Managing Financial resources and decisions Assignment
Assignment Task One
a) Identify the potential sources of finance available and explain why financial planning is important.
For a registered company in Hong Kong there would be potentially many sources of finance and the firm shall choose between the available sources to keep the cost of financé low. The best sources can be any of the following:
a) Use firms own retained earnings
b) Go for issuing new stocks in the Hong Kong financial market
c) Issue new bonds and debentures in the open market.
d) Take medium to long term loans form the banks or financial institutions.
e) Use operating lease form of financing long term asset acquisition.
However before deciding about the most appropriate sources of financé to be sued by the company, it must be made sure that the management of the company has made appropriate evaluation of the pros and cons of the sources being decided to be used. This would make sure the firms efficiency is enhanced through cost reduction in the medium to long term.
However, it must be kept in mind that sourcing of financé in the long term is part of a financial planning process for most registered firms anywhere in the world(Atrill & Eddie, 2012).
As per (Bennett, 2000)a financial plan is the plan which is researched , analyzed and documented by the management of a firm to make sure funds are available in abundance when the same is required by the company and the same can be utilized in profitable projects to make sure the firms future growth is not reduced and profitable and lucrative projects are not left out because of lack of investable funds.
A properly defined financial plan recognizes the funding needs and make provisions to get the same from cheaper sources and the benefits of a well-made plan is numerous as documented below:
a) The plan would recognize the need of funding and also tell the management the timing of the funding needed.
b) The estimated inflow of funds from current operations would also be recognized and taken into plan period.
c) The gap between the funds needed and funds available are determined.
d) The sources would then be finalized keeping the fund size and the cost of the funding source(Cottrell, 2012).
e) This would make the overall cost of capital lower.
f) Value of share would increase in the coming future period.
g) Financial risk of the firm would go down.
b) Identify and evaluate both long term and short term sources of finance for a project implemented by a listed company. Offer definitions, and assess the advantages and disadvantages for each of the sources you identify and when each would be most appropriate.
a) Issue new Shares: New Equity can be issued in the open market either at par value or at a premium to make sure the firm has enough capital to deal with new project undertakings or expansion projects.
b) Issue Bonds: another option which is often explored in the market is issuing bonds to the capital market to raise capital. However, this source involves the payment of periodical interest to the bondholders. The interest is generally required to be disbursed twice in a year and this is one of the preferred sources because it brings tax benefits.
c) Retained Earnings: this is one of the most preferred sources of financing long term expansions of a project. As the source is internal the funding does not involve any cost and thus would lower the firms overall WACC. This source also has the advantage of being available immediately(BAKER & CORTRELL, 2011).
d) Long term Loans from banks and other financial Institutions: Banks often provide needy companies with required capital for medium to long term projects with a reasonable interest rate structure. Like the interests paid on bonds and debentures the interest cost or finance costs payable on the loans are also likely to give the firm tax benefits and this makes the availing of this source attractive.
e) Another source of financing long term equipment is operating lease. Under this source equipment's whose costs are substantial can be taken on lease and the same would be required to keep the overall cost down. Under this the firm would pay a periodic lease rental to the firm's lessee and this would reduce the tax payment for the firm.
c) Analyze the costs associated with different sources of finance and explain how these costs impact the financial statements.
Issue of Equity stocks
1. it will increase the firm's equity and reduce the financial risk of the issuing firm.
2. Gearing of the firm would reduce and part of the issue can be utilised to reduce the level of debts.
3. The issue of equity would increase the issuing firm's dividend paying liability.
4. Would increase the firms overall cost of capital.
Issue of bonds
a) Bonds are like the debts and would increase the gearing of the firm.
b) Increase in the firm's financé cost.
c) Brings reduction in taxes.
d) Increase the financial leverage and risk for the issuing firm.
Bank Loans
a) Bank loans are like the debts and would increase the gearing of the firm.
b) Increase in the firm's finance cost.
c) Brings reduction in taxes.
d) Increase the financial leverage and risk for the issuing firm.
e) Increase in long term liabilities shown in the balance sheet.
Operating Lease
a) Does not increase the long term liability.
b) Brings tax benefits as the lease rent likely to be paid by the lessor is deductible for tax.
c) However, from 2107 onwards the same would be treated as financial leases and long term liabilities(Brearly , Myers & Allen, 2012).
d) Capital which would have been used to purchase the equipment would be saved and can be utilised in other expansion projects.
d) Assess the information needs of three stakeholders - such as owners or financial institutions.
