Financial Managementis an integral part of business operations. It is a way to utilise available funds in efficient and effective manner by which the organizational objectives can be accomplished (McKeown and et.al, 2012). The aim of the report is to understand the role of financial planning and control for business owners. It focuses on resources available for a sole trader who is going to start a new business and it will also help the entrepreneurs in understanding principles involved in managing financial resources. In the following report budget for six months is analysed and a project has been evaluated using different investment techniques. The last part of report shows the comparison of WM Morrison Supermarkets PLC and J Sainsbury PLC as per their financial ratios.
Every business needs funds from starting up a new unit till the commencement of business. There are different sources of finance available with business owners, which can be divided into two major parts: internal sources and external sources. Internal sources are the sources in which entrepreneur gets funds from within the business whereas in external sources business funds can be raised from outside the business.
Personal savings: Business owners’ personal saving can be used for financing the business. If company needs funds this will be the easiest and cheapest source of finance.
Funds from family, friends and relatives: This is an important internal source of finance. Entrepreneurs can raise money at little amount of interest.
Retained earnings: Usually companies keep some amount apart from the profits of last year’s, which is known as ploughed back profit. It can be used for financing the business unit.
Reduction in working capital: By cutting the stock level and reducing the expenses, business can raise money.
Sales of existing assets: Owner can sell its obsolete assets and can raise sufficient funds in order to run business.
It can further be divided into three parts: long term, medium term and short term.
Bank loans: Borrowing from bank for a limited period of time through paying interest amount can be a secured source of finance.
Issue of shares and debentures: It is a source of public financing. Business can issue its share and debentures to general public.
Business grants: Government will also be source of finance in the case of multinational companies. A government body provides funds to capable companies at certain lower interest rate from banks. (Würfel, 2003).
Leasing & Hire purchasing: Leasing involves using an asset by paying an amount for a specific time on the other hand hire purchasing includes buying assets through paying a part of amount as down payment and rest amount can be paid in instalment.
Bank overdraft: Banks give a facility to its clients that they can withdraw money from their accounts at a greater value than the balance in account, so the business can meet its short term liabilities.
Debt financing: in this source business sells its bills receivable to a debt factoring company at discounted prices (Cullum, 2013).
As in the given case, business owner who is planning to open a new business, he will be considered as the sole trader business. There are various sources of finance for a new sole proprietor’s business. The owner will need at least £100000 to start up the business unit. £50000 of personal saving can be used to finance the business. That can be good and easy source of finance. If owner is unsuccessful then he can get bankrupt. The rest of money can be got through family members, friends and relatives. If sole trader borrows funds from friends and family members it can successfully manage the funds and try to give back. In the case it fails to give back he will only fail out with them. Owner can also take trade credits from its suppliers. Good relationships with suppliers will help him to take credit for 1-2 months. If he wants to go for long term financing then he can choose mortgage financing through the shop or renting the business place at some amount. Bank loans and overdrafts can be taken by which business can get short term financing. He also has to pay interest against loan. Through above options, owner can finance its business (Sekirin, 2003).
There are different types of costs which are associated with the business owner. The sole trader will incur two costs one is start-up costs and ongoing costs. As he has personal savings to invest in business which is the easiest and cheapest form of finance, but it holds a great degree of personal and financial risk. If the business fails, owner will lose all savings that cannot be earned back easily (Subramanian, 2012). The business can also use the funds from family, friends and relatives but it includes interest rate risk and personal relations will spoil if he fails to pay back. So owner has to maintain good relations with these fund providers by paying back their money at time. In the case of bank loan, owner needs security to keep with the bank. It can be its house or other assets. On the other hand it has to pay interest which can be a huge amount ( Loughran, 2010). In starting of new business it will be difficult for him to pay the interest amount. To acquire land and building, he could exercise mortgage option but it has to pay a big amount. If the owner will include other members in its business, it will turn into partnership business and then he has to share profits with other partners thus its individual profits will decrease. Issuing shares and debenture generate dividend and interest cost. In the next year of business he can use retain earnings as a source of finance. In this situation he will face operating cost .As in upcoming years, as the amount of profits will increase, the business will have to pay more dividends to share holders and the company’s plucked profits will go down (Lee, 2008).
Sound financial planning is the backbone for a successful business as it is required to gain expected success in business. Financial planning plays an important role in any business. It provides the way to operate business while handling the financial resources. The financial planning helps to understand the flow of cash with in the business. It is the best way to monitor assets of a business. The importance of financial planning for business can be seen when a company is facing problems of outstanding debts and rising cost., at that time it will helps company to get out from that situation .As the owner has not decided the business yet, so the financial planning will help him in finding out available business options .In a new business it helps the owner to find out the available sources of finance. It also helps in increasing cash flows by carefully monitoring the spending patterns and expenses of business. Financial planning includes the ways to insure the business and its risk (Francisco, 2009).Insurance of coverage can provide peace of mind. For a sole trader it is beneficial in determining short and long-term financial goals and creating a balanced plan to meet those objectives. It will give stability to future business options. Financial planning ensures better –options to deal with risk especially when expenses are increase continuously but income looks stable. So new business owner need to have proper financial planning so he could use its all available resources in efficient manner (Bean and Hussey, 2011).
