Financial Management and Decision Making in Ethiopia: Empirical Evidence

Research Review: Financial Management and Resource Allocation

MFRD

Table of Contents
MFRD..............................................................................................................................................1
INTRODUCTION ..........................................................................................................................1
TASK 1 .......................................................................................................................................1
1.1 Internal and External Sources of finance available with the company.................................1
1.2 Implication of different sources of finance...........................................................................2
1.3 Appropriate sources of finance which can be used by the company to achieve the desired
business project...........................................................................................................................2
2.1 Cost of different sources of finance......................................................................................3
2.2 Importance of financial planning. ........................................................................................3
2.3 Information needed by different decision maker..................................................................4
2.4 Impact of finance on financial statements.............................................................................4
TASK 2............................................................................................................................................5
3.1 Analyses of budgets and its appropriate interpretation.........................................................5
3.2 Calculation of unit cost.........................................................................................................6
3.3 viability of a project using investment appraisal
technique....................................................................................................................................7
TASK 3............................................................................................................................................9
4.1 Main financial statements.....................................................................................................9
4.2 Various type of financial statements used by different company. .......................................9
4.3 Calculation of appropriate ratios. .......................................................................................10
Conclusion.....................................................................................................................................10
References......................................................................................................................................10

INTRODUCTION
Finance is the management of large amount capital that takes place in the organization. In
simple words, it can be said as the management of all investment and banking activities that
affects the assets and liability of the company. Atlantic Airlines Company is the British cargo
airline company headquartered in Coventry, United Kingdom. It operates cargo flights
worldwide, especially within the Europe as a part of West Atlantic. The present report interprets
about the various sources of finance through which company can raise its funds as well as
describes about the effects of using these methods on the practices of company. In this report,
importance of financial planning is discussed. In this, per unit cost of the company is also
calculated considering the fixed and variable cost. At last, various ratios of the company are
calculated considering the financial statements in order to find out the company’s growth rate.
TASK 1
1.1 Internal and External Sources of finance available with the company.
Internal sources of finance External sources of finance
Retained profit Retained profit is the small
amount of profit which is
deducted from the profit of
every year and is kept as a
reserve. This profit is used by
company to meet its long term
requirement (Ageba and
Amha, 2006).
Bank loan Bank loan is the small
amount of money which
company borrows from the
bank in order to fulfill its
short term requirement of
the finance.
Friends and
families
Company can also raise its
finance by borrowing it from
the friends or the family
members. This method is
normally used at the time of
starting of new business. It is
used to meet short term
Issue of
shares
Company can raise its funds
by issuing shares to the
general public in order to
overcome the long term
requirement of the finance.

requirement of finance.
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1.2 Implication of different sources of finance.
Pros Cons Suitability
Retained profit Helps to meet out
sudden requirement of
funds at the time of
emergency (Vitez,
2014).
Holding the profit as
the reserve that can
affect the
shareholder’s mind.
Is used for expanding
of business or
purchase of new
machinery.
Friends and families No security needs to
be submitted and rate
of interest is also less.
Small amount of funds
can hurt the
relationship of the
friends and families.
Suitable for making
payment to the
creditors and
suppliers.
Issue of shares Finance collected
needs not to be return
back to the
shareholders after
some time.
Dividend needs to be
paid to the
shareholders out of the
profit earned (Beaver,
McNichols and Rhie,
2005).
Suitable for expanding
business.
Bank loan Helps to meet quick
requirement of funds
by submitting small
amount of security.
High rate of interest
needs to be paid
For meeting short term
requirement of fund
like payment to the
suppliers or paying
large amount of
interest.
1.3 Appropriate sources of finance which can be used by the company to achieve the desired
business project.
Atlantic Airline Company wants to pay dividend to its shareholders because this year company is
facing some losses in its business practices. Therefore, in order to overcome this problem,
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company can raise its finance by using internal and external sources of finance (Managing
Financial Resources and Decisions. 2010). It can take fund from friends and family or if it not
possible, so company can raise its capital by taking bank loan.
Friends and Family: Atlantic company can take finance from its friends and family
members in order to make payment to the shareholders. This is one of the safe methods of raising
funds. This source can aid company to maintain its brand image in the market. In this case, rate
of interest is low.
Bank loan: Atlantic company can also raise finance in order to pay dividend to its
shareholders through bank loan (Bellas, Toudas and Papadatos, 2007). By using this method,
company will be able to raise the small amount of fund. In this method, company needs to keep
something as a security in the bank in order to avail loan. But at the same time, company also
needs to pay high rate of interest to the bank.
Thus, these are the two sources of finance through which company can raise its finance in
order to pay dividend to the shareholders.
