Financial Strategies and Accounts (1)

7/21/2019 Financial Strategies and Accounts (1)

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[FINANCIAL STRATEGIES ANDACCOUNTS]


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Understanding Financial

ObjectivesFinancial Aims:the broad, general goals of the nance andaccounting function or department within an organisation.Financial Objectives:the specic, focused targets of the nanceand accounting department within an organisation.Financial Strateies:long-term or medium term plans, devised atsenior management level, and designed to achieve the rmsnancial objectives.

Financial Tactics:short-term nancial measures adopted to meetthe needs of a short-term threat or opportunity.

Financial Objectives

he e!amples set out below illustrate the types of nancial objectivethat a business might pursue"

#ash FlowMany businesses get into fnancial diculties because o lack ocash ow rather than lack o overall proftability. Consequently, it is

vital that businesses set themselves cashow targets to ensurethey are able to keep operating. !.g.

$aintaining a minimum closing monthly cash balance, fore!ample a minimum cash balance of %&',''' would be asensible target for a small newsagents

(educing the ban) overdraft by a certain sum by the end of the

year For new start-up companies, it is li)ely an overdraft will be

needed to support everyday e!penses *nterest means it is not advisable to sustain an overdraft,

therefore businesses may set objectives with this in mind #reating a more even spread of sales revenue

+preading costs more evenly

chieving a certain level of liuid, non-cash items

(aising certain levels of cash at a particular point in time

+etting contingency funds

#ost $inimisation" business that reduces its costs can beneft in two ways# keepingprices the same thereore having a higher proft margin, or reducing

the selling price to attract more customers. !.g. chieving a certain cost reduction in the purchase of raw

materials


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(educing wage costs per unit

owering levels of wastage

(elocating the business to the least cost site

(educing the cost per thousand customers of the business

promotion and advertising *mproving the e/ciency of production by reducing variable costs

per unit

(O#0 argets$he success o a business is invariably demonstrated by its proft

levels. Clearly, large frms will achieve higher proft levels than

smaller businesses, so the proft needs to be compared to the si%e

o a business. !.g.

chieve an (O#0 that e!ceeds the level recorded for theprevious year by a certain percentage

chieve an (O#0 that compares favourably to the average (O#0achieved in the U1

chieve an (O#0 that e!ceeds the level of a particular

competition

+hareholders (eturns

" business must satisy the needs o its shareholders&owners. Manyshareholders assess a business in terms o dividends received

because a high dividend is likely to be linked to high proft levels

and sound fnancial perormance. !.g.

2igh dividend per share which will indicate a well performingbusiness and will benet shareholders with increased dividends

2igh dividend yield - shows the dividend paid as an percentageof the mar)et value of the share. his can be compared tointerest rates in ban)s or alternative investments

*ncreasing the share price as this tends to re3ect the value of thebusiness, therefore if a business retains its prots and growssuccessfully, the share price should increase

2igh earnings per share. +how prot made by each individualshare in a business, and is a good indicator of e/ciency


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*nternal *n3uences on Financial Objectives

*nternal factors that a4ect nancial objectives are those within a

business, such as its wor)force, resources and nancial position.

#orporate Objectives5he overall aims of an organisation are a )ey in3uence on theobjectives of a functional area, such as the nance department. henance department must ensure that its objectives are consistentwith the corporate objectives of the business.

2uman (esources 62(75

chieving nancial objectives depends on the e4orts and s)ills ofthe wor)force. 04ective planning of the wor)force and a goodrecruitment and training policy can enable a business to increase itsprotability, by increasing the e/ciency of the wor)force. 2owever,there can be a con3ict between the needs of the wor)force and thebusiness nancial objectives.

Finance5 business in a healthy nancial situation is in a much betterposition to achieve high levels of prots and cash-3ow. *t can fund

investment into items such as research and development, newtechnology and mar)eting campaigns that may help improve itsoverall nancial performance. #onseuently a such a business canset more challenging objectives.

Operational Factors5he nance department relies on each of the functional areas inorder to reach its objectives. *f the operations management functionof a business is operating e/ciently, the rm will be able toproduce goods of high uality and low cost. his will lead to goodsales revenue and high prot margins, and enable the business toachieve uite challenging nancial objectives.


