Submission v2_MFDR - Finance-1

8/10/2019 Submission v2_MFDR - Finance-1

1/25

[Document title][Document subtitle]

Students name [Email address]

Abstract[Draw your reader in with an engaging abstract. It is typically a short summary of the

document.When youre ready to add your content, just click here and start typing.]


2/25

AbstractKnowing the costs of financing is a prerequisite before selecting the proper financing sources.

This assignment is about the financing issues of business. To obtain requisite financing for

the organization, it is necessary to have proper knowledge over the financing terms andmethods. Knowing the costs of financing is a prerequisite before selecting the proper

financing sources. In this assignment, we have discussed several advantages and

disadvantages for different financing methods, cost of finance, financial planning and

information and many other issues that help to know about the financing in organization.

Different books and journals have been used to answer the requirements in the assignment.


3/25

Table of contentsAbstract ...................................................................................................................................... 1

Introduction ................................................................................................................................ 5

Requirement 1 ............................................................................................................................ 6

Task 1.1: Necessity of finance in business and available sources of financing ..................... 6

Necessity of finance in business ........................................................................................ 6

Available sources of financing ........................................................................................... 6

Equity financing ............................................................................................................. 6

Debt financing ................................................................................................................ 6

Lease financing .............................................................................................................. 7Task 1.2: Implications of different financing sources ........................................................... 7

Implication of equity financing .......................................................................................... 7

Implication of debt financing ............................................................................................. 7

Implication of lease financing ............................................................................................ 7

Task 1.3: Analysis of suitable source of finance for the case studies .................................... 7

Case study 1: An engineering firm .................................................................................... 7

Equity financing for this firm ........................................................................................ 7

Debt financing ................................................................................................................ 7

Lease financing .............................................................................................................. 8

Case study 2: Individual financing .................................................................................... 8


Debt financing ................................................................................................................ 8

Lease financing .............................................................................................................. 8

Case study 3: Large plc. ..................................................................................................... 8

Equity financing for this firm ........................................................................................ 8Debt financing ................................................................................................................ 8

Lease financing .............................................................................................................. 8

Case study 4: Local Do It yourself firm............................................................................. 8


Debt financing for this firm ........................................................................................... 9

Lease financing .............................................................................................................. 9

Case study 5: Rugby club .................................................................................................. 9



4/25

Debt financing ................................................................................................................ 9

Lease financing .............................................................................................................. 9

Requirement 2: ........................................................................................................................... 9

Task 2.1: Analysis of the cost of financing............................................................................ 9

Cost of equity financing ..................................................................................................... 9

Cost of debt financing ........................................................................................................ 9

Cost of lease financing ..................................................................................................... 10

Task 2.2: Importance of financial planning ......................................................................... 10

Task 2.3: Importance of information for the process of decision making ........................... 10

Example from a firm about the importance of information ............................................. 10

Task 2.4: Various finance sources in financial statements .................................................. 11

Equity financing in financial statements .......................................................................... 11Debt financing .................................................................................................................. 11

Lease financing ................................................................................................................ 11

Requirement 3 .......................................................................................................................... 11

Task 3.1: How financial decisions are based on budgeting ................................................. 11

Task 3.2: Pricing and unit cost ............................................................................................. 12

Task 3.3: Investment decisions ............................................................................................ 12

Analysis of the investment decision by Payback period .................................................. 12

Analysis of the investment decision by Net Present Value ............................................. 12

Decision ........................................................................................................................... 13

Requirement 4 .......................................................................................................................... 13

Task 4.1: Main financial statements .................................................................................... 13

Statement of comprehensive income ............................................................................... 13

Statement of Financial Position ....................................................................................... 13

Statement of cash flow ..................................................................................................... 13

Statement of changes in equity ........................................................................................ 13Task 4.2: Formats of financial statements for different business ........................................ 13

Statement of Comprehensive income .............................................................................. 14

Statement of financial position ........................................................................................ 14

Statement of changes in equity ........................................................................................ 14

Examples of 2 real life company ..................................................................................... 14