Information is key in medium to long term planning for most business organizations. The information is to be used by different stakeholders for different purpose. The shareholders of a company would need information regarding profitability and liquidity to make investment decision. Prospective investors of a firm would need the profitability information to decide whether to purchase shares in the firm.
The management of the firm would use the financial statements to prepare management reports of various kinds to make relevant decisions regarding new investments, expansion projects, expanding into new markets introducing new product range etc(Carl S. Warren, 2012).
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Assignment Task Two
a) Identify the Net Value or the Net Cash Flow (before applying the discount factor) of the project and also the Net Present Value (after applying the discount factor). Analyze and explain the advantages and disadvantages of the techniques adopted here.
The net cash flows from the proposed project is calculated as follows:
|
Years
|
Cash Inflows
|
Cash Outflows
|
net cash flows
|
|
|
$'000
|
$'000
|
$'000
|
|
0
|
0
|
1000
|
-1000
|
|
1
|
110
|
30
|
80
|
|
2
|
120
|
35
|
85
|
|
3
|
130
|
40
|
90
|
|
4
|
140
|
45
|
95
|
|
5
|
150
|
50
|
100
|
|
6
|
160
|
55
|
105
|
|
7
|
170
|
60
|
110
|
|
8
|
180
|
65
|
115
|
|
9
|
190
|
70
|
120
|
|
10
|
200
|
75
|
125
|
As all the year has seen cash inflows and outflows in all the years involved in the project except the first year (in first year there is only the initial investment) the net cash flow would mean the excess of cash inflows over the concerned cash outflows related to the project.
Thus the net cash flows are calculated as follows:
Net cash flow = cash inflows - cash outflows.
When the net cash flow is negative it means the company has invested in the project and when the net cash flow is positive it means the firm has been able to get cash flows as contribution from the project. As such there is a net cash investment in the initial year which is year 0 and in each of the subsequent year the firm has been able to get cash return form the project(Vernimmen, 2011).
Calculation of the Discount Rate of the project:
The project in which a firm has invested money or is proposed to invest money shall be evaluated with the help of firms project specific WACC.
The firm has invested a sum of $1,000,000 in the project out of which a sum of $500,000 is invested in the form of equity and another %=$500,000 is invested in the form of Debts.
Equity = $500,000
Debt = $500,000
Cost of equity = 8%
cost of debt = 12%.
Weightage of equity = $500,000/ $1,000,000 = .5
Weightage of Debt = $500,000/ $1,000,000 = .5
Thus the project specific cost of capital is calculated as follows:
Cost = .5 X 8% + .5 x 12% = .10 = 10%.
So the discount rate with which the firm would calculate the projects net present value is 10%.
Calculation of NPV
|
Years
|
Cash Inflows
|
Cash Outflows
|
net cash flows
|
PVF @ 10%
|
PV of cash flows
|
|
|
$'000
|
$'000
|
$'000
|
|
|
|
0
|
$0
|
$1,000
|
-$1,000
|
1.000
|
-$1,000
|
|
1
|
$110
|
$30
|
$80
|
0.909
|
$73
|
|
2
|
$120
|
$35
|
$85
|
0.826
|
$70
|
|
3
|
$130
|
$40
|
$90
|
0.751
|
$68
|
|
4
|
$140
|
$45
|
$95
|
0.683
|
$65
|
|
5
|
$150
|
$50
|
$100
|
0.621
|
$62
|
|
6
|
$160
|
$55
|
$105
|
0.564
|
$59
|
|
7
|
$170
|
$60
|
$110
|
0.513
|
$56
|
|
8
|
$180
|
$65
|
$115
|
0.467
|
$54
|
|
9
|
$190
|
$70
|
$120
|
0.424
|
$51
|
|
10
|
$200
|
$75
|
$125
|
0.386
|
$48
|
|
NET PRESENT VALUE
|
|
|
|
-$394
|
The net present value of the project is negative $394,000. This means if the firm choose to invest the sum of $1,000,000 in the project then the net return form the investment after taking into consideration the discounting of the project would be ($394,000). So the firm shall resist frominvesting in the project and explore for more similar projects.
b) Identify the Undiscounted Payback period and the Discounted Payback period and evaluate whether the pricing strategy that has generated the inflows is viable in this scenario.
