Managing Financial Resources and Decision Assessment Answer
The main focus of the following financial report is to reflect the understanding of the different sources of finance available to a business along with its implications and impact on the financial statements. In addition to this, this report has been provided information related to financial decisions in consideration to the budget, unit costs/pricing decisions, and project viability with using capital appraisal techniques. Knowledge of different financial statements and their usage in the evaluation of financial performance have also demonstrated in this report. This is a comprehensive report about managing financial resources and decisions.
Sweet Menu restaurant t is one of the most promising and well-known restaurants situated in Gants Hill in East London. After availing the desired amount of success, the restaurant is planning to open its two new branches in Central London and Croydon. For the purpose of facilitating this business expansion within the country, the restaurant requires funds between £300,000 and £500,000, for which there is a need of finding some crucial source of finance.
For the business, there are specifically two different sources of finance available:
External source of finance
For the purpose of arranging the funds, the restaurant can consider external sources for finance. Under this category, the restaurant can have long term and short term loans and borrowings from banks and other financial institutions. In addition to this, the company can also arrange funds from different sources such as debentures, Mortgage loans, and issue of equity and preference shares. These all are external sources of funds.
Internal source of finance
Along with external sources of finance, the restaurant can also arrange funds from internal sources. In this regard, the company can arrange funds from owner’s equity, and retained earnings, sales and leasing of own properties. In addition to this, the company can also liquidation of existing stocks can be proved as an effective measures for generating funds for the business expansion (Geddes, 2011).
On the basis of the analysis of different sources of funds, three specific sources namely long term Loans, debentures and retained earnings can be considered as the most prominent source of finance for the restaurant’s further expansion.
For Sweet restaurant three sources of finance have been highlighted which are having different implications over businesses
1. Bank Loan
The first source of finance selected by the company can be bank loan. From banks and other financial institutions, the company can have both long term and short term loans. In this measure, the company would require to pay regularly to the bank. The principle amount and interest is the total payable (Fabozzi and Peterson, 2013). It is one of the most effective sources as the company can generate significant amount of funds on relatively lower interest rates.
The company can also issue its debenture in the market. In this measure, the company would require to pay a pre determined interest rates to the debenture holder. This is quite risky measure as it leads to enhance the risk of the bankruptcy for the company. In any case, whether it is profits or loss, it is the liability of the bank to repay the debenture along with interest rate (Needles, Powers and Crosson, 2010). The rate of interest would be higher in this measure as compared to the bank loan.
3. Retain Earning
The company can finance its business operations and strategic plans with the help of retain earning. Retain earnings are the internal sources of the finance which is generated from the profits of the last year after meeting all the expenses. This is an effective source as the company is not required to pay any interest cost on this fund (Ferran and Ho, 2014). The company has limited obligations of repaying this amount, which can allow it have some risky business decisions. However, with the help of this source, the company can finance limited financial requirements as span of retain earnings are quite limited.
On the basis of the analysis of different sources and their implications over the business, it can be reflected that retain earnings can be considered as the most appropriate and effective source of finance as the cost of capital and risk involved in this measure is quite limited. With the help of this measure, the restaurant would not require to pay any interest amount. Owing to this reason, it is a safest measure of finance.
However, the company can employ this measure only for meeting small and limited financial obligations as retain earnings of the company are not quite high. Owing to this reason, for the purpose of meeting long term and high capital requirements, the company needs to relay on bank loans only, as it is a reliable and less costly source of fund. The company can approach the bank for rising long term, as well as, short term borrowing (Needles, Powers and Crosson, 2010). Banks also provide the facility of repaying the borrowing on instalment basis, which reduces the financial burden from the company.
2.1 Analyse the costs of the different sources of finance that you have identified for Sweet Menu Restaurant in task 1.3 above.
For different sources of finances, there is needed pay off associated costs in order take advantages of a particular potential source. As defined in task 1.3 above, Sweet Menu Restaurant are required to pay costs of bank loan, retained earnings and debentures as these are chosen sources of finance (Webster, 2014). In case of bank loan, Sweet Menu Restaurant are required to pay bank charges, fee of loan processing, interests on the principle amount or estimated monthly instalment (EMI).
