Business Finance: Practices and Recommendations for Cash Flow Management
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This report covers business finance practices of Trend Ltd and Thorne Estates Limited. It discusses concepts such as profit, cash flow, working capital, receivables, inventories, and payables. It also provides recommendations for improving cash flow through better working capital management.
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Table of Contents Executive Summary........................................................................................................................3 Task 1...............................................................................................................................................3 1. Explain....................................................................................................................................3 2. Impact of company's operational management on financial results.......................................5 3. Steps recommended to improve company's cash flow through better working capital management................................................................................................................................5 Executive Summary.........................................................................................................................7 Task 2...............................................................................................................................................7 1. Monthly cash budgets from 1st Jan to 30th April 2021..........................................................7 2. Recommendations to the management of Thorne Estates Limited.........................................7 References......................................................................................................................................10 Appendix........................................................................................................................................11 Monthly cash budgets...............................................................................................................11 2
Executive Summary Business finance involves taking up financial management of the business concerns. It includes both revenue and capital management in order to ensure smooth financial health of the business(Burns and Dewhurst, 2016). This report aims to cover business finance practices of Trend Ltd (TL) which manufactures gym clothing and footwear. For Trend Ltd, concepts such as profit, cash flow, working capital, receivables, inventories and payables are discussed and their impact over the financial results of the company are determined. Steps to improve company's cash flow through better working capital management are also discussed. Task 1 1. Explain A. Profit and cash flow Profit- Profit is any revenue in excess of cost. In accounting, profit refers to the financial benefit that is derived when total revenue of the business exceeds over the total expenses of the company. It is either retained by a company to provide for future operations or is distributed to shareholders as dividend. It is obtained in profit and loss account which is also known as Income Statement.Acompanydividesitsprofitandlossaccountintovariousstages-firstis manufacturing profit which is known as gross profit. Further, other administrative and selling expenses are reduced from the gross profit to arrive at operating profit. Furthermore, all non- operating expenses and income are adjusted to arrive at the final figure of net profit, also known as net income. This profit is then adjusted with corporate tax to arrive at the figure of profit after tax. This amount is said to be profit available for shareholders. Cash flow- Cash flow refers to the total flow of cash in a business concern over a specific period. Cash receipts are taken as inflow while cash payments are taken as outflow. When inflow of cash exceeds outflow in a business, it is known as favourable position for the businessandcompanyisabletogeneratemorevalueforthestakeholders.Cashflow management is extremely important for companies to ensure smooth business operations. Therefore, companies prepare cash budgets to act as standards for operations. These budgets are monitored and reviewed periodically like monthly, quarterly, semi-annually or annually, to make necessary adjustments. Further cash flow statement is prepared as a part of financial statements of a company to assess overall cash inflow-outflow position during the year or reported period. 3
Cash flow statement is divided into three parts - cash flow from operating activities, cash flow from investing activities and cash flow from financing activities. Operating activities includes activities related to sales, purchase, payroll, etc. Investing activities takes into consideration inflow and outflow related to investments of the company, loans forwarded, interest received, fixed assets sale - purchase, etc. Financing activities takes into account change in capital structure, loans availed, interest paid, dividend paid, etc. Difference between two- Most primary difference between profit and cash flow is that the profit is only an accounting entity which is used to report net income generated in business while cash flows represents inflow and outflow of real cash. In other words, profit represents profitability of the business while cash flow represents liquidity of the business. Another difference is that profit of a company is generated using accrual accounting system while cash flow of the business is determined using cash accounting system. B. Working Capital, receivables, inventories and payables Working Capital- Working capital includes two components - current assets such as cash,receivables,etc.andcurrentliabilitieslikepayables,short-termloans,etc.andis represented as the net difference of the two. When current assets exceeds current liabilities, it is taken as positive working capital of the business(Cheng, Li and Tong, 2016). Receivables-Account receivables represents those people who owe money to business such as trade debtors. These are currents assets of the company and reflects such amount that will generate revenue for company in near future. Company maintains a separate system for negotiating with trade debtors to manage debtors payment cycle. Inventories- Inventories refers to all the merchandise that a company manufactures and trades in. It is held by company between manufacturing or ordering till order fulfilment for delivery. It can be either in form of raw materials, intermediate products or finished goods. Payables- Account payables represents those people who business owe money to, such as trade creditors. These are currents liabilities of the company and reflects such amount that will have to be paid by company in near future. Company maintains a separate system for negotiating with trade creditors to manage creditors' payment cycle. C. Impact of change in working capital on cash flow 4
