Unit 2 Managing Financial Resources and Decisions

Unit 2 Managing Financial Resources and Decisions


Managing Financial Resources & Decisions



Introduction
Top of FormBottom of Form| In this report we are going to help Mr T Jones to start his fast food restaurant in Manchester. Mr T. Wants to start a franchise restaurant Wimpy and needs help with the financial resources and planning part.   Step one, there are different souses of finance and it’s divided into internal and external finance, money that comes from within a company and the opposite any way in which company raises financing other than using its own money. (See page 4). We are now going to go thru different options of finance for Mr T franchise.|

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Task 1

1.1 Range of sources of finance for different businesses.

Here are most common sources of business financing for small or large businesses. * assets /”love money”
* banks/credit unions,
* government assistance
* business partners/strategic alliances
* venture capital ”angel investors”
* “going public” , PLC

Assets/ ”love money”

Top of FormBottom of Form| It is essential for a start-up business to have personal savings, assets in order to finance the business and make it work. However in most cases it’s rare for start-up businesses to have enough personal savings to completely finance the whole business. In order to have chance to borrow money from the bank you need to have some amount of savings and bankers tend to see the amount of personal savings you are willing to put in to your business as an indicator of a business owner’s commitment to the business.  

”Love Money” is just as it sound, money from family and friend who support your business. Money is provided as a loan or as a gift, either way’s there should be agreement document between bout parts that includes record of everything that has been said.|

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Banks /credit unions

One of the most common sources of financing that is used by business owners is banks, credit unions and other financial institutions. Before loaning any money out most financial institutions will require a business to make a detailed business plan which usually consist of financial statement for the business including proposals if the business is just starting up which can include personal statement of net worth, discussion on industry and target market etc. Before lending any money out financial institutions will consider the level of risk your company represent. The important part which lenders pay particular attention to are: * cash flow and profitability * management capability

* working capital
* level of debt
* personal net worth of the business owner
* historical trend and ratios

Government assistance

Government assistance is available for business owners in form of grant and loans which are mostly targeted at specific industries or ares. There are strict criteria which must be met by the business in order to obtain government financing.   Some examples of government agencies and organizations in UK Such grants and loans from government can be very valuable source of financing.

Business partners/strategic alliances

Top of FormBottom of Form| Some businesses enter into partnership or alliances with other business owners to obtain financing. Both parties involved are the ones to organize the partnership and these can include formal partnership, joint ventures or joint ownership. It is crucial for both parts to decide issues such as sharing of profits, control, decision making and responsibilities before entering into partnership.  |

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Venture capital

Top of FormBottom of Form| Venture capitalists also called”Angels” are individuals with capital to invest into businesses which have potential to strong growth. Often enough angels are willing to invest in smaller businesses with growth potential. ”Angels” are usually very beneficial to businesses because they are successful businesspersons and are prepared to help and give advice. They also have contacts in the financial and business communities which is always an advantage.   It can be a hard decision for the business owner because some ”angels” wish to have an equity position in the business before contributing financially, which means that the business owner may lose control over the business.|

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Going Public PLC
When the company have grown to an appropriate size or have valuable and exciting business opportunity available to them “going public”, selling your company shares to the public or even listing them on a stock exchange may be an option. Which can give access to huge capital and at the same time increase the value of the business owner’s shares which they retain. Some sources of finance offer special benefits. Selling stock is among the fastest ways to get access to a large amount of cash, and its money you'll never need to pay back directly. Internal sources of finance keep control within the company and don't subject you to interest payments on loans. ordinary shares and preference shares

Figure 1How finances are divided in diferent parts

Finance for Mr. T franchise (operated as sole trader) and for the franchise holder (operated as a Public Limited Company)

There are different type of financial options for Mr. T franchise. Franchise is when you bye into existing company for example McDonalds. Some franchisers offer their own financial programs as a help or the company have partnership with a particular lending company which can make it easier to gain funding. Here are some financing options:  Internal

•        You can always go the traditional way by borrowing money from friend and family or investing your assets into the franchise.   External
•        You can get a loan from many banks. If you can provide a strong business plan.   •         Find business partner
SBA-Backed Financing,
these is one of the popular business loans and it can be obtained by those who do not qualify for traditional financing options.   There are several innovative companies that will roll your retirement plan into a business loan. There are no penalties associated with this type of retirement fund conversion. This type of loan enables you to invest in a business without mortgaging your home or using your property as collateral.  

