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Importance of Financial Management | Business Growth Hacks

765 Downloads1 I Published: 30 Oct ,2019

Introduction

Efficient management of funds and controlling over economic activities activities are main aspects of business. Availability of sufficient funds is the life blood of any business, it is possible with the help of financial management (Osei-Assibey, 2013). It assists in determining the capital composition, selecting appropriate source of finance and in taking investment decisions. Present report is based on the Clariton Antiques Ltd, it is engaged in selling of antiques item. Before five years cited firm was started by four partners and currently it has developed its unique image in the corporate market. Current assignment will discuss the unincorporated and incorporated business and sources of finance for these business units. Discussion upon appropriate source of finance for Clariton will be done in this study. Cost of dividend, interest and tax will be illustrated in this report. Impact of venture capital and finance broker on accounting statements will be described in this assignment. Cash budget and financial analyses of two investment projects will be done in this report. In addition, report will compare year2016 financial ratios of Clariton with previous year (Bahar, M.N. and Kheradmand, 2013).

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Task 1

1.1 Sources of finance

Every enterprise needs money to get going and to run their operations well. There are many options available of raising money but firms have to select suitable option (Jirka, Woolf Solomon and Lehmann, 2015).

Unincorporated business

These are commercial entities which do not require any formal legal registration with the government. Owner is the person who is responsible for liability of the organization. Clariton Antiques Ltd is formed by four partners, it is working as unincorporated business (Xiang, Worthington and Higgs, 2015). Sources of finance available for such firms are discussed as below:

  • Personal savings:As Clariton is the partnership firm so all four partners can invest their own capital in the business. It is cheaper financial source as partners need not to repay this amount to any lender so no economical cost is attached with it (Agrawal, Catalini and Goldfarb 2014). For raising money they can also introduce one more partner in the firm, capital of new partner will help in expanding the business and this amount will be used to open another branch.
  • Bank loan: Unincorporated business like Clariton can also apply for bank loan. Financial institutes provide money to start up firms at lower interest rate. Cited firm can get tax benefit on it. It is the best way to collect huge amount and repayment is also easy (Chugan and Singh, 2014).

a) Incorporated business

These are formally registered entities, owner is not liable of firm’s liability. Sources of finance are available for such kind of business are as following:

  • Retained earning:It is internal source and profit of the company which is retained by the firm for further development of the business. As internal funds are its own capital so there is no burden of repayment (Mancusi and Vezzulli, 2014).
  • Venture capital:Investment of investors can raise capital of the organizations. They invest their money for getting high returns and firms have to pay dividend to them. But they become equity holders in the entity and get rights to take decisions in the organization, by this way ownership get diluted (Newman, Borgia and Deng, 2013).

1.2 Implications of different sources

  • Internal sources

Internal sources are funds which are available inside the business and used by owner for expansion of the business. Retained earnings is one of the major economic internal source. In this organization needs not to repay this amount so no economic implication is of this sources. Apart from this no legal consequences have to face by entity while using this source (Rupeika-Apoga, 2014). As it is own capital so ownership does not get diluted. This financial source can generate more earnings in the corporation. Personal saving is another internal source of finance, no economic cost is attached with it. The positive implication of this source is that possession remain to the owner and controlling power does not get shared to others (Tsai, 2015). No legal agreement is required to form by owner. Sales of assets is another source in which owner will not need to pay amount and controlling remains in the same hand. Firm has to give advertisement in new paper regarding selling and have to make contract with purchaser.

  • External sources

These are such funds which are collected by the firms from outside sources. It is called equity financing in this organization share their possession with lenders. One of the most common external source is venture capital in this owner of the entity has to share ownership with lenders. They have to give stake in the business and have to pay dividend to them it is economic implication of this source (Zheng, Xu and Gu, 2013). Legal agreement form between both parties and both have to be agree. Bank loan is another type of external source it is debt financing in which company pays interest to banks against loan. Legal contract between lender and borrower made in which they clarify terms and conditions of loan. Ownership and controlling remain in same hand (Boyer and Blazy, 2014).

1.3 Appropriate source of finance for Clariton Antiques Ltd

Expansion of business is main objective of the Clariton which can be fulfilled by taking loan from banks. It would be appropriate source of finance. As interest rate for startup business are low so it is affordable and partners will be able to take their decisions without any third party influence. This economic source can help in raising capital of the cited firm significantly. Borrowing money from financial institute is easy and cited firm can open new branch easily with this money (Herzallah, Gutiérrez-Gutiérrez and Munoz Rosas, 2014).

