses than income, then it will be required to reduce expenses and possibly identify new ways of making money. If there is a possible cash deficit then the finance manager should evaluate the possible options to obtain finance to maintain the company operations without any interruptions.

Myers (2004, pp. 75-81) has stated that another important component to be looked at in preparing a budget is how to reach certain financial goals. Thus it is important to consider short term and long term cash flow targets when preparing a full cash budget. Also on the other hand it is essential to consider the accuracy of underlying data such as estimation of monthly cash receipts, seasonal factors, political factors, pattern of cash receipts from debtors in case of credit sales etc. On the other hand estimation of cash payments should be considered. Also the expected purchases in each month should be forecasted. That is if the firm intends to increase their stock levels, the annual purchases should be increased in proportion to the increase in stock level. Based on this the organisation needs to determine when the payment is to be obliged. The accuracy of these would ensure the accuracy of overall cash outflow forecasts. Apart from the regular expenses, the company needs to plan cash outflow for the other obvious expenses such as tax payments. Also it is important to consider contingency funds in the budget as well.

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TASK 2

L02: Be able to make financial decisions based on financial information

According to the given scenario the pricing strategy used is the cost plus pricing method where a fixed percentage would be added on the top of the total unit cost. Global Manufacturing Company has added a 10% mark up on their total cost. The company selling price can be calculated as follows.

Purchases 90,000
Other direct expenses 15,000
Direct labour 34,900
Electricity and water 100,000
Production overheads 150,000
Plant and machinery 5,000,000
Total cost 5,389,900
Unit cost 53,899
SP (10% markup) 59,289

When making pricing decisions it is highly important to consider the unit cost of a single product and the expected profit margin. This is because then the company would be able to decide a more accurate price which will cover their total cost of manufacturing. On the other side it is also important to consider the competitor pricing strategies as well in order to offer a competitive price to the market which is not over-priced. Also if Global Manufacturing Company decides to practice a market penetrative strategy then they have to minimise their total unit cost and offer the product at a comparatively lower price compared to the other rivals. This would enable Global Manufacturing Company to achieve a super profit through increased no of units sold. Therefore deciding on unit cost is highly important when arriving at pricing decisions.

TASK 3
L03: BE ABLE TO MAKE FINANCIAL DECISIONS BASED ON FINANCIAL INFORMATION
  1. (1) Payback period

According to Crosby (2008) payback period refers to as the length of time required to recover the cost of an initial investment. The back period for the given projects based the scenario can be calculated as follows.

Plan A = 2 years + (12000/24000)

= 2.5 years

Plan B = 2 years + (25000/25000)

= 3 years

Plan C = 2 years + (18000/36000)

= 2.5 years

(a)(11) Net present value

According to Myers (2004), the net present value can be defined as the difference between the present value of cash inflows and the present value of cash outflows. In general terms the investments with higher positive NPV are considered to be financially viable. Thus the net present value of the given projects can be calculated as follows.

Plan A

  Yr0 Yr1 Yr2 Yr3 Yr4
Initial cost (60,000)        
Savings   24,000 24,000 24,000 18,000
Net cash flow (60,000) 24,000 24,000 24,000 18,000
DF(15%) 1 0.87 0.756 0.658 0.572
PV (60,000) 20,880 18,144 15,792 10,296
NPV 5,112        

Since the NPV is positive the given investment opportunity is financially viable.

Plan B

  Yr0 Yr1 Yr2 Yr3 Yr4
Initial cost (75,000)        
Savings   25,000 25,000 25,000 25,000
Net cash flow (75,000) 25,000 25,000 25,000 25,000
DF(15%) 1 0.87 0.756 0.658 0.572
PV (75,000) 21,750 18,900 16,450 14,300
NPV (3,600)        

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As the gibe project generates a negative NPV the investment is considered to be not financially acceptable based on the NPV guidelines.

Plan C

  Yr0 Yr1 Yr2 Yr3 Yr4
Initial cost (90,000)        
Savings   36,000 36,000 36,000 27,000
Net cash flow (90,000) 36,000 36,000 36,000 27,000
DF(15%) 1 0.87 0.756 0.658 0.572
PV (90,000) 31,320 27,216 23,688 15,444
NPV 7,668        
  1. Recommendation

Based on the above NPV calculations the plan B is considered to be financially not viable due to its negative NPV (36,000). On the other hand plan A and C are considered to be financially viable. As the plan C generates a higher NPV which is 2556 more than the plan A, the plan C is recommended in the financial terms. But on the other hand there are other factors also to be looked at before making the final decision such as the risk level, the level of accuracy of the underlying assumptions such as discounting factor and the period etc.

TASK 4

The given financial analysis is based on the financial performance by Nokia.

