Finance in an SME Assignment

Finance in an SME

Table of Contents
INTRODUCTION...........................................................................................................................3
TASK 1............................................................................................................................................3
Sources of finance........................................................................................................................3
TASK 2............................................................................................................................................4
Ratio analysis...............................................................................................................................4
TASK 3............................................................................................................................................6
Discussing investment appraisal techniques................................................................................6
TASK 4 ...........................................................................................................................................8
Approaches of business valuation................................................................................................8
TASK 5............................................................................................................................................9
Concept of ethics and its potential impact on decision making in SME’s...................................9
TASK 6..........................................................................................................................................10
Module learning log...................................................................................................................10
SUMMARY ..................................................................................................................................10
REFERENCES..............................................................................................................................11

INTRODUCTION
Finance can be defined as the activities which are concerned with the debt, credit,
banking, capital markets, investments and money. Finance in small and medium enterprises is
considered as the funding of SMEs which is related with the areas such as how the activities and
operations of such enterprises are backed up by the money, what kind of source of finance is
used for running the business etc. The present report will focus on Brompton Bicycle Ltd., a
bicycle manufacturing company based in United Kingdom and is the largest manufacturer of
bicucyloe in the country whose annual production is 36000 units out of which 80 % of
production is exported. The report will highlight different sources of finance, ratio analysis of the
company, application of investment techniques for evaluating a investment of company,
approaches of business valuation. Further, it will also cover impact of ethical values on decision
making of SMEs and a learning module log.
TASK 1
Sources of finance
Sources of finance implies the channels through which an enterprise obtains its funds.
They are classified on the basis of following basis of Time period, ownership, control and source
of creation of funds.
Internal sources:
Retained earnings:
These are the profits which are ploughed back in the business. Sometimes for growth and
expansion purpose, enterprises does not distribute all of its profits into its members or investors,
rather holds it back. Such ploughed back profits are known as retained earning which is an
internal source of finance (Classification of Sources of Funds, 2019).
External sources :
Debentures:
It is an external source of finance in which company borrows money by offering long
term security at a fixed rate. Such debt is backed up by the assets of business.
Loans :
Enterprise finance its operations by borrowing money from public financial institutions
and commercial banks by mortgaging of company's assets and at a charge of fixed interest.
Time period

Long term sources :
Funds which is required for a period of more than 1 year are considered as long term
sources of finance (Han, Zhang and Greene, 2017). Fixed capital requirements of company are
financed through these sources. Examples are :
Equity : Funds are obtained by selling the share of company to people in capital markets.
The money is does not create any fixed charge on assets and it does not have to be paid back to
investors during the normal course of business.
Other examples are preference shares, debentures, venture capital etc.
Medium term :
Funds when are needed for expenses or operations whose benefit will last for more than
one accounting year such as advertisement expenses, are financed through these sources.
Example are : Loans from commercial banks, lease financing etc.
Short term :
Funds when are required for meeting daily expenses of business such as working capital
requirements are financed through this sources (Cole, 2018).
Examples : trade credit, commercial paper, factoring, bank loan etc.
Owned & Borrowed capital :
Financing trough equity, preference share, retained earnings are considered as owned
capital. Equity capital is not required to repaid during the lifetime of company. However, these
sources dilutes the control of business in the hands of shareholders.
Borrowed capital includes loans, debentures, public deposited which creates a charge on
company's assets and possess contractual nature. Fixed rate of interest has to be paid at specified
time mentioned in document and the principal amount has to be repaid at specified date (Cole
and Mehran, 2018).
Sources of finance of Brompton:

