Business Finance and Accounting Concepts

This assignment delves into fundamental business finance and accounting principles. It covers the preparation of key financial statements such as income statements and balance sheets for sole traders and partnerships. Additionally, it examines various sources of finance available to businesses.

Managing Financial Resources
and Decisions

Table of Contents
INTRODUCTION...........................................................................................................................1
TASK 1............................................................................................................................................1
1.1 Sources of finance for unincorporated and incorporated businesses....................................1
1.2 Implication of using internal and external sources of finance..............................................2
1.3 Appropriate source of finance for Clariton...........................................................................3
TASK 2............................................................................................................................................4
2.1 Analysing cost of financial sources.......................................................................................4
2.2 Importance of financial planning..........................................................................................5
2.3 Assessment of information for making financing decisions.................................................6
2.4 Impact on financial statements..............................................................................................7
TASK 3............................................................................................................................................8
3.1 Cash budget...........................................................................................................................8
3.2 Calculation of unit costs for making pricing decisions.........................................................9
3.3 Assessment of viability of projects.......................................................................................9
TASK 4..........................................................................................................................................11
4.1 Financial statements components........................................................................................11
4.2 Financial statement formats................................................................................................11
4.3 Comparison of financial ratios............................................................................................13
CONCLUSION..............................................................................................................................16

INTRODUCTION
Financial management can be determined as an effective and efficient management of
funds of the company. It means the financial activities of procurement and utilisation of funds
are properly planned, controlled, directed and organised in order to achieve organisational
obejctives.. The main purpose of financial management is that the adequate funds are available
and utilised in an optimum manner to ensure profit maximisation and sustainability of the
enterprise (Loorbach and Rotmans, 2010). For ensuring that, the operations of an organisation
are carried out smoothly and it is essential to have a sound capital structure which can be ensured
by effective financial management strategies. The present report discusses about Clariton
Antiques Ltd. which is in partnership of four partners and it has been started as an
unincorporated firm. It has grown steadily over the time and established goodwill in London
market and now it is planning to acquire a building for opening one more branch.
In this study, various sources of finance that can be used by Clariton are discussed for the
said purpose. Further, it analyses the implications of using external and internal; sources of
finance. Moreover, it provides an understanding of venture capitalists and financial brokers as a
source of finance.
TASK 1
1.1 Sources of finance for unincorporated and incorporated businesses
a) Unincorporated businesses
These types of business do not have separate identity from its owners who are fully liable
for all activities of the business. The main examples of unincorporated businesses are
partnerships, sole proprietorship and the family trusts (Bradley, Wiklund and Shepherd, 2011).
There is no legal registration and the liability is limited.Clariton is operating as an
unincorporated business and the following sources of finance are available to it: Personal Savings: One of the main sources of finance which can be used by Clariton
Antiques Ltd. is personal savings. The owners and partners of the business invest their
savings or capital which can be used for expansion and the growth purposes. The main
advantage is that interest cost is saved because the company is not liable to pay interest to
the lenders.
 Bank loans: Another major source of finance that can be available to an unincorporated
business Clariton is taking loan from the bank. The bank will charge interest at a
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specified rate on the loan amount till the repayment of loan.. The company have to
provide some security or personal guarantee at the time of availing loans (Simonovic,
2012). It will increase the cash flow and thus will help in attaining firm's goals.
b) Incorporated business
When a company carries out legal procedures to get registered, it is known as
incorporated businesses. They are considered as the legal entities in the eyes of law and have
separate identity from its owners. Moreover, they can sell stock shares of investors for raising
money and can avail various tax benefits. The main sources of finance available to the
incorporated businesses are: Retained earnings: It is one of the major internal sources of finance which can be used
for raising the capital. It is the profit which is not distributed among shareholders and is
retained by the business. It is also known as ploughing back of profits (Huston, 2010). It
is quite beneficial as there is no interest cost or floatation cost involved and also there is
no dilution of control of the company.
 Venture capital: It is the source of financing which is provided by the investors in small
or start up companies that have long term growth potential. The main advantage is that
funds are available for expansion and development purpose.. But the major limitation is
loss of control as the investors would like to involve in the decision making of business.
