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Introduction

In times of financial turbulence like recession things like negative impact on economy, restricted flow of funds and society getting impacted in form of pay cuts, loss of jobs become common. In a similar circumstance faced by us where we are also forced to quit our job and left barren. To keep up the pace with life we are planning to start our own business. Business to be started up requires an initial investment in form of capital. With the personal saving of £ 50,000 I am looking for an additional funding of £ 1 million to begin my business.
Business is an activity which requires the mobilisation in the form of funds. Success of operations depends upon the quality of management to make available to them the funds and resources necessary to achieve the desired objectives. Thereby, finance becomes a very critical area of resort management evaluation. It requires a wise approach to ensure that the funds are procured from a source and for a tenure that is convenient for the organisation. A critical evaluation of the same is being done underneath.

 

Task 1

P1.2 The implications of different types of sources of finance

Sources of Finance/Implications	Equity Shares	Debentures	Term Loans	Retained Earnings	Lease Financing	Hire Purchase	Stock Control
Legal	Issue of Equity Shares has to be as par the legal guidelines set out by the companies act,2006 or any other legal statue in effect thereof	Debentures too are issued only in accordance with the Companies act,2006 and the power of the debenture holders is also defined by the statue	Term Loans are procured from commercial banks and large financial institutions. Thus, there is not set regulation curbing or monitoring the availing of term loan by an organisation	Retained earnings are an internal source of fund generation. Thus organisation specific guidelines only are effective in case of retained earnings and no other legal statue monitors the same	Lease financing is done between the lessor (organisation) and the lessee (lease provider) they may or may not enter into a formal contract for the same. Thus legal implications of the same depend upon the nature of contract entered into.	Hire purchase is a debt undertaking and is obligatory for the organisation to pay the installments or else the hire vendor has the right to repossess the assets granted and also sue the organisation in case of non -payment	Its an organisation specific measure to generate funds and has no separate legal implication associated.
Financial	Equity shares form the core capital base of the organisation and they are also important basis of funding for heavy capital intensive proposals or expansion program’s. Return to equity shareholders is the dividend on net profit earned by the business and is an appropriation of profits	Debenture holders are entitled to a fixed interest on the face value of debentures held by them. An organisation necessarily has to pay such interest annually and may not abstain from the same.	Term loans also are required to be catered with a fixed interest charges as the cost of financing and is an obligation for the organisation to cater periodically	There are no financial implication of retained earning other than reduction in the final profits available for distribution to shareholders	Lease rental is the financial implication created upon entering into lease financing.	The payment of installment which includes the interest is a financial implication of entering into a hire purchase contract.	There are usually no major financial implication of such measure of generating funds.
Dilution of Control	Equity shareholders are owners and they have a say in the management due to the virtue of the voting rights associated with the shares held by them. Issue of equity shares thus leads to dilution of existing control of management	There is no dilution of control	There is no impact on control pattern	There is no dilution of control	There is no dilution of control	There is no dilution of control	There is no dilution of control
Bankruptcy Threat	Equity shares do not pose any considerable bankruptcy threat as the dividend payable to them is not obligatory but is voluntary.	Default in interest payment on debentures (which is a secured debt) starts to recur it may pose a financial crunch this may force bankruptcy	Non-payment of installments in lieu of loans starts recurring and may pose a financial crunch thus may force to stage of bankruptcy	Retained earnings usually do not have any bankruptcy threat integrated in them	A lessor may not force an organisation to stage of bankruptcy but regular defaults in payment of lease rentals may put entity into financial threat	No direct bankruptcy threat associated with such a financing.	Usually no serious bankruptcy threat associated.

P1.3 Analysis of the appropriate sources of capital

The sources of finance are categorized in two different types, which are:

• Internal sources
• External sources

Internal sources- Internal sources of financing are present intra organisation ex, retained earning etc. the advantage of internal sources of funds is:

• Flexibility: The organisation may use them for whatsoever purpose they deem fit i.e. either short term or long term.
• Cost: The cost of procuring such finance is usually, the cheapest of all

External sources- Financing from external sources is the finance procured form sources external to the organisation. This sources of finance and funding can be availed in the form of issue of shares, debentures, bank loans, hire purchase, lease financing etc. (Hussain, 1989)

The advantages of external sources are:

• Large fund: External sources are a major source of generating large funds. Internal sources are majorly generated by accumulation so immediate huge fund requirement is met only by procuring funds through external sources.
• Process of acquisition of funds: Raising funds via internal sources is comparatively more time taking than generating via external sources. 
• Retained earnings: Retained earnings are that portion of profit that is retained by the company for its own use i.e. not apportioned to the shareholders.

Advantages:

• Retained earnings helps the organisation to become self-sustained and enables it to be saved from any unforeseen astringencies in financing. It helps in strengthening the liquidity position of the organisation.
• Implications: Continuous retention would hamper the funds available to the shareholders and thus impact there earnings, this might become negative to the shareholders sentiments.
• Equity shares- Equity shares are regarded as common stock of the business. The holders of equity enjoy exclusive rights like voting, sharing of profits etc.

