TABLE OF CONTENTS 0. 1 Introduction of Finance in your organization…………………………………….. Task: 1: Be able to explore the sources of finance available to Sainsbury’s 1. 1: Identify the sources of finance available to Sainsbury’s…………………………………….. 1. 2: assess the implications of the different sources of finance in Sainsbury’s…………. 1. 3: select appropriate sources of finance for a project in Sainsbury’s………………….. Task: 2: Be able to analyses the implications of finance as a resource within a business 2. 1: assess and compare the costs of different sources of finance in your Sainsbury’s…….. . 2: explain the importance of financial planning in Sainsbury’s……………………………. 2. 3: describe the information needs of different decision makers……………………………. 2. 4: describe the impact of finance on the financial statements in Sainsbury’s………………. Task:3: be able to make financial decisions based on financial information in Sainsbury’s 3. 1: Analyse budgets and make appropriate decisions in Sainsbury’s………………………….. 3. 2: Calculate unit costs and make pricing decisions using relevant information………………. 3. 3: Assess the viability of a project in Sainsbury’s using investment appraisal techniques…….
Task:4: Be able to analyse and evaluate the financial performance of Sainsbury’s 4. 1: Explain the purpose of the main financial statements in Sainsbury’s………………………… 4. 2: Describe the difference between the formats of financial statements for different types of business………………………………………………………………………………………… 4. 3: Analyse financial statements using appropriate ratios and comparisons, both internal and external of Sainsbury’s…………………………………………………………………………… Conclusion………………………………………………………………………………………. Reference………………………………………………………………………………………… Self evaluation……………………………………………………………………………………. Definition:
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According to Webster’s Ninth New Collegiate Dictionary” the science on study of the management of funds and the management of fund as the system that includes the circulation of money, the granting of credit, the making of investments, and the provision of banking facilities. ” TASK:1: BE ABLE TO EXPLORE THE SOURCES OF FINANCE AVAILABLE TO SAINSBURY’s: 1. 1: Identify the sources of finance available to Sainsbury’s: In general, a “sources of finance” is how you get money for a major deposit. A source may you paycheck form employment, from unemployment, from investments, or family help.
There are two major sources of financing available to Sainsbury: * Internal sources * External sources The souces of finance that come form the business assets or activities are “Internal sources of finance” Retained profits: If business (Sainsbury) had made profit after paying all its cost in a successful trading year, it could use some of that profit to finance future activities. sales of existing assets: Sainsbury can finance new activities or pay off debts by selling its assets such as property, fixtures and fitting, machinery, vehicles etc. ut down stock level: Businesses will usually hold some stock. It can be useful for a business (Sainsbury) if there is an unexpected increase in demand from customer. Stock level tends to rise during economic slowdowns as goods are not sold and pile up instead. The finance that comes from outside the business (Sainsbury) known as External source finance. There are three types of external sources of finance. Long term, medium term, short term. Long term sources of finance: In business (Sainsbury), funds required for working capital and fixed capital is known as long term finance.
It includes share, debenture, long term loans and grants. Medium term sources of finance: the sources which are used to finance a business (Sainsbury) for a period of more than a year but less than 10 years are medium term sources of finance. these type of finance is obtained for expansion or modernisation of existing plants. it includes leasing, hire purchase, medium term loan. Short term sources of finance: the sources of finance ar used to business activities in the short term that are usually going to last less than one year.
There are some kind of short term sources of finance in the form of debts such as bank overdraft, bank loan, creditors, debt factoring. FIG: 1: SOURCES OF FINANCE 1. 2: Assess the implications of different sources of finance in Sainsbury: As we discuss above there are many sources of finance for company to choose but we must consider about elements related risking, legal, financial and dilution of control and bankruptcy. Issued of debts: first, the company (Sainsbury) must concern about tax implication. When issuing debt, the company has to pay tax after they pay interest for debt holders.
