Sources Of Finances Available To A Business Finance Essay
|✅ Paper Type: Free Essay||✅ Subject: Finance|
|✅ Wordcount: 2853 words||✅ Published: 1st Jan 2015|
Starting and running a successful business in the current world is not easy. Due to the rising costs and falling value of stocks, consumers have been left little money to spend. This has led many investors to sell their stock at a loss or just to break even. One way of maintaining a profitable business is constantly injecting some capital into it. Below we identify the major sources of finance available to a business.
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Bank Overdraft – This refers to a short-term credit facility that is provided to a business by the bank. It is one of the most common that a business can use to raise some to receive extra. A bank overdraft permits an account holder to withdraw more the amount of money they have in their bank account. The overdraft attracts interests on the amount overdrawn (Shaw 2011).
Loan – Business loans can be classified as either long term, medium or short term. Although loans are regarded as costly way of raising extra capital, it is ideal for long-term business projects such as development and expansion.
Grants – As a source of finance, grants are offered to businesses for services or programs that profit the local community. Grants are offered by large private firms and government agencies.
Retained Profits – A business can plough back some of its undistributed profits back into the business. Retained profits are the amount of money held by a business to provide financial back-up in times of need. This is acknowledged as the most ideal way of raising extra capital in business as there is no interest or extra charges incurred.
Working Capital – Working capital refers to the sum of money that a business has set aside meant for financing the day to day activities. Working capital is also ideal as a source of addition capital since no cost is incurred (Shaw 2011).
LO1 – 1.2 Implications of finance as a resource
The main sources of finance are credit unions, banks as well as private investors. Funds from other income streams such as rented properties and money from stock are also credible sources of cash to finance a business. Each source of finance is associated with a set of implications such as the amount that is paid as interest on a bank loan, penalties for late payments as well as other infractions set in the contract between the borrower and the lender. Although the implications might be more or less the same as those of regular banks, credit unions may however set their interest rates at a lower figure. Private Investors: The use of private investors as a way of financing a business will attract a legal agreement that is bidding to both the seller and the buyer. Although the agreement maybe at times verbal, the implication of avoiding a written legal contract between the two parties involved might be severe and one party may fail to honor their obligations. Good private investors are know not lend money to business people until they performed due diligence on the businesses (Ralph 2005).
Sources of finance from dividends, sale of stock or rented properties is practical and more lucrative. However, these kind of financial sources have been associated with a number of implications. For instance, stock prices may fall drastically leaving the investor with huge losses. The solution to finding the right sources of finance is to look at the benefits and drawbacks, and come-up with the best fit for a given business loan, investment prospect and other financial needs.
LO1 – 1.3 Appropriate sources of Finance
There are so many sources of finance that a business can choose from and it therefore up to the business owner to select the most appropriate way to finance business projects. To fund that important business project, a business may seek a loan from bank as well as any other financial institution with lending services. Another appropriate method of raising the necessary finance is by requesting for a bank overdraft. Another method that has become quite popular is raising finances through venture capital. Investment specialists and merchant banks might be willing to finance fast-growing and promising business project. Venture capital is a composition of chare and loan capital. Lucrative business projects may qualify for funding and assistance through grants offered by the government and other non-governmental organizations. For instance, low interest loans and grants may be offered to business that establishes their operations in the rural areas. One of the viable ways of financing ongoing and expensive business ventures is by leasing expensive equipment. This helps the business to save a lot of money. Lastly, businesses may raise finance through trade credit. This is a short term source of finance that makes it possible for business to purchase items on credit and pay later (Incstaf 2010).
LO2 – 2.1 costs of different sources of finance
The cost associated with loans (debt financing) is interest while the cost of investments (equity financing is share of the profits or dividends. Comparing the costs for different sources of finance may involve the analysis and calculation of cost of capital. This may involve comparing the interest charges on a loan with the businesses with the total percentage of accumulated profits or retained earnings that belong to the investor. Business owners seeking loans from a number of banks should compare the payments terms and interest rates being offered. Even very little variations in the interest rate can tote up to considerable amounts over a long period of time. Unsecured Short-term loans, for example lines of credit, usually have a high rate of interest as compared to long-term secured loans such as mortgages. The fact trade credits and bank overdrafts attract high interest rates make them to be too costly (Higham 2004).
