Table of Contents Choosing a Financial Source 1. Sources of Finance……………………………………………………Page 3 2. Term Length of Funding……………………………………………… Page 5 3. Venture Capital Sources………………………………………………. Page 5 Decision Making 1. Team Building………………………………………………………… Page 6 2. Cost of Finance……………………………………………………….. Page 7 3. Flow of Cash………………………………………………………….. Page 8 4. Balance Sheet…………………………………………………………. Page 9 Financial Performance 1. Financial Statements………………………………………………….. Page 11 2. Balance Sheet and Accounting Ratios………………………………… Page 12 3.
Comparisons between financial statements…………………………… Page 15 Financial Analysis 1. Cash Flow Statement…………………………………………………. Page 18 2. Cash Flow with Inflation……………………………………………… Page 19 3. Investment and project appraisal……………………………………… Page 20 Bibliography……………………………………………………………. Page 21 Choosing a Financial Source 1. Sources of Finance As every business needs to draw on sources of finance David too need to obtain adequate funds. These supply the business with the funds to carry out its actions. There are a variety of sources of finance. Some of the more important ones include: Personal Investment and friends/family •Loans and Overdraft •Share Capital •Venture Capital •Retained Earnings Personal Investment and friends/family When commencing a new business, very often the initial funds invested will come from the individual’s personal savings. The tendency of business start-ups to approach relatives and friends to help finance the venture is also a widespread practice. David can start from investing the finances available to him on person or borrowed from friends/ family. This can be the balance of his bank account or the use of his assets.
The advantage will be the trust his gaining within the other financial providers by risking his own money. Loans and Overdraft Banks provide money to build money. Decisions on interest are the most important. Banks are very active in this market and seek out businesses to which they can lend money. Of the two methods of giving you finance, especially in small and start-up situations, always prefer to give an overdraft or extend the current limit rather than make a formal loan. Overdrafts are a very flexible form of finance which, with a healthy income in your business, can be paid off more quickly than a formal loan.
Loan on the other hand is an amount of money borrowed for a set period within an arranged settlement plan. The repayment amount will depend on the size and duration of the loan and the rate of interest. Bank loan also will be a good idea for David as it is the option for fixed assets cost. But on the other hand he has to think about the disadvantage such as paying the interest for funds he is actually not using, providing a form of security and cashflow problems occurs with the regular payments. Share Capital Another way of funding the business is to collect investment in the form of shares while setting up a Limited Company.
This could be an excellent idea as it is the most important source of long-term finance for a limited company. Share Capital is raised through the sale of shares to individuals or institutions, who in return for their investment receive interest in the form of a payment, which represents a share of the profits made by the business. The two most common forms of shares are •Ordinary Shares: These shares give the right the holders to the remaining divisible profits after earlier interests. In case of liquidation the share holders are permitted to recover their money by selling the left over resources of the company. Preference Shares: These shares carry a fixed rate of payment, the holders of which, subject to the conditions of issue, have a prior claim to any company profits available for allocation. Preference share holders may also have an earlier claim to the repayment of capital in the event of termination. Venture Capital Venture capital is where some individuals join together or institutions to offer finance for new businesses that are just starting-up. They look for hopeful businesses and invest in them, hoping that the businesses will develop and that they will build revenue. This is similar to issuing shares.
However in the David’s point of view this can be too risky strategy. Retained Earnings When David starting up the new business retained earnings from the parent company can b e used as a financial source. Retained earnings is a percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business or to pay debt. It is recorded under shareholders’ equity on the balance sheet. (Investopedia) 2. Term Length of Funding The influence of length term of the funding can be established from an organisation’s business plan, which means answering the following concerns. What is the business? •What is the market? •Prospective for business •predict profit figures •Prospects for the investor/lender •Competition from other software developers. Depending on the nature of the project and bearing in the mind the fact it has to generate profit in short time, Medium term funding is the best suitable for David. This provides the possibility of paying the loan back in a practical period; accordingly David can then focus on his efforts and resources only towards the growth and development of the business.
On the other hand getting a long term loan for David will not be easy task as the business going to be a newly started one. How ever medium term loan is a much appropriate option and with the successful growth of the business bank will provide more facilities and it will attract and invite more investors. 3. Venture Capital Sources Venture capital is a type of private equity capital provided by outside investors for financing new, growing, or struggling businesses. Venture capital investments are generally high-risk investments but offer the potential for above-average return.