Mr. T franchise holder that operates as PLC can open the company to the public and issue more shares.

1.2 The implications of diferent sources of finance

Banks/Credit unions

Every financial source has set of implications for example when you borrow money from the bank you will need to pay certain amount of interest as well as other agreements between lender and borrower, such as being penalized for late payment. The interest is usually fixed by the debt holders.When borrowing from credit unions the rules will be much the same as with regular banks, however the rate of interest may be lower.

When company makes loss they still have to pay the interest. If Mr. T. fails to pay interest, the debt holders will become creditors. In this case, franchisee have to find methods, sell their assets to repay money to debt owners. If not Mr. T will be sued and the director may end up in the prison.

Putting yourself into debt is not always the best option. Because by increasing debt you are increasing risk and profit out of the company.

Assets/ Love money

Having personal savings and other asses make a great source of capital but the drawbacks are that if you put your personal savings into a business venture you could lose it all. Other assets options such as retirement accounts, placing such assets at risk may not be good for you, especially if you’re approaching retirement age and are running out of time to rebuild drained accounts.

When borrowing money from family members and you cannot repay the loan as promised your family reputations as well as your financial reputation is at risk. This risk should be taken in consideration when borrowing money from family. As well as the responsibility of keeping the members involved, informed and updated.

Government assistance
Top of FormBottom of Form| The disadvantages of government loans is that just like other loans they come with interest rate that are typically far below what you can get on your own. Unfortunately it’s not so easy to get government assistance. Because it not available for every type of business. As well as the budget issues from year to year may affect the availability of funds. Finally government loan is still a loan and you will have to pay it back.|

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Venture capital ”angel investors”
With private investors, there will be a legal agreement between the buyer and the seller; however, sometimes, these agreements are simply verbal contracts. The implication of not having a written legal contract between both parties can be serious when one side fails to live up to his or her obligations.

The best private investors will not give money to business people until they have performed due diligence on companies; due diligence is the process of checking financial statements, and measuring assets against liabilities.

Going public

If Mr T decides to go public he needs to consider to give certain element of control over the company. As well as to take responsibility over a group of shareholders who have partial ownership right. When you share the risk with others, you’ll also have to share the profits.

Mr T must pay after tax when issuing new ordinary shares. Because ordinary shares are not tax deductible. This means that when the main point of company is net profit. MR T should consider about issuing how many shares or debts in order to pay lowest tax and bring highest profit. When it comes to preference shares, tax does not affect directly and just as ordinary shares this is paid out from the earnings after tax.

In addition shareholders have something to say about the CEO of the company and whether or not this person should stay in that position. For example Easy Jet’s chief executive officer stood down after ten years and was replaces by former RAC PLC CEO Andrew Harrison.

So when Mr T issues new shares, he needs to make sure that the percent of shares he holds are still more than 50%. Because the more stake the share holders hold, the more control of the company they have.

1.3 Advantages and disadvantages of the finance option, evaluate whether the finance option is appropriate for franchise funding?

The good news for Mr T is that it’s easier for franchise companies securing loans. Because of the established franchises that have a history of selecting successful franchisees and a history of success. When choosing appropriate source of finance factors need to be considered:

How much money is required?
* If the amount of money is large then it’s not realistic or available through any sources.

Which option is the cheapest one?
* How much money that need to be paid to secure the initial amount? * How much is the interest that has to be paid on the borrowed amount? * Cheapest form of money to a company comes from its trading profits.