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Managing working capital and cash flow are both fundamental to the organisation and interact with each other during financial performance analysis of the company. Working capital represents difference between a company's current assets and current liabilities or in other words, it determines the short-term money a company is required to pay to its short-term liabilities. Current assets includes cash and cash equivalents which are point of discussion in the cash flow management. Positive working capital means business have sufficient funds to cover its current liabilities and be a reflection of its strong financial position and good cash flow position. On the other hand, negative working capital could have meant that business does not have sufficient funds to cover its current liabilities. It could also mean that company has either made a huge cash outlay in near time that it is now short of funds or large funds are required in near future which is not available in business. Such situation extended for a long time is not positive situation for the company and might be able to create liquidity challenges for the businesses in future(Tenca, Croce and Ughetto, 2018). 2. Impact of company's operational management on financial results In the given company Trend Ltd., operating profit of£60 million was reported last year. This is a respectable figure and shows the profit making capabilities of the business. However, as per the information provided, profitability was compromised with the attitude of owner Arpha as well as because of the way the working capital was being managed. £10 million was owed to company by debtor Tkechers, £12.5 million amount is outstanding from another debtor which has run into dispute and company is stock piling materials to avoid work halt in the meantime a dispute is resolved with major supplier. Also, to avoid further disputes, Arpha is not ready to pressurise other clients for payments. All these are capable of having huge negative influence on working capital and profitability of the business. It has also been provided that company's debt has increased from £60 million in the last year to £95 million in the present year. This means that company had £35 million more funds in the company while £20 million has been outflow because of the investment it made in a company. This has not only impacted financing decisions of the company but also investing decisions of the cash flow. 3.Stepsrecommendedtoimprovecompany'scashflowthroughbetterworkingcapital management On the basis of above-mentioned analysis, following recommendations is suggested to the company for improving their working capital management: 5
Company must try to recover the money as soon as possible from all its debtors to avoid further interest loss and the risk of running in under-liquidation. Further, such debtors who have history or track record of non-payment or late payment must be dealt in a different manner or not dealt with altogether. Company has £12.5 million in dispute with Sadidas which has withheld its payment. Manager Arpha believes this dispute arose due to sub-standard supply of materials by a supplier and as a result, has withheld its payment. Now, the supplier is threatening legal action. Company is running into disputes which is not only harmful for cash flow and working capital of the company but also, for its operations and growth opportunities. Therefore, it shall try to settle disputes as soon as possible(Akan and Tevfik, 2020). Furthermore, Arpha has built a level of stock in one of its warehouse which is more than required to avoid disruptions during dispute resolution period. Company shall avoid over- stocking as it would cause unnecessary cost of holding inventories. Rather, it should make provisions for emergency supply of raw materials by some other supplier. 6
Executive Summary Primary goal of business finance is to maximise wealth of the shareholders for which it needs to undertake necessary decisions relatedto the working capital management, cash management, etc. This report aims to cover business finance practices of Thorne Estates Limited which advertises and sell residential property on behalf of its customers. For Thorne Estates Limited,anillustrativecashbudgetispreparedforfourmonthsandthenfurther recommendations are made to management of company to improve cash management on the basis of observations made during preparation of cash budget. Task 2 1. Monthly cash budgets from 1st Jan to 30th April 2021 Cash budget is an estimation prepared to assess cash receipts and disbursements in a defined future period. In other words, it is an estimated projection of position of cash and cash equivalents in the company in a future period. It includes forecasting changes in inflows and outflows of cash due to revenue received, expenses incurred and loan payments and receipts (Bouma, Jeucken and Klinkers, 2017). It has been provided that Thorne Estate Limited is in the business of advertising and selling residential property on the behalf of its customers. Average price of the property sold by the company is £180,000 on which company charges a fee of 3% on sales. One-third fee is received in the same month of sale and two-third is received next month. Further, it has been stated that company has nine employees who gets paid monthly and are also, given bonus of £140 for each additional property sold over 20 properties. Furthermore, company incurs variable and fixed costs as per its operational process. Additionally, it has been provided that company intends to dispose surplus vehicles and expects to earn £20,000 out of them for a net book value of £15000. Cash Balance at the beginning of January 2021 is expected to be a deficit of £20,000. 2. Recommendations to the management of Thorne Estates Limited Challenges In the information provide noteworthy points are that company has been in business for a short time only and therefore, does not have much of the trends related to its past performance that can help it and act as reference point for forecasting future cash cycles' development. It has also been provided that company has an outstanding tax liability amount and that it intends to 7
