University of California
Type of paper: Thesis/Dissertation Chapter
Business Managing financial resources and decisions
Mrs. Jessica Bell wants to setup her own company which will provide accounting and consultancy solutions. She has collected other necessary information and other aspects are also easily available to her. The name of the company is JAC SOLUTIONS. The company needs $800000 to bear the cost of establishment, working capital and seed capital. She already has 200000 pounds and needs to get 600000 pounds through sources of long term and short term finance. We need to analyze different sources of finances that can eb taken to consideration for bearing the cost of working capital, seed capital and establishment costs. We also need to determine the implications and related advantages and disadvantages of the sources of finance. Apart from this, Mrs. Jessica Bell wants to purchase a property of 350000 pounds for the business purpose and for this she is considering a long term loan for 12 years and a mortgage of 25 years. She has 70000 pounds for initial deposit for the property. Now we need to calculate and analyze that which one will better option for her for buying the property. Apart from this she needs to understand the meaning and importance of financial planning and the information that are needed about a business by the investors and shareholders. We also need to describe the different types of budgets and the importance of budget analysis in decision making process. we will also analyze the financial statements of a profit making organisation.
Four sources of finances that are available to JAC SOLUTIONS She can consider some sources of finances as discussed below-
Venture capital funds support growing firms during their inception stages and before they are going for initial public offerings of shares. Firm will get venture capital as a form of equity capital. It represents a highly risky investment in the hope of earning higher return in future. It typically invests into equity or quasi equity instruments in financial market which will be able to share the risk and profit of the investee firm. Venture capitalist not only invests in the new company but also guides the firm actively in taking major decisions. Financial burden of the assisted firm tends to be low. Venture capitalist normally close it position by liquidating the investment from the assisted firm after 7 years. (Chandra, 2011, p.436).
Personal or commercial loans from banks and financial institutions are one of the most popular forms of financing. It includes long term and short term loans. Long term loans are useful to finance fixed assets and large expenses like buildings, property and machinery. Short term loans are having duration of one year or less. These are mainly helpful for to pay day to day business expenses like payroll, inventory or any urgent requirements.
Private equity has become an integral part of the financial services industry in the world in last two decades for funding in small new business. Private equity companies are those which have their own pools of capital invested by different institutions or high net worth individuals and run by such managers who have deep knowledge in financial market linked to the performance of the funds. Private equity companies have their own set of written agreements upon which they judge the investee companies. They also participate in board meetings and can take managerial decisions (Chandra, 2011, p.437).
Small Business Administration
SBA helps to facilitate loan for a new business venture through a third party lender. It provides various types of financial assistance for the business which are effective and are designed to meet key needs. It includes debt financing, bonds, equity financing. In case of debt financing, SBA does not provide loans directly to the business. But it sets the guidelines for the
requirement and then it is lent by lenders, micro lending institutions etc. guarantee of the loan is given by the SBA. Thus a SBA loan is similar to a commercial loan for a business (SBA, 2013).
Implications of Venture Capital
Venture capital is one of the important sources of finance. If an entrepreneur decides toi take the help0 to raise finance for his/her business then he/she may go to the venture capitalists. In this case, the entrepreneur needs not to worry about the finance, the venture capital organisation will look after it but the venture capital firm will also take part in the managerial decisions of the organisation.
Advantages and disadvantages of sources of Finance
Pros and Cons of Venture Capital Financing
The main advantage of venture capital financing is the venture capitalists gamble on the new company. If the new succeeds they earn high rate of return but if the new idea fails then they absorb their losses. If the business fails the new firm won’t have any burden on them. Beside this venture capital also help to grow business quickly. As the venture capitalists have a share in the new business, thus it’s also their interest to improve the network of the business with rich investors who might become more profitable for the business (Cetindamar, 2003, pp. 29-30). There are also some disadvantages of venture capital financing. Venture capitalist owns a large portion of stake in the new company. Although the new company need not to repay the money of the investors but it has some limitations. Venture capitalist invests his money in exchange of shares of the company. This reduces the number of shares in the hand of the founder of the company.
Implications of Bank Loan
Bank loan can be taken to generate additional finance for the organisation. The implications of bank loan are that it can be arranged against some securities and the borrower needs to pay a fixed rate of interest. The bank will not interfere in any of the managerial decisions.