How big is the risk?
* If the franchise project has less chance of making profit then the risk is higher than the one that does. * Potential sources of finance take this into consideration and may not lend money to higher risk business projects, unless if there is some agreement or guarantee that their money will be returned.

How long do you want to borrow the money for?
* Consider if you want to borrow for a long term or short term project and therefore decide what type of finance company suites your needs better.

When it comes to Mr.T he could put in more internal profit by trying borrowing some more money from family and friend. Because there is no interest rate paying back and it’s more flexible. Nevertheless, if he could not access some more internal profit chances are big that he could get a loan from a bank. Du to his good savings account which is well over the 20 percent needed as start capital. The loan should be short term so that the interest rate is as low as possible. In addition the franchise Wimpy could help Mr. T choosing source of finance.

Initial cost of Franchise: £13000
Training course costs: £1200
Deposit and initiallease payment for permises: £7500
Sundry cost:£5000
Sum: £38 700
Balance in savings account: £9500

Task 2

2.1 For each finance options analyse the various costs associated with each option.

Assets/ Love money
* You should be prepared to put down about 20% of the cash you will need from personal funds. * You must provide information about the performance of the business to the people involved.

Banks /credit unions
* Interest rate is the main cost here.
* The single most important issue in landing bank financing is your credit rating. You will need to present a complete loan package including a personal financial statement, copies of personal tax returns for three years, and verification of the source of your down payment.

Business partners/strategic alliances
* You will have to give away part of the profit.

Government assistance
* Interest rate is the main cost.

Going public
* By issuing shares you must pay the cost of providing shareholders with information about the performance of the business.

2.2 Importance of financial planning.

As Alan Lakein said ” Planning is bringing the future into the present so that you can do something about it now”.
Here are some importent factors to think about when planing finance:
Income
Its very importent for Mr T to manage his income more efficiently, specaly in the start up face. Analysing income expenditure and budgeting in order to increas cash flow.
Cash flow
In order to generate cash flow in to the company careful tax planing is important as well as budgeting and prudent spending. While increasing the cash flow into the company it will be posibule to invest. Capital

Financial planning is a must to create balance between outflow and inflow of funds so that stability is maintained.
Growth
Financial planing helps making gowth and expansion which helps in survival of the company, long term. In addition financial stability reduces uncertainties which helps the company to expand.

Poor cash management leads to negative consequences such as not being able to make pay roll. Whith a financial plan that is structured to always have cash over and not less, helps the business owner sleep better at night. It easier to take advantages of opportunities that arise when you have capital. For example to purchase investory from a supplier at temporarily reduced price.

2.3 Assess the information needs of different decision makers.

Different decision makers want different information. To be able to provide everyone with corect information business use ratio analysis, that shows relationship between two relevent items in the financial statement. Short term lender prefers to know about Liquidity ratio of the business, companys ability to pay its bills. Long term lenders want to know the measuring relationship between proprietor’s funds and borrowed funds that indicate the degree of debt financing in a company, Leverage ratio. Activity Ratio shows the effectivesness of the company in utilizing its funds, its degree of efficiency as well as its standard of performance, also known as efficiency and performance ratio. Profitability ratio reflects the overall efficiency of the organization, its ability to earn return on capital employed or on issued shares as well as effectiveness of its investment policies.

From shareholders point of view, they generaly expect a reasonable return on their capital as well as safety of their investment.

Figure 2 Ratio groups

Figure 3Business Ratio table

2.4 The impact of finance on the financial statements

Balance shit is a overwue of your assets as well as your liabilities, which sums up your equity in your business. In the example you can see that balance sheet is divided into two major sections. The first section gives you a clear picture of your ”Assets”. The second part is ”Liabilities and Owners Equity.”

The order of a balance sheet is to go from the most liquid to the least liquide.
For example you can see under the heading “current assets” and the first heading is cash, because cash is the most liquid of your assets.
After cash comes receivables, money owed you from customers. When you receive the money the receivable turns into cash. Since inventory is not as liquid as either cash or receivables this falls below them. Next assets are property and equipment.