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(esources vailable5 business, which over time has built up a strong resource base, willbe able to target and achieve a strong nancial performance. heseresources might be in the form of premises, well-)nown brandnames, or the uality of the wor)force.

he 8ature of the 9roduct5he success of a business is heavily in3uenced by its product andservices it o4ers. *n many cases, successful businesses havehappened to be in the right place at the right time.

0!ternal *n3uences on Financial Objectives0!ternal factors are those outside the business, such as the state ofthe economy and the actions of competitors. 90+0 describese!ternal factors that can a4ect a business.

9olitical Factors5Financial objectives are often guided towards the wishes of theshareholders. 2owever, the great openness has also led toe!pectations on businesses to serve the needs of other groups, suchas the wor)force, customers, the local community and the

environment.

0conomic Factors5he state of the economy is a major in3uence on the nancialperformance of businesses. For e!ample, if an economy is inrecession, customers will purchase fewer products and so lowersales and prot targets will be set. For businesses dealing withlu!ury products, it is li)ely that these targets will be signicantlylower. For some businesses, such as those selling staple foods, therewill only be a limited.

+ocial Factors5+ociety is constantly changing and businesses must adjust to suitsociety. 9eople now e!pect access to businesses :;


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egal Factors5*n some industries, legal reuirements have a big impact on theobjectives of a business, and changes in these reuirements willlead to modied nancial objectives.

0nvironmental Factors5>rowing environmental awareness among consumers and actionsby pressure groups have had nancial implications for businesses.cuiring supplies and raw materials from environmentally friendlysources is now an aim for many businesses as they try to minimisetheir carbon footprint.

Other e!ternal factors that can in3uence nancial objectives includemar)et factors 6as products go through the product life cycle,

objectives will have to be modied7, competitors actions andperformance 6competing may lead to lower prot margins or limitedcompetition may increase them7, and suppliers 6as they can have amajor impact on costs7.

Using Financial ?ata to$easure and ssess9erformance

wo )ey nancial documents )ept by a rm are5

@alance +heet

document describing the nancial position of a

company at a particular point in time, by comparingitems owned by the company 6assets7 with the amountsit owes 6liabilities7

*ncome +tatement n account showing the income and e!penditure 6and

thus prot or loss7 of a rm over a period of time6usually a year7

(evenue


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#apital e!penditure is when cash is spent on an item that will

be used over and over again that will help the business in

future years A a non-current 6!ed7 asset

(evenue e!penditure covers spending on day to day items

such as wages, o/ce consumables, operating e!penses,

rental payments and mar)eting e!penditure.

he signicance of the distinction between capital and revenue

e!penditure lies in accountancy practice. basic rule of accounting

is matching or accruals concept. Bhen calculating a rms prot any

income should be matched to the e!penditure involved in creating

that income. (evenue e!penditure o4ers little problems, however

capital e!penditure needs to be allocated over several years 6the

lifetime of the asset7. For e!ample, if a machine cost %C','' andwould be used for C years, the e!penditure would be %&',''' per

year for C years rather than a lump sum.

!r"#enceis another accounting convention. ccounts should

ensure that the worth of the business in not e!aggerated, therefore

rms are slightly pessimistic in estimating the value of its assets

De$reciati%n is a fall in value of an asset over time& re3ecting the

wear and tear of the asset as it becomes older. he three causes of

depreciation are time, use and obsolescence.

@alance +heets

he balance sheet loo)s at the accumulated wealth of the businessand can be used to assess its overall worth. *t lists the resourcesthat a business owns and the items it owes.*n addition, it shows the capital provided by the owners. #apital isprovided through either the purchase of shares or the agreement toallow the company to retain or Dplough-bac) prot into thebusiness, )nown as reserves, rather than using it to pay furtherdividends to the shareholders.

Assets: *tems that are owned by an organisation. ssets are

generally grouped into two categories5 noncurrentand current.

o *n general, n%n'c"rrentassets are purchased to allow the

business to operate continuously. and and buildings, machineryand vehicles are acuired so that rm has the euipment fromwhich to operate. hese are e!amples of tanibleassets.Intanibleassets include goodwill 6brand names and patents7.

o C"rrentassets are short term items that circulate in a business

on a daily basis and can be e!pected to turn into cash within a


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year. 0!amples of currentassets are inventories 6stoc)s7,debtors, the ban) balance and cash. *nventories are valued atcost paid, rather than e!pected sale price.

