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Importance of Managing Financial Resources & Decisions

4522Downloads1 I Published: 23 Dec ,2019

Introduction

Now-a-days, financial decisions becomes the key or central element of the business success which assist entrepreneurs to generate sufficient amount of capital and utilize it optimally for accomplishing the goals. In UK, small and medium sized enterprises make substantial contribution to the growth and success of the country. Therefore, the assignment is prepared here to examine the financial requirement of a small sized retail store named ABC Ltd to deliver excellent retailing services to the people. The report will emphasize on identifying distinguish sources of capital to meet corporate funding needs. Furthermore, it will present the various key decisions like costing, pricing, long-term investment decisions etc. for the proper functionality. Lastly, a well-established and leading hotelier, Hilton Hotel & Group’s financial performance will be examined and compared with the rivalry Marriott.

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1.1 Available source for financing the business

In the corporate world, finance takes very important place and the corporations needs the respective resources in proper and adequate manner. When the ABC Ltd. has not adequate finance then there are various kinds of sources are available which provide such kind of services to it. In context to this, various types of sources of finance which are available are such as follows:

Sale of assets: It is an internal source of finance where the company raise fund using internal condition of the firm (Brigham and Ehrhardt,2013). As per the source the ABC Ltd. sale it's those assets and equipments which are unused and unproductive for the firm. After selling the assets whatever sum of money comes is to be use in business expansion.

Equity financing:Another source of finance is equity which is mostly used external financing source by the firms. In this the company issues it's shares in the stock market which are purchased by the shareholders. Further, investment which is made by the investors is to be used by the business entity for expanding the firm.

Bank loan: It is also external financing source which provides financial resources and services to the company for expanding the firm in another market. Here the management has to fulfil all the process of applying loan and then bank determine valuation of it. After that the ABC Ltd. able to raise fund easily in the market. It is little costly and risky as compare to equity financing.

1.2 Assessing various implications of financing sources on firm

Financing sources

Legal implications

Financial Implications

Dilution of control

Sales assets

Being an internal source for raising finance there are any kind of legal rules are not implement there.

Using an internal source it leads to reduce total assets of the firm. While helps to increase sales and turnover at the end of year (Nickel, Saldanha-da-Gama and Ziegler, 2012).

There is no dilution of control.

Equity financing

Here the company needs to listing in the stock market because without this it not able to issue shares in market.

In this case, equity capital will be improve in the business which is beneficial for it. Apart from this financial leverage of the company will also improve.

In this control is diluted with new shareholders.

Bank loan

The ABC Ltd. has to complete all the documentation process and show its liquidity position to the bank.

In this the company has to give interest amount to the bank in terms of cost of finance which lead to reduce net profit.

Control will not dilute with bank loans.

1.3 Selection of the most appropriatesource of finance

From the above mentioned different source of finance equity financing is the most widely used and effectual source in order to raising fund. Moreover, it can be said thatequity financing is appropriate and suitable for the enterprise. Benefits and disadvantages of respective sources are as below:

Advantages: Very main benefit of the equity is that the company able to raise fund whenever it wants without valuing firm in the retail industry of UK. Further, the ABC Ltd. Company is able to increase market presenceand enhance level of capital in the business. Along with this cost of finance is very low as compare to another financing sources (Brigham and Ehrhardt, 2013).

Limitations: When the company going to issue shares then it needs to listing in the stock market. Because without listing it cannot issue shares in the market which lead to reduce capital raising. In addition to this, it has to provide dividend amount to the potential stockholders on yearly basis by which profit level get affected.

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2.1 Cost of various sources of finances

There are variety of sources that can be used by the business, every sources has some financial cost towards the business. With reference to the selected retail business, it will incur following financial cost on various financial sources, mentioned hereunder:

Bank borrowings: Getting loans from banks bring obligations to ABC ltd to pay a fixed interest charge inclusive installment as the cost. It has one benefit that is tax benefit which offer opportunity to ABC Ltd to minimize taxation burden.

Share capital: It bring dividend obligations to the business which is required to be paid by ABC Ltd to investors for the risk undertaken by investing their capital. Unlike debt, it does not offer any tax benefits to the ABC Ltd (Drechsler and Natter, 2012).

Hire purchase: Vendor provide flexible payment facilities to the buyer through deciding periodical installments which includes some interest charges.