The interest rate is normally dependent on the risk as well as the credit rating score of the borrower. If a business need financing for a fixed period of time mostly less than a year, it could be more suitable for the business to borrow from friends and family or set up a short term loan from a bank. As an additional cost to the business, banks may require security or collateral for the loan being secured as insurance against loan defaults.
LO2 – 2.2 importance of financial planning
Financial Planning is the practice of determining the amount of capital needed as well as the competition of the capital. The process of financial planning involves creating policies, objectives, procedures, budgets and programs concerning the financial activity in concern. Financial planning ensures the adequate and effective financial and investment policies. Some of the importance’s are as outlined;
Financial planning guarantee the adequate utilization of funds
Financial Planning assists in maintaining a reasonable stability between the inflow and outflow
In addition, Financial Planning guarantees that the suppliers of funds are effortlessly investing in businesses that observe financial planning. It has also been attributed in facilitating expansion and growth programmes which assists in the long-run survival of the business.
Financial Planning decreases uncertainties with respect to shifting market trends by eliminating these hindrances, financial planning helps in maintaining profitability and stability in a business (Higgins 2011).
LO2 – 2.3: Information needs of different decision makers
There are various parties keen on the information of a business. These parties can be classified as either internal or external depending on how interested they are in the business and the influence they have on the organization. They also need different forms of information and based on their requirements.
These are internal parties of the organization and they need information for sound decision making when it comes to productivity of the firm, income belonging to shareholders, asset base of the company (net worth or payable), as well as the availability of assets (cash) for future development.
These are also internal parties whose purpose of acquiring information on the organization is totally different from that of its proprietors. Workers are mostly worried about their wages and other remunerations from the job and the permanence of the company for the safety of their employment. Their main areas of interest are the organization’s economic information, productivity of the business and any future development plans (Suthaharan 2010).
Financial institutions like banks and lenders also have a keen interest on the financial reports of the company, especially if the company wants to borrow funds for expansion or for settling operational costs. Banks are interested in gearing ratio of the organization (a form of ratio involving the loan capital and equity capital). Profitability of the firm: liquidity ratio, interest covers (capacity to offset interest charges if the loans are acquired); fixed assets foundation to obtain the information regarding the securities obtainable for the loan etc are all necessary to financial institutions.
Government/ Regulatory institutions
The government is interested in how much profit the company is making and if it is paying the correct tax charges for their income. The government also checks for other forms of applicable tax charges; compliance with the managerial bodies’ systems (bookkeeping principles, Colombo stock exchange requirements etc (Suthaharan 2010).
General Public/ customers
The general public is interested in knowing the operation of the firm and the stability of the employment.
LO2 – 2.4: Impact of finance on the financial statements
Presently, companies frequently smother monetary statement like the balance sheet, statement of cash flows and the income statement. Once the financial statements have been released at the end of a financial year, they may have huge impacts on the investors and other stakeholders. Hence, it is up to the company to make sure that all the information the financial statement is correct.
Impact on Stock Price – the stock of a company can be greatly impacted by financial statements. In making their investment decisions, several investors use financial statements to establish the viability of investing in certain stocks. The upward and downward movements of stock prices are dependent on the information presented in the statements (Stansky 2010).
Financing Decisions – financial statements are likely to affect the likelihood of accompany to acquire funding. If a business is attempting to take out a production loan, the lender will routinely scrutinize the financial statements of that company. Lenders are more likely to invest in businesses that have good financial statements.
