Report On New Sources Of Development Finance

Sources of finance available to a business

Discuss about the Report on New Sources Of Development Finance?

Identification of sources of finance

Owner’s investment:

This is personal funds or savings of a business owner or his or her family and friends which is invested in the business.

Retained profits:

Retained profits are earnings that remain after payment of all sorts of obligations and get reinvested in the business (Bodie and Merton, 2011).

Sale of assets: An organisation can sale its assets such as product inventories, unused lands and equipments for raising funds.

Bank loans: Bank loans are funds borrowed from banks against set rate of interest and set date of repayment.

Purchase of shares: Public limited companies have the option to sell shares via stock exchanges to raise funds from the public (Jarrow et al., 2011).

Grants: Some business has access to local and central government grants for purchasing certain types of businesses.

Sources of finance	Advantageous implications	Disadvantageous implications
Owners investment	Quick access, no interest burden, no application forms	Money cannot be used on other items
Retained profits	No need to borrow funds and hence, no question of interest payment, no loss of control or ownership (Bishop, 2004).	Money is not available or scarcely available for alternative spending
Asset sale	Quick and easy access, no loss of ownership or control	Sale of too much assets may reduce company assets and hamper operations
Bank loan	Asset guarantees and interest obligations removes pressure from the borrowing organizations as well as from the bank. The organisation retains ownership and control	Presence of interest burdens and obligation to pay the principle on fixed date. Considerable high credit score is required (Newlyn, 2005)
Shares	Large funds can be obtained with no interest burden	Loss of ownership and control
Grants	No repayment is required	Only available under highly necessary conditions

For evaluation of appropriate sources of finance, an expansion project has been selected that involves public limited company retailing grocery products opening of two new stores in London.  Upon evaluation, it has been found out that the most suitable sources of finance for the company are bank loan which is a debt finance and sale of shares, which is equity finance.

These two sources of finance has been considered as appropriate sources because of the flowing reasons

Bank loan

Bank loan is a cheaper source of finance and more debt provides cost advantage (Newlyn, 2005). Moreover, it does not lead to loss of ownership or control and the time required to use the loan fund can be kept within the loan period. However, taking in to consideration the fact that debt financing is associated with interest obligation and put the company on to interest rate risk, it has been decided to keep debt financing below 40% in the capital structure of the expansion project.

Shares

Issue of shares is costlier than debt financing and leads to dilution of ownership and control. However, taking in to consideration the fact that it is easily available, free from interest burdens and a large amount of fund can be obtained, the company has decided to cover 60% of its capital structure with equity financing.

Analysis of costs of sources of finance

Owner’s investment: The main costs of owner’s investment are costs of providing financial reports, conducting audits, share flotation and administrative and legal costs.

Identification of sources of finance

Retained profit: Retained profit is connected to opportunity cost i.e. cost of losing the opportunity of using the funds for alternative expenditures (Groppelli and Nikbakht, 2011).

Sale of assets: Sale of assets is costly in the sense that it leads to loss of company value and organisational efficiency.

Bank loan: The main costs associated with bank loan are interests, factor charge and costs of providing lender information

Sale of shares: Costs associated with sale of shares are issuing costs and dividends.

Grants: The major costs connected to grants are administrative, fund application and application form filling costs (Groppelli and Nikbakht, 2011).

Financial planning is helpful to an organisation in many different ways. Financial planning aids an organisation in appropriately funding its own activities through identification of financial priorities, allocation of funds for meeting expenses, reduction of credit use, uncertainty and financial affairs related conflicts and facilitating investments and savings to reach financial goals.

Along this line, it can be stated that financial planning streamlines the process of management and monitoring of incomes and expenses, creating investment opportunities, saving funds and creating a long – term capital base.

Internal decision makers

Shareholders: Shareholders of an organisation require considerable amount of information regarding profitability, asset base, net worth and cash availability.

Managers: Managers require wide range of information regarding profit performance, growth, planning, controlling and organizing activities.

External decision makers

Government: The government needs wide range of information to know whether an organisation complies with regulatory bodies, creates employment, contributes to economic growth, supports environment addresses green issues and climate change and pays income tax.