1.2 Implication of using internal and external sources of finance
a) Internal sources
The funds which are generated internally by a business are retained earnings, personal
savings, and sale of assets by business etc. These are the own funds of the company that can be
utilised for its expansion. Retained earnings: The amount of profits that is retained by a company and is not
distributed as dividend to the shareholders is known as the retained earnings. The process
of utilising the retained profit as a source of finance is known as the ploughing back of
profits. There is no issue cost and interest cost involved in this source of finance. Further,
as there is no involvement of the third party so there is no dilution of control
(Fischhendler and Heikkila, 2010). Thus, retained earnings do not lead to dilution of
control and ownership. Moreover, there are no legal formalities which are required to be
complied while using retained earnings as a source of finance. Therefore, there is neither
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economic implication nor legal implications that have to be faced by Clariton Antiques
Ltd. for using retained earnings.
 Sale of assets: It is a short term source of finance which can be used for raising money
(Öberseder, Schlegelmilch and Gruber, 2011). Clariton Antique Ltd. can sell its assets in
the market and utilise the fund raised through the sale of assets for acquiring the building
to open a new branch. There are no interest cost and issue cost associated with this.
Moreover, there is no dilution of control or ownership. The company has to enter into a
legal agreement for selling assets, so there would be some legal implications that the
company will face.
b) External sources
The funds that are raised from the external market are external sources of finance like
bank loans, equity shares etc. and it involves timely repayments of amount.
- Bank loans: One of the major sources of finance is borrowing money from banks which
involves payment of interests at the fixed intervals and timely repayment of loans. Clariton
Antique Ltd. needs to provide security or personal guarantee for availing the loan. Thus, there is
economic implication on the company as it is required to pay timely interests and also bank can
demand security (Sources of Finance, 2017). A legal agreement is made between financial
institution and borrower so in case of failure of repayment, the agreement provides the right for
recovery of loan. So, legal implications can arise in case of failure of repayment of loan at the
specified time.
 Equity shares : The company can also raise funds through issue of equity shares. Various
procedural formalities are required to be complied before opting this as a source of
finance, so there is legal implication. Also, dividend is required to be paid to the
shareholder which causes economic implications. Moreover, there is dilution of
ownership as shareholders become the owners of the company and can influence decision
making in the organisation.
1.3 Appropriate source of finance for Clariton
Clariton Antique Ltd. is engaged in the business of selling antiques in and for this it
purchases products from the suppliers and then, sell them in the market. The company wishes to
expand its business and for this, additional funds are required. But before opting any source of
finance, it has to consider the implications and costs related with different sources of finance.
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The best alternative through which Clariton can raise funds is availing a bank loan because the
repayment schedule is quite simple and the company is in a position to meet its repayment
obligation within the time frame (Finkler, Smith and Purtell, 2016). Moreover, there would be no
dilution of control and ownership that will enable the firm to carry out its operations effectively.
Also, the interest rates are low for small businesses and various tax benefits are available.
Therefore, it is the most appropriate source of finance for Clariton Antiques Ltd.
Another source of finance which can be used by the firm is through retained earnings i.e.
company can utilise its own funds for the expansion purpose. This is beneficial as there is no
need of interest payment and company would not be liable in case of failure of repayments.
Further, control is not diluted, so there is no change in ownership that helps the company to
make decisions without any interruption by others. Moreover, there are no legal implications
involved in this source of finance.
TASK 2
2.1 Analysing cost of financial sources
There are two ways of measuring cost of raising funds – equity and debt. Cost of debt is
determined as an effective rate that is paid by the company on the amount of its current debts.