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dispose surplus vehicles for an expected gain of£5000. Company is expecting to have a deficit cash balance at the starting of budgeted period. All these points paint company in a different picture. Challenges with company: No large historical trends - From above-mentioned points, it can be deduced that company does not have large past to draw upon references as well as company cannot be sure of the estimates it has taken, to prepare the budget as the future is unpredictable and company is preparing budgets on its present operational standards without giving any due provision or reserve. Therefore, in case any contingency arise in the future, cash budget prepared by the company will be render ineffective(Katz and Green, 2018). Deficit cash flow- It has been provided that company is expected to have a deficit cash balance in the opening of January, 2021. It has prepared budget for 4 months and is expecting to have positive cash flows by the end of 4 months budgeted period. In addition, if in the budgeted period company gets erratic cash flows, every planning will be render ineffective. Under-liquidation and over-liquidation both are issues for financial planning of a business for under-liquidation can lead to halt in operations while over- liquidation can be result of wasted growth opportunity. Recommendations In light of the above conditions, below mentioned recommendations are suggested to company so that it can be sure of having smooth cash flow management: In order to ensure that deficit cash balance problem does not arise again, company needs to reconsider negotiating with its business associates like suppliers, lenders, vendors, and other creditors, etc. It should be made clear with business associates that company needs to revise its contracts to suit its cash flow position and a win-win situation would be created for both the sides. A good business partner is always supported by associates and therefore, they should provide company with better terms. Other than negotiating deals with business associates, company must try to increase its sales and reduce costs. It should try to change its marketing practises to get more customers and then sale them. It can offer discounts and other incentives to attract customers. Success of cash budget of the company is based on achievement of revenue targets otherwise, whole budget target will be missed and cash planning of the company would be disrupted. In order to avoid such issues, company shall make a flexible budget and 8
monthly review them to identify any variations before it can turn disruptive. Variance analysis helps prepare corrective actions that keeps cash management of the business on track. Further, company can also create a budget which have multiple scenarios of different revenues and expenses to understand the method to be adopted to if such situation arises. However, budget preparation can be expensive and company need not make it at the cost of its cash flow management. ï‚·Budgetpreparedbythecompanyisverycompactandhasneitherconsidered contingencies nor included room for other expenses that can put cash management to trouble. Therefore, company shall make more elaborate budget and also, provide for additional funds as reserve and provisions. Budget shall be carefully divided into right heads so that correct expenses and their pattern can be identified. This will help company optimise their revenue and expenses structure(Cowling, Liu and Zhang, 2016). 9
References Books and Journal Akan, M. and Tevfik, A. T., 2020. Fundamentals of finance. InFundamentals of Finance. De Gruyter. Bouma, J. J., Jeucken, M. and Klinkers, L. eds., 2017.Sustainable banking: The greening of finance. Routledge. Burns,P.andDewhurst,J.eds.,2016.Smallbusinessandentrepreneurship.Macmillan International Higher Education. Cheng, P., Li, L. and Tong, W. H., 2016. Target information asymmetry and acquisition price.Journal of Business Finance & Accounting,43(7-8), pp.976-1016. Cowling, M., Liu, W. and Zhang, N., 2016. Access to bank finance for UK SMEs in the wake of therecentfinancialcrisis.InternationalJournalofEntrepreneurialBehavior& Research. Katz, J. A. and Green, R. P., 2018.Entrepreneurial small business. McGraw-Hill Education,. Tenca, F., Croce, A. and Ughetto, E., 2018. Business angels research in entrepreneurial finance: Aliteraturereviewandaresearchagenda.JournalofEconomicSurveys,32(5), pp.1384-1413. 10
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Appendix Monthly cash budgets Cash Budget of Thorne Estates Limited (for January - April 2021) ParticularsJanuary (in £)February (in £)March (in £)April (in £) Receipts: Expected Sales revenue540006300099000144000 Sale of assets20000 Total receipts540006300099000164000 Payments: Salary26250262503255038850 Variable expenses9000135002250027000 Fixed Overhead4300430043004300 Interest3000 Outstanding tax liability95800 Total Payments395504405062350165950 Net Receipts144501895036650-1950 Bank balance at beginning-40000-25550-660030050 Bank balance at end-25550-66003005028100 Working Notes: DecJanFebMarApr Unit Sold1010152530 Average Price180000180000180000180000180000 Fees54005400540054005400 Total fees540005400081000135000162000 Receipt18000540006300099000144000 December36000 11
January1800036000 February2700054000 March4500090000 April54000 Total sales revenue540006300099000144000 Average annual salary35000350003500035000 Monthly payment2916.672916.672916.672916.67 Total monthly salary26250262502625026250 Bonus630012600 Total monthly Payments26250262503255038850 12