Financial Statement of David Jones ............................................................................. 14

Financial statement of Myer Holdings ......................................................................... 15

Task 4.3: Ratio measurement ............................................................................................... 16


5/25

Profitability ratio .............................................................................................................. 16

Liquidity ratio .................................................................................................................. 17

Activity / efficiency ratio ................................................................................................. 17

Interpretation of ratios...................................................................................................... 17

Example from 2 separate firm and interpretation about their ratios ................................ 17

Activity Ratios ............................................................................................................. 17

Liquidity Ratios ........................................................................................................... 18

Solvency Ratios ........................................................................................................... 19

Profitability Ratios ....................................................................................................... 20

Conclusion ............................................................................................................................... 23

References ................................................................................................................................ 24


6/25

IntroductionThere are some factors of production. Any kind of business, whether it is production or

service oriented business, it requires some factors of production. Capital, human resource,

land and entrepreneurs are those factors of production(Chung, et al., 2010). All of these

factors is dependent on the adequate supply of money or capital. So, financing or capital is a

significant issue in business. Managing the proper financing sources and obtaining adequate

finance for the business is necessary to ensure the smooth flow of business(Brigham &

Daves, 2012).

This assignment is about the financing issues of business. To obtain requisite financing for

the organization, it is necessary to have proper knowledge over the financing terms and

methods. Knowing the costs of financing is a prerequisite before selecting the proper

financing sources. To ensure proper working capital as well as to minimize the cost of the

capital at the same time requires proper planning and budgeting(Loayza & Rancire, 2006).

In this assignment, we have discussed several advantages and disadvantages for different

financing methods, cost of finance, financial planning and information and many other issues

that help to know about the financing in organization. Different books and journals have been

used to answer the requirements in the assignment.


7/25

Requirement 1Task 1.1: Necessity of finance in business and available sources of financingNecessity of finance in businessA business can be production based or service based. Whatever the nature of the business, it

requires several factors for operating the business. As per Gitman & McDaniel (2008), 4

factors of production are-

1. Capital,

2. human resource3. land

4. and entrepreneurs

Without proper capital, it is not possible to continue the production or operation of business.

It is not possible always for the owners to manage the required capital by themselves(Gitman

& McDaniel, 2008). So, owners of the business have to collect required capital from various

sources. So, it is obvious that, business needs financing for running the business.

Available sources of financingAs per Ross et al. (2010), Financing in a business can be of 3 types. Those sources are-

Equity financingEquity financing means to collect financing from different sources by giving the financers a

portion of the ownership. Equity financing includes-

1. initial public offering

2. repeat public offering3. Personal saving etc.

Debt financingCollecting money as a debt for the business is considered as debt financing. It includes-

1. debt from friends and relatives

2. debt from banks

3. debt from financial institutions

4. bonds


8/25

5. investment organizations

Lease financingLease financing is a form of financing in which machineries or assets are acquired as a form

of financing and thus capital is formed.

Task 1.2: Implications of different financing sourcesDifferent financing sources have different implications. Some of the implications are-

Implication of equity financingEquity financing is beneficial for the organizations as it provides ownership to raise finance.

As a result of this financing, profit or loss is shared to the owners(Chandra, 2005). Whenthere is profit, shareholders will receive dividend, when there is no profit, dividend is not

paid.

Implication of debt financingDebt financing increases cost for the organization though it creates some benefit also.

Whether there is loss or profit, firm has to pay a fixed portion of interest to the debtors. It

often needs collateral to collect debt financing(Prasanna & Prasanna, 2011).

Implication of lease financingLease financing helps to increase capital by taking machine or non-current asset as lease and

pay for the asset on an installment basis. Installment may contain interest or cost of financing.

Task 1.3: Analysis of suitable source of finance for the case studiesCase study 1: An engineering firmLease financing is suitable for this engineering firm to obtain capital of 540,000 (in the form

of machineries & building). The implication of each of the financing sources is as follows for

this case-

Equity financing for this firmEquity financing may require more time and legal procedures for this case. If the company is

not listed in the stock exchange it may have to go a long way for this equity financing.