2.1 Cost of different sources of finance.
Retained profit: It is the method which is used by company to meet the long term
requirement of finance. This profit is normally used by company to expand its business or
purchase the high price machinery (Bellas, Toudas and Papadatos, 2007). It is a type of reserves
which is kept by company out of the profit earned. But at the same time, it affects the cost of the
business. Company needs to use its reserve amount which it has kept for some other purpose.
Friends and Family: It is a method of meeting up the short term requirement of finance.
But at the same time, it can hurt the relationship between the friends and family members. If,
company is not able to pay back the money taken from the friends and family on time then it can
affect the relationship between both of them.
Issue of Shares: Issue of shares will help company to meet its long term requirement of
finance by issuing shares to the general public (Bentz, 2007). But at the same time, it will also
increase the cost of company. Atlantic company needs to pay dividend and interest to its
shareholders out of the profit earned.
Bank loan: Bank loan will aid the company to meet its short term requirement of finance
by simply paying the small amount of security to the bank. But in lieu of which cost of the
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company will increase. Company need to pay high rate of interest to the bank against the loan
taken.
2.2 Importance of financial planning.
Financial planning is the planning of all the activities in advance which in turn will assist
company to easily achieve the desired objective. Therefore, some of the importance of financial
planning is as follows:-
Reduces uncertainty: Planning of all the activities in advance will assist company to
reduce the chances of uncertainty that may take place in the organization (Cetorelli and Strahan,
2006). Condition of uncertainty arises, if proper planning is not made by the company.
Properly allocate the resources to different department: Planning of all the financial
activities in advance will aid company to easily allocate the right amount of finance to each and
every department according to the requirement of that particular department.
Avoid shocks and surprises: Financial planning of all the activities in advance will assist
company to avoid the condition of shocks and surprises. If, all the activities are planned properly
and various strategies are made accordingly, then condition of shocks and surprises can be
avoided.
2.3 Information needed by different decision maker.
There is different type of information which is required by the decision maker in order to
take necessary decisions. Therefore, some of the important information required by the decision
maker can be availed by using the most two important document of the company (i.e. financial
statements and audit report).
Financial statements: - Financial statements are the prepared in order to calculate the
growth rate of the company. It is also used by the company to find out inflow and outflow of the
cash from and within the organization. These statements are also aid the decision maker to know
the profit earned by the company (Chandra, 2011). Different types of financial statements which
can be used by the decision maker are profit & loss account, balance sheet, cash flow statements
and income statements. These statements are normally used by the manager of the company,
shareholders, general public, suppliers, creditors and the government.
Company audit report: - Company audit report is prepared by the company itself or by
the person appointed by the government. This report is prepared to find out whether any fraud
has been taking place or not. It is also prepared in order to find out the actual position of
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business. Therefore, this report is normally used by the manager in the form various strategies
and by the government in order to calculate the amount of tax which company need to pay
(Wahlen, Baginski and Bradshaw, 2014).
2.4 Impact of finance on financial statements.
Retained profit: - Retained profit will affect the liabilities of the company. Increase
retained profit will increase the liability of the company (Tulsian, 2002). Therefore, Entry of
retained profit will be shown on the liability side of the balance sheet.
Friends and family: - Borrowing of finance from the friends and family will increase the
expenses of the company because company need to pay interest to the friends and family
members from who they have collected the fund. Thus, entry of this will be shown on debit side
of the profit & loss account.
Issue of shares: - Issue of shares will increase the liability of the company and at the same
time expenses of the company will also increases (DRURY, 2013). Thus, the entry of this will be
shown at the debit side of the profit and loss account and in balance sheet under the head of share
capital.
Bank loan: - Bank loan will increase the cash of the company but at the same time its
expenditure will also increase. Therefore, entry of this will be made on the debit side of the profit
and loss account and at the liability side of the balance sheet.
Profit and loss account
Particular Amount(Dr.) Particular Amount(Cr.)
To interest paid to
friends
…..
To dividend paid …..
To interest paid to
bank
…....
Balance sheet
Liability Amount Asset Amount
Issue of shares ….... Cash(+) …..
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Retained profit ….
TASK 2
3.1 Analyses of budgets and its appropriate interpretation.
Appendix 1
From the following budget it could analyzed that company growth rate is increasing. It
outflow of cash is increasing constantly but at the same time its inflow of the cash is also
increasing which is one of the beneficial factor from the company. At the same time it could also
be concluded that Atlantic Airline Company is in good position. It is also seen that its sales is
double the purchase made.
