Financial Resource Management and Investment Decisions Report

This report provides a comprehensive analysis of financial resource management and investment appraisal techniques, focusing on a case study of Taste Plc, a medium-sized catering business. It identifies various sources of finance, including trade credit, bank overdrafts, retained earnings, bank loans, issuing shares, and leasing, along with their respective advantages and disadvantages. The report compares and contrasts right issues of shares and loan notes, discussing their implications on the company's financial structure and control. It evaluates the appropriateness of different financing sources for acquiring buildings and non-current assets, recommending the issuance of equity shares. Furthermore, the report delves into working capital management, the interpretation of financial statements, including profit and loss, financial position, and cash flow statements, and the application of investment appraisal techniques like payback period and net present value. It also examines the relationship between cash flow and profit, emphasizing the importance of financial planning and the needs of financial statement users. Finally, the report concludes with an overall opinion on the company's current performance and recommendations for future financial strategies.

Managing financial
resources
and Decisions
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Table of Contents
INTRODUCTION................................................................................................................................4
2.0 Identifying sources of finance available to business............................................................4
2.1 Types of business..................................................................................................................4
2.2 Sources of finance available to business...............................................................................4
The table consists of following sources of finance along with advantages and disadvantages-.4
2.3 Compare and contrast right issue of share and loan notes....................................................6
2.3.3 Implication of right issues and loan stock..........................................................................7
2.4 Appropriateness of source of finance for buildings and NCA............................................7
2.5 Working capital- Advising board of directors on a source of finance..................................8
2.5.1 Definition...........................................................................................................................8
2.5.2 Importance of working capital...........................................................................................8
2.5.3 Sources available for WC...................................................................................................9
3.1 Statement of profit and loss................................................................................................10
3.2 Statement of financial position...........................................................................................10
3.3 Statement of cash flow........................................................................................................10
3.4.1 WACC for each three options..........................................................................................10
3.4.2 Gearing for each three option...........................................................................................11
3.4.3 How did it impact financial statements............................................................................11
3.5 Earning per share................................................................................................................12
3.5.1 what information does this provides................................................................................12
3.5.2 Earning per share calculation..........................................................................................12
3.5.3 Explaining the answer......................................................................................................12
4 Investment appraisal..............................................................................................................13
4.1 Why it is important to appraise potential investment..........................................................13
4.2 What are the risks to future cash flow?...............................................................................13
4.3 Different type of techniques................................................................................................13
4.3.2 Calculating pay back period.............................................................................................13
4.3.3 net present value method of appraisal.............................................................................14
4.3.4 Calculation of net present value.......................................................................................14
4.4 Recommending board of directors......................................................................................15
4.5 Unit cost..............................................................................................................................16
5.0 Cash flow vs profit..............................................................................................................17
5.1 Main trends and messages contained within cash flow......................................................17
5.2 Importance of financial planning........................................................................................17
5.3 Explain why company may be profitable but run into liquidity problem..........................17
5.4 Users of financial statements and their needs....................................................................17
5.4.2 What information they need.............................................................................................18
6.0 Interpretation of the financial statements.....................................................................................18
6.1 Ratio Analysis.....................................................................................................................18
6.1.1 Profitability ratios............................................................................................................18
6.1.2 Liquidity ratio..................................................................................................................19
6.2 Overall opinion on the company’s current performance.....................................................19
7.0 Main difference in financial statements........................................................................................19
CONCLUSION..................................................................................................................................19
REFERENCES...................................................................................................................................21
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INTRODUCTION
Finance is regarded as one of the most crucial resource of the enterprise as it is directly
associated with the aims and objectives of organization. Further, initiatives are taken by
management of every company so that it is possible to deal with unfavourable situations such as
inadequacy of finance etc. Proper management of financial resources provides base to organization
in gaining competitive advantage and in turn acts as development tool. Moreover, different sources
of finance are available to business with the help of which company can satisfy its requirement. IT
is the first and foremost duty of management to decide which source to adopt for raising funds such
as internal or external one (Wahlen and et.al., 2011).
Apart from this to judge the feasibility of project investment appraisal techniques are
effective which involves net present value, internal rate of return etc. Such methods helps in
selecting the appropriate proposal and in turn funds can be allocated accordingly. For carrying out
the present study organization chosen is Taste which is a medium sized company and at present
management wants to expand its catering business which has been growing over the past six years.