Depreciation on a balance sheet is a non- cash expense and it shows that this assets go down in value over time.

This kind of financial statement is called a “balance sheet” because the assets always equal your liabilities and owners’ equity. Double-entry bookkeeping is very practical. It serves as a check to make sure a transaction has been properly recorded. For example if the first thing Mr T buy

Is a desk, he has assets of office equipment. If he paid cash, he don’t owe any liabilities so the desk is called owners’ equity.

Looking at our balance sheet you can see under current liabilities, your account payables as the first item listed. Accrued liabilities refers to payroll taxes and sales taxes that usually may not be due for another month or two.

Also under current liabilities is debt that is due within a year. So, the current 12 months of payments for equipment would be shown as a current liability. Following that we have long-term debt, which are items that are due after the current year.

Following total liabilities is the section called "owner's equity" which is the owner's interest in the business.
Task 3

3.1 Analyse budgets and make appropriate decisions.

Budget states future financial projections of revenue, expenses and expected profits.
When planing the budgeting for different enterprices, cost is divided into variable
fixed and joint cost. Variable cost is out of pocket cost for input which is always in a budget statement. Fixed cost is associated with building and equipment investment. While Joint cost is usualy a fixed cost that is common to more than one enterprice. For example depreciation for equipment used in business. There are diferent types of budgeting sustems:

Enterprice budget
States the costs and income of the production for one type of product, during one cycle of production.

Whole farm budget
Adds up the cost as well as the income from each enterprice budget to determen total expenses and income for the company as a whole.

Partial budget
Shows the effect of a small change on the companys functune. Not counting in the unaffected parts of the overall company’s budget. This budget is used as a guide when making small decisions.

Cash flow budget
Shows expenses of the company over a fixed time. Provides information of whether or not expected total cash income will be adequate to cover the expenses. Cash flow budget can be useful when purchasing major product or service.

Mr T Budgeting Wimpy

When setting up his budget Mr T can create appropriate decision bu using above budgeting sustems as base. * By setting reasonable goals for each product.
* Calculating accurate cost for each products in the restaurant. * Figuring out the brakeven price and net return for the restaurans each product to be able to cover all the costs and make a profit. * By choosing the right management strategy to help Wimpy achive production as well as price goals. * By comparing the returns the company make from each of its products, helps to better assess and plan the profitability for the whole restaurant. * Budgeting important information for future planning and loan applications.

Figure 4Planing budget steps

3.2 Explain the calculation of unit costs and make pricing decisions

(Total fixed costs + Total variable costs) / Total units produced

You can see the cost per unit calculation above. It shows how fixed cost such as building rent is added to variable cost, direct material and the number is divided by the total number of units produced.

* Total fixed cost is remaining fixed it dose’n get effected by the production units.   * Variable cost is not fixed it varies in relation to either production volume or services provided

For example Mr T cost per unit:
* Total variable cost: £ 5000
* Fixed cost: £7000
* Tatal dishes: 1000

(£7000 + £5000 )/ 1000 = £12 cost per unit

3.3 Assess the viability of a project using investment appraisal techniques.

Here are some investment apprasals:
* Consider whether an investment project is worthwile or not. * Is used for all type of investment, from new machinery to a whole producton unit. * Managrs are allowed to make a informed choice regarding the viability of the project.


Here are financial techniques of investment appraisal:
* All costs and different revenues can be forecast for future years. * Business will be looking to miaximize profits.
* Some key variables like interst will not shift.

Ways of investment appraisal:
* Payback period
* Accounting rate of return
* Net present value

Payback period

Looks at how long it takes to pay back the initial cost of the investment and how much revenue the assets will generate. For example if you buy a machine that costs £50000 and you produce 50000 items that you sell for 50p each it will take you two years to pay the initial investment. By knowing this you can chose the shortest time to payback the initial investment.