From the above balance sheet it can be seen that the funds for the business are raised
from share capital and it also has retained earnings in form of share premium and other reserves
which is can use in the future contingency and other requirements. This can be seen that the

company do not have any outside borrowed funds and hence there is no interest burden on the
company Brompton.
TASK 2
Ratio analysis
Gross profit margin :
This refers to the profitability ratio which is concerned with measuring the revenue which
is left deducting the cost of sales.
Formula : Gross profit /sales*100
Operating margin :
It is another profitability ratio which measures the profit which is left after paying all the
operational expenses of the business such as salaries, office expenses, general expenses,
stationary etc.
Formula : Operating profit /sales*100
Return on Equity:
This is a ratio which is concerned with assessing the financial performance of the
company which shows the efficiency of company's management regarding how effectively it is
utilising the assets for generating profit (Uechi and et.al., 2015) .
Formula : Net income / shareholders' equity
Return on capital employed:
It is a financial ratio which is concerned with profitability and the effectiveness
with which the capital of company is employed.
Formula : Earning before interest and tax (EBIT) / Capital employed
Current ratio:
It is the ratio which measures the liquidity of the organisation regarding company's
ability of repaying its short term liabilities with its available short term assets. Ideal current ratio
is 2:1 which means that company has 2 times of assets of repaying each of its short term
liabilities (Gabric, 2018.).
Formula : Current assets / current liabilities
Quick ratio:

It is one of the indicator of organisation's liquidity. It measures the capability of business
concern to repay its short term liabilities with its highly liquid assets. The ideal acid test ratio is
1:1.
Formula : Current assets- prepaid expenses- stock / current liabilities
Inventory turnover period:
This ratio measures the frequency of sales. It means number of times inventory has been
sold or consumed in a year.
Formula : Sales / average inventory
Debtors' collection period:
This refers to the length of duration for recovering the dues from debtors. Credit period is
allowed to customers for increasing the sales (Muritala, 2018).
Formula: Average debtors / net sales
Creditors payable period:
It is a financial ratio which is concerned with measuring the number of days which the
company takes for paying its liabilities – trade payables.
Formula : Average Accounts payable / COGS* Number of days
Gearing ratio:
This ratio measures the financial leverage of the company which assists in evaluating the
financial health of the organisation.
Formula : Long term debt + short term debt + bank overdrafts / shareholder's
equity
Interest coverage:
This ratio is related with measuring the ability of company to tackle its outstanding debt.
Market analysts says that a company cannot grow until it has the capability of paying interest on
its existing liabilities (Robinson and et.al., 2015).
Formula : EBIT / Interest expense
Ratio analysis
Ratios 2015 2016 change
Profitability ratios
Gross profit
margin
10.29/27.48
=0 .37 11.26/28.42
=.39
0.02

Operating margin
2.15/27.48
= 0.07
1.76/28.42
=0.06 0.01
ROE
1.81/13.49
= 0.13
0.29/14.63
= 0.019
0.111
ROCE
2.15/13.49
= 0.16 1.76/ 14.63
= 0.12 0.04
Liquidity ratios
Current ratio
12.27/26.92
=0.45
12.09/34.43
=0.35
0.10
Quick ratio
8.99/26.92
=0.33
7.95/34.43
=0.23 0.10
Efficiency ratios
Inventories
turnover period
27.48/ (.38+0.32)/2
= 19.62
28.42/
(0.32+0.41)/2
=19.46 0.17
settlement period
for receivables.
(3.3+3.4)/27.48
=0.24
(3.4+4.3)/28.42
=0.27 0.03
settlement period
for payables
2.7/17.18* 365
=57.36
3.4/17.15*365
72.36 15
Gearing ratios
Gearing ratio - - -
Interest coverage - - -
Profitability ratios
Company is having GP ration of 39% in 2016 as compared with previous year 2015 of
37 % company is manufacturing company so it will not high GP ratio but it should be above 50%
so that it can efficiently meet its operational expenses. All its direct cost are covered in
production of products. But comp[any still have to focus on managing its cost of manufacturing
so that it can raise its profits. Company has shown growth of 2% which shows it is improving its
costs. The net profits of company is not high which means it is not efficiently managing its
operations. Return on capital employed of company is 12% in 2016 and it has fallen from 16% in
2015. The fall shows that performance of company is going down and company is not making
effective use of its capital employed. Whereas return on equity of company has increased by
11.1% from previous year. Increase in return shows that company have increased its
performance by taking new strategies. Company has to take considerable steps for improving its
profitability ratios.