Leasing: On leasing, ABC Ltd needs to make interest payment to the lessor for the services provided and it is the financial cost of leasing.

2.2 Significance of financial planning in a business

Financial planning is a process of devising plans, policies and financial strategies for accomplishing financial targets. The significance of financial plan is provided here as under:

  • ABC Ltd managers can create the best capital structure through making a right combination of fixed and fluctuating source of capital for the cost management and profit enhancement.
  • Not only the collection of funds, but its effective and efficient utilization is too important, therefore, through making an excellent plan, ABC Ltd can use their funds in an optimal manner and minimize cost.
  • Budgetary planning is the part of it that enable ABC Ltd to get standard revenue & control operations for the effective cost management (Greene, Brush and Brown, 2015).
  • It provide financial safety and security through maintaining surplus funds at each and every point of time to meet urgencies.
  • It provide an assurance against dramatically and drastic change in market environment like sudden market volatility, shortage of material, high cost of transportation and so on.

2.3 Informations needed for financing decision-makers

When the ABC limited company raising fund from internal as well as external sources then the respective sources needs different kinds of information data. Various decision makers require several kinds of informations are such as related to company’s financial performance, valuation, reputation etc. When performance of the firm is higher and better in the retail industry then decision makers attract to invest more money in that firm which helps to expand organisation up to greater extent. In regarding to this, external decision makers are needs to take data and informations regarding financial conditions. Because higher the level of profit provide more return to the investors (Healy and Palepu, 2012).

Key decision makers are such as partners, venture capitalists, banks, share or stock market and those financials who provide finance and fund to the company. They require very basic and key information of the company is such as its profitability and credibility in the industry. Further, the bank seeks towards business valuation in the overall market and industry where it operates. In addition to this, venture capitalist require information related to the return on investment ratio as well as profit of the firm. Moreover, stock market need information which are related to the profit and investor ratios. Because higher the profit and investor ratio provide more amount of return on the investment made by shareholders.

2.4 Impact of finance sources on the financial statements

Every financial source is reported and properly disclosed in the financial statements, therefore, it will impact the financial statementsof the business in following manner:

Interest cost is shown under the income statement which in turn decrease net return of the firm. ABC Ltd will need to disclose interest payment before deduction of tax liabilities, therefore, it minimizes the taxation burden and maximize net profitability. In balance sheet, it will reduce cash & its equivalent as under the cash flow statement, it is shown as cash outflow from financing activities because it is related to long-term fund collection like debt, lease, hire purchase and others. On the other hand, debt collection is reported under long-term/non-current obligations and in assets, cash balance improved.

In contrast, dividend payment is shown under the P&L account from the net profitability and remainder is called retained profits. However, in the B/S, it is subtracted from the cash balance as it reports as cash outflow from financing activities (Cambra-Fierro, Melero and Sese, 2015). In against to this, share capital is reported under the head total equities which indicates excess of total assets over liabilities.

Due to equity financing capital raises which lead to reduce gearing and debt to equity ratio withing the company. On the basis of more finance financial stability of the business entity will be imporve in the industry up to greater extent. Hence, it can be said that through equity financing firm will be able to recover and fulfil amount of debt and create psoitive impact on the balance sheet.

Bank loan affects on the balance sheet in negative as well as positive both ways of the company. When firm raise fund through the bank loan then long term debt will increase in the balance sheet of the entity which lead to enhance total liabilities. On the other side capital will be raise due to which total assets and financial stability improves and impact positively on the balance sheet.

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3.1 Preparing budgets and its analysis for the best decisions

Particulars

April

May

June

July

August

September

Opening cash position

900

1220

1765

2465

3119

3737

Cash inflow

           

cash sales

2050

2500

2850

3040

3230

3600

Total

2950

3720

4615

5505

6349

7337

cash outflow

           

Purchase

820

1000

1140

1216

1292

1440

Labor

350

375

420

570

630

670

variable overheads

260

280

290

300

340

360

Fixed payment

300

300

300

300

350

350

Total

1730

1955

2150

2386

2612

2820

Net cash position

1220

1765

2465

3119

3737

4517

Above cash budget analyzed that ABC Ltd’s cash inflow shows a rising trend as it goes from 2050 to 3600 in the last month. It happens because of high availability of disposable income to the public, growing lifestyle and larger demand. In contrast, under the cash outflow, purchase remains constant to 40% of turnover, it goes increased from 820 to 1440. However, labor’s wages shows a sudden and drastic increase in July to 570 whereas variable shows increasing trend with the increase in sales and fixed payments gone up in last two months to 350. Total cash outflow goes up from 1730 to 2820, and net cash position depicts a surplus plus growing trend throughout the years from 1220 to 4517.