Apart from this, the local authority has granted business planning permission to extend its current
premises. Various tasks have been covered in the report which involves sources of finance,
importance of financial planning, investment appraisal techniques etc.
2.0 Identifying sources of finance available to business
2.1 Types of business
There are different types of businesses such as public, private and partnership etc. which
carry out their businesses effectively in order to produce good quality of products and services. All
of these businesses have different requirement in conducting their business and completing all
business activities. However, it is highly depend on management that what kind of sources are
preferred to satisfy their business purpose.
2.2 Sources of finance available to business
The table consists of following sources of finance along with advantages and disadvantages-
Sources Feature Advantage Disadvantage
Trade credit
(Short term)
It is considered as one of the
most effective practice of
vendors which allows
business to place and receive
orders without giving
immediate payment.
Main advantage of adopting
this source is minimal cash
outlay through which
shelves of business can be
stocked. Discount received
on the payment made within
Main disadvantage of
adopting this source is
fess and penalties when
supplier has right to
impose penalty on the late
payment made by
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certain number of days is
also another benefit
(Mumford, Schultz and
Osburn, 2001)
company.
Bank
overdraft
(Short term)
It is the facility granted by
bank to withdraw more
amount than those lying in the
account
Main advantage of using this
source is that it is flexible in
nature where one can take it
for whatever amount it is
required.
Main disadvantage of
using this source is that
high rate of interest is
charged by bank and in
turn it is costly for
company (Wahlen and
et.al., 2011).
Retain
Earnings
(Short Term)
Retain earnings are the part of
profit which is saved by the
organization to meet any
future contingency.
Using of retain earnings
does not required to incurred
any expenses related to
interest or even organization
does not have to repay this
amount.
Accessing of all the
financial source of fund
from retain earnings may
become disadvantage for
the business to meet any
uncertain or imperative
need of finance during
daily course
Bank loan
(Long term)
Taste Plc can take loan from
financial institutions present
in the market. Firm can take
loan from bank at an cheaper
rate of interest.
Main advantage of adopting
bank loan as a source of
finance is that it enhances
liquidity position of
company
Major disadvantage of
using this source is that it
increases expenses of the
company as firm has to
pay large amount in the
form of interest.
Issuing
shares
(Long term)
Taste plc can issue equity
shares in the market to general
public and can obtain funds
from investors (Wildavsky,
2006).
Main advantage of using this
source is that they are liquid
and can be easily sold in the
market. Further, company do
not have any obligation
regarding payment of
dividend.
Main disadvantage of
using this source is that
payment of dividend on
equity shares is not tax
deductible expenditure
and cost of equity is
highest among all the
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sources of finance.
Leasing
(Long term)
This long term source of
finance helps the company to
acquire the assets by paying
the lump sum amount.
Main advantage of leasing is
that it assists the business to
repay the amount in
instalment basis and also
does not require to pay
amount in immediate
manner.
Disadvantage of leasing is
that some it becomes
expensive for the business
and also the organization
is not the personal owner
of the assets purchased on
leasing.
So, these are some of the sources of finance which are appropriate for Taste plc. By selecting
the most appropriate source it is possible for management to extend its business premises and in
turn it is possible for carrying out overall operations in effective manner. Apart from this, selection
of right source of finance can enhance profitability level of the organization and in turn can save
major cost associated with the business.
2.3 Compare and contrast right issue of share and loan notes
2.3.1 Right issue
Right issue can be regarded as the form of dividend in which business enterprise grant rights
to its existing investors so that they can purchase shares of the firm at an discounted price. In this,
management offer shares to its present investors instead of others (Mohsin, 2013). Further, right
issues are mostly preferred by public limited organizations as they prefer to raise funds with the
help of equity shares rather than debt.
Implications
Therefore, it is beneficial for Taste organisation to raise funds with the help of equity shares. On the
other hand, loan notes are financial instruments in which borrower provides written form to the
lender which involves interest rate which borrower has to pay. It also takes into consideration the
time period in which company has to repay the entire amount of debt.
Right issue affects controlling power of the business because it has direct influence on
ownership structure. By this issue shareholders of the firm get right to make decision for the
business. Further, it also provide comparatively less funds to equity issue. It is because right issue is
made by company on the price lower than market value.
2.3.2 Loan notes
Taste plc can also issue loan notes which are easily convertible into equity shares after a
predetermined period of time. Raising funds with the help of right issue is regarded to be more
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effective for Taste plc as compared with debt issue. In case when business enterprise satisfies its
financial needs with the help of existing shareholders then it is not required by firm to incur extra
expenses for attracting them (Mumford, Schultz and Osburn, 2001).