Hence, issuing debts will reduce the profit chargeable to tax and increase company profit available for dividends. The effect here is they don’t have pay tax on the interest from holding the debt when they receive profit, they must pay interest for debt holders first then pay corporate tax on remain money. When they use debt, the use of debt will increases the corporate tax shields and they have to pay an amount interest for bank or other sources. However, when using debt sources, the existing shareholders stake would not be diluted because debt holders don’t have any voting right in company.
It means when issuing more or less debts, the stake of the existing shareholders would not be reduced and the authority of chief executive officer as well as the management of company will be intact. With the debts, the company must have obligation to pay interest for debt holders. The interest is fixed by the debt holders and becomes the expense of the company. If company makes a loss, they still have to pay its interest charges. If they cannot pay interest, the debts holders will be become creditors. In this case, the company have to find method even sell their assets to repaid money to debt owners.
If not, the company will be sued and the director of the company may be goes to prison. Apart from cost of debt is normally much cheaper than the other costs such as cost of preference share, ordinary share, and issue debt is also financial risk. “Large amounts of debt can lead to increased risks of bankruptcy” because debt owners can take control of the company if they don’t receive their interest payment. Finally, because of Articles of Association, or the trust deeds of existing loan stock, there may be legal restrictions on the company’s power to borrow.
Issued of equity: as we know, there are two kinds of share: ordinary shares and preference shares When company issues ordinary shares, the company has to pay cost of ordinary shares when issuing new ordinary shares. This payment will be paid after tax so ordinary shares are non tax deductible. In other words, the company issues shares will pay for corporate tax more than issues debts. The main point of company is net profit so company should consider about issue how many shares or debts to pay lowest tax and bring highest profit. With the preference shares, tax does not affect directly.
Although when a company issues preference shares, it needs to pay the cost of preference shares, this is paid out form the earnings after tax. Therefore, it is similar to ordinary shares, preference shares are not tax deductible. As like as debt owner, the existing shareholders, stake would not be diluted because the preference shares don’t carry voting right so it will dilute the control of existing shareholders. Therefore, the authority of chairman is not being affected. However, it is not similar to debt owners and preference shareholders. In the stock market, each ordinary share has one vote.
It means that the shares will give the holder the right to vote on company issues such as board election, plan of company, company policy and so on. Therefore, it will influence the control of the chairman. When the company issues new ordinary shares, the percentage of stake of the chairman will reduce. Hence, when company issues new shares, he must consider carefully about how many shares he will keep avoiding the dilution of control. In other words, he must ensure the percent of shares he hold when company issues new shares are still more than 50% because the more stake the shareholders hold, the more control of the company they have.
With legal implication, the company has the obligation to pay the dividend for shareholders including preference shareholders and ordinary shareholders. The preference will be received the fixed rate of dividend and preference will be received the fixed rate of dividend and preference dividends must be paid before any ordinary can be paid. On the other hand, the dividend ordinary shareholders receive depends on the profits made by the firm so it is more risky than preference share.
With ordinary shares, the company don’t have dividend to pay, the market value of the shares will be fail. As a result, the value of company will meet difficult to mobilize funds. About the risk implication, the preference shareholders have lowers risk than ordinary shareholders. The preference not only receive fix rate of dividend, receive dividend before ordinary shareholders but also when the company goes bankrupt, they have the right to receive money from the sales of fixed assets of the company prior to the ordinary shareholders.
Moreover, when the company issues new ordinary shares the dividends of the existing ordinary shareholders will decrease unless they buy more new ordinary shares because the number of ordinary shares increase, the dividends per share decreases. In addition when company goes bankrupt, they can only receive money from selling company’s asset after debt owner and preference shareholders. As regard the financial implication, the factors that influence the cost of preference shares are flotation cost and preference shares price.