Funding organizations: These organizations require considerable amount of information regarding profitability, liquidity, fixed and current asset base, interest cover and gearing ratios.

Customers: The information requirements of customers are lesser in comparison to that of others however; they require considerable information regarding quality of goods and services of an organisation and extent of ethical compliance.

Finance	Impact on balance sheet	Impact on income statement
Owners investment	Increases owners equity fund	Increases net income
Retained profits	Increases owners equity	Increases net profit after tax
Asset sale	Decreases current on long – term assets depending on the type of asset sold (Atkinson, 2005)	Increases non – operating income
Bank loan	Increases short – term – long term asset and liability by the same amount liability depending upon the type of loan taken (Finney, 2011)	Increases interest expense
Shares	Increases owners equity	Increases non – operating income
Grants	Increases short – term – long term assets	Increases non – operating income

Analysis of budgets with appropriate decisions

Calculation of cash budget

The following cash budget has been prepared for forecasting cash inflows and outflows from a new grocery soap during the first six months of its operation

Particulars (£)	April	May	June	July	August	September
Cash inflow
Credit sales	693000	762300	838530	922383	1014621	1116083
Cash sales	77000	84700	93170	102487	112736	124009
Total cash inflow	770000	847000	931700	1024870	1127357	1240093
Cash outflows
Cash purchases	650000	520000	416000	332800	266240	212992
Credit purchases	60500	48400	38720	30976	24781	19825
Rent payment	30000			30000
Bank loan repayment	16500	13200	10560	8448	6758	5407
Other expenses	88000	70400	56320	45056	36045	28836
Total cash outflow	845000	652000	521600	447280	333824	267059
Net cash flow	-75000	195000	410100	577590	793533	973034
Opening cash balance	50000	-25000	170000	580100	1157690	1951223
Net cash flow at the end of the month	-25000	170000	580100	1157690	1951223	2924257

Analysis of cash budget

Analysis of the above cash budget reveals that in the month of April, there will be a cash deficit of £-25000.  This cash deficit can be managed and converted to cash surplus by stringent credit policies, bank reconciliations and negotiation of flexible credit terms with suppliers.

Assessment of implications of sources of finance

Analysis also reveals that after the month of April there will be cash surpluses for the next five months and the figures are expected to be £170000, £2924257, £1157690, £1951223 and £580100 for the months of May, June, July, August and September respectively. This surplus cash can be used for paying current debts and for investing in profitable projector expansions.

Unit cost

Unit cost is the total cost incurred in the process of manufacturing and delivering one unit of a product.

The formula for calculation of unit cost is

Per unit cost = (total variable cost + total fixed cost) / total number of units sold

Another formula is

Per unit cost = (Selling price – profit) / number of units sold.

From the above formula, it is clear that unit cost is obtained by deducting mark up profit from selling price.

Pricing decisions

Since variable costs change as per changes in level of operations and fixed cost do not change as per the same, variable cost is more relevant in the context of pricing decisions. This is mainly because of the fact that variable cost act as an important determinant of breakeven point i.e. the point at which income and expense is same for a business. 

Different investment appraisal techniques

Some of the most important project appraisal techniques have been described below

Project appraisal technique	Definition	Decision rule	Advantages	Disadvantages
Net present value (NPV)	NPV is present value of future cash flows – present value of initial investment (Johnson, 2009).	A project is accepted when NPV is positive	Time value money and entire life cycle of a project is considered	Method is complex and sensitive to cost of capital  (Wilkes, 2010)
Payback period	It is the time taken to recover initial investments	A project is accepted when calculated payback period is shorter than targeted payback period	Simple and easily understandable technique.	Over – simplified and ignores time value of money
Internal rate of return (IRR)	It is the rate of return at which initial investment is equal to present value of future cash flows	A project is accepted when IRR is greater than cost of capital (Johnson, 2009).	Takes in to consideration time value of money	Fails to give accurate results in case of mutually exclusive projects.