The best example of debt financing is bank loan (Verbeke and Tung, 2013). Cost of equity
means the return of investors i.e. the amount that is paid by the company to its shareholders. We
Finance Ltd. is a venture capitalist who are engaged in making investments in small or start up
businesses that have potential for long term growth like Clariton Antiques Ltd. and in return
wants to have a stake in the company. On the other hand, financial brokers are the persons who
helps in arranging funds for the organisation. They help in availing bank loans and in return
charge commission. Both these are important sources of finance for the company. The costs of
these funds are mentioned hereunder :
a) Dividends : Dividend can be determined as a return that is provided to the shareholders of the
company for investing their money in the company. This cost will be incurred by Clariton, if it
go for venture capital as the investors have legal right to get entitled for dividend. Thus, it
increases the financial burden on the company. Moreover, venture capitalists are demanding 20%
stake in the company which is a high rate and lead to dilution of control.
b) Interest : When the company borrows loan from a bank, it is required to pay interest at a
timely interval. If Clariton goes with financial brokers to avail bank loan, then, it would be
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required to pay annual interest that would create liabilities on the company for long term. Interest
is a cost for the firm that reduces its net profit (Shehu and Akintoye, 2010). In addition to this,
1% brokerage is an additional cost for Clariton Antiques Ltd. For example – if it takes a loan for
£10,00,000 and the interest rate charged by the bank is 2% annual then cost would be:
= £1000000*2% + £10,00,000*1%
= £20000 + £10000
= £30000; will be the cost of interest if cited firm borrows money from a bank.
c) Tax : The company is required to pay tax at a specified rate on the income earned and
that is a cost for the organisation. For instance, tax rate is 30%, then, the cost can be
calculated as
= £10,00,000* (1-0.3)*2%
= £14000 + 1% brokerage
= £14000+ £10000
= £15000
2.2 Importance of financial planning
Financial planning can be defined as the process where financial resources are utilised
effectively and efficiently for the purpose of accomplishment of organisational objectives. It
enables the enterprise in determining its future capital requirements and for maintaining contro l
over the costs (Bunse, Vodicka and Ernst, 2011). Economic forecasting is a tool that aids an
organisation in effective cash management and making viable investment decisions. It helps in
minimizing risk as firm can make a reasonable forecast of future decisions. It actively monitors
the financial activities of the organisation and make comparison of actual revenues. It is
imperative to make proper coordination between different functions of the organisation such as
sales, finance, production etc. on order to control overall cost and achieve the objectives of the
organisation.
a) Budgeting : Budget is an essential tool that can affect the overall operations of a business. IT
helps in analysing future and make plans accordingly. It is a summary of income and expenditure
of an entity that is made item wise. It is an indispensable tool in the hands of manager that assist
in prioritizing the spending and proper managing of cash in the business. Effective financial
planning helps in formulation of proper budget. It will ensure that there is neither shortage nor
surplus of funds in Clariton Antiques Ltd.
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b) Implication of failure to finance adequately: Ineffective and improper financial decisions
can adversely affect the performance of a business. Economic forecasting helps the management
of Clariton Antiques Ltd. in making proper economic decisions which would minimize the risk
of failure (Molly, Laveren and Deloof, 2010). Moreover, it assist in managing the inventories of
the firm that would help in meeting customer demands and ensure there is no surplus inventories
that increases the carrying cost of stock.
c) Overtrading : Clariton Antiques Ltd. is engaged in the business of selling antiques and
for this, it purchases products from suppliers and then sell in the market, so, it is critical
for the firm to first identify the demand in the market and then order goods accordingly.
Financial planning helps in minimization of over trading issues. It assist in raising the
cash inflows of the company and reducing any kind of wastages.
2.3 Assessment of information for making financing decisions
For making effective economic decisions, it is essential to have financial information.
The details regarding profit and loss account, balance sheet, assets and liabilities, expenditure,
sales and purchase and profit are major information that should be known to individual for
making financing decisions.
a) The partners : The operations of Clariton Antiques Ltd. are carried out by its four partners
who have invested their money for starting the business and also for its expansion and
development (Wolf, 2011). Various information is required before making investment such as
profit sharing ratio, solvency ratio, liabilities, gearing ratio, inventory turnover ratio and other
market requirements. This helps in effective decision making and to forecast returns on the
amount invested in the business.
b) Venture capitalists : We Finance Ltd. are willing to invest money in Clariton Antiques Ltd.
But before making investment decisions, it needs to have information about dividend policy,
current liabilities of the company, profit history, gearing ratio, market worth, income generating
capacity etc. All these details assists venture capitalists to take effective decisions.