Accounting rate of return
Compares the profit generated by the investment to the cost of the investment.

ARR = Average profit/initial cost of investment * 100

The figure in percent gives the business clear idea of the average rate of return. It helps business to compare this figure to other alternative investments.

Net present value
Discounting cash flow by accounting inflationary pressures as well as interest rates. It helps you to understand how much you would need to invest now to earn a certain amount in the future. You can compare what would happen if you invested in other projects or saved.

Task 4

4.1 Discuss the main financial statement.
There are four main financial statements:
Balance sheet
Shows financial position at a given point in time.

Income statement
Shows revenues minus expenses for a given time and period ending at a specified date.

Statement of owner’s equity
Also known as statement of retained earnings or equity statement.

Statement of cash flow
Summarizes sources and uses of cash, indicates whether enough cash is available to carry on routine operations.

By analysing financial statements it helps to see that profits are being earned on the invested capital in the business or not. As well as helpful to compare the trends regarding various expenses, purchases and sales. By analysing the trends and other analyses it provides the business with sufficient information regarding actual growth potential of the company.

The financial statement helps to make comparative study regarding profitability with the data of other companies. While the main purpose of financial analysis is to add financial strength to the business. In addition analysis also helps in taking decisions such as funds required for purchase of new machines and equipments.

4.2 Compare appropriate formats of financial statements for different types of business.

There are four financial statements formats.

* Balance sheet
* Income sheet
* Equity statement
* Statement of cash flow

Balance sheet
Balance sheets have to sections, assets and liabilities. This statemnt shows how a companies income and output balances against each other. Balance sheets look diferent and varie in complexity dipending on the size of business

Income sheets
Shows whether business made profit or lost money during speecific fiscal period.
You can find two diferent types of income sheet, single and multipule step sheet.
Where multistep sheet includes more detail information as compare to single step.
Is usuful for smal as well as big business organisations.

Equity statement
Shows change in the company’s retained earnings such as equity statement. It shows information on dividends, operational profits as well as losses.

Cash flow
Cash flow statement indicates the effect of the above statements on the company’s cash flow. This statement is used usualy by bankers, accounting stuff, investors and potential employees.

4.3 Interpret financial statements using appropriate ratios and comperisons, both internal and external.

Different types of ratios
Profitability ratio
Shows the companie’s ability to generate returns on its sales, assets and equity.
There are four types of profitability ratios:
1. Ordinary shareholders return funds: net profit after tax *100/ ordinary share capital

2. Return on capital employed: net profit before tax and interest *100 / share capital long term capital 3. Net profit margin returns: net profit before tax and interest * 100 / sales

4. Gross profit margin: gross profit *100 / sales

Eficiency ratios

Shows how well a company uses its assets and liabilities internaly.
There are four types of efficiency ratio:

1. Average stock turnover period: average stock held * 365 / cost of sales

2. Average settlement period for debtors: trade debtors * 365 /credit sales

3. Average settlement period for creditors: trade creditors * 365 / credit purchase Fixed asset turnover: sales / fixed assets

Liquidity ratios

Shows the ability of a company to meet its short term financial obligaions.

Current ration: current assets / current liabilities

Current ration: current assets / current liabilities

Acid test ratio: current assets (excluding stock) / current liabilities

Operation cash flow to maturing obligations: operating cash flows / current liabilities

Gearing ratios

Shows the relationship of owner’s equity to borrowed funds.

Gearing ratio: long term liabilities/ share capital + reserves + long term liabilities

 
Investment ratios
The a relationship of gains from investment resulting from insurance operations to earned premiums.

Different ratios make it easier to know the helth of the company as well as comparing budget forecast, previous years ratios and other companies ratios.

Conclusion

Mr T will have to adjust his financial strategy with time when he gets more experience. The good thing of being franchise is that he can always get support from franchise holder. It helps to set SMART goals in budget and cash flow, always being organized and keeping track with the financial progress and always having financial security, Mr T can sleep better at night.

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