Application of the NPV technique

In the following table, NPV of  an expansion project has been calculated

Cash flow (£)	Project A	Discounting rate	Discounted cash flows
Investment (cash outflow)	143000
Year 1 – cash inflow	38500	1	34997
Year 2 – cash inflow	49500	1	40887
Year 3 – cash inflow	60500	1	45436
Year 4 – cash inflow	71500	1	48835
Total discounted cash flow			170154
NPV			£27154

Since NPV of the project is positive, the project can be considered feasible and profitable and thus, the same should be accepted.

Discussion on the main financial statements

Balance sheet: Balance sheet is important because it is the statement of financial position on a particular date. It aids in depicting what is claimed and owned against assets. The main elements of a balance sheet are assets, liabilities and owners equity (Foulke, 2006).

Profit and loss account: Profit and loss account is important in the sense that it depicts income and expenditure (Fridson and Alvarez, 2007). It serves the purposes reflecting earning capacity. Main elements of this statement are incomes and expenses.

Criteria	Sole trader	Partnership	Limited company
Representation	Financial statements reflect age records and audit trail	Financial statements represent profit, loss and capital contributions	Main forms of financial statements are balance sheet, income statement and cash flow statement
Focus	Financial statements depict income tax and NI	Cash balances of partners are represented	Profitability, liquidity, efficiency and solvency
Complexity	Least complex	Moderately complex	Highly complex
Requirement	Not mandatory	Not mandatory	Mandatory

Calculation, analysis and interpretations of ratios have been done in the context of BA

Ratio	Calculation	2012	2013	2014	Analysis	Interpretation
Profitability ratios
Gross profit margin	Gross profit / net sales x 100	16	15.4	15.4	Gross profit margin shows a decreasing trend	Overall profitability of BA is decreasing
Net profit margin	Net profit / net sales x 100	4.77	5.29	6	The trend of net profit margin is increasing	Profit from operating activities and pricing strategies of BA is increasing (Horrigan, 2010)
Liquidity ratios
Current ratio	Current assets / current liabilities	1.27	1.26	1.2	The trend of current ratio is decreasing	Short term liquidity position is deteriorating
Quick ratio	(Current assets – inventories) / current liabilities	0.43	0.42	0.37	The trend of quick ratio is also decreasing (Palmer, 2006)	Short term liquidity position is deteriorating
Gearing ratios
Debt to equity ratio	Total debt / total equity	1.53	0.54	0.94	Debt to equity ratio shows a shows a decreasing trend	The percentage of debt in capital structure of BA is decreasing thereby indicating reduced exposure to interest rate risk and bankruptcy risk (Weston and Brigham, 2006).

References

Atkinson, A. (2005). New Sources Of Development Finance. Oxford: Oxford University Press.

Bishop, E. (2004). Finance of international trade. Amsterdam: Elsevier.

Bodie, Z. and Merton, R. (2011). Finance. 3rd ed. Upper Saddle River, NJ: Prentice Hall.

Finney, R. (2011). Office finances made easy. New York: AMACOM.

Foulke, R. (2006) Practical financial statement analysis. New York: McGraw-Hill.

Fridson, M. & Alvarez, F. (2007) Financial statement analysis. New York: John Wiley & Sons.

Groppelli, A. and Nikbakht, E. (2011). Finance. 3rd ed. Hauppauge, N.Y.: Barron’s.

Horrigan, J. (2010) Financial ratio analysis. New York: Arno Press.

Jarrow, R., Maksimovic, V. and Ziemba, W. (2011). Finance. 3rd ed. Amsterdam: Elsevier.

Johnson, R. (2009) Capital budgeting. Belmont, Calif.: Wadsworth Pub. Co.

Newlyn, W. (2005). Finance for development. 4th ed. [Nairobi]: East African Pub. House.

Palmer, J. (2006) Financial ratio analysis. New York, N.Y.: American Institute of Certified Public Accountants

Weston, J. & Brigham, E. (2006) Managerial finance. Hinsdale, Ill.: Dryden Press.

Wilkes, F. (2010) Capital budgeting techniques. London: Wiley.