Cost of retained earnings to Sweet Menu Restaurant is zero at the time of using it for further expansion because it is a kind of reserve for dealing with future contingencies. In a case of any urgency, where there is a need for working capital to keep business sustainability or solvency in a longer run, Sweet Menu Restaurant would have required funds due to unavailability or insufficient reserves. For debentures as a source of finance, Sweet Menu Restaurant will require to pay off fixed percentage of interests to the debenture holders on the amount (Needles and Powers, 2013). This source will also include cost incurred on issuing of debentures.
2.2 Explain the importance of financial planning for Sweet Menu Restaurant with reference to the new business project.
Financial planning plays a very significant role in particular to the new business project. This will provide essential information related to the cash flows to the new business project for Sweet Menu Restaurant. This means that whether there is a sufficient cash or cash reserve in a business to initiate the new business project. Financial planning will provide information of the expected sources of cash inflows and cash outflows in order to assist in determining financial requirement to meet differences between cash inflows and outflows. Moreover, financial planning will also provide an answer to the question about cash requirement that would be required to accumulate from different external sources of finance (Drake and Fabozzi, 2012).
Financial planning is also important to determine if the new business project of the new business project would yield good profits in return of the capital investment. Financial planning is important to prevent from unexpected critical problem or loss from the new business project (Gibson, 2010). This will also provide direction to the project and financial manger to take appropriate decisions and keep financial control in respect to the end targets, so as to keep off failure of finance for Sweet Menu Restaurant with reference to the new business project (Drake and Fabozzi, 2012).
Prior taking any expansion decision of Sweet Menu Restaurant, it is very essential to give consideration to the information needs of different decision makers. It is because information needs provide a base for decision making to the decision makers. It is very much crucial to abreast decision makers with required and relevant information for taking right decision. Details of the information needs of different decision makers are given below:
- Business Managers: They require information of the internal and external affairs of the company in all aspects. In the internal context, business managers require information about actual financial status, short and long term obligations/claim of outsiders, net revenues growth, profitability growth, and employees’ attitude and work behaviour. In the external context, they need information about close competitors, economic position, paying ability and existing status of external sources of finance in the capital structure (Warren Reeve and Duchac, 2011). With this information, business managers can determine potential risks or threats to the business sustainability. Besides that, external market information is useful for managers to bring changes in the existing strategic policies or to formulate new strategies for business competitiveness.
- Investors/Creditors: They require information of Sweet Menu Restaurant in terms of liquidity position, return on capital employed efficiency, market performance, goodwill, brand value and market share. All these information needs will help investors and creditors to take decision whether an investment in this business will yield reasonable returns at the minimum risk of bad debts or failure (Webster, 2014).
2.4 Using the most recent financial statement of Sweet Menu Restaurant given below, explain the impact of the sources of finance identified in task 1.3 on the financial statements of Sweet Menu Restaurant.
On the financial statement of Sweet Menu Restaurant, the preference to bank loan as a source of finance will affect statement of balance sheet and statement of income and loss. Interest payment on the principle amount in case of bank loan will increase expenses in the statement of income and loss; however, it will be recorded as liabilities in the statement of balance sheet (Watson and Head, 2012).
The use of retained earnings for meeting financial need of business will not have any direct affect on the financial statements. In the statement of net work, value of retained earnings will quite lower. Issue of debentures will affect statement of balance sheet as it will record as long term liabilities, and payment of interests in the profit and loss statement. Therefore, financial statement of the company has considerable affected from the use of short or long term sources of finance (Watson and Head, 2012).
Cash budget for the period of four months has been prepared which shows the position as regards cash of the restaurant. From the cash budget, it has been observed that the restaurant will face problems of cash deficit in all the four months except the month of November. However, the deficit is getting reduced in the upcoming months but the position in not turning into surplus. Therefore, the restaurant is required to arrange finance from the external sources such as bank loan or issues of securities to the public. The restaurant can get the van (£12,000) financed from bank which will lower down the cash payments in the month of September to £28,850.