Liabilities: ?ebts owed by an organisation to suppliers,shareholders, investors or customers who have paid in advance.

o 0!amples of non-current liabilities include debentures and long-

term or medium-term loans. ?ebentures are !ed interest loanswith a repayment date set a long-time into the future

o 0!amples of current liabilities are creditors, ban) overdrafts,

corporation ta! owing and shareholders dividends due forrepayment.

Ca$ital:Funds provided by shareholders to set up the business,

fund e!pansion and purchase !ed assets. *t generally ta)es twoforms5

o S(are Ca$ital: Funds provided by shareholders through the

purchase of shares.o Reserves:hose items that arise from increases in the value of

the company, which are not distributed to shareholders asdividends, but are retained by the business for future use.

*t is important to )now the purpose of the balance sheet" (ecognising the value of the business

>aining an understanding of the nature of the rm.

*dentifying the companys liuidity position.

+howing sources of capital.

(ecognising the signicance of changes over time.

*ncome +tatements

n inc%me statementdescribes the income and e!penditure of a

business over a given period of time.

9urpose of the prot and loss account A

o (egular calculations of prot throughout the year help

managers to review progress before the nal end-of-year

accounts are completed.o o satisfy legal reuirements to do so.o 9ublication allows sta)eholders to see if a rm is meeting their

needs.o #omparisons can be made between two di4erent rms.o 9otential investors can see if the rm is able to provide a good

return.


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o 2elps identify whether the prot earned by the business is

sustainable 6Eprot uality7

he prot and loss account is divided into three sections, these are"

the trading account, the prot and loss account and theappropriation account5

he trading account records the turnover of the company and

the Dcost of sales. herefore this account calculates the grossprot. >ross prot indicates how e/cient a business is atconverting its raw materials or stoc) into a nished product.

he prot and loss account, on the other hand, loo)s at theturnover minus the !ed costs" thus calculating the operating

prot. his is the revenue earned from everyday tradingactivities minus the costs of carrying out these activities.

he appropriation account is a statement which shows what

happens to prot" how it is used or distributed. ypically, it willshow how much prot is retained by the business and howmuch is given to the shareholders.

he prot and loss account is structured in a specic way for threemain reasons.

&. he rst reason is that the trading account enables a businessto see how e/ciently it is at turning materials into salesrevenue.

:. he prot and loss account shows the e/ciency of a rm incontrolling its overheads and e!penses.

G. he appropriation account is of particular interest to shareholders. business that is using most of its prots to pay highdividends will please shareholders loo)ing for a uic) return.

2owever, shareholders with a long-term interest in thebusiness may prefer to see high retained prots, as these willbe reinvested into the business to boost prots in the future.

Bor)ing #apital

iuidity A the ability to convert an asset into cash without loss or

delay

he wor)ing capital shows the net current assets of a rm. *t is the

day-to-day nance used in a business, consisting of current assets

minus current liabilities. *t is a measure of liuidity, and rmsgenerally want to have between &.C and : times as many assets


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than liabilities. ess than this, the rm is becoming illiuid, more

than this it is too cautious and should invest more.

working capital=current assetscurrent liabilities

Of course the balance sheet is just a snapshot of the wor)ing capitalposition at a point in time 6the balance sheet date7. *n reality, abusiness is constantly settling liabilities, ta)ing money fromcustomers, buying inventories and so on. his is )nown as the)%r*in ca$ital c+cle, as illustrated below5

*n the diagram above5 he business uses cash to acuire inventories 6stoc)s7 he stoc)s are put to wor) and goods and services produced.

hese are then sold to customers +ome customers pay in cash but others buy on credit. 0ventually

they pay and these funds are used to settle any liabilities of thebusiness 6e.g. pay suppliers7

nd so the wor)ing cycle repeats

*n3uences on wor)ing capital levels5

ime ta)en to sell stoc) ime ta)en by customers to pay for goods #redit period o4ered by suppliers

#auses of di/culties5

Failure to control inventory levels

9oor controls of receivables

9oor controls of payables

#ash 3ow problems


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9oor internal planning and coordination

0!ternal factors

+olving problems5

*nventory control - ow inventory levels mean no storages

costs, however you miss out in purchasing economies of scale.