Calculation of Undiscounted Payback Period
|
Years
|
Cash Inflows
|
Cash Outflows
|
net cash flows
|
cumulative net cash flows
|
|
|
$'000
|
$'000
|
$'000
|
$'000
|
|
0
|
$0
|
$1,000
|
-$1,000
|
-$1,000
|
|
1
|
$110
|
$30
|
$80
|
-$920
|
|
2
|
$120
|
$35
|
$85
|
-$835
|
|
3
|
$130
|
$40
|
$90
|
-$745
|
|
4
|
$140
|
$45
|
$95
|
-$650
|
|
5
|
$150
|
$50
|
$100
|
-$550
|
|
6
|
$160
|
$55
|
$105
|
-$445
|
|
7
|
$170
|
$60
|
$110
|
-$335
|
|
8
|
$180
|
$65
|
$115
|
-$220
|
|
9
|
$190
|
$70
|
$120
|
-$100
|
|
10
|
$200
|
$75
|
$125
|
$25
|
The total cumulative cash flow at the end of the 9th year is -$100. And the total net cash flow in the tenth year of the projects operation is $125. Thus a portion of the projects cash required to be recovered would take place in the 10th year. Thus the exact Payback period is:
Undiscounted payback period = 9 years + ($100/$125) = 9 years and .8 years.
So the firm's payback period is 9.8 years which is just a shade lower than the projects life period.
Calculation of Discounted Payback Period
|
Years
|
Cash Inflows
|
Cash Outflows
|
net cash flows
|
PVF @ 10%
|
PV of cash flows
|
cumulative net cash flows
|
|
|
$'000
|
$'000
|
$'000
|
|
$'000
|
$'000
|
|
0
|
$0
|
$1,000
|
-$1,000
|
1.000
|
-$1,000
|
-$1,000
|
|
1
|
$110
|
$30
|
$80
|
0.909
|
$73
|
-$927
|
|
2
|
$120
|
$35
|
$85
|
0.826
|
$70
|
-$857
|
|
3
|
$130
|
$40
|
$90
|
0.751
|
$68
|
-$789
|
|
4
|
$140
|
$45
|
$95
|
0.683
|
$65
|
-$725
|
|
5
|
$150
|
$50
|
$100
|
0.621
|
$62
|
-$662
|
|
6
|
$160
|
$55
|
$105
|
0.564
|
$59
|
-$603
|
|
7
|
$170
|
$60
|
$110
|
0.513
|
$56
|
-$547
|
|
8
|
$180
|
$65
|
$115
|
0.467
|
$54
|
-$493
|
|
9
|
$190
|
$70
|
$120
|
0.424
|
$51
|
-$442
|
|
10
|
$200
|
$75
|
$125
|
0.386
|
$48
|
-$394
|
The total cumulative cash flow at the end of the 10th year -$394. And there is no more cash flows after the tenth year as the projects life is only 10 years. Thus the Projects won't be able to have a discounted payback period as the project won't have enough discounted present values.
The most appropriate pricing strategy for the pricing decision will be the unit cost pricing strategy. Unit costs are the costs that are calculated by the company per unit of the total output,. In other words, it can be inferred that the Unit Cost is the cost that is calculated or the production of one unit and is a combination of the fixed cost and variable cost. The fixed costremains constant throughout whereas the other cost is the variable cost that increases or decreases with increase or decrease with respect to the total production team. This costing method is useful in some of the business with less or very low fixed costs. The larger companies' fixed cost eventually becomes low because of the lower fixed rate through the economies of scale bcause of locker and eventually lesser business.
In the unit pricing costing, the cost per unit remains the same irrespective of the increase and decrease in the total output. The unit based costing helps in understanding the exact amount of cost that is incurred per unit. Since the unit price remains constant, there are no chances pf incorrect presumption about the prices, thus , providing a clear picture of the exact cost which incurs and is indifferent with the total cost increasing or decreasing.
The unit cot is calculated by dividing the total cost upon the total number of units produced, in the numerical it can be represented as :
(Total Fixed Cost + Total Variable Cost ) divided by the total number of units produced. In case of service industry, the same can be calculated on the basis division of the Variable costs by the total number of jobs performed or the total number of working hours.
Also, unit costing will help in understanding whether the given budget is the under budget or the over budget of the company. Unit costing is the standardized base to calculate and compare the total cost on the basis of the absolute calculation related to the per unit pricing. This will also help in understanding the current cost expenditure and plan to explore and set the new pricing strategy that will help in undermining the future perspective and the profitability of the business.
c) Assess whether Aston Ltd should continue with this project.
