Business Finance: Working Capital, Funding & Investment Appraisal

This report provides a comprehensive overview of business finance, starting with an analysis of working capital and its importance for long-term survival, highlighting the role of accounts receivables, payables, and inventory management. It then assesses the suitability of internal finance sources like retained profits, sales of stock, and asset liquidation, followed by an examination of external finance options such as equity shares, bank loans, and factoring. The report further applies capital investment appraisal techniques, including NPV, IRR, and payback period, to a practical investment decision scenario for ABC Limited, demonstrating how these tools aid in evaluating investment feasibility. Finally, it applies cost-benefit analysis to the same investment, calculating the cost-benefit ratio to determine the economic viability, concluding that the investment is economically feasible based on the analysis. Desklib offers a wide range of similar solved assignments and study resources for students.

Business Finance
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Table of Contents
Introduction......................................................................................................................................3
Task 1...............................................................................................................................................4
1.1 Analyze the constituent parts of working capital......................................................................4
1.2 Justify its importance for the long-term survival of a company................................................4
Task 2...............................................................................................................................................5
2.1 Assess the suitability of three different internal sources of finance for particular business
needs................................................................................................................................................5
Task 3...............................................................................................................................................6
3.1 Judge the appropriateness of three different external sources of finance for particular business
needs................................................................................................................................................6
Task 4...............................................................................................................................................6
4.1 Apply the techniques of capital investment appraisal to making a particular investment
decision............................................................................................................................................6
Task 5...............................................................................................................................................9
5.1 Apply the techniques of cost benefit analysis to making a particular investment decision.......9
Conclusion.....................................................................................................................................11
Reference list.................................................................................................................................12
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Introduction
Finance is an integral part of every organization. Management of finance is a major function for
every business. Starting from ensuring the survival of a business during odd times to bolstering
the success during good times, finance is a significant part of every business. Managing finance
in a business helps the business in influencing the abilities of the business such as license
acquiring, development and expansion into new markets, purchase of inventories and other
services, employment of staff, etc. This report discusses about the various aspects of business
finance along with showing how a company can be managing its finances with the application of
various tools and techniques.
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Task 1
1.1 Analyze the constituent parts of working capital
Working capital refers to the financial metric, which is used in an organization for representing
the operating liquid position of the organization that is available to it (Banos-Caballero et al.,
2014). Any organization can be calculating its working capital through the computation of the
difference between its current assets and current liabilities. The current assets and the current
liabilities of a company are the two important components of the working capital of the
company. As stated by Bhattacharya (2014), the working capital can be segregated into the
following constituent parts -
 Accounts receivables - The amount of money due to a company from its customers to
whom the company had sold off goods at credit is known as accounts receivables. Also
called sundry debtors or simply debtors, accounts receivable is a major constituent part of
working capital.
 Accounts payables - The amount of money payable by a company to its suppliers from
whom the company had purchased goods and services for producing them to its
customers on credit is known as accounts receivables. Also called sundry creditors or
simply creditors, accounts payable is another major constituent part of working capital.
 Stock in hand or inventories - The primary assets of a company, which it converts to
revenues earned from sales are the inventories of the company. Higher value of
inventories leads to higher working capital. However, in case if inventories are
abnormally high, it is an indication of wasteful use of the company’s working capital.
1.2 Justify its importance for the long-term survival of a company
It is necessary for every business to ensure strong and effective working capital management.
Effective management of working capital helps a company in different ways and ensures it long-
term survival (Corelli, 2016). As stated by Sagner (2014), a company can be ensuring long-term
survival due to the following points -
 Working capital helps a company in improving its credit profile and its solvency
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 It assists a company in generating better returns from the capital invested by it
 It leads a company towards the generation of higher profits with the help of effective
management of receivables and payables
 Working capital also helps a company in increasing its value through the generation of
free flow of cash
 It acts as competitive advantages of various businesses
 It helps a company in increasing the capacity of the company for facing various shocks
and surviving even when there is excess demand in the market
 Lastly, it facilitates a company in continuing the production of its goods and services
without any interruption
Task 2
2.1 Assess the suitability of three different internal sources of finance for particular
business needs
Financing helps a company in various ways, for example helping in expanding long-term
projects, assisting in introducing new goods and services, etc. (Aliona, 2017). As stated by
Peirson et al. (2014), there are various sources of finance, which are internally available in a
company. A few of them are as follows -
 Retained profits - As stated by Storey et al. (2016), retained profits can be referred to as
the profits of a business that have been retained after distributing dividends to all its
stockholders. This amount retained can be utilized in a company for different purposes
such as capital expenditure, acquisition or merger, marketing, expansion into new
markets, etc.