Advantages:

• The company need not pay any financial accounting charges like interest for procuring funds via equity shares.
• It market capitalisation of the company and hence enhancing its overall credit worthiness
• These are a permanent source of finance as they are redeemable only at the time of liquidation.

Implications:

• A huge base of equity shares affects the overall control of the company.
• They are not liquid in nature.

Debentures:

• Debentures are a loan stock which are issued by a company for a fixed tenure and requires a payment of fixed monthly interest thereon.

Advantages:

• The flotation cost of issuing debentures is cheaper than any other mode of public subscription.
• The interest payment on debentures helps in saving tax as it is tax deductible.
• Debt financing does not impact the control pattern of the organisation.

Implications:

• Huge financing by debt creates a heavy financial obligation on the organisation and this    may cause a financial distress.

Bank loans

Advantages:

• Procuring them is the simplest of all.
• It helps in saving tax as the interest paid on them is tax deductible.

Implications:

• Sometimes it becomes very complicated to procure a bank loan.
• The rate of interest payable on a bank loan is comparatively higher.

Task 3

P3.1 Analysis of budget

Easy Electronics ltd Budgeted Profit and Loss Account for the six month period ending 31December 2013.

	£'000	£'000
Sales		35,830
Less: Cost of sales		(18,878)
Gross profit		16,952
Profit from disposal of equipment		100
		17,052
Less: Expenses
Administration cost (£2400 + £675)	3075
Distribution cost	3,481	(6,556)
Profit before interest and tax		10,496
Loan interest		(500)
Profit before tax		9,996
Less: Corporation tax @ 23%		(2,299)
Profit after tax		7,697

	Months
Receipts (in flows)	Jul	Aug	Sep	Oct	Nov	Dec
	£'000	£'000	£'000	£'000	£'000	£'000
Receipts from cash sales	1,500	1,575	1,653	1,818	2,000	2,200
Receipts from Debtors	3,333	3500	3,675	3,859	4,245	4,669
Receipt from disposal of fixed asset				400
Total receipts (A)	4833	5075	5,328	6,077	6,245	6,869
Payments (out flows)
Payments to trade creditors	1,636	1,800	1,890	1,985	2,084	2,292
Salaries and wages	900	990	1,089	1,198	1,318	1,450
Variable overheads	800	880	968	1,084	1,214	1,360
Administrative cost (excludes monthly depreciation £100,000 for July - Sept and £125,000 for Oct - Dec )	400	400	400	400	400	400
Distribution cost	400	440	484	557	640	960
Capital expenditure				3,000
Dividends						1,000
Corporation tax				900
Interest and other finance charges					500
Total payments (B)	4136	4,510	4831	9124	6156	7462
Net cash flow (surplus or (deficit)) C = (A-B)	697	565	497	-3,047	89	-593
Opening cash balance (D)	1000	1697	2262	2,759	-288	-199
Closing cash balance (C+D)	1697	2262	2,759	-288	-199	-792

Sales Revenue	35830
Less: Cost of sales	18878
Gross Profit	16952
Less: Expenses
Administration Cost	3075
Distribution Cost	3481
EBIT	10396
Units Sold	650,036
Revenue Per Unit	16

Sales Revenue (55.12*90%) * (650,036*120%)	38696383.07
Less: Cost of sales	22653600
Gross Profit	16042783.07
Less: Expenses
Administration Cost	3075000
Distribution Cost	3481000
EBIT	9486783.066
Units Sold (650,036*120%)	780,043
Revenue Per Unit	12

	WM Morrison Supermarkets		J Sainsbury Plc
Ratio Analysis
	2011	2010	2011	2010
Liquidity or Short term Solvency Ratio
Current Ratio	0.57	0.55	0.65	0.58
Liquidity Ratio	0.24	0.24	0.35	0.31
Time Ratio
Average Collection Period	3.95	4.36	1.80	1.61
Creditors Payment Period	29.12	31.01	31.16	31.76
Asset Management Ratio
Stock Turnover Ratio	23.27	25.83	23.77	25.99
Profitability Ratio
Gross Profit Margin Ratio (%)	6.89	6.97	5.43	5.50
Net Profit margin Ratio (%)	5.36	5.30	3.58	3.92
Return On Assets (%)	12.53	12.44	8.68	9.78
Berry Ratio (%)	3.95	3.79	3.09	3.04
Return on Capital Employed (%)	12.53	12.44	8.68	9.78
Debt Management Ratio
Gearing Ratio (%)	42.02	29.61	66.18	57.28
Interest Coverage Ratio	6.09	21.33	6.79	8.13

Liquidity Ratio:

Current Ratio: It represents the capability of the organisation to cater to its debt payments. It is computed by the formula,

Current Ratio= Total Current assets / Total current liabilities

None of the organisation is seen to have the ideal ratio moreover the current ratio for WM Morrison and J Sainsbury have almost been similar. Howsoever J Sainsbury is observed to have a better debt management system overall as its current ratio is slightly better than WM Morrison

Liquidity Ratio:  Liquidity ratio depict the capability of the organisation to pay its short term debts as and when they fall due. It is computed by the formula,

Liquidity Ratio = (Total current assets- inventory) / (Total current liability – Bank Overdraft)

The absolute liquidity ratio for J Sainsbury has been higher than WM Morrison. A better liquidity ratio signifies a better liquidity risk management of J Sainsbury in comparison to WM Morrison.