When a project is being considered by a firm for investment the same is generally undertaken if it has proven potential to earn benefits for the firm and is capable of increasing the firms value over the projects life period. For example, if a project has a positive NPV it would be able to increase the firms value. If it has negative NPV then the firms value would come down. This is why a project shall be rejected if the NPV is negative.
The current project being considered by the Firm is negative $394.
Thus the firm shall not accept the project as it would potentially not benefit the frim over the long term.
Similarly,the payback period is an indication of how soon a project which is being considered for investment by the company would return the initial investment put into the project. The sooner a firm gets the initial investment back the better a project is considered. In this case the payback period which is being considered by this analysis is the undiscounted payback period. But the payback period of the project is little weak at 9.8 years as the projects life term is 10 years. Thus the project does not seem to be good enough as it is taking a lot of time to get back the investment returned(Weetman, 2013).
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Assignment Task Three
a) Identify and discuss the purpose of the two main financial statements shown below for a UK company Tesco plc.
One of the most important function of the management of an organization is to supply necessary information to the stakeholders of the organization in question (Tesco Plc) regarding the operations of the firm in the recent financial year so that they can gauge the operational efficiency of the firm. The results of the frim in terms of profitability, the position of the firm as afar as the assets are concerned and the cash flows in the same period are very important to the stake holders to take decisions regarding the investments they have made and this is the same for many prospective investors waiting in the wings(Revsine, Collins, & Johnson, 2008). As far as the financial statements are concerned the same is also used by the management and the board of directors of the firm to take decisions regarding using and allocating the available financial resources in the best possible projects(English, 2015).
The financial statements in question are the income statement and the statement of financial position of the Tesco Plc. The income statement is prepared by the Tesco management with the sole aim of informing the stakeholders of the ability of the firm to generate profits. Apart from information on profit it provides detailed information related to the volume of revenue generated during the current and previous years, the concerned cost of sales, gross profit ability, operating margins and the various types of expenses related to the enterprise. Because in the financial statements generally prepared for two consecutive years the same can be used by the users of the statements for a trend analysis and cam n thus be able to make out a general trend and favorable or unfavorable change that's in operation(Dichev, 2008).
On the other hand, the other statement known popularly as the balance sheet is prepared to statement the strength of the firm in terms of revenue generating assets and consequent liabilities on the last day of the year. The information which is included in the balance sheet is generally used to calculate the solvency position of the firm on that day, the funding pattern of the company and liquidity position of the company as well.
Apart from the above mentioned uses of the statements the same can be used to analyses the same for the following purpose:
The information which is available through the twin statements above are also helpful for many others such as:
a) Lenders of the Tesco Plc would use the information contained in the financial statements to take decisions regarding lending in the near future and volume of credit to be provided to the firm.
b) Investors in the market would also use the same information to decide about investing in Tesco plc and similar companies.
c) Trade unions would use the information in the financial statements to bargain for higher wages based upon the perceived capacity of the firm to pay.
b) Evaluate why different formats of financial statements are used for different types of business in UK.
Different forms of business use different types of statements to show the nature of operations undertaken by them. For example, the manufacturing organisations would often include the manufacturing information in their income statement but a trading firm would prepare a normal income statement showing sales and profits. On the overhand the non-profit organisation like a club or a chartable institution would prepare and income and expenditure account to show the year incomes and consequent expenditure.
The formats for three different types of institutions are provided below:
Manufacturing Account year ended 31.12.2015
|
Raw Materials- Opening Stock
+ Purchase of raw materials
Less: Raw Materials- closing Stock
|
100,000
800,000
200,000
|
|
Raw materials used in production
|
700,000
|
|
+
Direct wages
Factory overheads
|
250,000
350,000
|
|
Gross Factory cost
|
1,300,000
|
|
Add: Work in Progress -opening
Less: Work in Progress - closing
|
100,000
150,000
|
|
Factory cost
|
1,150,000
|
|
Add: Office overheads
Depreciation on office Equipment's used
Managers salary
Postage and stationery
|
10,000
50,000
40,000
|
|
Cost of production
|
1,250,000
|
|
Add: finished stocks -opening
Less: finished stocks - closing
|
100,000
150,000
|
|
Cost of goods sold
|
1,200,000
|
|
Add: selling overheads
|
100,000
|
|
Cost of sales
|
1,300,000
|
|
Profit (sales - cost of sales)
|
200,000
|
|
Sales for the period
|
1,500,000
|
Income statement of a Trading Company
|
Sales for the period
|
1,000,000
|
|
Less: cost of goods sold (COGS)
|
600,000
|
|
Gross Profit
|
400,000
|
|
Less:
|
|
|
Salaries of the employees
|
100,000
|
|
Research and development expenditures
|
50,000
|
|
Selling and general expenditures
|
25,000
|
|
PBIT (profit before interest and taxes)
|
225,000
|
|
Other incomes
|
25,000
|
|
Fiancé cost for the period
|
50,000
|
|
PBT (profit before taxes)
|
200,000
|
|
Less: corporate taxes @ 30%
|
60,000
|
|
Profit after taxes
|
140,000
|
The trading and profit loss account of a treading account is generally prepared together and not in isolation. The trading company derives revenue form trading or selling goods by procuring the same form other producers whereas the revenue of a manufacturing firm is derived from selling the goods which are manufactured by itself.