EXPLAIN THE PURPOSE OF THE MAIN FINANCIAL STATEMENTS

According to the idea by Graiser (2004, pp.24-32), the purpose of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions. When applied to the company Nokia, the purpose is to provide financial information to their prospective investors, managers, financial institutions, customers, employees etc. The analysis of financial statements would be critically important for the investors to make their investing decisions in purchasing shares. The format of these financial statements can vary with the size of the businesses. The Nokia has a very comprehensive financial statement due to their highly expanded business over different countries. Further they have shown the profit/ (loss) attributable to equity holders of the parent and non-controllable interests at the end of the financial statement.

(B) ASSESS THE INFORMATION NEEDS OF DIFFERENT USERS

Information needs of different users can be summarised as follows.

  • Employees – to get an idea about their future job safety and other related rewards and incentives based on company performance (promotions, salary increments, bonus etc.), to ensure their future career developments and career progression within the organisation
  • Government – for tax collection purposes, to ensure social responsibility aspects
  • Shareholders – to make better investment decisions (capital gains), to forecast the future liquidity of the share, to know any probable right issues or share dilutions
  • Suppliers – to know the credibility of their supplies
  • Customers – to ensure the quality of the goods or services offered, to know the social responsibility aspects of the company
  1. Ratio Analysis

Ratio analysis is generally considered as a tool to carry out a quantitative analysis of the information in a company’s financial statements. On the other hand these financial ratios would enable a company to undertake effective planning and financial management.

The below financial ratios are calculated based on the 2012 financial information based on its official website. Nokia 2012 key figures are attached at the end of the appendix.

(Source: http://www.nasdaq.com/symbol/nok/financials?query=income-statement)

The financial performance can be analysed as using following ratios.

Gross profit margin = Gross profit/ Sales * 100

= 11,061,000 / 39,784,000 * 100

= 27.8%

Net profit margin = Net profit/ Sales * 100

= 3,267,000 / 39,784,000 * 100

8.2%

The financial position can be analysed using following ratios.

Current ratio = Current assets/ Current liabilities

= 27,526,000 / 10,370,000

= 2.65

Quick ratio = Current assets – Stocks/ Current liabilities

= 27,526,000 – 2,028,000 / 10,370,000

= 2.45

Gearing = Debt/ Debt + Equity * 100

= 6,798,000 / (6,798,000 + 10,628,000)

39%

When evaluating the above ratio analysis it is clear that the higher gross profit margin of 27.8% has lowered to the net profit margin of 8.2%. It is possible that the company has a higher operational cost and the cost breakdown needs to be analysed further. When considering the current ratio and quick ratio they are at a better level indicating efficient performance. But those needs to be further compared with industry comparisons. The gearing ratio seems to be average high where it is possible that the company has financed through more debt rather that equity. The gearing ratio also needs to be further analysed using industry average. In overall terms the company performance and positions seems to be at a sustainable position which shows future stability.

Figure 1: The ratio analysis

Source: http://www.simplifiedfm.com/wp-content/uploads/2013/02/Types-of-Ratio-Analysis

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TASK 5
L05: UNDERSTAND THE SOURCES OF FINANCE AVAILABLE TO A BUSINESS AND UNDERSTAND THE IMPLICATIONS OF FINANCE AS A RESOURCE WITHIN A BUSINESS
5.1 IDENTIFY DIFFERENT SOURCES OF FINANCE

According to the view by Nutt (2002, pp.251-263), when selecting different sources of finance, it is essential to evaluate the future impact as well. There are two different sources of finance such as debt or equity finance. Generally equity finance is considered to be expensive than the debt financing due to its preliminary costs. On the other hand it is advisable to evaluate additional factors such as probable forecasted interest rates, requirement of a security or bank guarantee, the loan capital repayable terms, additional business disclosure requirements etc. It is possible to compare different sources of finance available as follows.

  1. Financing through private banks and other financial institutions
  • Different types of loans such as operating loans, finance loans, term loans, mortgages and credit cards etc.
  • Additional disclosure requirement of business planning and budgets (cash flows and profitability)
  • Loan security or guarantee obligations
  1. Loans and grants offered by Government

 

  • Specific industries are granted loans at concessionary interest rates in order to promote certain industries
  • Concessionary interest rates are given based on factors such as contribution to society, size of the investment, probable foreign cash inflows etc.
  • Would require additional reporting systems and disclosure requirements
  1. Business partners or strategic alliances
  • Required to select a reliable, strong business partner
  • Ability to share the capital requirements and business risk
  • Possible issues in sharing profits and decision making
  1. Venture Capitalist Investment
  • Would invest in companies having cash flow issues and make short-term business decisions to recover their cost of investment within a short period of time
  • Considered to be business turn-around experts
  • Boost profitability through aggressive cost control
  • Minimal attention towards the social responsibility aspects
5.2 ASSES THE IMPLICATION OF THE DIFFERENT SOURCES OF FINANCE

Based on the view by Pettinger (2000, pp.123-135), there are different financing options for a business such as using retained earnings, financing through a private bank loan , financing through institutional investors, venture capitalist investments, investing in debentures and share market etc. In general terms the government loans would have a benefit of ability to obtain concessionary interest rates by minimizing the finance cost. On the other hand obtaining finance from a venture capitalist would be comparatively disadvantageous due to them taking short term decision making in order to realise their investments within a shorter time frame. Also if obtaining finance from a bank loan (either medium term or long term) most probable there will be loan covenants which would add additional obligations and restrictions for the company. These would be as to requirement of obtaining approval for all major financing decisions made by the company such as share dilutions, additional loan facilities, changing company ownership, major investment decisions etc.