Debt financing

Debt financing may be suitable for this firm, but the higher cost of interest rate may affect its performance.


9/25

Lease financingLease financing is suitable for this firm as the repayment in installment basis will help the

firm to get rid of lump sum payment.

Case study 2: Individual financingDebt financing is suitable for the individual as he requires more $110,000 (180000 70000)

capital. The implication of each of the financing sources is as follows for this case-

Equity financing for this firmEquity financing is not available for this person as he is not a company. He may go for

partnership but that will also require some legal procedures.

Debt financing

Debt financing is suitable for this person. Debt financing from relatives, friends, banks or any

investment institutions can help to establish business.

Lease financingLease financing is not available for this person as he will purchase a land.

Case study 3: Large plc.Equity financing is suitable for this firm. The implication of each of the financing sources is

as follows for this case-

Equity financing for this firmEquity financing is suitable for this firm as it is a large plc.And require $4.5 million of

capital.

Debt financingDebt financing may be suitable for this firm, but the higher cost of interest rate may affect its

profitability.

Lease financingLease financing is not available for this company as it will procure a site.

Case study 4: Local Do It yourself firmDebt financing is suitable for this local firm. The implication of each of the financing sources

is as follows for this case-

Equity financing for this firmEquity financing is not suitable for this firm as it is a local firm and have to go a long way for

legal procedures for equity financing.


10/25

Debt financing for this firmDebt financing is suitable for this firm, as it needs to increase working capital for the

business.

Lease financingLease financing may not be suitable for this entity as it have to increase working capital.

Case study 5: Rugby clubEquity financing from the member is a suitable financing source for the rugby club. The

implication of each of the financing sources is as follows for this case-

Equity financing for this firmEquity financing from the club members is suitable for this firm as it is a club and require

$550000 of capital.

Debt financingDebt financing may not be suitable for this club as the higher cost of financing may cause

loss for the club.

Lease financingLease financing is not available for the club will improve the grounds.

Requirement 2Task 2.1: Analysis of the cost of financingDifferent source of financing has different type of cost. Analysis of the cost of financing is

given below for different sources-

Cost of equity financingCost of equity financing is lower compared to other sources(Pandey, 2010). Again, in equity

financing when there is loss, business doesnt need to pay div idend or interest. Shareholders

get the portion of profit or loss in equity financing.

Cost of debt financingDebt financing requires to pay a fixed interest that is higher in amount. So, cost of debt

financing is higher compared to equity financing.


11/25

Cost of lease financingLease financing has higher interest rate but it is payable in installment basis, which reduces

the risk to pay at single time.

Task 2.2: Importance of financial planningFinancial planning is of great importance for the organizations. Some of the importances are-

1. Organization needs financial plan to get idea about the required capital and working

capital

2. The estimation about the cost of capital also require financial planning

3. Without financial planning no budget can be prepared

4. We need financial planning in organizations to reduce the cost of capital (Chandra,

2005)

5. In order to select the best source of financing, we need financial planning

Task 2.3: Importance of information for the process of decision makingInformation is power in todays world. In organization, it has great importance. Some of the

importance of information is discussed below-

1. Information provides background for any task in organization

2. To know about the profitability of any task, organization needs information

3. Information helps to decide the managers which one is good for organization and

which one is bad.

4. Information helps to assess and evaluate the performance for any specific activity and

take necessary actions

Example from a firm about the importance of informationABC firm is deciding to go for business expansion. Primarily it has selected 3 regions for

their new facility. The available options are-

1. Bristol

2. Birmingham

3. Coventry


12/25

Now, the manager of the ABC firm has to select anyone of the available options. This

decision have to be taken based on some information. Information about the available people,

buying capacity of consumers, social standard and the probable demand in theseregions will

help to take the proper decision for their investment. So, without information, no decision can

be made that bring benefit for the organizations.