3.2 Calculation of unit cost
Appendix 2
After calculating the unit cost at 33.33% mark up on cost price and 30% return on capital
employed it could be concluded that company should its product at 33.33% mark up price in
order to achieve high profit on selling price of per unit cost. Company is able to earn Rs. 7.32 on
selling price per unit if it chooses to sell its product at 33.33% mark up price as compared to that
of 30% return on capital employed.
3.3 Viability of a project using investment appraisal technique.
There are various techniques used by the company in order to decide which product
company need to choose. Therefore, some of the basic techniques are:-
Calculation of Payback period (initial investment = 100000)
Project A Project B
Year Cash flow Cumulative Cash flow Cumulative
1 50000 50000 30000 30000
2 60000 110000 40000 70000
3 70000 180000 50000 120000
4 80000 260000 60000 180000
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Payback period= A+ (B/C)
Where,
A= last year negative cumulative cash flow.
B=abstract value of cash flow at end of the year
C= cash flow in next year
Payback period (A) =1+ (100000-50000)/60000
=1.8333 years
(B)=2+ (100000-70000)/50000
=2.6 years
From the following calculation it could be seen that Payback period of project B is more
as compared that of project A. Therefore, Atlantic airways Company should go with project A.
Because the less payback period will assist the company to gain the capital invested with the
short period of time.
Calculation of NPV
Project A Project B
Year Amount
Discounted
value@10%
Discounted
cash inflow Amount
Discounted
value
@10%
Discounted
cash inflow
1 50000 0.909 45450 30000 0.909 27270
2 60000 0.826 49560 40000 0.826 33040
3 70000 0.751 52570 50000 0.751 37550
4 80000 0.653 52240 60000 0.653 39180
Total 199820 137040
Less- Initial
Investment 100000 100000
Net Present
value 99820 37040
From the following calculation it could be interpreted that Net present value of project A
is more as compared to project B. Therefore, in order to earn more profit Atlantic company
should go with project A.
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Calculation of IRR
Year Project A Project B
0 -100000 -100000
1 50000 30000
2 60000 40000
3 70000 50000
4 80000 60000
IRR 47.63% 24.89%
From the following calculation it could be concluded that IRR of the project A is more as
compared to project B. Therefore, in order to gain more return on investment Atlantic Airways
Company should move on with project A.
Calculation of ARR
Accounting rate of return (ARR) = Average profit/Initial Investment*100
Project A Average Profit = Total Profit/number of year
=260000/4=65000
ARR = 65000/100000*100
0.65%
Project B
Average Profit = 180000/4
=45000
ARR =45000/100000
=0.45%
From the following calculation it could be analyze that Average rate of return of project A is
more as compared to project B. Therefore, in order to increase the level of profitability Atlantic
Airways Company should move on with project A.
Therefore, at last it can be concluded that Atlantic Airways Company should go with project
A in order to gain the profit and quick recover the amount invested. If it wants to increase its
level of profitability and quickly earn profit on the investment made.
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TASK 3
4.1 Main financial statements.
Profit and loss account: - Profit and loss account contains all type of income and
expenditure made by the company during the financial year (Hursti and Maula, 2007). It aids the
company and other shareholders to know the amount of net profit earned by the company at the
end of every financial year. These statements are used by the managers, shareholders, general
public, employees and government in order to now company current market position, profit
earned, amount of taxes paid and to prepare various activities.
Balance sheet: - Balance sheet contains all the asset and liability left out with the company
at the financial year. It shows whether the company position is good or bad. If liability of the
company is more as compared to its assets than it can be said that company position is not good.
This statement is used by the government, shareholders and the manager in order to find out the
liquid cash available with the company and what company growth rate is.
Cash flow statements: - Cash flow statement contains all the transaction made in cash and
in cash equivalents. These all transaction all divided into three different activities (i.e. operating,
financing and investment activity). This statement is used by the manager in order to found out
the flow of cash from and within the organization (Peterson and Fabozzi, 2012). This statement
is also used by the manager to prepare various strategies.
4.2 Various type of financial statements used by different company.
Ltd. Company:- Both private and public ltd. Company need to prepare all type of
financial statements like income statements, profit and loss account, balance sheet and cash flow
statements (Ryan, 2005). Preparation of all these statements under the government law.
Preparation of these statements helps the company to find out the amount of profit earned by
them and what is its growth rate.
Partnership: - Partnership firms are the firms which are owned by two or more persons.
This firm is required to prepare only income and expenditure accounts. Preparation of other
statements is not compulsory. They prepare these statements in order to find out the profit earned
by the company at the of financial year.