The dividend does not affect the cost because it is fixed. On the other hand, the factors that influence the cost of ordinary shares are flotation cost, the dividend payment, and the growth rate. 1. 3: Select appropriate sources of finance for a project in Sainsbury’s: Factors need to be considered when choosing an appropriate source of finance: Amount of money required: a large amount of money is not available through some sources and the other sources of finance may not offer enough flexibility for a smaller amount.
Cheapest option available: the cost of finance is normally measured in term of the extra money that needs to be paid to secure the initial amount. The typical is the interest that has to be paid on the borrowed amount. The cheapest form of money to a business comes from its trading profits. The amount of risk involved: a project which has less chance of leading to a profit is deemed more risk than one that does. Potential sources of finance take this into account and may not be lend money to higher risk business projects, unless there is some sort of guarantee that their money will be returned.
Length of time of the requirement for finance: a good entrepreneur will judge whether the finance needed is for a long term or short term project and therefore decide what type of finance company wish to use. TASK:2: BE ABLE TO ANALYSE THE IMPLICATIONS OF FINANCE AS A RESOURCE WITHIN A BUSINESS: 2. 1: Asses and compare the costs of different sources of finance in your Sainsbury’s: When the company (Sainsbury) intent to use one of finance source, they need to concern about the cost of finance of this source to have suitable choice.
In general, cost of finance is the cost when you use the money of other people. Therefore, it can be consider that cost of debt is interest and cost of equity is dividend. Company has three methods of finance and the cost of finance of each source is shown as follow: Option:1: Source of financecost of financeweight ageWACC Equity15%100%15% COST OF CAPITAL= 15% Option:2: Source of financecost of financeweight ageWACC Bank loan10%70%7% Equity15%30%4. 5% COST OF CAPITAL11. 5% Option:3: Source of financecost of financeweight ageWACC Equity15%35. 2%5. 388% Bank loan10%35. 92%3. 592% Government loan5%28. 16%1. 408% COST OF CAPITAL10. 388% According to the table above, we can see that in option 1, company use only the source of finance is equity. Moreover, in option 2 beside equity, they use bank loan more and in the last option, they combine equity, bank loan as well as government loan and the option 3 can be considered the best way to raise capital for Sainsbury. We must care about the various cost which issue shares and debts including bank loan and government loan must be incurred.
According to the table above, it can easily to see that the WACC of the option 3 is shortest. It means using this cost, the company will pay money for the cost of finance shortest. Moreover, with ordinary shares, they must pay tax before they pay dividend for shareholders. With bank loan and government loan, they don’t need to pay tax. With ordinary shares, the main cost is dividend. Another cost is when they issue shares they must pay the cost of providing shareholders or owners to known information about the performance of the business. With loan of bank and government, interest rate is the main cost. 4. : Explain the importance of financial planning in Sainsbury’s: According to john myre,” financial planning is the act of deciding in advance the financial activities that are necessary for achieving corporation’s goals. ” Income: it is important to manage income of company (Sainsbury) more efficiently and the cash, need analysis, income expenditure budgeting will show best way possible in managing income. Thus, proper management of income is necessary in increasing cash flow. Cash flow: tax planning, careful budgeting and prudent spending are aspects that need to pay attention to generate cash flow in company (Sainsbury).
Thus, financial planning will important to determine what should be done to generate cash flow in order to make investing possible. Investment: it is necessary for a company to identify best investment opportunity to the present financial situation or not thus, financial planning can help to evaluating the best investment opportunity. Capital: an efficient financial planning can helpful to create a strong capital base. Thus, a company can think about investments and therefore improve its financial position. 2. : Describe the information needs of different decision makers: Different decision makers will want information according to their interest. A long term lender will always want to know about gearing ratio of company, while short term lender will want to know about the liquidity ratio of the business. Manager needs accounting information to take managerial decision. Ratio analysis: the ratio shows relationship between two relevant items in the financial statement. The relationship is shown as a ratio. Different ration calculable on a business financial statement are: Liquidity ratio:
Current ratio Acid test ratio Working capital ratio: Stock turnover ratio Average debt collection period Average credit taken from creditors Profitability ratio: Return on capital employed Gross profit margin ratio Profit before interest and sales Profit after sales Solvency ratio: Financial gearing ratio Debt/asset ratio Interest cover ratio On the basis of calculation of above rations necessary decisions can be taken by relevant parties. 2. 4: impact of finance on the financial statements in Sainsbury’s: Obtaining finance from different sources bring about a change in the financial statement.