Retained earning can also be used by Clariton for further development of the company. In this no economic cost is attached so economically it is another appropriate source of finance available to the business. Power and possession will be in control of all partners and they will not have to share it. So it would be suitable source of fiancé for the cited firm. With the help of both source organization will be able to raise money and would be able to open another branch easily (Hossain and Kauranen, 2016).

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Task 2

2.1 Cost of financial sources

Every source has some economic or legal cost attached with it. It is the responsibility of financial manager to opt the suitable option which can raise capital with minimum cost. For instance if Clariton goes with bank loan then interest cost is associated with it, as cited firm has to pay annual interest on borrowed money (Herzallah, Gutiérrez-Gutiérrez and Munoz Rosas, 2014).. If it opts venture capitalist then dividend cost is associated with it as it would be necessary to pay dividend to investors. Same as possession cost is also associated with this source of finance. If it tries to raise capital with the help of sales of assets then advertisement cost has to bear by the organization. “We Finance Limited” has approached to Claritoin for investment and it has demanded 20% stake in the business. Finance brokers are another source of finance which can be chosen by cited firm. Cost of venture capital and finance broker are as below described:

Dividends: It is the cost which is attached with venture capital. As Clariton will have to pay dividend to “We Finance limited” (Hossain and Kauranen, 2016. Apart from this entity will get rights to attend board meetings and its decisions will have to consider by partners. As it is equity financing, We finance is demanded 20% stake means every year organization will have to pay 20% dividend of its profit (Boyer and Blazy, 2014)..

Interest:It is another cost which is associated with finance broker, as bank will charge 2% annual interest and broker will charge commission of 1%. So it will create economic burden on cited firm (Herzallah, Gutiérrez-Gutiérrez and Munoz Rosas, 2014). It is also called as debt financing. For instance Clariton wants loan of 500000 then cost of interest would be :

Interest= 2%* 500000 + 1% brokerage

Interest= 10000+5000

Interest cost= 15000

Tax:It is another cost which is associated with both the sources, as cited firm will have pay tax on its profit. Then can reduce net profit of the organization. For instance 30% corporate tax is to be paid by them then cost of tax will be calculated as:

Cost of debt = 2% * ( 1- 0.3) * £500,000 = £7000

Plus 1% Admin fee = 1% * £500,000 = £5,000 which means total debt cost is 12000.

2.2 Importance of financial planning

Economic forecasting is the process of determining the future capital requirement in the business. There are several reasons due of this it is very important (Herzallah, Gutiérrez-Gutiérrez and Munoz Rosas, 2014).The main reason is that it helps in taking investment decisions and by this way organizations will be able to ensure adequacy of funds. Long term profit planning can be done by entities by making effective financial planning. Foreseeable problems of business can be solved by the corporation easily with the help of economic forecasting. Company can face external changes through availability of enough funds (Tsai, 2015).

  • Budgeting: It is one of the main reason of making financial planning. Estimation of cash inflow and out flow is termed as budget. Economic forecasting helps Clariton in making proper budget so that utilization of funds can be done significantly. By this way issues related to surplus or shortage will not take place in the cited firm (Rupeika-Apoga, 2014).
  • Implication of failure to finance adequately: Wrong decision related to investment and any other economic activity can be negative for the organization. Company can get failed to run their operations well. If firm fails to generate income or profit due to insufficient funds which means financial planning of the organization is not good (Herzallah, Gutiérrez-Gutiérrez and Munoz Rosas, 2014).
  • Over trading:Clariton is engaged in selling of antiques items. In this business it should ensure the cited firm purchase goods from suppliers as per the demand of consumers. Huge difference between demand and supply can crate problem for the cited firm. Issues related to over-trading can be minimized with the help of financial planning (Hossain and Kauranen, 2016).

2.3 information require to make effective decision

Financial information are those details which define the worthiness of the company. Before granting loan or before investing big amount in any organization, all investors and banks look upon the economic condition of the organization. These details can be gathered by looking upon the accounting statements of every year. This information help them in taking appropriate decisions (Osei-Assibey, 2013.).