The manager needs proper information to make efficient decision. There are various persons included in business who also need information regarding the company’s financial performance in order to make their decisions. Before opening a new business, sole trader has to do market research through which he can decide particular business and its growth opportunities in future. Then business needs the finance to start up operation. The information of various sources of finance will help the business to raise funds. The fund providers will also require information about past performance of owner’s business and the opportunities to make profits on invested amount. Business should also set the objectives and the time frame to achieve that objective. The whole financial information of company can be gained through financial reports of company (Baker and Nofsinger, 2010).
The financial report shows the financial health of organizations. The owner can get funds through two ways such as debt financing and equity financing. Debts financing includes bank loans and issue of debentures while equity financing includes issue of shares. These all sources of finance have a major impact on company’s financial statements. If company will use debt financing it will impact income statement and balance sheet both. P&L will show huge expenses as company has to pay interest against debts. In the balance sheet liabilities will show high debts . Equity financing will also impact on income statement as company will pay more dividend and its retained earnings will come down (Barry and Gerstman , 2007).
The six month cash budget of Easy Electronics has been given, which is starting from the month of July and ends to December. While having budget it can be interpreted that the sales of company is continuously increasing. In July it was 1500000£ and reached to 2200000£ in December. The sales revenues are only 30% of net sales and settlement period for credit purchase is 30 days (Grant, 2005). This shows the company will earn rest amount in coming month. The company has received 400000£ in October from disposal of fixed assets. On the other hand, expenses of the company have also been increased as company has paid huge amount of salaries in every month as in July 900000£, August 990000£, September 1089000£, October 1198000£, November 1318000£ and in December 1450000£. It indicates that company has appointed new employees in the office. The company’s administration costs are stable in each month which is 400000£.Deperciation cost from July to September is 100000£ and it increased by 25% in October to December and reached at 125000£.The distribution cost is also increasing per month. In the month of October it had paid 900000£ for corporate tax and in November it had paid 500000£ for interest and other finance charges. The whole budget indicates that company is going to have losses in upcoming months as its closing cash balance in last month is going negative. The closing balance of company in all months from July to December is: 1697000£, 2262000£, 2759000£, (288000£), (199000£) and (792000£). The company has to take steps to reduce its cost expenses (Götze, Northcott and Schuster, 2007).
Easy electronics Ltd. is a company manufacturings aluminium computer cases and now company wants to evaluate the project through investment appraisal techniques which are analysed below. Net present value method has been used to determine the viability of project at two different discount factors such as 10% and 15%.The above table shows if company exercises the option of 15% discount factor it will give positive NPV which is 564000£ and the same project will give positive pay off at 15%discount factor (Clark and all, 2011).
The payback period method has been used in the case in order to find out the time associated with the investment to recover initial investment amount. In this case, Easy Electronics Ltd. will cover its initial cost in 3rd year of business commencement. It means after three years of business, company will have profits over its expenses (Chapman, R.J., 2011).
The record which outlines the financial activities of business is known as financial statements. It is also denoted as financial reports. These statements give important information about efficiency and affectivity of business operations. Financial statements are of three types: income statements, balance sheet and cash flows statement.
Income statements: Income statement or profit and loss statement shows the income and expenses of business for particular period of time. It can be monthly, quarterly, half yearly or yearly. It has two parts, namely, incomes and expenses. If incomes side is excess, business earn net profit and if expenses are more than income business earn net loss.
Balance sheet: The balance sheet shows the financial health of a business for a financial year and it is prepared at every year ending. It has two parts: assets and liabilities. Balance sheet is based upon double entry system and accounting equation says that both the sides of balance sheet have to be equal.
Cash flow statement: It shows the flow of cash during the financial period. There are three types of activities such as operating, investing and financing activities (Hung, 2000).
The aim of financial statement is to show financial performance of company. Every company has to make its financial statement in order to provide financial information to its various stakeholders.
Partnership firm: The partnership firm prepares the income statement because its main task is to divide the profits and losses between the partners.
Listed Company: while following the rules and regulations of Company’s act 1956, a public listed company has to make all financial statements such as income statement, Balance sheet and cash flow statement.
Sole proprietors: A sole trader operates individually in business so it has to make cash flow in order to judge the financial performance of company.
In the case different types of financial ratios are given of two companies, WM Morrison Supermarkets PLC and J Sainsbury PLC for two years 2010 and 2011.
Liquidity ratios: These ratios show ability to meet short term debts. In 2010 current ratios of Supermarkets PLC was .55 which has increased in 2011 by .2% and has become .57. J Sainsbury Plc’s current ratio in 2011 is .65 which was .58 in 2010.The current liquidity ratios of two companies are .24 and .35 respectively. This shows the ’supermarkets financial position is better than the position of Sainsbury.
Profitability ratio: Gross profit of Supermarkets PLC is 6.89 and for Sainsbury PLC it is 5.43. The profit margins of Supermarkets have been increased in 2011 by 2% while the Sainsbury’s profit margin has been decreased by .34. The net profit margin is also showing the same trend. Return on capital employed has also been increased for Supermarkets Plc. which shows the company is making profits continuously.
In the whole report various sources of finance and their implication for a Sole trader have been explained. The report concludes that Easy Electronic Ltd. should reduce its selling price by 10% as its sales will increase by 20%. It can also use 15% discounting factor option which will give positive pay off. If company will use Payback period method it will cover its initial cost in coming three years. The financial ratio of Supermarkets PLC and J Sainsbury PLC have also been evaluated in order to compare the financial position of both. It can be concluded that financial health of Supermarkets PLC is better than J Sainsbury PLC.