Time Ratio

Average collection period: It represents the number of days taken by company to recover cash from its debtors. The formula for computing it is,

Average collection period = (Receivable*365) / Sales

Lower is preferable because inability to collect funds from debtors is an opportunity cost to the organisation. WM Morrison has funds locked in with debtors for comparatively greater number of days than J Sainsbury this signifies that J Sainsbury has better debt collection system.

Creditor payment period ratio: Account receivable ratio measures the company’s efficiency in paying its trade creditors. It is computed by the formula,

Creditors Payment Period Ratio = (Accounts Payable* Number of Working Days)/Net Credit Purchases Both the organisation take a lot of time to pay its creditors this is not advisable as this may result in loss of suppliers trust & overall marketing strategy goodwill.

Asset Management Ratio:

Stock turnover ratio: It depicts how many times a company’s inventory is sold over and replaced, generally computed by,

Stock turnover ratio = Sales/ Inventory

The inventory turnover ratio for both of the companies has been almost similar with a slight difference existing. A low ratio implies poor sales and thus excess inventory. A high ratio signifies strong sales or ineffective buying.

Profitability ratio

• Gross profit margin ratio: This ratio tells the gross profit generated out of every pound of revenue. Formula for computing this is,
• Gross profit margin ratio = (Gross profit/Total sales) *100 WM Morrison has a better gross profit ratio than WM Morrison in both years.  The gross profit ratio of J Sainsbury fell by 0.075 than 2010 whereas the gross profit ratio for WM Morrison decreased by 0.09 % in comparison to 2010.Higher ratio signifies a better expense management.
• Net profit margin ratio: This ratio signifies the net profit generated out of every unit of pounds earned. The formula for its computation is,
• Net profit margin ratio = (Net profit/Total sales) *100 It may be seen that Profit margin for WM Morrison is higher than J Sainsbury for all of the years. A lower net profit denotes lower margin of safety.
• Return on assets: This ratio depict the return generated on every unit of assets held by the organisation. It represents the management’s efficiency in using its asset to generate profits. (Horrigan, 1978) It may be seen that ROA for WM Morrison is higher than J Sainsbury for 2011 as well as 2010.
• Berry Ratio: It is the ratio between the gross profit earned and the operating expenses. A higher ratio means the firm is more profitable. The formula for its computation is,
• Berry Ratio = Gross Profit/ Operating Expenses The berry ratio of WM Morrison has been better than J Sainsbury which depicts its better profitability status than J Sainsbury.
• Return on Capital Employed: This ratio measures a company’s profitability and the efficiency with which capital is employed. It is computed by the formula,

ROCE = EBIT/ Capital Employed A stable ROCE is assumed to be the basis of analysis and decision making the ROCE for WM Morrison has increased by 0.11 % in comparison to 2010 whereas, J Sainsbury’s ROCE went down by 0.9 % than 2010.

Debt management ratio

• Gearing Ratio: Gearing ratio is a financial ratio that compares some form of Capital to borrowed funds.  It is a measure of financial leverage. Higher the gearing ratio higher is the risk of financial distress. J Sainsbury has a very high gearing ratio in comparison to WM Morrison for both of the years this is a symbol of possible liquidity threat that J Sainsbury might have to face in case of a financial astringencies.
• Interest Coverage: This denotes the ability of the organisation to pay the interest on its outstanding debt. It is computed by,
• Interest Coverage = EBIT/ Interest Charges for the period Ideally it should be over 1.5.Interest Coverage ratio of WM Morrison has seen a sheer decline in 2011, J Sainsbury’s interest coverage ability also may be seen to have reduced over the period.

References

Kalra, A (2013).Strategic Financial Management, 3rd Edition, IGP Publications
Hussain, A (1989). A textbook of business finance, East African Publishers
Lacy, R. H (2001).Financing your business, Made E-Z publishers
Holtz, H (1983). 2001 sources of financing for small business, University of Michigan, Arco Publishers
Adams, C. (1977). Appraising information needs of decision makers. 1st ed. San Francisco: Jossey-Bass.
Cousins, D. and Piper, A. (1970). Costing. 1st ed. London (St Paul's House, Warwick La., and E.C.4): Teach Yourself Books.
Horrigan, J. (1978). Financial ratio analysis. 1st Ed. New York: Arno Press.