Obtaining the services of expert venture capital firm would be helpful for David, because these firms are competent of fixing ample funds effectively and efficiently to begin the business. When finding Venture investors The BVCA – British Private Equity and Venture Capital Association provide, promote all the services that David will require. On the other hand other options available for David will be Alternative Investment Market (AIM) and Angel financing. Alternative Investment Market (AIM) is the London Stock Exchange’s international market for smaller growing companies.
It gives young, venture capital-backed start-ups to enter a small sector of the stock market before making their entry into the London Stock Exchange. In Angel financing, the person who is going to start a business looks forward to obtain the expertise help from its business angels. Business angels are wealthy, entrepreneurial individuals who provide capital in return for a proportion of the company equity. They take a high personal risk in the expectation of owning part of a growing and successful business. Television show Dragons Den provides a good example. Decision Making 1. Team Building
There is absolutely nothing wrong with going it alone as a beginner. Being self-educated reduces David’s dependence on others for advice. However creating your team of professionals and establishing a trusting relationship with each of them can reap significant benefits. More importantly this saves the time and gives chance make more money without a frustration. What all David need to know when to use which professional, and for what purpose. Main roles that David initially can use and there functions given below •Human Resources Consultant – This person does a key job by helping to choose and recruit a suitable team for new business.
Performance Management, employee Relations, workplace Health, Safety and Wellbeing, development and implementation of HR projects will be other responsibilities which will reduce the work load on David. •Research and Development Manager – Keeping up to date with everyday changes, understand the main components of the proposed project and make a decision on how they can be put together effectively will be the main activity of this job.. Having complete knowledge of the factors that influence the car dealer business, and how they should be addressed, aware of technological and changing customer needs will be the other side. Project manager- The main role is to manage the project and lead the project team to ensure the unity of command which is necessary to achieve success. Has to have excellent communication skills to work with all staff, suppliers and customers. The Project Manager will report directly to David and will work closely with the other members and heads of the team to ensure that projects are completed in accordance with company policies and clients needs on time and to the budget. Marketing Manager- This role will be helpful to market the product during and after the completion. Also concerned with research and development, manufacturing, sales and distribution, advertising, promotion, business analysis and forecasting. Required to identify the potential market segment and to keep the project team update. •Software Engineers- Team of engineers will bring out the real work to build up the planned software. It is vital that all the components and factors are dealt with, and the software is significantly tested before it is launched. . Cost of Finance Method of FinancingCosts Bank Loan•Administration Fee -A fee that includes the processing fee, underwriting fee, and document preparation fee. •APR- The Annual Percentage Rate. This is one of the main factors you should take into consideration when choosing the loan. It is the total of interest on the loan plus any other charges that may occur with the loan Venture Capital•Arrangement fee – This is usually a percentage of the amount of the investment.
Part of the fee is payable on acceptance of the offer •Due diligence costs – These costs are charged by the industry experts and accountants as assessment fees of the proposal •Legal costs – These fees are payable to solicitors who’s experienced with the VCs for the arrangement assistance. •Monitoring fee – Annual fee of percentage of the investment •NED costs – Cost of the non- executive director fees who is appointed by the venture firm Share Capital•Admission fee – A fee charged for application processing and admitting shares to trade. Floatation fee – Charged for staying in and depends on the value of shares admitted to the exchange trading. •Annual fee- For each year of share quotations an annual fee is charged, which depends on the company market capitalisation at the end of previous year. Personal Investment•Opportunity Cost- if an asset such as capital is used for one purpose, the opportunity cost is the value of the next best purpose the asset could have been used for. 3. Flow of Cash Flow of financial resources of a business is the fuel that enables it to survive and grow and also the main indicator of business health.
When measuring the flow of financial resources cash flow of the business becomes a key element. There are two types of cash flow documents that need comprising on a monthly basis. The first document is the Cash Flow Forecast that forecasts the estimate of the cash income and expenditure over a period of time: usually twelve monthly forecasts per year. The second type of cash flow document is a Cash Flow Statement. The statement records the actual cash income and expenditure at the end of the ‘forecast’ period. The closer these two documents are, in financial terms, the more understanding and control over the business.
The advantages of both of these are straightforward. •Explains where the cash is tied up •Can spot potential bottlenecks and act to reduce their impact •Helps to plan ahead •Helps to reduce the dependence on the bankers and save interest charges •Can identify surpluses which can be invested to earn interest •Will help to be in control of the business and can make informed decisions for future development and expansion Furthermore cash flaw is always described as a cycle for the reason of business uses cash to acquire resources.
The resources are put to work and goods and services produced. These are then sold to customers, Business gathers and deposits the funds and so the cycle repeats. But what is significantly important is that the active administration and control these cash inflows and outflows. When monitoring the cash flow and preparing forecasts and statements a cash flow cycle like given below will be a vast support. 4. Balance Sheet The accounting balance sheet is one of the major financial statements used by accountants and business owners.