Implications
Apart from this, Taste plc is having sound financial position and therefore it is easy for
enterprise to attract existing investors in short period of time. Business entity can satisfy its
financial needs with the help of debt issue. In case when loan notes are issued then management has
to pay interest to its holders after regular interval (Jury, 2012) . Moreover, as compared with equity
sources, raising finance with the help of loan notes imposes high cost in front of company. For loan
notes company has to provide security in against of loan. For this financial source company has to
pay interest cost in regular time period. In addition to this organization has liability to repay the
principle amount as per the described contract. This source does not affect controlling power of the
business.
2.3.3 Implication of right issues and loan stock
The implication of right issues can be understood in term of cost and time take to issue of
shares. Also, management need to pay the dividend on right time so as to determine long run
success of the firm with increased rate of return. Furthermore, loan is the another imperative aspect
of finance which take high interest rate on loan. Accordingly, corporation need to pay cost on right
otherwise credit rating of organization get affected.
2.4 Appropriateness of source of finance for buildings and NCA
Equity finance
Advantages
On the other hand main advantage of equity financing is that it enables company to have
more cash in hand, it is less risky as compared with loan. The right business angels and venture
capitalist can bring value and they can explore growth ideas. Further, investors are often prepared to
provide follow up funding as business expands. All these are main benefits of employing equity
financing and is beneficial for the business.
Disadvantage
Further, main disadvantage of this source is that time is required to search for right investor of firm.
After analysing both the sources of finance right issue of shares and loan notes it has been
found that appropriate source for company is issuing shares in the market for purchasing building
and non current assets. By issuing equity shares in the market firm can attract large number of
investors and main advantage of this source is that it does not creates financial burden on the
enterprise as compared with debt financing (Murphy, 2001). Depending on the type of investors
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business losses power to to take effective management decisions and sometime company has to face
legal along with regulatory issues to comply with the raising finance. Moreover, it is possible for
enterprise to better satisfy need of its shareholders and in turn it will have positive impact on brand
image of firm. Taste plc is having good financial position in the market and due to this basic reason
business enterprise can easily provide good return to its investors as per their expectations. Apart
from this, in near future firm can easily accomplish its desired goals along with objectives which is
beneficial for the enterprise in every possible manner. This source of finance has been selected for
firm by considering its pros and cons. Financial needs of enterprise can be easily satisfied when
shares are issued in the market and this provides large number of opportunities to business in terms
of rise in profitability level along with sales. Main implications of choosing issue of shares as
source of finance is that firm has to pay dividend to its investors and voting rights along with major
share in the decision making is transferred to shareholders of organization. This is one of the major
implication of this source of finance which company has to consider necessarily.
Debt finance
Advantages
Main advantage of debt financing to Taste plc is that interest on loan is tax deductible, loans
can be taken for both short and long term and business relationship ends when money is paid back
(Broadbent and Cullen, 2012). It supports business in satisfying short term needs. Further, loan
repayment is quite simple along with interest on loan. Debt does not dilute ownership of the
businesses especially those who are operating on smaller basis.
Disadvantages
Main disadvantage of this source is that money has to be paid within a fixed period of time
and in case if company focuses on too much debt then management has to deal with cash problems.
Further, other cons of this source is that mostly of the lenders provide severe penalties for late
payment which takes into consideration charging fees, late fees etc.
Issue of shares
Company can issue shares in the market through which it is possible to satisfy financial needs of the
business and in turn it acts as development tool for the business (Nofsinger and Varma, 2005)
Advantage
Main advantage of considering this source to business is that it supports in satisfying financial
needs of the business and large amount of funds can be obtained easily for carrying out operations
in the market.
Disadvantage
Main drawback of this source is that it increases overall cost of the company where company has to
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pay dividend to its investors along with voting rights. Therefore, it is unfavourable for the business.
2.5 Working capital- Advising board of directors on a source of finance
2.5.1 Definition
The term working capital refers the fund available to business for carrying out operation or
production activities. It is calculated by getting difference of current assets and liabilities.
Furthermore, Working capital is regarded as the cash which company uses in order to successfully
carry out its business operations. Key components of working capital are debtors, creditors and
stock. This source of finance is most appropriate as through this liquidity position of enterprise can
be enhanced easily and in short period of time and company can easily cover all the major
expenses.