Liquidity ratios
Liquidity ratios of company shows that it is not having strong liquidity position. Standard
current ratio is 2:1 whereas it has ratio of 0.35 in 2016. the current assets of company are not
sufficient to meet its current liabilities. The rise may be because the companies are not having
pending collection for its sales. Quick ratio is 0.23 as against standard of 1:1 which shows that
even after excluding inventory its liquidity is not rising. Ratios shows that company's liquidity
position of has gone down from previous year. Company is not able to raise its liquidity.
Company has to implement new plans so that its liquidity is increased. It is important for
company to improve its liquidity position otherwise it may affect operations of company.
Efficiency ratios
From above efficiency ratios it can be identified that inventory ratio for 2015 is 19.62 and
for 2016 it is 19.46. from the inventory ratio it can be figured out that company is having good
cash flows for running its operations. Settlement period of receivables have increased which
shows that company is becoming flexible in its cash collections. Company have to stop at this
level as rising above this level may affect cash flows of company. Settlement period of payables
has gone high in 2016 from 2015 by 15 points. High settlement period shows that company is
having problems to meet its debt over short time. High ratio will give time to utilise the money
over other operations for raising returns.
The above table depict the changes in the various ratios of the company Brompton for
two consecutive years, 2015 and 2016 and the variance or changes in the ratios of two years. For
the profitability ratios no major changes can be seen means the profitability level of company
cannot change from 2015 to 2016. A shift of 10% in both current and quick ratio can be seen
which means the liquidity position of the company is not good at all. The company do not have
any outside debts so there is no interest burden on the business.
TASK 3
Discussing investment appraisal techniques
Investments needs to be evaluated and analysed in terms of benefits its is going to
provide is worthy enough or not. Following are the investment appraisal techniques :
Net present value method (NPV):
The profitability of a project or investment is assessed by ascertaining the variation
between cash inflows that will generated by investment in future and initial cash outflow.

Positive NPV means investment is profitable and should be accepted and if negative , then
should be left out.
Year Cash inflows
Discounting
factor @ 12% Discounted cash inflows
1 10000 0.893 8928.57
2 22000 0.797 17538.27
3 36000 0.712 25624.09
4 48000 0.636 30504.87
5 60000 0.567 34045.61
Total cash inflows 116641.40
Initial cash outlay 100000
NPV 16641.40
The NPV of the investment is 16641.40 which is positive & profitable. Thus, it can be
said that it should be accepted by the Brompton Bicycle Ltd.
Internal rate of return :
It means the rate which represents the NPV of all cash inflows generating from an
investment equals to 0. It is basically applied for assessing the attractiveness of the proposed
investment. An investment having a greater IRR than cost of capital of investment, then it must
be accepted. The IRR calculated to be 17.03% which is higher than the cost of capital and thus,
investment should be accepted.
Payback period:
This refers to the period in which the proposed investment will cover its costs. Lower the
payback period, higher is the attractiveness of the investment and vice-versa (Back to basics:
Investment Appraisal Techniques, 2018).
Pay back period : 3.67 years is acceptable because the time taken for recovering the cost
is lower than life of investment.
Discounted pay back period :
It refers to the time taken by an investment for recovering its costs by considering the
discounted present values of cash inflows and initial cash outflow.
Discounted payback period is 5.15 years which higher the number of cash inflows years,
thus it should not be accepted.
Year Cash
inflows
Discounting
factor @
Discounted
cash inflows
Cumulative
cash inflows
Cumulative
cash inflows

12%
1 10000 0.893 8928.57 8928.57 10000
2 22000 0.797 17538.27 26466.84 32000
3 36000 0.712 25624.09 52090.23 68000
4 48000 0.636 30504.87 82595.8 116000
5 60000 0.567 34045.61 116641.41 176000
Discounte
d pay back
period 5.15
Pay back
period
recovered in
3 & 4 year
In 3 year 68000
balance in
4th year 32000
recovery in
5th year 0.67
Pay back
period 3.41
NPV and discounted pay back period methods are considered as best method for
evaluating the profitability of an investment or project because both of the methods takes into
consideration the future value of money from which more accurate decision making regarding
the purchase of fixed asset or other investment is facilitated.
TASK 4
Approaches of business valuation
Valuation of business refers to a procedure through which an organisation focuses on
assessing the economic value of entire business or of a business unit. The purpose of valuing the
business is to facilitate a snapshot of organisation's financial health to interested stakeholders
There are different approaches through which a business can be valued such as :
Asset approach :
In here, the management of the company ascertains the value of their business on the
basis of the assets of the company. The aim of this approach is to identify the asset's fair market
value less liabilities. Basically, the valuation is done by considering the components of the
balance sheet of the business concern (Business Valuation Approaches, 2019). Under this
approach, the business is valued by using different methods such as assets accumulation method
and capitalised excess earning method.