2.4 Impact on financial statements
The impact of venture capitalists and finance broker would be different on the financial
statements of Clariton Antiques Ltd.
a) Venture capitalists
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If the investment is made by We Finance Ltd., it would greatly affect the financial
statements of the firm. The venture capitalists wants to have a strake of 20% in the business,
which will lead to increase in expenditure of the firm that would be reflected from the income
statement. In addition to this, as they are making investment in the company, so they will
become shareholders and would be entitled to dividend (Venture Capital, 2017). Thus, payment
of dividend would become a liability of the firm and impact the balance sheet. But, the
substantial investment made by them will set off this liability as asset side will get stronger due
to increase in capital. There would be impact on the cash flow statements of the firm due to
increase in cash flows as a result of investment made by We Finance Ltd. in the firm. Therefore,
if Clariton Antiques Ltd. goes with venture capitalists, then, it would have impact on major
financial statements of the entity including income statement, balance sheet and cash flow
statement.
b) Finance broker
Financial brokers act as an intermediary between entities and financial institutions. If
Clariton Antiques Ltd. go with finance broker to avail a loan from the bank, then, it will have to
pay commission or brokerage to the brokers and make scheduled payment of interest to the bank.
This will increase the expenditure side of Profit and Loss account and thus, have impact on P&L.
The long term liabilities of an organisation increases when loan is taken from financial
institutions (Michalski, 2012). Borrowing amount from bank will have impact on the balance
sheet of the firm. Increase in capital would positively impact the asset side of the balance sheet.
Moreover, cash flow statement of the firm would get affected as investment would lead to
increase in cash flows. On the other hand, payment of interests and brokerage will be treated as
expenses or cash outflows.
TASK 3
3.1 Cash budget
Cash budget is estimation of outflows and inflows of a cash over a specified time period
of an organization. It ensures that the entity has adequate and sufficient funds to carry out its
operations (Fischhendler and Heikkila, 2010). It also helps in developing effective strategies so
that managers can control any excess costs incurred.
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It can be interpreted from the above cash flow that Clariton Antiques Ltd. was not
generating cash revenues in the initial months as its cash payments were more than the sales. It
can be seen that the income in the month of January is £157500 that is very low as comapred to
its payment which was £807250. As negative cash balances are depicted from the cash budget, it
can be stated that in the beginning, the cash management was not effective in the firm. But after
that the company has controlled its expenses and was able to meet its liabilities. The company
needs to improve its revenues that can be done by increasing cash flows of the entity. Trade
discount can be offered to the customers for enhancing cash flows of the firm. This would help in
gaining attention of more users and hence, increasing profitability of the company.
3.2 Calculation of unit costs for making pricing decisions
The sum total of all the expenses that are incurred by an organisation to produce one unit
is known as unit cost. Clariton Antiques Ltd. is not engaged in manufacturing of antique items, it
purchases goods from suppliers and sell them in the market. There are mainly two types of costs
– fixed cost and variable cost. Fixed costs are the ones that do not vary with production or
demand of goods and services i.e. they remain constant (Huston, 2010). For example – rent of
premises, salaries of staff etc. On the other hand, variable expenditures are dependent on the
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production and demand of products and vary according to them. For example – transportation
costs, utility bills etc.
Unit cost= Fixed + variable costs / total no. of units produced
Say, for example – company wants to purchase 5000 units of antiques, rent paid is £18000,
salaries to staff is £17000, transportation costs are £15000 and utility bills amount to £10500, in
this case unit cost will be calculated as follows :
Unit cost = [(18000 + 17000) + (15000 + 10500)] / 5000
Unit cost = £12.1
Pricing decision : Selling price of a unit can be easily determined with the help of unit cost using
this formula -
Selling price = Unit cost + (Unit cost * percentage of profit)
For instance, if the cited organisation wants to earn a profit of 15% and unit cost is £12.1 (as
calculated above), then selling price can be calculated as follows :
Selling price = £12.1 + (£12.1*15%)
= £13.915
Thus, if Clariton Antiques Ltd. sells its item @ £13.915, then, it would be able to earn 15%
profit.