Task 2.4: Various finance sources in financial statementsIn financial statements, various sources of finance is shown as below-

Equity financing in financial statementsEquity financing is shown in the liability part as the equity of the organization. Equity can be

shown as shareholders equity in the Statement of Financial Position.

Debt financingDebt financing is shown in the liability part as the debt or long term / short term loan of the

organization(Chung, et al., 2010). Debt can be shown as loan from bank/ financial institutions

or other sources in the Statement of Financial Position.

Lease financing

Lease liability is shown in the liability part of the Statement of Financial Position. Leaserepayment is shown in the statement of Comprehensive Income and in the Cash flow

statement.

Requirement 3Task 3.1: How financial decisions are based on budgetingBudgeting is the process of making some financial plans about any future activity. Financial

decisions in organizations are often based on budgeting. Some of the ways how budgeting

influences the financial decisions are-

1. Financial decisions require estimation about future cash inflow and outflow

2. Financial decisions require information about profitability which may be available in

budgeting(Morten, et al., 2010)

3. Before taking any financial decisions, management need to know about the viability

of any activity


13/25

Task 3.2: Pricing and unit costXYZ Ltd has the following information of production-

Fixed cost = $100000

Variable cost = $20 per unit

Number of production = 10000 unit

So, per unit cost = (100000 / 10000) + 20

= 30 per unit

So, total production cost is $30 per unit. If the profit margin is 20%, the price of the product

will be = 30 120% = $36

Task 3.3: Investment decisionsIn this task, an investment decision is to be taken based on some analysis.

Analysis of the investment decision by Payback periodPayback period for the investment = (1000 / 200) = 5 years

So, the payback period is 5 years for this investment.

Analysis of the investment decision by Net Present Value

NPV = R 1 (1 + I)-n

Initial Investmenti

= 200 {1 (1 + .1) -6} / .1 1000

= 200 4.35 1000


14/25

= 871 1000

= -129

Note: 10% rate of interest has been taken for calculation

DecisionBased on the above Payback period and NPV calculation, I will suggest not to take the

investment opportunity as it generates negative NPV and take long time to get the invested

amounts.

Requirement 4Task 4.1: Main financial statementsFinancial statements are prepared in order to provide the material information about the

financial performance of the organization(IAS-1, 2007). As per IAS 1: Presentation of

Financial Statements , there are 4 components of financial statements. Those are-

Statement of comprehensive incomeAll kinds of income and expenses are included in this financial statement. This reflect the

gross profit, operating profit, net profit, EBIT etc.

Statement of Financial PositionStatement of Financial Position was previously called as Balance Sheet. This includes the

assets and liabilities of an organization and represent the financial position of an organization

in a point of time(IAS-1, 2007).

Statement of cash flowStatement of cash flow includes all the cash inflow and outflow of an organization during the

financial year.

Statement of changes in equityThis financial statement includes the information showing the financial information regarding

the changes in owners equity.

Task 4.2: Formats of financial statements for different business

Different types of business may contain different types of financial statements. The types andformats are discussed below-


15/25

Statement of Comprehensive incomeStatement of comprehensive income is suitable for company but may be named as income

statement for small organizations as it was named previously.

Statement of financial positionPreviously statement of financial position was called as balance sheet. This is same for all

kinds of business.

Statement of changes in equityThis is applicable for companies as it includes information about the ownership and owners

equity of the organization.

Examples of 2 real life company

Financial Statement of David JonesDavid Jones is a famous clothe retailer around the world. A financial statement of David

Jones is shown as below-


16/25

Financial statement of Myer Holdings

Myer Holdings is a famous large departmental store group. A sample of its financialstatement is shown below-


17/25

Task 4.3: Ratio measurementRatio analysis helps to determine the performance irrespective of the monetary value and

help to compare themselves with the other competitors in the industry.