Hust *n time system is e4ective (eceivables control A receivables should be )ept to a

minimum, however the o4er of credit may increase sales

though *f credit is o4ered, credit control must be strict

*nvoices and reminders #hasing up people a)ing people to court #redit rating

9rot Iuality


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he balance sheet and income statement provide much useful

information for a user of accounts to better understand how the

business is doing. +ome useful analytical tas)s would include5

#omparing performance over time5

danger with just loo)ing at one years results is that the numbers

can hide a longer term issue in the business. @y loo)ing at data over

several years, it is possible to see whether a trend is emerging.

#omparing performance against c%m$etit%rsor the industry as a

whole5

comparison against competitors provides a useful way for

management and shareholders to assess relative performance. 2asthe business revenues grown as fast as close competitorsK 2ow has

the business performed compared with the mar)et as a wholeK

,enc(mar*inagainst bestLinLclass businesses5

#omparison against other businesses who are not direct competitors

can also be useful A particularly if they help set the standard that

the business aims to achieve. #are has to be ta)en with this,

though. he benchmar) business might operate in a very di4erent

industry, with signicantly di4erent prot margins and balancesheet norms.

+trengths and Bea)nesses of Financial ?ata

@alance +heet has been designed

to help people judge a companys

performance A can assess siJe, net

assets, liuidity position and

sources of capital of a rm.

*ncome +tatement can help

calculate a rms prot level,

assess whether or not to buy

shares, loo) at prot uality and

how prot is being used.

+ta)eholders can e!pect regular

and accurate data

9ublished accounts are chec)ed by

independent auditors

+ome valuations are partially

subjective ?i4erent accounting methods can

be employed ccounts show what has happened

rather than why 9ublished accounts focus on

protability


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accuracy of the data as a measure of current performance and

potential performance.

*nterpreting 9ublishedccounts

Financial information is always prepared to satisfy in some way theneeds of various interested parties 6the Musers of accountsM7.+ta)eholders in the business 6whether they are internal or e!ternalto the business7 see) information to nd out three fundamentaluestions5

&. 2ow is the business tradingK:. 2ow strong is the nancial positionKG. Bhat are the future prospects for the businessK

For outsiders, published nancial accounts are an important sourceof information to enable them to answer the above uestions. osome degree or other, all interested parties will want to as)uestions about nancial information which is li)ely to fall into oneor other of the following categories, and be about5

9erformance rea 1ey *ssues

!r%-tabilit+ *s the business ma)ing a protK 2ow e/cient is the business at

turning revenues into protK *s it enough to nance

reinvestmentK *s it growingK

*s it sustainable 6high uality7K

2ow does it compare with the

rest of the industryK

Financial E.cienc+ *s the business ma)ing best use

of its resourcesK *s it generating adeuate

returns from its investmentsK *s it managing its wor)ing

capital properlyK

Li/"i#it+ an# Gearin *s the business able to meet its

shortLterm debts as they falldueK

*s the business generating

enough cashK

?oes the business need to raisefurther nanceK

2ow ris)y is the nance


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structure of the businessK

S(are(%l#er Ret"rn Bhat returns are owners

gaining from their investmentin the

businessK

2ow does this compare with

similar, alternative investmentsin

other businessesK

9rotability (atios

Ret"rn On Ca$ital Em$l%+e# 0ROCE1:his ratio shows the operating prot as a percentage of the capitalemployed. Operating prot is considered to be the best measure ofperformance, as it focuses only on the businesses main tradingactivities. *t also can be used to compare between rms overseas,as it is prot before ta!, meaning various ta! rates in di4erentcountries are not considered.

ROCE ( )=operating profitprofit before tax

total equity+noncurrent liabilities100

Bith (O#0, the higher the percentage gure, the better. he gureneeds to be compared with the (O#0 from previous years to see ifthere is a trend of (O#0 rising or falling. >enerally, (O#0 tend to be&'-&CN, however anything above interest rates is usually deemedacceptable.*t is also important to ensure that the operating prot gure used forthe top half of the calculation does not include any e!ceptional

items which might distort the (O#0 percentage and comparisonsover time.o improve its (O#0 a business can try to do two things5

*mprove the top line 6i.e. increase operating prot7 without a

corresponding increase in capital employed, or $aintain operating prot but reduce the value of capital

employed

>earing>earing focuses on the capital structure of the business A thatmeans the proportion of nance that is provided by debt relative to


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the nance provided by euity 6or shareholders7. *t measures theproportion of assets invested in a business that are nanced bylongLterm borrowing.