For example, through asset accumulation method, company can determine the value of
its assets as it is the increase in the assets of financial nature through savings, investments or
earnings. It can be measured as the change in the value of investments in monetary terms,
amount which is reinvested or the change in the assets' value owned by the company.
Market approach :
In this approach, management focus on determining the value of business by comparing
the historic sales of similar businesses in the industry. Real market conditions are used for
figuring the worth of the business of an organisation. In this approach company uses
transactional data for determining the value of the company. The method includes the
transactions of public, private companies along with the measures of valuation of public
companies by using market data relating to current stock (Bowe and Van der Horst, 2016).
For example, in the business of Brampton, the management can value its business by
looking at the bases for comparisons such as sales of bicycles of similar business enterprise in
terms of size and nature located within UK.
Income approach :
Under this approach, the business is valued on the basis of the capability of company's to
yield the desired economic result for its owners. The main objective of this approach is to
ascertain the business value as a function of economic outcomes. Discounted cash flow and cap
rates are its methods which the manager uses for assessing the worth of the business.
TASK 5
Concept of ethics and its potential impact on decision making in SME’s
Ethics is a terms which signifies the beliefs or values which differentiates between right
or wrong about a phenomenon or a thing. Conducting business operation within the framework
of corporate governance and ethics aids Brompton in establishing and creating a good working
conditions. Basic ethics which the enterprises must have are integrity and trust. Business ethics
involves all the obligations which the SMEs have towards customers, employees, suppliers,
neighbours and even competitors.
Ethics greatly impacts the decision making of SMEs. For example, people desires to
work for the organisation which is high on its ethical practises. This way, ethics plays great role
in Brompton in deciding the policies and procedures relating recruiting & selection. Because
reputation of brand plays a great role in the success of the SMEs, the top management has started

incorporating ethics in the corporate policies increasingly. If an organisation behaves in the
ethical manner, its results are instantly reflected on the healthy working environment, great
reputation, amazing workforce, happy customers & suppliers. Also, ethical practises makes sure
that all the legal compliances are properly adhered by the company which helps in avoiding any
legal interference in the operations of the business. Ethical practises in Brompton are evident
through its policies such as:
 A written document which lays out all the necessary ethical codes and standards
 Training for employees, supervisors and mangers in relation to ethics
 A well established system for confidential and honest reporting of company's material
information.
Ethical practises in Brompton Ltd helps in generating and sustaining trust. Decisions
making process of the company is affected largely as moral values of the organisation decides
the culture of company, the kind of environment , an organisation have. All these things
significantly affects the productivity and proficiency of company. For example, due to the ethical
code of conduct, the company voluntarily recalled around 144000 of the bicycles in the pursuit
of safety worries regarding the defective parts in the cycles. Such a practises enhanced the brand
reputation in the market where people believed that Brompton possess high moral and ethical
values (Commuters power Brompton to 15% rise in sales, 2018).
TASK 6
Module learning log
From the subject module of Finance in SME context i have gained an insight over what a
small and medium enterprise is and how the functions are it undertaken which includes its
funding, incorporation, selection of projects, financial statement preparation, cost behaviours,
the financial and managerial accounting related with the SMEs'. I learned that to starts a Small
medium business. The main requirement is related with raising and collection of funds and
operating the business, i came to know the source of funds in the week 1 lectures over this topic.
I have learned that the financial statement for SME includes balance sheet, income statement,
and cash flow statement. From the lecture of Week 2 i gained learnings related with the financial
accounting and more precisely over the ratio analysis and its important for the SME business.
The ratio plays a vital role in the decision making process of the business and assist the
management of the business in making decision with considering the profitability, liquidity,