Pros and Cons of Bank Loans
The advantages of bank loan are that bank loans are cheap than equity financing and incase of bank loans the bank does not interfere in the managerial decisions of the company. The disadvantage of is that it carries interest which should be refund with the principle amount in a specific duration of time. If the company is unable to repay it within stipulated time period then the bank can overtake the assets of the company which may leads to bankruptcy.
Implications of Private Equity
The implications of private equity are quite similar with the implications of venture capital. The implications of private equity are that this helps to get additional finance and take the responsibilities of the business and help to take appropriate decisions.
Pros and Cons of Private Equity
The main importance of private equity investment is that it involves introducing a new partner to the business that will share the responsibilities of the business and help in the managerial decisions. It also helps the business to raise equity at higher price and private equity firms also the help the new company by bringing additional skills and new business networks that will be more profitable for the new company (Benjamin, 2000, p.27). Private equity firm also has some kind of limitations. The promoter of the new company is accountable to the private equity firm for any kind of major decisions.
Implications of SBA
The implications of SBA are that it helps to get third party loan like bank loans easily.
Pros and Cons of SBA
The main important advantage of an SBA is that if the company treats the SBA loan properly then its chance of getting bank loan gets easy. It also has some disadvantages like it doesn’t invest directly in the new business.
Sources of finances for buying the property
Mrs. Bell wants to a buy a property of 350000 pounds and she has 70000 pounds in her hand for initial deposit which is 20% of the property. Thus she needs to get funding for 280000 pounds.
Long term loan
Long term loans are useful for buying property and these are for generally more than 12 months. In this case Mrs. Bell wants to take a long term loan of 280000 pounds for 12 years. In UK the current rate of interest is near about 6% for long term loans (Money.co.uk, 2014).
Mortgage is a debt instrument which is secured by a specific real estate property and the borrower of the mortgage is bound to pay back the principle with interest rate within a time period. It is used to buy large amount of real estate. In UK the current rate of mortgage is 6% and here the duration of mortgage will be 25 years.
Total Interest Payment
£ 4,278 £ 3,267
The cost of the long term loan will be 4,278 pounds per month and total interest will paid of 336000 pounds. The cost of the mortgage will be 3,267 pounds per month. Total interest will be 700000 pounds. Thus we can see that the monthly interest of long term loan is higher than the mortgage payment but we should consider that in case of mortgage payment we need to pay more amount of total interest along with the principle amount than the long term loan. But for a starting business it will be better to pay less monthly installment because it is not sure about how money it will be able to earn in the beginning. Thus mortgage payment method should be chosen as the interest payment will be less.
Financial planning can be defined as calculating about expected expenses and revenues for the coming financial year. Financial planning is necessary for a business organization to conduct the business activity in a smooth way.
Financial planning is important because it states about the probable necessary income and expenditures which will help to earn profit for the business organization. Financial planning includes budgeting method in which managers prepare a budget about upcoming income and expenses that the company has to taken care of. It helps us to set up a sales target and goals for production process. Cash budget states about the future cash receipts and payments for a specific period. It typically takes into account a period in the nearest future. The cash budget helps the business to decide when revenues will be sufficient to cover expenditures and when the organization will need to look for outside financing. It is done monthly to look after the liquidity position of the company. Thus if cash budget has surplus amount of cash then it can be said that the company is well going by fulfilling the revenue target within the budgeted expenditures.
Financial statements provide financial information to the investors and creditors regarding financial performance of the company. Analysis of financial statements helps the managers to make decisions by understanding the financial condition of the company (Wild, 2006, pp.12-15). For instance, the creditors and banks (capital providers) are generally interested in the safety and profitability of their investment. The balance sheet of the company gives them an idea about where their money was invested by providing detailed information about the assets of company. Shareholders’ equity shown in the balance sheet is important for making decision making because it shows the changes in various equity components including retained earnings. The total net-worth of the company is the sum of retained earnings and shareholders’ equity. Growth in shareholders’ equity by increasing retained earnings implies accumulated investment returns (Swart, 2004, pp.300-302).