  • The partner:Personal saving is one of the cheapest source of finance, as Clariton is partnership firm so all partners can invest their own capital in the cited firm. But before investing amount they need information like total assets value, previous profit, dividend, liability etc. By going through all these detail partners can make their investment decisions (Hossain and Kauranen, 2016).
  • Venture capitalist: Before investing in Clariton “We Finance Limited” will require information like profit history, growth ratio, liquidity position of the company, track record, net assets value, tax paid by firm, dividend policy, solvency ratio etc. These details help investor in taking their investment decisions.
  • Finance broker:Brokers have good contact with banks they can arrange loan for the start up firm like Clariton antique Ltd. But before granting loan to them they need information like market position of the company, repay capacity, previous liability (long term and short term), assets value, and credit worthineness of partners (Osei-Assibey, 2013.). All these details can help broker in knowing whether given amount will be repaid by borrower or not. On behalf of that, brokers take their decisions.

All these detail help people in knowing real position of the organization so that they can decide how much amount should be invested in the organization.

2.4 Impact of sources on financial statements

Venture capitalist and finance brokers are two main source available for Clariton antiques Ltd. Cited firm can raise its capital by using these sources, but these impact on the financial statement of the organizations (Osei-Assibey, 2013.).

  • Venture capitalist:Investors invest their money in the business for getting higher return. Their money increase cash inflow in the business and impact on the cash flow statement of the organization. As We finance limited is asking for 20% stake in the business which means Clariton will have to pay 20% dividend to capitalist. That amount will reflect into income statement in the expenses side. Dividend paid can decrease revenues of the company. But it enhances capital side of balance sheet that is the positive impact of venture capitalist in the balance sheet account (Chugan and Singh, 2014).
  • Finance broker:they are mediators and support business in selling their assets and in granting loan for them. By selling assists balance sheet get affected as it decreases assets of company. If Clariton takes loan then it will increase long term liability and it will reflect in the liability side of balance sheet. On other hand it will impact positive on the balance sheet as capital side will get strong. But cited firm will have to pay tax, brokerage and interest to bank and brokers. So this would be expenses for the entity and it will impact on the income statement of the organization (Osei-Assibey, 2013.).. .

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Task 3

3.1 Prepare cash budget

Cash budget is the projection or review of expected cash receipt and payments. By this way organizations can estimate their future revenues significantly and can make strategies to enhance cash inflow in the near future. Usually it is prepared by the firms for one year and then it gets broken down in monthly periods. It has three key components cash inflow, estimation of outflow and cash balance. Main objective of preparing cash budget is to project cash position of firm in future period. Proper utilization of ideal cash can be done with the help of cash budget (Osei-Assibey, 2013.).

From the above cash budget of Clarion it can be analyzed that management of working capital of cited firm is not good. In the month of January its cash inflow was 157500 whereas in the same month total payments were 807250. This figure shows that cash management strategy of the organization is poor. Company is not capable to manage their operations well. But in the month of February it has been shown that Clariton has improved its performance and in this month it was able to manage its liability as cash inflow was higher than cash outflow. In further months also it has performed well (Tsai, 2015). Now it has to look upon increasing sales of the company so that funds can get raised and cited firm can expand or open its new branch easily. For that it can give trade discounts to customers. It is good strategy and can help in increasing sales revenues of the entity.

3.2 Unit cost and pricing decisions of Clariton Antiques Ltd

To sell one unit of goods expenditure incurred by the firm is called as unit cost. By this way cost of company can be measured by the finance measures. Clariton sells antiques items to end users, for such type of entities it is important to calculate unit cost. For the cited firm fixed expenditures would be salaries and rent of premises. As these expenses do not get influenced by demand. Variable cost of the company would be utility bills, transportation cost etc. As if demand is high then variable cost will get increased (Rupeika-Apoga, 2014).

For instance: rent paid by cited firm 25000, salaries to staff 30000, transportation charges 25000 and utility bill 15000. In addition, Clariton is assuming to produce 100000 units then calculation of unit cost would be:

Unit cost= 25000+30000+25000+15000/10000

Unit cost = 95000/10000

Unit cost= 9.5

It means cost to sell one unit is 9.5, on behalf of that cited firm can set its prices. If it is assumed that Clariton wants profit of 30% then

Selling price= cost per unit + unit cost* profit percentage

Selling price = 9.5+ 9.5*30%

Selling price=9.5+ 2.85

Selling price=12.35

So if Clariton set its price 12.35 then it can get profit of 30% easily. Hence, it can be said that to take pricing decision it is necessary to calculate unit cost. It would help the firm in making appropriate pricing decisions.