Implications of obtaining external funds can be summarised as follows.

• Influences on the business strategic decision making and business control – mostly by the private/institutional investors

• Significant hit on business bottom line – due to higher interest cost charges

• Requirement to obey additional rules and guidelines – loss of business control

• Restrictions on obtaining other financial services form the other financial institutions

5.3 DESCRIBE HOW THESE SOURCES OF FINANCE IMPACT THE FINANCIAL STATEMENTS

The different sources of finance would have a considerable impact to the financial statements. As for an example obtaining finance from a bank institution would reduce the overall profitability due to the higher interest portions. Also obtaining external loans would increase the liability position of the balance sheet by affecting the gearing level (Alexander, 2000). On the other hand debt financing would increase the gearing level of the company by increasing the company risk level.

5.4 EXPLAIN HOW FINANCIAL PLANNING CAN BE BENEFICIAL FOR ANY BUSINESS

Based on the Lynch (2006, pp.87-95), financial planning can be defined as series of steps or goals used by an individual or business, the progressive and cumulative attainment of which are designed to accomplish a financial goal. On the other hand financial planning provides direction and meaning to your financial decisions. This would enable a company to plan out their existing resources in a more effective manner and to obtain the maximum usage. Also financial planning would enable to understand how each financial decision you make affects other areas of your finances. On the other hand this would help to review organisational short and long-term effects on their future objectives.

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CONCLUSION

The report has identified different financing sources available for a company and the implications from each financing option have been evaluated. Based on the given discussion it is recommended to evaluate other related factors such as additional financial disclosure requirements, loan covenants, requirement of bank guarantees and securities etc. When analysing individual sales and cash budgets, it is advisable to re-consider the underlying assumptions and breakdown of individual budgetary items. It is recommended to evaluate different financial indicators such as gross profit margin, net profit margin, current ratio, quick ratio, gearing ratio etc. Also it is recommended to obtain debt financing more than equity financing because in general terms debt financing is considered to be cheaper than equity financing.

The significance of financial planning for a business has been discussed by evaluating the implication of the different sources of finance to corporates. In addition information needs of different decision makers have been assessed using different examples.

REFERENCES

Alexander, E. (2000), Rationality Revisited: Planning Paradigms in a Post- Postmodernist Perspective, Journal of Planning Education and Research, 19, pp.242-56

Barney, J. (2000), Firm resource and sustainable competitive advantage , Journal of Management, Vol. 17, No. 1, pp. 99-120

Baum, A. and Crosby, N. (2008), Property Investment Appraisal, 3rdEdition, Blackwell DTZ (2009): Money into Property, pp.256-261

Bryson, J. and Anderson, S. (2000), Cash budget preparation, Public Administration Review, 60:2 pp.l4-3-62

Bryson, J., Cunningham, G. and Lokkesmoe, K. (2002), what to do when stakeholders Matter: The Case of Problem Formulation for the African American Men Project of Hennepin County Minnesota, Public Administration Review, 62:5 pp 568 -84

Graiser, A. and Scott ,T. (2004), Analysis of financial statements, The Secured Lender, Vol. 60 Issue 6, November/December, pp.24-32

Lynch, R. (2006), Corporate Strategy, Fourth Edition, Financial Times Prentice Hall, pp.87-95

Myers, H. (2004), Trends in budgeting and forecasting, European Retail Digest, spring, pp. 75-81

Nutt, P. (2002) , Why Decisions Fail, Avoiding the Blunders and Traps That Lead to Debacles, San Francisco, CA:Berrett-Koehler Publishers, pp.251-263

Pettinger, R. (2000), Investment Appraisal, A Managerial Approach, Palgrave Macmillan, pp.123-135

Shen, V. R. (2002), Projection of future resources and expected returns, Journal of Financial Review and resources, pp. (251-253)

Mansour, F. A. (2001), comparing cost accounting standards with existing accounting standards, Management Accounting, pp.37-42

APPENDIX

The Nokia financial figures of year 2012 are attached herewith.

  • Total revenue = 39,784,000
  • Cost of sales = 28,723,000
  • Gross profit = 11,061,000
  • Total operating cost = 7,794,000
  • Net profit = 3,267,000
  • Total current assets = 27,526,000
  • Total current liabilities = 3,572,000
  • Long term debt = 6,798,000
  • Total equity = 10,628,000
  • Stocks = 2,028,000

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