If the shareholders of this business choose to include debt capital to finance this project then it is very important for the business to have healthy financial statements. Since debt capital is a fixed obligation that requires regular repayment of interest along with principal. The business will have to pay regular interest on outstanding capital even if it incurs losses and has to liquidate assets. If the business is not able to earn more than its cost of capital then the net-worth of the investors will turn negative and business will be a failure. The most important impact of sources of finance on financial statements arises from sale of assets and loan. The impact of loan on financial statements include reduction in net profit due to servicing of interest rate liability; higher provisions for doubtful debts; and increase in liabilities along with increase in assets where funds were employed. The sale of asset helps organizations to realize cash immediately. This strategy is generally employed when the organization is unable to generate sufficient cash from core operations.
It is constructed to estimate the future sales and it can be broken into currency and units. It is used to set a target for sales goals for the company.
It estimates the number of uni8ts of output which should be produced to meet the sales target. It also states about various costs that are involved in the manufacturing process.
Material budget is constructed after calculating the production requirements after preparing the production budget. It includes cost and amount of raw materials that is needed to conduct the production.
It is used to calculate the labor hours which will be needed to produce the required amount of output.
It is an expectation of future cash receipts and consumptions for a specific time period. It typically takes into account a period in the nearest future. The cash budget helps the business to decide when revenues will be sufficient to cover expenditures and when the organization will need to look for outside financing.
The master budget is a one-year budget arranging record for the firm incorporating all different budgets. It matches with the financial year of the firm and may be broken down into quarters and, further, into months. On the off chance that the firm plans for the master budget to make continuous record, moving from year to year, then ordinarily a month is added to the end of the budget to encourage arranging. This is also known as continuous budgeting. How budget analysis is useful to make appropriate decision
Budget Analysis is very much helpful in making appropriate decisions. Budget helps the organization to decide about the necessary cost and sales target to fulfill. With the help of a budget, management can take proper decisions about the performance of the employees in meeting the target. Budget also helps to determine the efficiency of the managers in fulfilling the target work (The Times 100, 2014). Here we can take example of cash budget. Cash budget is very much necessary as it makes us understand about the situation of cash flow in the company. It is constructed by deducting all the expenses from the sources of cash income. It is done monthly to look after the liquidity position of the company. Thus if cash budget has surplus amount of cash then it can be said that the company is well going by fulfilling the sales goal within limited expenditures.
All profit making organization conducts some transactions everyday which has to be recorded in respective accounts so as to ascertain and reflect the true position of financial resources. Here we have taken the example of Tesco as the profit making Organization to describe the main financial statements (see appendix). The income statement of Tesco shows the total revenue of 64826 million pounds. It has gross profit of 4584 million pounds and operating income of 3074 million pounds. The company has earned 124 million pounds as net profit for the financial year 2013. From the balance sheet of the company we can see that the total current asset is 13096 million pounds and total current liabilities are 18985 million pounds. The total asset is 50129 million pounds. The total liabilities and equity is 50129 pounds (Bloomberg, 2014). The Profit and Loss account provides information regarding total revenues, cost of sales, and gross profit. The gross profit is amount of money generated by the firm from direct sale of goods and services to customers which takes into account the direct cost of production (like cost of raw materials, labors, overheads, etc.). It also provides administrative and operating expenses and profit. The net profit for the period is shown in the reserves and surplus section of balance sheet.
Without the P&L account it will not be possible for organizations to analyze true position of business on particular date. The balance sheet reflects the true financial position of firm by showing the total assets, liabilities and equity capital of the promoters. The assets and liabilities are also classified according to time period (long-term or short-term). Long-term or fixed assets include land, machinery, furniture, etc. and long-term liabilities include term loans, debentures, etc.; short-term assets are cash, bills receivables, inventory, etc. The assets are financial resources owned by profit making firm whereas liabilities are resources owed by firm to internal and external stakeholders. The total assets should always be equal to total liabilities and owners’ equity capital. This is because liabilities are sources of fund and assets are application of funds implying that theoretically they should be equal (Gallagher and Andrew, 2007, pp.62-68).
From the above study we can see that there are different types of sources of finances available to Mrs. Bell like venture capital, private equity, bank loan and small business administration. Depending upon the implications and the related advantages and disadvantages she probably choose bank loan as the source of her necessary finance. We have also seen the meaning and importance of financial planning and how information related to financial statements are helpful to the investors, shareholders and employees of the organisation. Apart from this, cash budget is also very much essential for managers to take important decision regarding the current position of the company. Thus from the above study it can be concluded that to take any important decision in an organisation we need to analyze each and every aspect of the organisation and the financial position of the organisation.
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