LO3 – 3.1 Analyze budgets and make appropriate decisions
Once a business becomes operational, it is important tightly manage and plan its financial performance. One of the most effective methods of keeping the finances of a business on track is by creating a budgeting process. Managing, monitoring and creating a budget are important in guaranteeing the success of the business. The budget should help the business owner in allocating resources where they are required, so that the business remains successful as well as profitable. The budget process should be simple and should take into consideration what will be earned and spent in the business. Start-up businesses may run their businesses in a tranquil way and may not even require a budget. on the other hand, if a business is planning to grow and expand into the future, budgeting is one of the most effective way of managing funds and new stream of cash flows thus allowing the business owner to invest in fresh opportunities at the right time. A budget is an important planning tool that helps business in making appropriate decisions relating control of finances (Wendy 2006).
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LO3 – 3.2 calculations of unit costs and making pricing decisions
A Unit cost refers to the actual cost of delivering a single unit of a product or service. The calculation of unit costs is done with the intention of providing a basis of comparing the costs of different providers of goods and services. It can be used in identifying trends that might signal variations in productivity, resources as well as the quality of services. Unit costs may be termed as the benchmark for measuring performance (Damodaran 2011). By understanding how to establish Unit costs, a business can be able to promote effective use of funds. It can provide information that can be used to improve services. The use of unit costs can help in identifying economies of scale, assist in establishing fee policies, strengthening future applications as well as informing on the contracting processes, identify economies of scale, help to establish fee policies, and strengthen future grant applications. Making pricing decision can sometimes be a tricky and hard decision. For instance, if goods and services are priced too low, the business might not be able to cover all the expenses and if highly priced, the business might not realize any sales at all.
LO3 – 3.3 viability of a project using investment appraisal techniques
In nature, different Investment opportunities and projects vary considerably. Hence, project appraisal techniques were designed to assist business managers and investors make good decisions and choose the most viable projects. The real meaning of all investment appraisals is the evaluation of the value of proposals which need financial and economic commitment of resources, by taking into consideration the costs and benefits. For any business, making bad investment decisions can end in loss of opportunities to net new investors, limited future growth and poor financial and economic performance or the disappointment of shareholders. Investment appraisal intervenes at the stage where a business plan is transformed into its corresponding financial plan and the choice to finance its execution (Hassan 2008).
LO4 – 4.1 main financial statements
In a company, there are three major financial statements namely; the balance sheet-which is a report of a company’s assets, liabilities and stockholders’ equity as at a given time. Then there is the income statement which simply is a record of a company’s revenues and expenses during a certain financial period. The last major financial statement is the cash flow statement (commonly known as the statement of cash flows). This statement provides information on the changes that have occurred a company’s cash and cash equivalents during the similar period income statement (Leigh 2012).
LO4 – 4.2 formats of financial statements for different types of business
The income statement of a manufacturing business is different from that of a retail store. In this income statement (manufacturing), the first line is occupied by gross income followed by the subtraction of goods manufactured. This results to gross income. The second portion of the income statement records all expenses that are linked administrative, general and selling costs. This is again subtracted from gross income to disclose operating income (Steiner 2012). For smaller businesses and companies, the business may maintain very simple balance sheet but for large companies, the balance sheet is broken down into current assets and liabilities and long-term assets and liabilities. Several businesses use the accrual basis of accounting. This implies that they will identify income received from a sale after the sale has been completed and not essentially when the cash is received.
LO4 – 4.3 financial statements and Ratio
A ratio is an expression of a relationship between two or more quantitative variables. On the other hand, financial ratios show the interrelationships between different elements in the financial statements. The analysis of financial ratios involves determining a standardized connection between figures showing up in the financial statements as well as using those relationships known as ratios to evaluate the business’ financial performance and position. A number of techniques have to be used in ensuring that financial statements of different businesses have been simplified and made compatible. Such method may incorporate the use of great tools for example common sized financial statements and ration analysis. Financial ratios fall in one of the four classes, namely; liquidity (current ration, quick ration), profitability (return on assets, return on equity), investor (Earning per share) and long-term or risk (asset turnover, asset receivable turnover ratio) (Loth 2011).
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