2.5.2 Importance of working capital
Working capital is required by business for conducting day to day operations and is the
difference between current assets and liabilities. Main components of working capital are inventory
which takes into consideration raw material, work in progress and finished goods. In case of
excessive stock it will have high burden on cash resources of enterprise and can lead to decline in
sales volume. In order to keep better inventory control it is required to keep a track of stocks for all
the major items of inventory (Wildavsky, 2006). Receivable is another major component of working
capital which contributes large portion of current assets. Investment into receivables requires certain
costs such as opportunity and time value that business has to bear. Further, to manage receivables in
better manner management must have control on credits and must develop effective credit policies.
Cash and cash equivalents is also major component where proper management of cash supports in
determining the optimal size of the firm's asset balance. It represents correlation between
maintaining adequate liquidity with minimum cash in bank. So, these are some of the key
components of working capital and supports firm in conducting operations in better manner.
2.5.3 Sources available for WC
Different sources of finance are present for working capital of Taste plc which organization
can easily consider for satisfying its financial needs and in turn it acts as development tool. Further,
the major sources of working capital are bank loan, retained earnings etc which are appropriate for
taste plc in every possible manner (Nofsinger and Varma, 2005). Moreover, to meet working capital
requirement it is beneficial for company to adopt retained earning as source where internal savings
of the firm can be utilized. Apart from this taking loan from financial institution is also appropriate
as it can support management to deal with unfavourable situations and can assist in effective
utilization of financial resources. It can boost overall productivity and can enhance profitability of
the business in effective manner.
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On the other hand, company like taste plc is financially strong and its savings are quite high
due to which retained earning can be considered as most appropriate source which can support in
satisfying financial needs. Apart from this, if business enterprise is earning higher amount of profits
then sometime it is not possible to pay dividend to the investors and in turn it is having negative
impact on the firm (Jin, Yu and Mi, 2011). In case when taking loan from bank is considered as an
option by firm then organization has to pay large amount in the form of interest which is also an
major expense. Therefore, this are some of the major reason due to which retained earning and bank
loan has been considered as the sources for satisfying financial needs of the enterprise.
Through effective management of working capital it is possible for enterprise to meet its day
to day expenses and in turn raises overall profitability level of the organization. By appropriate
management of working capital organization can manage their liquidity in order to pay their current
obligation in timely manner. In addition to this, they can avail trading opportunity in order to
enahcne their profitability.
Most effective source of finance for working capital is bank overdraft as it is the facility
granted by bank to withdraw more amount than those lying in the account. Moreover, firm can
easily satisfy its financial requirement by considering this financial source. For this financial source
organization is required to pay bank charges i.e. interest on the additional amount withdrawn
(Kastantin, 2005). In addition to this, they can manager their components of working capital to
generate financial source. For this aspect, they can delay their creditor payment and can make
policies to recover amount from debtors early. For this they are required to provide cash discount to
the debtors so they will be influenced to make cash purchase instead of credit one.
3 Financial statements
3.1 Statement of profit and loss
The statement of profit and loss is prepared for meeting the business requirement by
calculating the profitability. It facilitates to record the transaction related to indirect income and
expenses to be incurred.
3.2 Statement of financial position
Balance sheet is known as statement of financial position which consists detail information
related to liabilities, assets and liquidity of corporation. This assists investors to take right decision
with regard to investment. Thus it aids to assess the performance of corporation in the marketplace
and meet need of different stakeholders in an effectual manner.
3.3 Statement of cash flow
This is another important statement which reflect financial information related to three
major activities of business. This includes income from operating activities, investing as well as
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financing activities. Under this transaction regarding payment of loan and sale of old assets all are
recorded so as to analyse the actual performance of corporation.