The balance sheet is also referred to as the statement of financial position. Balance sheet is a listing of assets and liabilities, and the final number shows net equity of the company. BT Group’s balance sheet for march 2007 gives a good example. Assets: belongings of the business; assets are separated into two types. Non Current Assets – The items are tangible and have long term value, in the case of David the examples of fixed assets are building, equipment, etc. these are the items which are not likely to switch to cash within twelve months.
Current Assets – Are the items which are expected to convert to cash within twelve months, examples in David’s case would be software product, bank, debtors (in case of credit sale). Liabilities: Obligations on the business; are also divided into two types Long term liability – These are the non current year’s payment of all loans like mortgage or bank loan in David’s case Current liability – These are the liabilities which are due within the next twelve months like bank overdraft, creditors (in respect of credit purchase) in David’s case.
Equity: This describes the investment made by the owners or stockholders of a business. On a balance sheet, equity represents assets less liabilities. Same as Net Worth in a business Financial Performance 1. Financial Statements As discussed in the previous chapters starting his business a limited company will be more beneficial in terms of financing. Also by becoming a limited company David will be able to have the necessary control over organisational functions and decision making process.
On the other hand he will not be held responsible for any liabilities acquired by the company and he will have his personal assets secured in the case of business collapse, as the liability of the members of the company is usually limited to the nominal value of their share. As all the limited companies are subject to Companies Act 1985 and as amended by 1989, it will be a legal requirement to prepare final accounts reports and submitted to the registrar of the company. According to Companies Act 1985, the companies are required to publish their annual accounting details in the benefit of their users and should contain A manufacturing account (if any – depending on business type) •A trading account •A profit and loss account •A balance sheet •A cash-flow statement Failing to submit these by the time of filing will be lead a company to face a fine and the updated penalties issued by Companies House are given below. Length of delay, measured from the date the accounts are duePrivate companyPublic company 3 months or less? 100? 500 3 months and one day to 6 months? 250? 1,000 6 months and one day to 12 months? 500? 2,000 More than 12 months? 1,000? 5,000 2. Balance Sheet and Accounting Ratios
As described earlier the accounting balance sheet is one of the major financial statements used by accountants and business owners and it presents a company’s financial position at the end of a specified date. As David needs to monitor the performance of the company in order to bring any change if required and in decision making process, balance sheet will provide vast assistance. The main technique used to analyse the information contained within the balance sheet is financial ratio analysis. Financial ratio analysis uses formulas to gain insight into the company and its operations.
For the balance sheet, using financial ratios can show a better idea of the company’s financial condition along with its operational efficiency. There are numerous amount of ratios in the financial world and can divide in to six main categories. One example from each category is explained below. Liquidity Measurement Ratios Liquidity ratios effort to measure a company’s capability to pay off its short-term debt obligations. This is done by comparing a company’s most liquid assets and its short-term liabilities. The Main example of the liquidity ratio is the current ratio. Current Ratio
The current ratio is a test of a company’s financial strength. It calculates how much money in assets is likely to be converted to cash within one year in order to pay debts that come due during the same year. The formula is Current Ratio =Current assets Current liabilities Profitability Indicator Ratios The objective of profitability relates to a company ability to earn a satisfactory profit so that the investors and shareholders will continue to provide capital to it. Company profitability is linked to its liquidity because earnings ultimately produce cash flow. Return on Capital Employed
ROCE is one of the most important profitability ratios which assess how much the capital invested has earned during the period. ROCE is an opportunity cost to the potential investor and when making decisions investor will always compare the return on capital invested. The formula is Return on Capital Employed = Profit Before Interest and Tax ? 100 Total Capital Employed Debt Ratio Debt ratios give a general idea of the company’s overall debt load as well as its mix of equity and debt. Debt ratios can be used to verify the overall level of financial risk a company.