 Sales of stock - According to Fields (2016), the stock of a company that has remain
stagnant for quite a while can be sold off at discounts for freeing up the availability of
cash in the company. Funds can be generated quickly through this internal source of
finance and utilized for various purposes.
 Sale of assets - Fields (2016) also opined that the assets of a company could also be sold
in order to generate funds for the company. Selling the old and obsolete assets of a
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company even at scrap value helps a company in financing its other operations such as
manufacture of new goods and services, purchase of new inventories, etc.
Task 3
3.1 Judge the appropriateness of three different external sources of finance for particular
business needs.
Sources of finance are available in a company externally as well (Storey et al., 2016). The
following are the three major external sources of finance for meeting particular business needs of
a company -
 Issue of equity shares - A business can be acquiring huge amount of funds from issuing
equity share capital to the public (Abor, 2017). This external source of financing is
beneficial for a company, as it is not mandatory to pay any interest to the shareholders
and can be used for meeting business needs such as investment in capital projects.
 Bank loans - A business can also be taking loans from banks that have to be paid within
a fixed time along with the rate of interest that had been decided to be paid when the loan
is taken (Qian and Yeung, 2015). Bank loans are advantageous as they are cost effective
and flexible.
 Factoring - Factoring refers to the source of financing in which the invoices of a business
are sold to any third party at discounted rates (Michalski, 2014). This source of financing
helps a business in order to meet up all the immediate and present requirements of cash in
a business.
Task 4
4.1 Apply the techniques of capital investment appraisal to making a particular investment
decision.
Investment appraisal is important to be conducted by every business before making investment
decisions (Gotze et al., 2015). This is because capital investment appraisal helps a business in the
determination of the potential risks involved in a business and the profits that a business can be
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determining from its investments. Gotze et al. (2016) opined that capital investment appraisal
assists a company in measuring investment feasibility and selecting the best alternative among a
number of potential investments.
There are various types of investment appraisal techniques, which help a company in analyzing
the economic feasibility of an investment from various different aspects. For example, the NPV
technique helps a company in analyzing the profits from its investment through the comparison
of the present worth of outflows and the present value of future inflows (Ben-Horin and Kroll,
2017). As stated by Brigham and Houston (2015), the IRR is another investment appraisal
technique, which measures the returns of a company from its investment at the point where the
investment’s NPV is zero. Another effective investment appraisal technique is the payback
period, which accounts for the time needed to recover the amount of money that has been
initially invested for a business (Lane and Rosewall, 2015).
For example, let it be considered that ABC Limited is a company, which has planning to
introduce a new range of products in the UK market. However, in order to do so, the company
requires investing an amount of 15 million. The estimation of the cash inflows in the company
for the next five years after the introduction of this new range of product is as follows -
Year 1 - 6 million
Year 2 - 9 million
Year 3 - 11 million
Year 4 - 15 million
Year 5 - 20 million
As per the above cash inflows and outflows of cash in the company, the following portion
contains the evaluation of the economic feasibility of the investment of the company -
NPV
Particulars Cash flow (in millions)
Initial investment - 15
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Year 1 6
Year 2 9
Year 3 11
Year 4 15
Year 5 20
Cost of capital 10%
NPV 26.20
IRR
Particulars Cash flow (in millions)
Initial investment - 15
Year 1 6
Year 2 9
Year 3 11
Year 4 15
Year 5 20
Cost of capital 10%
IRR 57%
Payback period
Particulars Cash inflow Cumulative Cash
Inflow
Initial investment - 15 - 15
Year 1 6 - 9
Year 2 9 0
Year 3 11 11
Year 4 15 26
Year 5 20 46
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Therefore, as per the information derived above, the payback period of ABC Limited’s
investment is as follows -
Payback period = 1 year + (9 / 9)
= 1 + 1.0
= 2 years
The calculations above indicate that the potential investment of the company ABC Limited has
the NPV of 26.2 million while the IRR of the investment is 57%. On the other hand, the payback
period of the investment is 2 years. This shows that the NPV of the investment is positive in
nature while the IRR of the investment is also quite high. It can also be analyzed that the
payback period of the investment is 2 years, which is also quite low and satisfactory in nature.