Profitability ratioProfitability ratio for this entity is shown as below-

Profit margin = net profit / net sales = 2000 / 7000 = 0.285 = 28.5%


18/25

Return on asset = net income / total asset = 2000 / 18000 = 0.11 = 11%

Liquidity ratioLiquidity ratio for this entity is shown as below-

Current ratio = current asset / current liability = 13000 / 6000 = 2.16 times

Activity / efficiency ratioActivity ratio for this entity is shown as below-

Asset turnover ratio = net sales / total asset = 7000 / 18000 = 0.38

Interpretation of ratiosAs per the ratio above, the performance of the company is satisfactory. It has good

profitability with a higher profit margin of 28%. The current ratio is also satisfactory that is

of 2.16 times. This indicates a satisfactory performance in terms of liquidity condition.

Efficiency of the organization is also good with an asset turnover ratio of 38%.

Estimating between external and internal comparisonExternal users require ratios relating to the organization in order to assess the profitability,

liquidity, financial strength and investment condition for business.

Internal users like the employee, management require information relating to the activity or

efficiency, profitability and financial leverage position.

Example from 2 separate firm and interpretation about their ratios

Activity RatiosActivity ratios measure how quickly a firm converts non-cash assets to cash assets. Activity

ratio of this entity also reveals the ability of the organization to convert its non-cash assets to

cash assets. We have included the financial

Activity Ratios

David Jones Myer Holding

Inventory turnover 1.40 1.72


19/25

Days of inventory on hand (DOH) 261 212

Receivables turnover 2.19 2.05

Days of sales outstanding (DSO) 167 178

Payables turnover 1.82 1.72

Number of days of payables 201 212

Fixed asset turnover 2.14 1.07

Total asset turnover 0.44 0.47

InterpretationsDavid Jones has better performance compared to Myer Holdings in terms of activity ratio.

We find better inventory turnover, receivable turnover and fixed asset turnover for David

Jones compared to Myer Holdings(David-Jones, 2012). The payable turnover ratio is also

satisfactory for David Jones compared to Myer Holdings.

Liquidity RatiosLiquidity ratios measure the availability of cash to pay debt. The liquidity ratios of this

company is calculated by the given procedures-

Liquidity Ratios

David Jones Myer Holding

Current ratio 7.91 5.34

Quick ratio 3.04 2.71

Additional Liquidity measure

Cash conversion cycle 227 178


20/25

Interpretations:David Jones has better performance compared to Myer Holdings in terms of liquidity ratio.

We find better current ratio and quick ratio for David Jones compared to Myer Holdings. The

cash conversion cycle is also satisfactory for David Jones compared to Myer Holdings.

Solvency RatiosRatio name Particulars Amount Ratio

output

Amount Ratio

output

Debt rati os David Jones Myer Holding

Debt to assets ratio Total debt

Total assets231577650

1713999860

0.13

206302341

2281584596 0.09

Debt to capital

ratio

Total debt

(total debt +

shareholders

equity)

231577650

1466529613

0.15

206302341

2048344598 0.10

Debt to equity

ratio

Total debt

shareholders

equity

231577650

1234951663 0.18

206302341

1842042258 0.11

Financial leverage

ratio

Average total

asset average

total equity

1531014483

1144018690 1.33

1994192228

459295268 4.34

Coverage ratios

Fixed charge

coverage

(EBIT + Lease

payments)

(Interest

payments +

Lease

payments)

206359974

1131636

182.35 459522631

227363

2021.0

97

InterpretationsDavid Jones has better performance compared to Myer Holdings in terms of solvency ratio.

We find better Debt to assets ratio, Debt to capital ratio and financial leverage ratio for David


21/25

Jones compared to Myer Holdings. The debt to equity ratio is also satisfactory for David

Jones compared to Myer Holdings.