Debt-Equity Ratio Measure used to measure a company’s financial health. The ratio is calculated by dividing the company’s long-term debt by the shareholders’ equity. The result is often referred to as gearing. The formula is Debt-Equity Ratio = Total Liabilities Shareholders’ Equity Operating Performance Ratios OPRs are measures of performance in relation to different segments of the company. These ratios look at how well a company turns its assets into revenue as well as how efficiently a company converts its sales into cash. Sales/Revenue per Employee
As a measure of personnel productivity, sales revenue simply measures the amount of cash sales, or revenue, generated per employee. The formula is Sales/Revenue per Employee = Total sales No. of Employees Cash Floor Indicator Ratios Cash floor indicater ratio will assist daid to focus on the cash being generated in the busines and what sort of a safety net it provides. Operating Cash Floor/Sales Ratio This ratio, which is expressed as a percentage, measures up company’s operating cash flow to its revenues and provides investors an idea of the company’s ability to turn sales into cash. The Formula is
OCE/Sales Ratio = Operating Cash Floor ? % Net Sales Investment Valuation Ratios These ratios are use by investors to value their possible or estimate investment the attractiveness of the assets. Most common is the P/E ration Price/Earnings Ratio P/E ratio is a measure of the price paid for a share relative to the annual income or profit earned by the firm per share. The formula is P/E Ratio = Price per Share Annual Earings per Share Limitations and Dangers of Using Ratios Using the ratios to forecast the future is not always advisable as the final ccounts are only partial information. If planning the future or comparing the business with the market using ration there are number of limitations will occur. •Given figures will be inaccurate without looking at the future plans •Staff capebilities are not recognised •Risk factor of the current business has not taken to the account •Problems can appear due to the inflation •Supplier and manufacturer reltions ignored. •Plant and machinery working conditions not included •Position comparing to the compititors has not given a suitable place . Comparisons between financial statements When comes to comparison of the financial statements in two different companies in different environment it can come up with a vast difference in the expenses and other cost accounts, in assets accounts and possibly in P/L account as well. Acid Test Ratio = Current Asst – Stock Current LiabilitiesAlliance pharma PlcBritsh American Tobacoo. 8075682 – 2852125 10802507 = 0. 48 5391000000-2056000000 4453000000 = 0. 75 Evaluation of two different business in uk has given below using 3 diiferent ratios.
Alliance pharma Plc is a phamceutical company and the other is the well known Britsh American Tobacoo. The balance sheets and Income statements are given in the next page. This compares the assests of the two companies which will become liqiud within next 12 months with the liabilities due. Results above proves that both companies not doing great in ATR but Alliance Plc is less liquid and find difficulties when paying the liabilities. ROCE = Net Profit ? 100 Capital Emp. Alliance pharma PlcBritsh American Tobacoo. 502540? 100 10431789 = 4. 8 % 2048000000? 100 6688000000 30. 6 % This compare the profitabilty of the two companies with the capitals employed. How ever it shows British American Tobacoo does far better earning ? 30. 60 for every ? 100 capital employed compareing to the other’s ? 4. 80 for ? 100. Net Profit/ Sales Ratio = Net Profit ? 100 RevenueAlliance pharma PlcBritsh American Tobacoo. 502540 ? 100 17252942 = 2. 91 % 2048000000 ? 100 9072000000 = 22. 57 % This figures also proves that British American Tobacoo does much better earing ? 22. 57 for every ? 100 pounds sales comparing to Alliances’s ? 2. 91. Financial Analysis 1.
Cash Flow Statement Assumed That sales are redusing and and upgrades are incresing. YEAR 0YEAR 1YEAR 2YEAR 3YEAR 4YEAR 5 Bank Loan 100,000. 00 Sales 103,250. 00 88,500. 00 73,750. 00 59,000. 00 44,250. 00 Upgrades 52,500. 00 97,500. 00 135,000. 00 165,000. 00 Total Earnings 103,250. 00 141,000. 00 171,250. 00 194,000. 00 209,250. 00 Investment 80,000. 00 Wages 80,000. 00 80,000. 00 80,000. 00 80,000. 00 80,000. 00 Other costs 37,500. 00 37,500. 00 37,500. 00 37,500. 00 37,500. 0 Loan Repayment principle 20,000. 00 20,000. 00 20,000. 00 20,000. 00 20,000. 00 interest 15. 2% 15,200. 00 12,160. 00 9,120. 00 6,080. 00 3,040. 00 Total Payments 152,700. 00 149,660. 00 146,620. 00 143,580. 00 140,540. 00 Surplus/Deficit 20,000. 00 (49,450. 00) (8,660. 00) 24,630. 00 50,420. 00 68,710. 00 Balance B/F 20,000. 00 (29,450. 00) (38,110. 00) (13,480. 00) 36,940. 00 Balance C/F (29,450. 00) (38,110. 00) (13,480. 00) 36,940. 00 105,650. 00
The first year is the year of costs as Davis has to set-up a business, build up the planned software and massive sum of finances are allocated to carry out the promotion activities in order to initiate the product in the market. Therefore this year has not generated the substantial profit; in fact, this has proven to be the year of loss. In the second year that loss has increased and shows that David is in a risk. However when the years passes by he is getting the loss reduced and starting to make profit where after 5 years he has clearly made profit overall more than his loss.