This portion of assignment shows how each source of finance is recorded and affects on the financial statement: personal savings: personal savings when lent to the business are considered as loan. The amount lent will appear as long term liabilities on the balance sheet and interest payments will be recorded in profit and loss account. Sales of assets: sale of assets will reduce the value of fixed assets on the balance sheet. The profit or loss make on sale of assets will be recorded in the profit and loss account of the year.
Ordinary shares and preference shares: The issues of ordinary and preference shares increase the value of equity capital in the balance sheet. If the issued shares market price is greater than nominal value of the share then share premium is also increased in the balance sheet. The no. of shares displayed in the balance sheet and preference share dividend too. Debenture: Debentures are a type of debt capital. The value of debentures along with the rate of interest and the repayment date is presented in the equity and liabilities section of balance sheet.
The interest paid on debenture is reduced from profits before tax is charged. Bank overdraft: this appears in the balance sheet as a current liability since it is a short term debt. The interest charges and bank overdraft fee if charged after deducted from profit and loss account before tax is charged. Loan: loan is long term debts and therefore come under long term liabilities in a balance sheet. The loan when displayed on a balance sheet will usually contain information about the repayment date and the interest charged on the loan. The interest is charged in the profit and loss account.
Venture capital: this is amount money invested in the business as equity capital and thus comes under equity capital in the balance sheet. The return for venture capitalists is a share of profits which is recorded in the appropriate account. TASK:3: BE ABLE TO MAKE FINANCIAL DECISION BASED ON FINANCIAL INFORMATION IN SAINSBURY’S: 3. 1: Analyze budgets and make appropriate decisions in Sainsbury’s: “Budget is calculated in units of one acre of facilitative budgeting for different enterprises sizes and to simplify calculations” For planning purposes, costs are divided into variable, fixed and joint cost.
Variable cost: it is the out of pocket cost for inputs. These are always included in a budget. Variable costs are directly with business volume. Fixed cost: these are the costs associated with building and equipment investment, they are prorated over a number of years. Joint cost: usually a fixed cost is common to more than one enterprise. Example depreciation for equipments used in business. Types of budget: Enterprise budget: it records the costs and income from the production of one single type of product, during one cycle of production.
Whole farm budget: it adds the costs and income from each enterprise budget along with the miscellaneous income and expenses, to determine total expenses and income for the company as a whole. Partial budget: it measures the effects of small changes in a company’s operation, leaving out unaffected parts of the overall company’s budget. This kind of budget provides quick information to help guide for small decisions. Cash flow budget: it tallies the cash receipts and expenses of the farm over a fixed time period. This budget shows whether or not expected total cash income will be adequate to cover cash expenses.
That is useful to assess major purchase. On the basis of above budgets company (Sainsbury) can create appropriation in its decisions: Set reasonable production goals for each product. Accurately calculate costs of production for each product. Estimate the breakeven price and net return a company need for each product in order to cover all costs and make a profit. Choose management strategies that can help company achieve production and price goals. Indentify problems that can cause company to Miss your production and price goals. Compare the returns company make from each of company’s product.
To better assess and plan for the profitability of the whole production. Quickly gather important information for business planning and loan applications. 3. 2: calculate unit costs and make pricing decisions using relevant information: The cost per unit is derived from the variable cost and fixed costs incurred by a production process, divided by the number of units produced. Variable cost such as direct material vary roughly in proportion to the number of units produced, though this cost should decline when as unit volume increase, due to greater purchasing discounts.