Surplus cash indicates that expected revenue will exceed the total expenditures and enable firm to meet their urgent financial requirement. ABC Ltd can utilize such cash availability in prodcutive purpose like it can invest the capital in profitable investment opportunity to get favorable return on it.

3.2 Unit cost and pricing decisions

In business, companies incur different types of expenditures which is categorized into two parts on the basis behavior that are fixed versus variable. Fixed, as name implies, it remains constant at various production level and do not change accordingly i.e. insurance, building rent, manager’s salary, depreciation and so on (DRURY, 2013). In contrast, variable cost changes accordingly with the variability in total output i.e. material requirement, labor’s wages and so on. Total cost is founded adding both the fixed cost as well as variable cost, as follows:

Total cost (TC) – Total Fixed Cost (TFC) + Total variable cost (TVC)

Items

Amount in GBP

Material consumed

60000

Wages paid to workers

30000

Variable manufacturing overheads

10000

Total variable cost (TVC)

100,000

Total Fixed cost (TFC)

20,000

Total cost (TC)

120,000

Number of units manufactured = 4,000

Unit cost = Total cost of production/Units manufactured

= 120,000/4,000

= 30

Pricing decision: Unit cost + 40% desired profit

= 30 + (30*40%)

= 30 + 12

= 42

Justification behind using 40% mark-up

Here, 40% desired target return has been taken using various components such as profit-maximization objectives, customers willingness to pay, their economic situation, market trend, growth in demand and competitors product pricing also. With the stated case, consumers are ready to pay high prices for the quality offerings and has strong financail position. In addition, managers are targeted to gain maximum return therefore, 40% desired profit mark-up is founded suitable.

At 40% mark-up on the total cost, retailer will have to charge 42 GBP for each unit. If entity wish to earn greater return then he needs to charge higher rate than 40% or vice-versa for getting adequate return and high success.

3.3 Investment appraisal techniques applications

Capital budgeting is one of the key technique that is used by the financial managers for the financial planning & success. This tools will help retailer, ABC Ltd to determine that whether a firm must invest or deny available investment opportunity for the business growth, expansion and success.

Payback period:

This technique is the simplest method that find out the recovery period of beginning cost of investment in a project. While dealing with mutually-exclusive projects, an investor must prefers a project with shorter payback period or vice-versa (Greene, Brush and Brown, 2015).

Accounting rate of return;

This method just computes or quantifies the return percentage on the total initial investment. Company always needs high return, therefore, prefers greater ARR.

Net present value:

It is the modern and also the best way of investment appraisal which discounts the cash flow to address the impact of market uncertainties. Total of discounted cash flows over the beginning cost of capital is called net present value.

Internal rate of return:

This method just find out the rate at where NPV does not exists, henceforth, there is neither any return nor loss exists at that rate.

Year

Investment 1

Investment 2

CCF (1st)

CCF (2nd)

Discounted factor @ 10%

Cumulative cash flows

Cumulative cash flows

Beginning outlay

-85000

-100000

-85000

-100000

1

-85000

-100000

2017

14000

12500

-71000

-87500

0.909

12727.27

11362.5

2018

29000

27600

-42000

-59900

0.826

23966.94

22797.6

2019

37500

40800

-4500

-19100

0.751

28174.31

30640.8

2020

45000

47600

40500

28500

0.683

30735.61

32510.8

2021

58000

60200

98500

88700

0.621

36013.44

37384.2

Internal rate of return

25.64%

20.12%

   

Net present value

46617.57

34695.9

Payback period:

Investment 1 =3 years + (4500/45000) = 3.10 year Or 3 year 1 month

Investment 2 = 3 years +(19100/47600) = 3.40 year Or 3 year 5 month

Year

Investment 1

Investment 2

Beginning outlay

-85000

-100000

2017

14000

12500

2018

29000

27600

2019

37500

40800

2020

45000

47600

2021

58000

60200

Total profit

183500

188700

Number of years

5

5

Initial investment

183500/5 years
= 36700

(188700/5 years)
= 37740

Accounting rate of return (ARR)