3.3 Financial analyses of two investment projects

Evaluation of the several project’s attractiveness with the purpose of investments are called investment appraisal techniques. There are many techniques through which evaluation can be done such as NPV, ARR, PBP etc (Mancusi and Vezzulli 2014).

Net present Value (NPV)

It is the calculative method through which finance manager can measure difference between present cash outflow with future returns. Discounting factor is involved in it to know the actual return value. It is effective tool through which it can be measured that whether investment will increase value of firm or not. It focuses of cash inflow, it may be possible that some projects would not generate income until three years, it does not mean that investment is not good. It is based on assumption so actual results may get differed (Mancusi and Vezzulli 2014).

14% PV factor is given, from the calculation it is analyzed that both are viable investments as both are giving positive results as per the expectation of Clariton. But cited firm should invest in project2 as it would be more feasible for the organization. Because it can increase firm’s value more than project1 (Net present value method, 2015).

Average rate of return (ARR)

It is another technique to evaluate the projects, As it concentrates on the specific return for particular time period. It focuses on net earning on investment. Time, risk factors are completely ignored by this tool (Mancusi and Vezzulli 2014).

From the calculations it can be said that both projects are good as in both Clariton can get return more than 35%. But if it has to choose one then defiantly investment in project2 is better because in this it is able to get high return of 43.56% this can give good return to the organization and can make capital side more strong.

Pay back period (PBP)

It is simple calculative method and pay focus on the risk factor, It defines that investment in such project which can give return soon would be more profitable. As company will be able to recover investment amount soon (Tsai, 2015).

From the above calculations it can be said that both are good investments, as in both Clariton can recover invested amount before its expectation. But it should go with project2 as, PBP value is less than project1 so it would be better decisions.

By looking upon the above calculations it can be suggested that project2 is better for the cited firm so it must invest in this proposal (Tsai, 2015).

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Task 4

4.1 Key components of financial statements

Accounting statements are the main aspect of business, it defines the performance of the organization.

  • Income statement:This is main important accounting record, it has two main parts profit and loss. It defines overall financial performance of the organization. If there is access expenditures then authorities can make strategies to make effective control over it.
  • Cash flow statement:It is another financial statement, which is prepared by all registered legal entities. It has two components cash inflow and outflow. This statement shows the cash management of the company and help in controlling over unnecessary expenditures.
  • Statement of change in equity and gains: It consists of two elements; equity shares and retained earning (Tsai, 2015).
  • Balance sheet:It defines the financial position of the organization. It has three parts; assets, liability and capital. Internal working performance of the entity can be measured by balance sheet.
  • Notes to financial statements: These are internal information’s and help investors in taking their investment decisions.

4.2 Comparison of financial formats of sole traders and partnership firm

Financial formats are also known as accounting records. As both organizations run their business separately. Their objective and purpose of preparing these statements are differed from each others. There are mainly three types of financial statements prepare by the firm; balance sheet, income statement and sole traders (Tsai, 2015).

Sole trader: It is separate entity, they need not to prepare statements by following international accounting norms. Balance sheet consists of two components assets and liability. Capital or equity are not included in balance sheet of sole traders. Profit and loss account has two elements income and expenditures. Profit of partners, divided to partners are not included in this record. Cash flow statement does not get prepared by sole traders (Osei-Assibey, 2013).

Partnership firms:These are such entities in which more than two partners invest their capital to run business. Capital of all partners are shown in the balance sheet. Clariton Antiques Ltd is the partnership firm so it has to include capital of all partners in this account. Income statement shows profit of all partners, it does not reflect in the sole trader’s income statement. Tax is necessary to include in the profit and loss account.

4.3 Financial ratios of Clariton Antiques Ltd

Performance of organizations can be measured by looking upon ratios. By this way cash management strategies and working process can be evaluated by the firms.

Profitability ratio:

Profit history, growth can be measured by this ratio. It is the simple calculative process and help in knowing economic position of the entity.

From the calculations it is found that Clariton is performing well as it sales has been increased to 1220 to 1255. Operating margin ratio has grown to 3.77% to 4.54% that shows that operating profit of cited firm has increased. Gross marginal ratio in 2015 was 14.34% whereas that is in 2016, 14.18%. It has declined but there is not much decrement. Net marginal ratio is in 2015, 1.89% but it has increased in 2016 and in this year it was 2.63%. These ratios explain that cited firm performing well and in near future its financial position will be strong.