Income and Expenditure account of a club
|
Expenditures
|
|
Income
|
|
|
To Rents paid
|
|
By subscriptions received for the period
|
|
|
To Salaries paid
|
|
By membership fess for the period
|
|
|
To Interest expenses
|
|
By receipts of government grants
|
|
|
To payment of honorarium
|
|
By receipt of unencumbered donations
|
|
|
To payment of electricity charges
|
|
By receipt of general donations
|
|
|
To lawn maintenance charges
|
|
|
|
|
To surplus for the period
|
|
By deficit of the period
|
|
The income and expenditure account prepared by a nonprofit firm is in the sale nature as of a trading frim but there are certain fundamental differences between the two accounts:
a) The trading company receives cash inflows in the form of revenue against goods sold by the firm. On the otherhand, the nonprofit organization would receive cash inflows form members in the form of membership terms and subscriptions for various charitable services rendered during the year. Cash inflows would also be there in the form of grants given to it by members of the society and sometimes the government itself.
b) The trading and manufacturing firms necessarily do business with the intention of making profit but a nonprofit organization odes business to render service. However, it is not uncommon for non-profits to make profits.
c) Using the financial statements detailed below, for Tesco plc, calculate a series of profitability ratios and liquidity ratios, analyze and interpret the results that you achieve and comment on the company's performance.
Profitability Ratios
Gross profit percentage for Tesco Plc (2013) = 4154/63406 *100 = 6.552%
Gross profit percentage for Tesco Plc (2014) = 4010/ 63557 *100 = 6.31%
Gross profit percentage revels the excess of a Tesco's revenue over and above the forms cost of sales for a period. Higher gross margins indicate lowering of the firm's costs and better performance of the firm's management in containing expenditure on procurement and sales. In 2013 Tesco plc is able to generate a gross margin of 6.552% which is quite low but in general in line with the retail industry. However, the performance of the firm has gone down in 2014 to 6.31% and this is worrisome since this indicates towards increase in expenses. The management shall look forward to containing the cost of sales in the coming years(Overview, 2013).
Net profit percentage for Tesco Plc(2013) = 24/63406 *100 = .038%
Net profit percentage for Tesco Plc (2013) = 970/63557 *100 = 1,52%
The net margin gives an indication towards the revenue that is retained by Tesco after accounting for all the expenses in a particular financial year. Higher margins indicate towards excellence and efficiency of operations. In 2013 Tesco was able to generate only a margin of .038% in net profit which is almost zero but the frim made quick turnaround to raise the same in 2014 to 1.52%.
However overall the profitability situation is of concern and the firm's directors shall make effort to reduce the same.
Liquidity Ratios
Current ratios for Tesco Plc - 2013 = 13,096 /18703 = .7002
Current ratios for Tesco Plc - 2014 = 15,572 /20206 = .7707
Tesco plc and similar firms are required to maintain a decent current ratio so as to be able to make payments to the firm's suppliers and lenders in time and thus allow the suppliers and lenders to get ready to increase lending in the short run to the firm in the times of need. In 2013 Tesco had a current ratio of .70 which is well below the ideal ratio. In 2104 there is marginal rise in the current ratio but the level remains of utmost concern(Barnes, 1987).
Quick Ratio for Tesco Plc (2013) = 9,352 /18703 = .5
Quick Ratio for Tesco Plc (2014) = 11,996 /20206 = .5936
The quick ratio of the firm is exactly the half of an ideal level which is required to be maintained by the firm. This means the firm would find it difficult to make payments to the lenders and suppliers form its own cash flows and would have to resort to short term borrowings to make the promised payments. Thus the situation is of concern if not grave and the firms management shall try to improve the cash situation in the next few years or so.