*n theory, the higher the level of borrowing 6gearing7, the higher the

ris)s to a business, since the payment of interest and repayment ofdebts are not MoptionalM in the same way as dividends. 2owever,gearing can be a nancially sound part of a businesss capitalstructure, particularly if the business has strong, predictable cash3ows.

Gearing ( )= noncurrent liabilities

totalequity+noncurrent liabilities100

business with a gearing ratio of more than C'N istraditionally said to be E(i(l+ eare#.

business with gearing of less than :CN is traditionallydescribed as having El%) earin

+omething between :CN L C'N would be considered normalfor a wellLestablished business which is happy to nance itsactivities using debt.

iuidity (atios

wo liuidity ratios A the current ratio and the acid test ratio A are

used in order to assess the ability of a rm to meet its short-termliabilities.lthough prot is the main measure of company success, rms canbe vulnerable to cash-3ow problems, so the ability of a rm to meetits immediate payments is a )ey test.+olvency A the ability of a rm to pay its debts on time.

C"rrent Rati%:his is a simple measure that estimates whether the business can

pay debts due within one year out of the current assets. ratio ofless than one is often a cause for concern, particularly if it persistsfor any length of time.

he formula for the current ratio is5

Current R atio= Current Assets

Current Liabilities

current ratio of around &.=L:.' is pretty encouraging for abusiness. *t suggests that the business has enough cash to be able

to pay its debts, but not too much nance tied up in current assetswhich could be reinvested or distributed to shareholders.


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low current ratio 6say less than &.'L&.C7 might suggest that thebusiness is not well placed to pay its debts. *t might be reuired toraise e!tra nance or e!tend the time it ta)es to pay creditors.

Aci# Test:8ot all assets can be turned into cash uic)ly or easily. +ome Lnotably raw materials and other stoc)s L must rst be turned intonal product rst. his ratio therefore adjusts the #urrent (atio toeliminate certain current assets that are not already in liuid form.+ince inventories are assumed to be the most illiuid part of currentassets, they are removed from the current assets total.

he formula for the acid test ratio is5

Acid Test=Curent AssetsInetories

Current Liabilities

+ome care has to be ta)en interpreting the acid test ratio. round&5& ratio is standard, however the value of inventories a businessneeds to hold will vary considerably from industry to industry 6e.g.selling fresh ca)es or selling cars7. good discipline is to nd an industry average and then comparethe current and acid test ratios against for the business concerned

against that average.Financial 0/ciency (atios

Financial 0/ciency ratios measure the e/ciency with which abusiness manages specic assets and liabilities. hey allow thebusiness to scrutinise the e4ectiveness of certain areas of itsoperation.

Receivables Da+s

he debtor days ratio focuses on the time it ta)es for trade debtorsto settle their bills. he ratio indicates whether debtors are beingallowed e!cessive credit. high gure 6more than the industryaverage7 may suggest general problems with debt collection or thenancial position of major customers.

he formula to calculate debtor days is5

Receiables !ays=Receiables

Reenue 365

he average time ta)en by customers to pay their bills varies fromindustry to industry, although it is benecial for all rms to have a


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minimum debtor days ratio. *t is often compared against the rms9ayables ?ays ratio.

mong the factors to consider when interpreting debtor days are5

he industry average debtor days needs to be ta)en into account

business can determine through its terms and conditions of salehow long customers are o/cially allowed to ta)e

here are several actions a business can ta)e to reduce debtor

days, including o4ering earlyLpayment incentives, aged-debtoranalysis or by using invoice factoring

!a+ables Da+s

9ayables ?ays is a similar ratio to debtor days and it gives an insightinto whether a business is ta)ing full advantage of trade credit

available to it. *t estimates the average time it ta)es a business tosettle its debts with trade suppliers. s an appro!imation of theamount spent with trade creditors, the convention is to use cost ofsales in the formula which is as follows5

"ayables !ays= "ayables

Cost of #ales365

*n general a business that wants to ma!imise its cash 3ow shouldta)e as long as possible to pay its bills. 2owever, there are ris)sassociated with ta)ing more time than is permitted by the terms of

trade with the supplier. One is the loss of supplier goodwill" anotheris the potential threat of legal action or lateLpayment charges. s anaverage, :P days is normally acceptable for receivables


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he asset turnover gure for a specic business can also varysignicantly from year to year. For e!ample, a business mayinvest in new production capacity in one year but the e!trarevenues might not arise until the following year

he asset turnover ratio ta)es no direct account of theprotability of the revenues generated

Invent%r+ T"rn%ver

+toc) turnover helps answer uestions such as Mhave we got toomuch money tied up in inventoryMK n increasing stoc) turnovergure or one which is much larger than the average for an industrymay indicate poor inventory management.

he stoc) turnover formula is5

InentoryTurnoer= Cost of Goods #old

Aerage Inentories %eld

*nterpreting the stoc) turnover ratio needs to be done with somecare. For e!ample5

+ome industries necessarily have very high levels of stoc)turnover.