Profitability RatiosDavid Jones

Profitability Ratios Numerator DenominatorNumerator

(Amount)

Denominator

(Amount)

Ratio

of

David

Jones

Return on Sales Gross Profit Margin Gross Profit Revenue 312,953,390 879,809,638 35.57%

Operating Profit MarginOperating

IncomeRevenue 276,036,881 879,809,638 31.37%

Pre Tax Margin EBT Revenue 251,464,593 879,809,638 28.58%

Net Profit Margin Net Income Revenue 238,626,594 879,809,638 27.12%

Return on Investment

Operating ROAOperating

Income

Average Total

Asset276,036,881 1,994,192,228 13.84%

ROA Net IncomeAverage Total

Asset238,626,594 1,994,192,228 11.96%

Return on Total Capital EBIT

Short & Long

Term Debt &

Equity

265,165,116 1,842,042,257 14.40%

ROE Net IncomeAverage Total

Equity238,626,594 1,534,896,960 15.55%

Myer Holding

Profitability Ratios Numerator DenominatorNumerator

(Amount)

Denominator

(Amount)

Ratio

Of


22/25

Myer

Holdin

g

Return on Sales

Gross Profit Margin Gross Profit Revenue 281,501,992 795,011,479 35.41%

Operating Profit MarginOperating

IncomeRevenue 237,722,960 795,011,479 29.90%

Pre Tax Margin EBT Revenue 216,029,857 795,011,479 27.17%

Net Profit Margin Net Income Revenue 193,503,627 795,011,479 24.34%


Operating ROAOperating

Income

Average Total

Asset237,722,960 1,531,014,483 15.53%

ROA Net IncomeAverage Total

Asset193,503,627 1,531,014,483 12.64%

Return on Total Capital EBIT

Short & Long

Term Debt &

Equity

216,840,467 1,234,951,663 17.59%

ROE Net IncomeAverage Total

Equity193,503,627 1,144,018,690 16.91%

Profitability Ratios David JonesMyer

Holdings

Return on Sales

Gross Profit Margin 35.57% 35.41%

Operating Profit Margin 31.37% 29.90%

Pre Tax Margin 28.58% 27.17%


23/25

Net Profit Margin 27.12% 24.34%


Operating ROA 13.84% 15.53%

ROA 11.96% 12.64%

Return on Total Capital 14.40% 17.59%

ROE 15.55% 16.91%

Interpretation of Profitability Ratios

David Jones has better performance compared to Myer Holdings in terms of profitability

ratio. We find better Debt to net profit margin and pre-tax margin for David Jones compared

to Myer Holdings. ROE and ROA is higher for Myer Holdings compared to David Jones.


24/25

ConclusionFinancing has become a major concern for the organizations. To understand the performance,

to measure the performance and to select the best suitable financing method and take the

actions, financing and budgeting is essential to the organizations.


25/25

ReferencesBrigham, E. F. & Daves, P. R., 2012. Intermediate Financial Management. s.l.:CengageLearning.

Chandra, 2005. Fundamentals of Financial Management. s.l.:Tata McGraw-Hill Education.

Chung, K. H., Elder, J. & Kim, J.-C., 2010. Corporate Governance and Liquidity. The

Journal of Financial and Quantitative Analysis, 45(2), pp. 265 - 291.

David-Jones, 2012. Annual Report of David Jones.

Deegan, C., 2009. Financial Accounting Theory. 3 ed. Australia: McGraw-Hill.

Gitman, L. J. & McDaniel, 2008. The Future of Business. 5 ed. s.l.:s.n.

Griffin, R. W., 2010. Principles of management. 9 ed. New York: Houghton Mifflin

Company.

IAS-1, 2007. Presentation of Financial Statements. International Accounting Standard.

Loayza, N. V. & Rancire, R., 2006. Financial Development, Financial Fragility, and

Growth. Journal of Money, Credit and Banking.

Morten, H., Snorre, L. & Brock, M., 2010. Corporate Finance. s.l.:McGraw-Hill

International.

Myer, H. L., 2012. Annual Report of Myer Holdings Ltd, s.l.: s.n.

Pandey, I., 2010. Financial Management. 10 ed. s.l.:s.n.

Prasanna, C. & Prasanna, 2011. Financial Management. s.l.:Tata McGraw-Hill Education.

Ross, S. A., Westerfield, R. W. & Jaffe, J., 2010. Corporate Finance. 7 ed. New Delhi: Tata

McGraw Hill Publishing Company Limited.

Submission v2_MFDR - Finance-1

Documents

Transcript of Submission v2_MFDR - Finance-1