I would advise David to invest less amount of money initially where he can make more profit. 2. Cash Flow with Inflation YEAR 0YEAR 1YEAR 2YEAR 3YEAR 4YEAR 5 Bank Loan 100,000. 00 No of Units sold 350300250200150 Inflated Unit cost295305. 325 316. 01 327. 07 346. 70 sales 103,250. 00 91,597. 50 79,002. 84 65,414. 35 52,004. 41 upgrades 54,337. 50 100,912. 50 139,725. 00 171,525. 00 Total Earnings 103,250. 00 145,935. 00 179,915. 34 205,139. 35 223,529. 41 Investment 80,000. 00 Wages 80,000. 00 82,800. 0 85,698. 00 88,697. 43 94,019. 28 Other costs 37,500. 00 38,812. 50 40,170. 94 41,576. 92 44,071. 54 Loan Repayment principle 20,000. 00 20,000. 00 20,000. 00 20,000. 00 20,000. 00 interest 15. 2% 15,200. 00 12,160. 00 9,120. 00 6,080. 00 3,040. 00 Total Payments 152,700. 00 153,772. 50 154,988. 94 156,354. 35 161,130. 81 Surplus/Deficit 20,000. 00 (49,450. 00) (7,837. 50) 24,926. 41 48,785. 00 62,398. 60 Balance B/F 20,000. 00 (29,450. 00) (37,287. 0) (12,361. 09) 36,423. 91 Balance C/F (29,450. 00) (37,287. 50) (12,361. 09) 36,423. 91 98,822. 51 The increase in inflation rate would result in the cost of expense. To address this operating cost David would certainly have to raise the price of the product accordingly. Due to increase in inflation rate from current position to 3. 5% and then after three years to 6%, would effect in the increase of the product package, consequently wages will also have to be increased. Rise in wages is also justified by the ever rising profit of David’s business. 3.
Investment and project appraisal Assuming that •Sales are riducing by 50 packages each year and upgrades are by 66%. •Price of package is ? 350 & upgrade cost is ? 250 •No bank loan taken/ Invested money from his Re-mortgage. •Wages get inflated as more staff hired. And the costs as well •Remortgage for ? 350000 and balance is ? 230000 also interest only for first 3 years. •Charges for the re-mortgage are neglected. YEAR 0YEAR 1YEAR 2YEAR 3YEAR 4YEAR 5 Re-mortgage 230,000. 00 Sales 122,500. 00 105,000. 00 87,500. 00 70,000. 00 52,500. 00 Upgrades 58,333. 33 102,500. 0 144,166. 67 177,500. 00 Total Revenue 122,500. 00 163,333. 33 190,000. 00 214,166. 67 230,000. 00 Investment 75,000. 00 Wages 60,000. 00 80,000. 00 80,000. 00 100,000. 00 100,000. 00 Costs 75,000. 00 76,500. 00 78,000. 00 79,500. 00 81,000. 00 Mortgage 14,000. 00 14,000. 00 Interest only 20,650. 00 20,650. 00 20,650. 00 20,650. 00 20,650. 00 Principle Total cost 155,650. 00 177,150. 00 178,650. 00 214,150. 00 215,650. 00 Surplus/Deficit 155,000. 00 (33,150. 0) (13,816. 67) 11,350. 00 16. 67 14,350. 00 Balance B/F 155,000. 00 121,850. 00 108,033. 33 119,383. 33 119,400. 00 Balance C/F 121,850. 00 108,033. 33 119,383. 33 119,400. 00 133,750. 00 •Comparing to the first 2 cash flow statements Mr. North can do much better by re-mortgaging his house rather than taking a bank loan . •It is visible that he always have a fair amount of balance to carry forward after paying off his liabilities. •His capebility of continuing or viability of the business is in a good possition after the 3rd year. •All Mr. orth has to concentrate is get the most out of his new sales staff and some how stop the reduction of his sales where he can get more money. BIBLIOGRAPHY Broadbent, M. , Cullen J. (2003), Managing Financial Resources, Butterworth-Heinemann Financial Management (University of Sunderland Course Book) Hansen, D. R. , Mowen, M. M. (2000), Management Accounting, South-Western College Publishing HNC/HND Course Book Lucey, T. (2003), Management Accounting, Gower Publishing, Cengage Learning EMEA Web www. businesslink. gov. uk www. FT. com www. google. com www. londonstockexchange. com/ www. tesco. com www. wikipedia. com