(36,700/183,500)*100

= 43.18%

(37,740/100,000)*100

= 37.74%

Recommendations

Investment 1 has shorter payback duration to 3 year 1 month hence, it is clear that recovery period of this project is smaller. Moreover, this project has greater ARR to 43.18% whilst in another one, it is derived to 37.74% hence, project A will give higher accounting period. However, under the discounting techniques, both the IRR & NPV gives favorable esults for the first project. Project A's NPV & IRR are comparatively greater to 25.64% & 46,617.57, in contrast, in the second one, it is derived to 20.12% and 34,695.9 which is comparatively lower. Thus, the results favors investment in first project and consider it more viable and should be undertaken by the management (Altenburg and Pegels, 2012).

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4.1 Types of financial statements

All the corporations or establishments needs to prepare their financial accounts adhering with the accounting standards, UK GAAP. It is important to construct final accounts on a regular period incorporating the results of all the monetary business transactions and activities. The important annual accounts that an organization needs to prepare are stated here as under:

Income Statement

This statements provides an overview of organizational revenues and incurred payments in connection with the regular transactions. The main target of making income statement is to determine the profitability performance by subtracting total expenditures from the generated revenues (Julian and Ofori‐dankwa, 2013). Income comprises sales, however, payments includes purchase, rent, salary, wages, insurance and others.

Balance sheet

It provides a snapshot of liabilities, assets and shareholder’s equity and mainly targeted at identifying the financial status of the firm. Analysts mainly use it to determine capital structure & working capital for assessing solvency & liquidity and managerial efficiency too to evaluable business performance.

Cash Flow Statement

This statement reconciles cash inflow and its disposal in operating, investing and financing activities to keep track of cash position of the firm over the period. It enables a business to identify the closing cash balance with the reasons behind change in cash balances at two different balance sheet dates (Fassin, 2012).

4.2 Final accounts differences in different organizations

Sole trader prepares income statement by reporting their revenues through trading activities like supply of goods and services, purchase, wages, salaries and other payments. As per this, excess of income over expenditures is called net profit or net loss which is totally available for the proprietor. However, partnership construct profit and loss account and net profit is being distributed among all the partners in their profit/loss sharing ratio. It also prepares partner's current account for the distribution of interest on capital, interest on loan, partner’s commission and so on. In contrast, companies and sole proprietor do not construct such type of account for the distribution of profit. On the other hand, companies prepare income statement as per the rules of company act and international accounting standards as well. It is prepared in decided format and every item is recorded in structure manner to know gross profit, operational return and net profitability (Keupp, Palmié and Gassmann, 2012). Unlike sole proprietor and partnership, they distribute a part of netreturn to the investorswhich is known as dividend, therefore, it is reported as earning per share and remainder as retained profits.

On the other side, sole proprietor’s balance sheet reported owner’s capital as investment, in partnership, every partner’s capital contribution is clearly disclosed in the B/S whilst in company, it comprises equity shareholder investment, share premium and retained profits. It also needs to prepare it as per the schedules for the harmonization accounting practices. In addition, sole trader & partnership do not require to construct statement of cash flow whilst companies are legally obliged to prepare it for knowing the reasons for change in cash. Partnership construct partner capital account to determine their total investment whereas companies prepare statement of change in equity for the same.

4.3 Analysis financial statements using financial ratios

Name of ratio

Formula

Hotel Marriott

Hotel Hilton

   

2014

2015

2014

2015

Profitability ratios

Gross income

 

1966

2123

6483

7207

Net income

 

753

859

673

1404

Revenue

 

13796

14486

10502

11272

Gross profit (GP) ratio

Gross income/sales*100

14.25%

14.66%

61.70%

63.90%

Net profit (NP) ratio

Net income/sales*100

5.46%

5.93%

6.40%

12.46%

Liquidity ratios

Current ratio (CR)

Current assets (CA) / current liabilities (CL)

0.63:1

0.43:1

1.11:1

1.05:1

Quick ratio (QR)

CA – (Closing stock + prepaid expenses) / CL

0.39:1

0.37:1

0.74:1

0.69:1

Efficiency ratio

Asset turnover ratio

Sales / total assets

2.02 times

2.24 times

0.4

times

0.43

Times

Return on asset %

 