+ome businesses have to hold large uantities of stoc) to meet

customer needs. hey may have to stoc) a wide range ofproduct types, brands, siJes etc

+toc) levels can vary during the year, often caused by seasonaldemand. #are needs to be ta)en in wor)ing out what theEaverage stoc) held is

business can ta)e a range of actions to improve its stoc) turnover,such as selling o4 slow-moving stoc), using lean production


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One very straightforward shareholder ratio is dividend per share.his shows the value of the total dividend per issued share for thenancial year.

he formula for dividend per share is5

!iidend per #&are= total diidends paid

nu'ber of s&aresissued

n ordinary shareholder would probably be pleased with a higherdividend per share as possible, however some with a large interestin the rm may wish for it to retain prots for future growth andtherefore more dividends in the future.

he problem with this ratio is that it lac)s conte!t. Be dont )now5a7 2ow much the shareholder paid for the shares A i.e. what the

dividend means in terms of a return on investment

b7 2ow much prot per share was earned which might

have beendistributed as a dividend

Divi#en# 2iel#he dividend yield builds on the dividend per share by e!pressing itas a percentage of the current mar)et price of the shares. his way,you can see the return and compare it to other investments, ban)interest rates and other rms.

!iidend (ield ( )= diident per s&are

'arket price per s&are

100

Qalue and limitation of ratio analysis

he main strength of ratio analysis is that it encourages asystematic approach to analysing performance. 2owever, it is alsoimportant to remember some of the drawbac)s of ratio analysis5

(atios deal mainly in numbers A they dont address issues li)e

product uality, customer service, employee morale A which mayignore corporate objectives

(atios largely loo) at the past, not the future. (atios are most useful when they are used to compare

performance over a long period of time or against comp - thisinformation is not always available

Financial information can be subject to Dwindow dressing

0!ternal factors need to be considered when drawing any

conclusions from these ratios

hey show whathappened rather than why

+electing Financial +trategies


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(aising Finance#ash is vital to any business and once a business is established itoften faces the challenge of raising nance to support e!pansion. good way to loo) at the nanceLraising options for a business is to

categorise them into sources which are from within the business6internal7 and from outside providers 6e!ternal7.

Internal S%"rces %3 Financehe main internal sources of nance for an established business are5

(etained prots

(eductions in wor)ing capital

?isposal of assets < sale R leasebac)

(etained 9rots5(etained prot is by some way the most important and signicantsource of nance for an established protable business. Bhen abusiness ma)es a net prot, the owners have a choice5 eithere!tract it from the business by way of dividend, or reinvest it byleaving prots in the business. +ome of the retained prot might bein the ban)" some might be spent on additional plant R machinery"perhaps some are reinvested in more inventories or used to reduceoverdrafts or loans. he total value of retained prots in a companycan be seen in the Eeuity section of the balance sheet.

8o interest charges, so they are cheap 6though not free7 Aopportunity cost

hey are very 3e!ible A management have complete control

over how they are reinvested and what proportion is )eptrather than paid as dividends

hey do not dilute the ownership of the company

hey restrict the value of dividends

Opportunity #ost

#an be said to Dhoard too much cash in the business

*f retained prots dont result in higher prots, there is the

argument that shareholders could ma)e better returns byhaving the cash for themselves

(eduction in Bor)ing #apital5+ome businesses undoubtedly operate with e!cess inventories andtrade debtors. $ore e/cient management of these current assetscan release cash. 2owever, a reduction in wor)ing capital has to besustainable for it to become a longLterm source of nance.*n most cases, a business that is growing will nd that it has tonance an increase in wor)ing capital over the longerLterm 6i.e. net

current assets will have to grow7.