Fixed cost such as building rent, should remain fixed it does effect by the production units. Though they can increase as the result of additional capacity being needed. Within these restrictions, then the cost per unit calculation is: (Total fixed costs + total variable costs)/ Total units produced For example: Sainsbury has total variable costs of $ 50000 and total fixed costs of $30000 in May. Which it incurred while producing 10000 widgets. The cost per unit is: ($30000 fixed costs + $50000 variable costs)/ 10000 units = $8 cost per unit Elements of Decision making process:
An objective that can be quantified for example maximization of profit or maximization of total cost Constraints many decision problems have one or more constraints for example limited raw materials, labor etc. A range of alternative courses of action in order to minimize costs of a manufacturing operation, the available alternatives may be. To continue manufacturing as at present To change the manufacturing method To sub contact the work to a third party Forecasting of the incremental costs and benefits of each alternative cause of action.
Application of decision criteria or objective function for example: calculation of expected profit or contribution and ranking of alternatives. Choice of preferred alternatives. Relevant costs for decision making: The costs which should be used for decision making are “relevant costs” CIMA defines “relevant costs as costs appropriate to aiding the making of specific management decisions” to affect decision a cost must be: future: past costs are irrelevant, as we can’t affect them by current decisions. Incremental: expenditure which will incur as a result of making a decision.
Cash flow: the disposal value of existing equipment is relevant and book value irrelevant. Common cost: costs which will be identical for all alternatives are irrelevant for example rent or rates on a factory. Sunk costs: it is also known as past cost which is always irrelevant. For example: dedicated fixed assets, development costs already incurred. Committed costs: a future cash outflow that will be incurred anyway. For example: contracts already entered into which can’t be altered. 3. 3 Assess the viability of a project in Sainsbury’s using investment appraisal techniques: Investment appraisal looks at whether an investment project is worthwhile or not * can be used for all types of investment from the purchase of a new piece of machinery to a whole production unit * it allows mangers to make a informed choice regarding the viability of the project. Financial techniques of investment appraisal: assumptions: * All costs and revenues can be forecast accurately for future years * Key variables like interest will not alter * The business will be looking to maximize profits. Techniques of investment appraisal: * Payback period * Accounting rate of return Net present value (discounted cash flow) * Discounted cash flow Payback method: this looks at how long it takes to pay back the initial cost of the investment. It needs to know how much revenue the asset will generate. For example if a machine costs $ 50000 and it produces items 50000 that retail for 50p each it will take 2 years to pay back the initial investment. it allows you to compare projects –which one takes the shortest time to payback the initial investment. It can take an investment less than a year to generate revenues that cover its cost.
Average rate of return: it looks at the profit generated by the investment compared to the cost of investment: ARR = Average profit/initial cost of investment * 100 This gives the business a % figure showing the average rate of return. Businesses can then compare this figure to how much they would get with alternative investments. Discounted cash flow: this considers what money will be worth in the future. Discounting reduces value of future earnings to reflect opportunity cost of an investment reasons why this exists: Risk Opportunity cost
Net present value: one way of discounting cash flow is looking at NPV. This method takes into account inflationary pressures and interest rates. The idea that the money increases in value. Looks at how much you would need to invest now to earn a certain amount in the future. Allow comparison of an investment by valuing all cash inflows from investment at the present value. You can compare what would happen if you invested the money in other projects or just saved it in the bank PV = FUTURE VALUE/ (1+ I) n TASK:4: BE ABLE TO ANALYSE AND EVALUATE THE FINACIAL PERFORMANCE OF SAINSBURY’S: 4. : Explain the purpose of the main financial statements in Sainsbury’s: Businesses report information in the form of financial statements issued on a periodic basis. GAAP requires the following four financial statements: Balance sheet: statement of financial position at a given point in time. Income statement: revenues minus expenses for a given time period ending at a specified date. Statement of owner’s equity: it is also known a statement of retained earnings or equity statement. Statement of cash flow: summarizes sources and uses of cash, indicates whether enough cash is available to carry on routine operations.