efficiency and investment criteria of the business. The ratios plays a vital part in comparing the
performance of the business with its past performance as well as from the competitors in the
market place. From the lecture of the third week I continued to learn over the importance and
significance of the financial ratios for the SME where I gained knowledge over the efficiency,
gearing and investment ratio. All these ratios are related with the figures presented in the
balance sheet which shows the actual performance of the business in terms of its asset, liabilities,
equity and debts. I can reflect this from my knowledge that the ratios are an important part to
analyse and evaluated the finical positions as well as performance of a business and a SME. The
module have given me insight over understanding the financial operations and structure of the
SME. From the week four lectures I got to know about the cost behaviours of SME as there are
various different cost for a business and its includes historic, opportunity, relevant, irrelevant,
fixed, variable, semi variable and other cost. All these cost are of vital importance as these assist
the production manager to identify the over all as well as unit cost of producing goods as then
determining the selling price accordingly. Overall the learnings from this module have been
immense and I have expanded my knowledge base regarding the financial and managerial
accounting related with SME.
SUMMARY
From the above report it can be concluded that a business can raise funds from different
sources which includes equity and debt finance. For the company Brompton it can be stated that
it do not have any debt finance in its capital structure rather it only has share capital and retained
earnings as source of capita. The ratio analysis depicts the financial performance of the
company. The Capital budgeting techniques assist the business in selection of profitable project
through use its difference techniques including NVP, pay back period and IRR.
REFLECTIONS
Above study shows that ratio analysis which has helped in learning impact of ratio
analysis and how they are important for organisation. They help company to analyse its
performance over various sectors. Ratios like liquidity, profitability and efficiency ratio shows
performance of company so that it can improve its position. Other investment technique like pay
back period. IRR and NPV approach enable company to make decision from its present
resources. These investment helps to find out whether the company should invest or not by

analysing future and present scenarios of company. Along with all these company is required to
follow ethics as it have significant impact on decision making of company.

REFERENCES
Books and Journals
Bowe, C. and Van der Horst, D., 2016. Business Valuation of Natural Capital; learning by
doing. Rethinking capital publication, Series 2 Natural Capital.
Cole, R. A. and Mehran, H., 2018. Gender and the availability of credit to privately held firms:
evidence from the surveys of small business finances. FRB of New York Staff Report,
(383).
Cole, R. A., 2018. Bank credit, trade credit or no credit: Evidence from the Surveys of Small
Business Finances. Trade Credit or No Credit: Evidence from the Surveys of Small
Business Finances (July 31, 2018).
Gabric, D., 2018. Determination of Accounting Manipulations in the Financial Statements Using
Accrual Based Investment Ratios. Economic Review: Journal of Economics and
Business. 16(1). pp.71-81.
Han, L., Zhang, S. and Greene, F.J., 2017. Bank market concentration, relationship banking, and
small business liquidity. International Small Business Journal. 35(4). pp.365-384.
Muritala, T. A., 2018. An empirical analysis of capital structure on firms’ performance in
Nigeria. IJAME.
Robinson, T.R and et.al., 2015. International financial statement analysis. John Wiley & Sons.
Uechi, L and et.al., 2015. Sector dominance ratio analysis of financial markets. Physica A:
Statistical Mechanics and its Applications. 421. pp.488-509.
Online
Back to basics: Investment Appraisal Techniques.2018. [Online]. Available through
<https://www.icas.com/education-and-qualifications/back-to-basics-investment-appraisal-
techniques-student-blog>
Business Valuation Approaches.2019. [Online]. Available through
<https://www.valuadder.com/glossary/business-valuation-approaches.html>
Classification of Sources of Funds.2019. [Online]. Available through
<https://www.toppr.com/guides/business-studies/sources-of-business-finance/
classification-of-sources-of-funds/>

Commuters power Brompton to 15% rise in sales. 2018. [Online]. Available through
<https://www.ft.com/content/c8657f6a-f22f-11e7-b220-857e26d1aca4>