Therefore, from the application of investment appraisal techniques it can be evaluated that ABC
Limited’s investment is economically feasible and the company should be accepting the
investment. Thus, in this manner, various types of investment appraisal techniques can be used
and applied in a company for making decisions on capital investment.
Task 5
5.1 Apply the techniques of cost benefit analysis to making a particular investment
decision.
The cost benefit analysis is also an efficient tool for making investment decisions of a company.
As stated by Boardman et al. (2017), the cost benefit analysis is an analytical framework that
assists a company in assessing the costs spent by it and the benefits of the investments and
policies proposed to the company. This technique focuses on the economic efficiencies of
investments through computation of net advantages that a company could be determining from
its investments. Comparing and evaluating the benefits and costs of a company in making
investment decisions. As stated by Josselin and Le Maux (2017), cost benefit analysis of every
investment can be performed using the computation of the cost to benefit ratio of that
investment. This ratio can be calculated using the comparison of the total costs and total benefits
of any investment.
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The cost benefit analysis can be done on the investment of ABC Limited as well. The following
discussion shows the calculation of the cost to benefit of the company ABC Limited -
Total cost needed for the investment = 15 million
Benefits to be earned from the investment = 6 million + 9 million + 11 million + 15 million + 20
million = 62 million
Consequently, cost benefit ratio = 61 million / 15 million = 4.066 = 4.07 million
Thus, the from above calculation, it can be determined that the cost to benefit ratio of ABC
Limited’s investment is 4.07. Since the cost benefit ratio is quite higher than that of 1.0, it can be
stated that the investment is economically feasible. Hence, in the same manner, cost benefit
analysis helps in making capital investment decisions in various other companies as well.
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Conclusion
Thus, from this report, it can be analyzed that business finance is vital for every business. It can
also be that finance has a significant role in every business along with analyzing the benefits and
constituents of working capital. The report helps in reviewing various external and internal
sources of finance such as retained earnings, share issue, bank loans, etc. From this report, it can
also be evaluated also be evaluated that cost benefit analysis and investment appraisal techniques
play a significant role for making capital investment decisions, which in turn helps in managing
finances.
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Reference list
Abor, J.Y., 2017. Venture Capital Finance. In Entrepreneurial Finance for MSMEs (pp. 87-105).
Palgrave Macmillan, Cham.
Aliona, L., 2017. Improvement of financing sources’ management for dwelling. Development.
Banos-Caballero, S., García-Teruel, P.J. and Martínez-Solano, P., 2014. Working capital
management, corporate performance, and financial constraints. Journal of Business
Research, 67(3), pp.332-338.
Ben-Horin, M. and Kroll, Y., 2017. A simple intuitive NPV-IRR consistent ranking. The
Quarterly Review of Economics and Finance, 66, pp.108-114.
Bhattacharya, H., 2014. Working capital management: Strategies and techniques. PHI Learning
Pvt. Ltd..
Boardman, A.E., Greenberg, D.H., Vining, A.R. and Weimer, D.L., 2017. Cost-benefit analysis:
concepts and practice. Cambridge University Press.
Brigham, E.F. and Houston, J.F., 2015. Fundamentals of Financial Management Concise 8E.
Corelli, A., 2016. Working Capital Management. In Analytical Corporate Finance (pp. 351-
378). Springer, Cham.
Fields, E., 2016. The essentials of finance and accounting for nonfinancial managers.
AMACOM Div American Mgmt Assn.
Gotze, U., Northcott, D. and Schuster, P., 2015. Selected Further Applications of Investment
Appraisal Methods. In Investment Appraisal (pp. 105-159). Springer, Berlin, Heidelberg.
Gotze, U., Northcott, D. and Schuster, P., 2016. INVESTMENT APPRAISAL. SPRINGER-
VERLAG BERLIN AN.
Josselin, J.M. and Le Maux, B., 2017. Cost Benefit Analysis. In Statistical Tools for Program
Evaluation (pp. 291-324). Springer, Cham.
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