11.03

13.27

2.55

5.42

Interpretation

From the above mentioned table of ratio analysis it can be assessed that gross as well as net profit both ratios are higher in the Hilton hotel in FY 2015 which are such as 63.90% and 12.46% respectively. It shows that Hilton's performance in this year is comparatively betterr than Marriott hotel. It may be because of effective pricing decisions, attractive marketing and promotional plan, exceeding demand, online reservation facilities and better control over the cost which brought good return to the hotel in this year. Apart from this according to current ratio the later hotel is able to perform well in the industry and recover debt obligations in efficient way as compare to Marriott hotel. Current ratio of Hilton and Marriott in accounting year 2015 are such as 1.05:1 and o.43:1 which clearly indicates that Hilton hotel has better liquidity position and it is financially sound in the hospitality industry (Lin, 2012). It indicates that Hilton hotel maintains good working capital in the business so that short-term liabilities, more importantly, suppliers can be repayed with the outstanding obligations on time. However, target CR and QR of the retail industry is derived to 2:1 and 1:1 which make it essential for the Hilton's managers to put their attention on maximizing their working capital in order to strengthen liquidity position. In terms of different efficiency ratios the Marriott hotel is better in the year 2015 as compare to Hilton hotel. The Marriott hotel is highly able to utilize its assets in proper way which lead to increase assets turnover ratio which is 2.24 times in the FY 2015. Optimum use of assets helps tio drive in greater revenues as in the year 2015, Hilton's total revenues exceeded by 11.16%.

Conclusion

After completing the above report, it becomes clear that every source has a different implication, therefore, ABC Ltd must choose a right combination of source for meeting out their financial need. Budgeting analysis founded that ABC Ltd needs to put stronger control over cash disposal and make policies in relation with increase in revenues for having a successful growth. Lastly, investment appraisal technique founded 2ndproposal highly suitable due to maximum NPV. Further, ratio analysis techniques founded that appropriate and right pricing mechanism, cost controlling measures, capital structure and working capital decisions helps to strengthen the financial performance for a successful business.

References

Books and Journals

  • Altenburg, T. and Pegels, A., 2012. Sustainability-oriented innovation systems–managing the green transformation.Innovation and Development.2(1). pp. 5-22.
  • Brigham, E. F. and Ehrhardt, M. C., 2013. Financial management: Theory & practice. Cengage Learning.
  • Brigham, E. F. and Ehrhardt, M. C., 2013.Financial management: Theory & practice. Cengage Learning.
  • Cambra-Fierro, J., Melero, I. and Sese, F. J., 2015. Managing complaints to improve customer profitability. Journal of Retailing. 91(1). pp. 109-124.
  • Drechsler, W. and Natter, M., 2012. Understanding a firm's openness decisions in innovation. Journal of Business Research. 65(3). pp. 438-445.
  • DRURY, C. M., 2013.Management and cost accounting. Springer.
  • Fassin, Y., 2012. Stakeholder management, reciprocity and stakeholder responsibility.Journal of Business Ethics.109(1). pp. 83-96.
  • Greene, P. G., Brush, C. G. and Brown, T. E., 2015. Resources in small firms: an exploratory study. Journal of Small Business Strategy. 8(2). pp. 25-40.
  • Greene, P. G., Brush, C. G. and Brown, T. E., 2015. Resources in small firms: an exploratory study.Journal of Small Business Strategy.8(2). pp. 25-40.
  • Healy, P. M. and Palepu, K. G., 2012. Business analysis valuation: Using financial statements. Cengage Learning.
  • Julian, S. D. and Ofori‐dankwa, J. C., 2013. Financial resource availability and corporate social responsibility expenditures in a sub‐Saharan economy: The institutional difference hypothesis.Strategic Management Journal.34(11). pp. 1314-1330.
  • Keupp, M. M., Palmié, M. and Gassmann, O., 2012. The strategic management of innovation: A systematic review and paths for future research.International Journal of Management Reviews.14(4). pp. 367-390.
  • Lin, W. T., 2012. Family ownership and internationalization processes: Internationalization pace, internationalization scope, and internationalization rhythm.European Management Journal.30(1). pp. 47-56.
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