Liquidity ratio

Liquidity position of the organizations can be measured by using this ratio. Current and quick are two main ratio which can help in knowing liquidity position of the firm.

From the above calculations it can be said that current ratio of Clariton was in the year 2015, 2.41 whereas in 2016 it has increased to 2.48. It can be calculated by dividing current liability from current assets. It can be depict that Clariton is able to repay its liability timely. Quick ratio is another liquidity ratio which is calculated by adding cash marketable security and account receivable, and divide it from current liability. Quick ratio has been increased to 2.27 to 2.33. It has full control over its obligations.

Gearing ratio:

It is another ratio which defines the financial performance of the organization.

From the calculations it can be said that company is performing ell and its gearing ratio was in 2015, 0.16 but in 2016 it has raised to 0.19.

Conclusion

From the above report it can be articulated that financial management is the only tool through which entities can ensure adequacy of funds and can generate high income. As aim of Clariton is to raise funds and to open one more branch it can be accomplished if cited firm goes with the bank loan or retained earnings. Both sources have less cost and entity can afford this cost easily. To reduce economic burden cited firm is required to make effective strategies such as trade discounts so that it can increase its sales. By this way cash income of the organization will get higher. Cash budget is the planning tool which help to measure cash activities of the company. ARR is the good investment appraisal technique through which organizations can take effective and profit giving investment decisions.

References

Books and Journals

  • Agrawal, A., Catalini, C. and Goldfarb, A., 2014. Some simple economics of crowdfunding.Innovation Policy and the Economy,14(1), pp.63-97. Morana, C., 2014. Insights on the global macro-finance interface: Structural sources of risk factor fluctuations and the cross-section of expected stock returns.Journal of Empirical Finance,29, pp.64-79.
  • Bahar, M.N. and Kheradmand, A., 2013. ANALYSIS OF FINANCIAL STATEMENTS CASE STUDY: ELDER AND FDC PHARMACEUTICAL COMPANIES.International Journal of Research in Finance & Marketing,3(5).
  • Boyer, T. and Blazy, R., 2014. Born to be alive? The survival of innovative and non-innovative French micro-start-ups.Small Business Economics.42(4). pp.669-683.
  • Chugan, P.K. and Singh, S., 2014. Modes of Export Finance and Firms’ Export Performance: A Study of Chemical Export Units.
  • Herzallah, A. M., Gutiérrez-Gutiérrez, L. and Munoz Rosas, J. F., 2014. Total quality management practices, competitive strategies and financial performance: the case of the Palestinian industrial SMEs.Total Quality Management & Business Excellence.25(5-6). pp.635-649.
  • Hossain, M. and Kauranen, I., 2016. Open innovation in SMEs: a systematic literature review.Journal of Strategy and Management.9(1). pp.58-73.
  • Jirka, S., Woolf, D., Solomon, D. and Lehmann, J., 2015.Climate finance and carbon markets for Ethiopia’s Productive Safety Net Programme (PSNP): Executive Summary for Policymakers.
  • Mancusi, M. L. and Vezzulli, A., 2014. R&D and credit rationing in SMEs.Economic Inquiry. 52(3). pp.1153-1172.
  • Newman, A., Borgia, D. and Deng, Z., 2013. How do SMEs with single and multiple owners finance their operations differently? Empirical evidence from China.Thunderbird International Business Review.55(5), pp.531-544.
  • Osei-Assibey, E., 2013. Source of finance and small enterprise's productivity growth in Ghana.African Journal of Economic and Management Studies,4(3), pp.372-386.
  • Rupeika-Apoga, R., 2014. Financing in SMEs: case of the Baltic States.Procedia-Social and Behavioral Sciences.150. pp.116-125.
  • Tsai, K. S., 2015. Financing Small and Medium Enterprises in China: Recent Trends and Prospects beyond Shadow Banking.
  • Xiang, D., Worthington, A.C. and Higgs, H., 2015. Discouraged finance seekers: An analysis of Australian small and medium-sized enterprises.International Small Business Journal,33(7), pp.689-707.
  • Zheng, X., Xu, Y. and Gu, L., 2013. Impact of Venture Capital Firms' Reputation on Investment Decisions.Journal of Applied Sciences.13(14). pp.2694.
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