3.3 Assessment of viability of projects
The methods that are used by organisations for making investment decisions and
ascertaining the feasibility of the project is known as investment appraisal techniques
(Simonovic, 2012).
1. Net Present Value : It is the difference between present value of cash inflows and
outflows and help in determining profitability of a project.
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Thus, investing in project 1 is a better option as its NPV is greater.
2. Average rate of return : It helps in assessing the percentage of profit on investment
(Bradley, Wiklund and Shepherd, 2011).
Both projects are viable as they are giving return above 35% but the company should opt for
project 2 as it provides higher ARR.
3. Pay back period : It helps in identifying real time in which invested amount would be
recovered by the firm (Loorbach and Rotmans, 2010).
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Both projects are able to give returns before 3.5 years so both are feasible but project 2 should be
opted as it is taking less time.
TASK 4
4.1 Financial statements components
Following are the components of financial statements which are as follows-
 Income statement- Main component of income statement is profit and loss. Thus, it helps
in managing cash so that net profit can be obtained by firm.
 Cash flow statement- It involves cash inflow and outflow that helps in managing the
value of cash within Clariton Antiques Ltd so that proper management of cash could be
done (Bessen and Meurer, 2013).
 Statements of changes in equity and gains- Retained earnings and shareholder equity are
the major components within such statement.
 Financial statement position- It involves assets, liabilities and equity as the major
component and helps in managing financial position of firm.
 Notes to the financial statement- It involves the disclosures that helps investors in
ascertaining the actual background of cited firm (Croce, Grilli and Murtinu, 2014).
4.2 Financial statement formats
Sole trader- In such type of firm it involves single entrepreneur and thus do no aim to prepare
balance sheet. They only focus upon maintaining income statement and involve income and
expenditure so that net profit could be identified (Deffains-Crapsky and Sudolska, 2014).
However, corporate tax also needs to be assessed within it so that it helps sole trader to
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comfortably prepare profit and loss statement. They are also liable to follow international
accounting standard.
Illustration 1: Income statement of sole trader
Illustration 2: Balance sheet of sole trader
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Partnership firm- Here, cited firm I,e, Clariton Antiques Ltd is partnership firm and thus need to
share profits among its partners as per their investment done. They also need to show income tax
returns within their income statement (Mayordomo, Peña and Schwartz, 2014). Further,
preparing balance sheet is essential for all the partners to identify their assets and liabilities.
Illustration 3: Balance sheet of partnership firm
Illustration 4: Partnership firm income statement
4.3 Comparison of financial ratios
Profitability ratio- It helps in possessing the ability to generate income within accounting year.
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Through evaluating the operating margin ratio, it helps in showcasing the operating profit
margin of business and generating operating income. Within the year 2015, operating profit was
3.77% while in 2016 it was 4.54%. Thus, it means that Clariton aims to manage its costs and thus
generate good source of income within its next branch also. While, the Gross margin ratio
showcases t hat profit that is generated has been decreased from 14.34% to 14.18%. Thus, it can
be showcase that cost of goods sold has been enhanced and thus it helps in increased net margin
ratio of firm. However, debt amount of irm has been minimized as it has decreased from 1.89 to
2.63%.
Liquidity ratio- Through evaluating the given figures it helps in measuring by the lenders.
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Current ratio has been dividing liabilities from total assets. It can be evaluated that actual
liquidity position of business helps in measuring by managers. In 2015 it was 2.41 to 2.48 in
2016. Quick ratio helps in showcasing the liquidity assets and thus easily convert into cash
whenever firm requires. Thus, it helps Clariton to pay its outstanding amount on time.
Gearing ratio- It helps in comparing the borrowed funds with equity.
It can be assessed that in the year 2015 it was 0.16 and it raised to 0.19 in 2016 which
means that debt amount upon firm has been increased.
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CONCLUSION
It can be concluded from the study that it is essential for business to manage its financial
resources so that effective decisions could be made regarding making investment. All the
financial decisions needs to be taken by the firm in regard to make proper actions. It has been
evaluate that Clariton financial performance is good a compared to previous year.
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