Sole proprietorship: - Sole proprietorship firm is one individual owned firm operated by
single individual. These firms are required to prepare only receipt and payment accounts, journal
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and ledger in order to record the daily transaction made (Thomas, 2008). These accounts aid the
firm to find out the income and expenditure made by the company profit earned at the end of the
year.
4.3 Calculation of appropriate ratios.
Appendix 3
After calculating the profitability, liquidity and activity ratio of the Atlantic company it can
be interpreted that financial position of the company is relatively good. Company has faces a
decline in its profit margin in the year 2013 as compared to that of year 2012. The reason behind
this could be that number of competitors has increased or its expenses increases than income
generated. But at the same time it is also interpreted that company is able to overcome the
declining condition faced by the company in the year 2013 as compared to 2014. In 2014
company is able to increase its level of profit earned. The reason behind this could be that
company is able to reduce its expenses. Another reason could be that company has started
conducting research and development in order to beat its customers and prepare various
successful strategies.
Conclusion
The following report emphasis on the various sources of finance available with the company
in order to meet its short term and long term requirement of finance. In this report importance of
financial planning is also discussed. In this report imaginary data is taken in order to calculate
the unit cost and to prepare the cash budget. In this report various ratios are also calculated by
considering the financial statements of Atlantic Airways Company. These ratios are calculated to
find out the market position and growth rate of the company.
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References
Books and journal
Ageba, G. and Amha, W., 2006. Micro and small enterprises (MSEs) finance in Ethiopia:
Empirical evidence. Eastern Africa social science research review. 22(1). pp.63-86.
Beaver, W.H., McNichols, M.F. and Rhie, J.W., 2005. Have financial statements become less
informative? Evidence from the ability of financial ratios to predict bankruptcy. Review
of Accounting Studies. 10(1). pp.93-122.
Bellas, A., Toudas, K. and Papadatos, K., 2007. The consequences of applying International
Accounting Standards (IAS) to the financial statements of Greek companies. In 30th
Annual Congress of European Accounting Association, Lisbon-Portugal.
Bentz, R. P., 2007. Acquiring and managing financial resources.
Cetorelli, N. and Strahan, P.E., 2006. Finance as a barrier to entry: Bank competition and
industry structure in local US markets. The Journal of Finance. 61(1). pp.437-461.
Chandra, P., 2011. Financial management. Tata McGraw-Hill Education.
DRURY, C.M., 2013. Management and cost accounting. Springer.
Hursti, J. and Maula, M.V., 2007. Acquiring financial resources from foreign equity capital
markets: An examination of factors influencing foreign initial public offerings. Journal
of Business Venturing. 22(6). pp.833-851.
Peterson, P. P. And Fabozzi, J. F., 2012. Analysis of financial statements. 2nd edition. John Wiley
& Sons.
Ryan, J.F., 2005. Institutional expenditures and student engagement: a role for financial
resources in enhancing student learning and development?. Research in higher
education. 46(2). pp.235-249.
Thomas, H.G., 2008, Managing Financial Resources. Open University Press .
Tulsian, C. P., 2002. Financial Accounting. Pearson Education India.
Wahlen, J., Baginski, S. and Bradshaw, M. 2014. Financial reporting, financial statement
analysis and valuation. Cengage Learning.
Online
Managing Financial Resources and Decisions. 2010 [pdf]. Available
through:<http://www.etclondon.com/index_htm_files/Selected-HNC-in-Business-units-
Unit-2-Managing-Financial-Resources-and-Decisions.pdf> [Assessed on 17th December
2015].
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Vitez, O., 2014. Sources of Finance Medium Term Borrowing[Online]. Available
through:<http://www.ehow.com/facts_5652982_sources-finance-medium-term-
borrowing.html>. [Accessed on 17th December 2015] .
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Appendix
3.1
Cash budget
July August September October November December
Opening bank
balance 10000 15500 22000 29400 38400 54200
Revenues
Cash sales 20000 22000 24000 26000 30000 32000
Total inflow 30000 37500 46000 55400 68400 86200
Expenditure
Cash purchases 5000 6000 7000 7000 4000 6000
Payment to suppliers 3000 3200 3300 3500 3600 3800
Payment of rent 4000 4000 4000 4000 4000 4000
Other expense 1000 800 800 1000 1100 1200
Repayment of loan 1500 1500 1500 1500 1500 1500
Total outflow 14500 15500 16600 17000 14200 16500
Closing cash balance 15500 22000 29400 38400 54200 69700
3.2
33.33 % mark-up on cost price 30 % return on capital employed
Direct cost 100000 Direct cost 100000
Fixed Cost 10000 Fixed cost 10000
Total Cost 110000 Total cost 110000
Units 500 Units 500
Cost per unit 220 Cost per unit 220
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