3.4 Impact of financial statements
3.4.1 WACC for each three options
Taste plc has three option for the investment i.e. issue of equity, issue of loan stock and issue
from equity and loan options. Financial evaluation of these options through WACC is as follows:
WACC = Weight of equity X Cost of equity + Weight of debt X cost of debt
Particulars Option 1 Option 2 Option 3
No of issue MV No of issue MV No of
issue
MV
500000@2 1000000 1000000 250000 @
2
500000
from loan
1000000
Profit before interest
and tax
(12/100)*1
000000
120000 (12/100)*1
000000
120000 (12/100)*
1000000
120000
PBIT
120000 120000 120000
Less: Interest 0
60000
30000
PBT 120000
60000
90000
Tax 30% 36000
18000
27000
PAT 84000
42000
63000
Dividend coverage
ratio
PAT/
Dividend
paid to
shareholde
rs
2 - - PAT/
Dividend
paid to
shareholde
rs
2
Dividend for equity
shareholders
PAT/2 42000 - - PAT/2 31500
No of shares 42000/500
000
8.40% - - 31500/325
000
9.69%
Re D0/p0
(8.4/200)
4.20% - - D0/p0
(9.69/200)
4.85%
Cost of debt - - I(1-t)/Pd
(6(1-.3)/3)
1.40% I(1-t)/Pd
(6(1-.3)/3)
1.40%
WACC 4.2*(4000/ 4.20% 4.2*(3000/ 3.50% 4.85*(350 4.42%
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4000) 4000)+1.4(
1000/4000
)
0/4000)+1
.4(500/40
00)
It is recommended to the board of directors of Taste plc to adopt second alternative which is
beneficial for management. By adopting this option it is possible for business enterprise to raise
funds by taking loan of 1000000 @ 6%. It supports in granting more balance upon the financial
obligations of the business enterprise. This source will provide tax shield to the company and they
have less financial cost (Jury, 2012).
3.4.2 Gearing for each three option
According to the above table in the first option debt financial resources are not available to
raise the finance. Owing to this, cost of equity is considered as cost of capital and the gearing ratio
cannot be calculated due to abase of debt in the capital structure. On the other hand, debt to equity
is 3:1 and 7: 1 in second and third option respectively. Thus, second option is feasible for
corporation in order to mitigate risk and to ensure stability.
It can be suggested from to board of directors that second alternative is the most optimal
option for the organization as it proves to be effective to raise loan of 1000000 @ 6%. Furthermore,
this option facilitates to provide tax shield and accordingly balance will be created in financial
structure of corporation.
3.4.3 How did it impact financial statements
By using second option of debt financial changes can be seen in balance sheet and income
statement of corporation. This is because long term obligation of company will be increased due to
access to debt financing. Similarly, cash equivalence will also be increased. Apart from this income
statement will be affected because profitability decreases due to financial cost.
3.5 Earning per share
3.5.1 what information does this provides
Earning per share is the most important information for shareholders because by this they
come to know regarding rate of return. Earning per share is regarded as the dividend or income
which shareholders of the enterprise receives by investing funds into the shares of company.
Further, investors of the organization are highly interested in knowing about income of the business
as through this they get idea regarding the level of return. Apart from this, taste plc is receiving high
income due to which it is possible for company to satisfy need of its shareholders in effective
manner (Mayer, Schoors and Yafeh, 2005). Further, investment decisions taken by investors are
directly linked with the growth and development aspect of the business enterprise. In order to
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determine the level of return profit after tax is divided by number of shares which they usually
receive from organization.
3.5.2 Earning per share calculation
Profit before interest and tax= 720000
Profit after interest= 720000 – 60000 = 660000
Profit after interest = 660000*(1-.3)
=462000
= PAIT/ no. of equity shareholders
=182/3000
=6.06%
Assuming option only debt has been used
£ 1000000 of 6% loan stock
Interest = 6 /100 * 1000000
= £ 60,000
No of ordinary shares = 3000000
EPS = 462000 / 3000000 = 0.154 p
3.5.3 Explaining the answer
So the calculation of earning per share represents that company is profitable on a
shareholder basis. Further, this is assisting enterprise in satisfying need of its target market in
efficient manner. Moreover, with the help of this it is possible for business to well satisfy need of its
target market and can act as development tool. This can allow business to attract large number of
investors and business can easily deal with the challenges present in business environment. On the
other hand, it is well known fact that every shareholder expects high return from company and this
need can be satisfied by management only when higher profits are earned and this in turn acts as
development tool for the entire company (Penman and Penman, 2007). Moreover, taste plc has to
apply larger efforts in enhancing its profitability level so that more return can be provided to the
target market and it can become easy for management to enhance overall performance of firm in the
market.
4 Investment appraisal
4.1 Why it is important to appraise potential investment
In order to know feasibility of the proposal investment appraisal technique has been applied
through which appropriate project can be adopted in which funds can be easily allocated. Further,
investment decisions are crucial in nature as large amount of funds are allocated by company with
aim to receive good return (Diefenbach, 2006). In short it directly leads to accomplishment of
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