Measuring the profitability: financial analysis help to ascertaining adequate profits are being earned on the invested capital in the business or not. Indicating the trend of achievements: these are helpful to compare the trends regarding various expenses, purchases, sales, gross profits and net profits etc can be ascertained. Assessing the growth potential of business: the trends and other analysis of the business provide sufficient information regarding actual growth potential of the company. Comparative position in relation to other firms: financial statements help to make comparative study of profitability with the data of other firms.
Assess overall financial strength: the purpose of financial analysis is to assess the financial strength of the business. Analysis also helps in taking decisions such as funds required for purchase of new machines and equipments. Assess solvency of firm: there are some tools of analysis which are helpful to express whether company has sufficient funds or not to meet its liabilities. 4. 2: Describe the differences between the formats of financial statements for different types of business: As we know, financial statements are formatted in four forms: Balance sheet Income sheet Equity statement Statement of cash flow
The difference between them is what these statements report. Balance sheet: balance sheets are divided into two sections: assets and liabilities. These statements are prepared to show, how a company’s income and output balanced against each other. Balance sheet often varies in complexity according to the size of business. Income sheets: it shows transformation of revenue into net income. Its purpose is to express, whether business made or lost money during a specific fiscal period. There are two types of income sheet: single and multi step sheet. Multistep sheet includes more detail as compare to single step.
Equity statement: equity statement represents change in company’s retained earnings. It includes information on dividends, operational profits and losses, all other charges to these earnings. Cash flow: it indicates the effect of the above statements on the company’s cash flow. This statement is useful for bankers, accounting staff, investors and potential employees. 4. 3: Analyse financial statements using appropriate ratios and comparisons, both internal and external of Sainsbury’s: Stakeholders get information from a company’s (Sainsbury) published accounts: * Level of sales * Amount of cash available * Value of debtors and creditors Level of debt and equity * Revenues generated * Costs and expenses etc This information is available for the last and for previous year but Sales of $1000000 are good or bad? Debtors of $500000 are good or bad? Revenue increase of 15% is good or bad? Absolute values are difficult to judge even an increase or decrease rate may be misleading, in order to achieve meaningful conclusions on a company’s performance, there is a need to make comparisons: Vs. previous years Vs. projected Vs. competitors Vs. industry averages Vs. known good performers Ratio analysis functions: Aids understanding of accounts Indicates relationships
Allows for comparisons Shows trends over time Provides additional information to the financial statements Steps of ratio analysis process: FIG: 2 CATEGORIES OF RATIOS: PROFITABILITY RATIO: it indicates the firm’s ability to generate returns on its sales, assets and equity. There are four types of profitability ratios: return on ordinary shareholder’s funds: net profit after tax * 100 / ordinary share capital return on capital employed: net profit before tax and interest *100 / share capital long term capital net profit margin: net profit before tax and interest * 100 / sales gross profit margin: gross profit *100 / sales
EFFICIENCY RATIO: ratios that are used to analyze how well a company uses its assets and liabilities internally. There are four types of efficiency ratio: Average stock turnover period: average stock held * 365 / cost of sales Average settlement period for debtors: trade debtors * 365 /credit sales Average settlement period for creditors: trade creditors * 365 / credit purchase Fixed asset turnover: sales / fixed assets LIQUIDITY RATIOS: liquidity ratio to the ability of a firm to meet its short term financial obligations when and as they fall due.
Current ration: current assets / current liabilities Acid test ratio: current assets (excluding stock) / current liabilities Operation cash flow to maturing obligations: operating cash flows / current liabilities GEARING RATIOS: it represents the relationship of owner’s equity to borrowed funds. Formula of gearing ratios: Gearing ratio: long term liabilities/ share capital + reserves + long term liabilities FIG: 3 INVESTMENT RATIOS: It is a relationship of gains from investment resulting from insurance operations to earned premiums.
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