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+ale < +ale R easebac) of ssets5+elling nonLcurrent assets such as spare land and buildings orredundant plant R euipment can result in a oneLo4 cash in3ow.2owever it is unli)ely to be a longLterm solution for a business thatneeds to raise signicant nance.sset disposals often occur when management grow the businessthrough acuisitions. he business they buy may have e!cess assetswhich can be sold, or !ed assets become redundant when theacuired businesses are merged into fewer locations.

he sale will give an immediate injection of cash into the

company

#an help when retrenching or when you have e!cess capacity

one-o4 source of nance

*f leasing bac), you may end up paying more than you wouldhave if you had have )ept the asset

E4ternal S%"rces %3 Finance

here are many ways for a larger business to raise nance frome!ternal providers. he main methods are outlined below.

+elling +hares5@oth private and public companies can raise nance by selling newshares in the company. Ordinary +hare #apital is money given to acompany by shareholders in return for a share certicate that givesthem part ownership of the company and entitles them to a share ofthe prots.

+cope for lots of investment A no limit on the amount

#an add value to the company if share prices increase

8eed to pay more dividends

ose control of part of the company

oan #apital5he three main methods of raising loan capital are5

@an) overdrafts

@an) loans

?ebentures

'ank (verdratsare when a ban) allows an individual ororganisation to overspend its current account in the ban) up to anagreed 6overdraft7 limit for a stated period of time. *nterest is paidper day you are overdrawn.

'ank )oans are sums of money provided by a ban) for a specic,agreed purpose. *nterest rates can 3uctuate and ban)s will needproof of ability to repay the loan.


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*ebentures are a longLterm source of nance. debenture is a formof bond or longLterm loan which is issued by the company. hedebenture typically carries a !ed rate of interest over the course ofthe loan.

#ost $inimisation

#ost minimisation aims to achieve the most costLe4ective way ofdelivering goods and services to the reuired level of uality. Forthis reason, it is vital to have communication with all departmentswhen underta)ing cost minimisation to ensure they are notadversely a4ected.9opular sources of cost reductions in a wellLestablished businessinclude5

0liminating waste R avoiding duplication 6lean production7

+implifying processes and procedures

Outsourcing nonLcore activities 6e.g. payroll administration, callhandling7

8egotiating better pricing with suppliers

Using the most e4ective methods of training and recruitment

*ntroducing 3e!ible wor)ing practices to better matchproduction and demand

ctions aimed at minimising costs need to be ta)en with care. he

danger is that overaggressive pruning of overheads, using cheaperraw materials or cutting pay rates might have a adverse e4ect onuality and customer service.lso, the business can be left with insu/cient capacity to handleune!pected or shortLterm increases in demand and cost reductionsby one department may surprise and


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#an improve motivation of

those responsible #omparisons can be made

between similar prot

centres *mproves decisionLma)ing

at a local level 6li)ely to becloser to customer needs7

Finance can be allocated

more e/ciently A where itma)es the best return

$ay lead to con3ict and

competition

9otentially deLmotivating if

targets are too tough or if

cost allocations are unfair 9rot centres may pursue

their own objectives ratherthan those of the broaderbusiness

$a)ing *nvestment ?ecisions*f a business wishes to grow, it needs to invest. he cash spent oninvestment in a business is normally referred to as capitale!penditure. his can be contrasted with spending on dayLtoLdayoperations 6e.g. paying for materials, sta4 costs7 which is )nown asErevenue e!penditure.he distinction between capital and revenue e!penditure is thatcapital e!penditure is on nonLcurrent assets which have anDeconomic life in the business A they are intended to be )ept, rather

than sold or turned into products.

here are several reasons why a business needs to invest in capitale!penditure5

S o add e!tra production capacityS o replace wornLout, bro)en or obsolete machinery andeuipmentS o support the introduction of new products and productionprocessesS o implement improved * systemsS o comply with changing legislation R regulations

*nvestment ppraisal is a uantitative, scientic approach toinvestment decision ma)ing, which investigates the e!pectednancial conseuences of an investment, in order to assist thecompany in its choices.

here are several methods available which help management ma)ethe decisions about which projects to invest in, which are describedand illustrated further below5

9aybac)

8et 9resent Qalue 689Q7

verage (ate of (eturn 6((7


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9aybac)he paybac) period is the time it ta)es for a project to repay itselffrom the net return provided by the investment, and is usuallymeasured in terms of years and months.

+imple and easy to calculate Teasy to understand the results

Documents

Financial Strategies and Accounts (1)