3.2 Explain the calculation of the unit costs (meal cost) and make pricing decisions using relevant information given above
The determination on the cost per meal has been presented in the table given below:
|Vegetables and other ingredients||1.50|
|Add: Mark up @40%||4.00|
|Add: VAT (£16*20%)||3.20|
|Total Bill Value||17.20|
The table as given above shows that the total cost is arrived at £10.00 per meal which includes the charges of material, labour, and overheads. The restaurant wants a mark up of 40% which means the selling price per meal excluding VAT will be £14.00. The restaurant is selling meal actually at the rate of £16.00 and the amount of VAT works out to be £3.20. The total billing Value per meal will be £17.20.
Payback Period of the proposals:
|Year||Cash Flows (£)||Cumulative|
|Payback Period (Years)||1.67|
In the case of proposal-1, the outflow of £1200.00 will be recovered in 1.67 years. This has been arrived at by as follows:
1 year + (400.00/600.00) = 1.67 Years
In the year-1, the restaurant will recover £800.00 and remaining £400.00 will be recovered in the second years.
In the case of second proposal, the payback period is 3 years. As can be seen in the calculation shown above that in the third year the cumulative cash flows is becoming nil which depicts that the outflows of £1200.00 have been recovered in full in this year.
Net Present Value of the Proposals
|Proposal-1: Net Present Value||10%|
|Year||Cash Flows||PVF@10%||Present Value|
|Proposal-2: Net Present Value||10%|
|Year||Cash Flows||PVF@10%||Present Value|
Decision to Choose Project
The payback period of the first proposal is lower than the second proposal which means that the first project is more beneficial. This is because initial capital investment made in case of the first proposal is easy to be retrieved within shorter time period that is 1.67 years as compared to the second proposal that undertakes 3 years. In the mutual exclusive project, a project with lower payback period is preferred as the best viable project. However, the net present value of the first proposal is lower than the second proposal which means that the second proposal is more beneficial (Fabozzi and Peterson, 2003).
This indicates returns from the second proposal are significantly higher. Thus, in case of selecting a project on the basis of NPV, a project that yields higher NPV than the other one is preferred as the best project. Therefore, the two different parameters of proposal evolution are giving different results. However, if the restaurant evaluates the proposals in terms of net benefits, the second proposal should be chosen.
The main financial statements are statement of balance sheet, statement of income and loss, statement of shareholders equity and statement of cash flow.
Statement of Balance Sheet:
Statement of balance sheet exhibits information of financial position or financial status as on the end of accounting and financial year. It mainly contains assets, liabilities and shareholder’s equity (Brigham and Ehrhardt, 2013). Assets in the balance sheet indicate valuable resources owned by a business organisation. This is categorised under current assets and fixed/net assets. Current assets are short term in nature and exist in form of cash or other assets that can easily exchangeable in cash within short period of time, for example, account receivables, inventor, marketable securities and short term investments (Webster, 2014; Brigham and Ehrhardt, 2013).
On the other hand, net assets are known as fixed assets which are acquired valuable property of business that kept for long period of time; for example, plant, land, building, office furniture and other equipments, as well as, it also includes goodwill, trademarks, patents and copyrights. Liabilities in the balance sheet are outstanding debts/claims of outsiders like investors, creditors and suppliers. Current liabilities are short term obligations that are being within one year or lesser; while net liabilities are long term liabilities or obligations that are being paid out for longer time period that means after the accounting or financial period (Webster, 2014).
Statement of Shareholder’s Equity:
Statement of shareholder’s equity presents portion of shareholders fund or claim of real business owners in the total business value or in against total assets. This statement mainly includes elements like equity share, preference share, paid up capital and retained earnings (Brigham and Ehrhardt, 2013).
Statement of Income Statement
Statement of income and loss presents information about financial condition in a particular period. It reflects business operations in relation to the net income or net loss to a business. Main elements of the profit and loss account include revenues/ net sales, expenses and lastly net income/profit or loss. Revenues depict income earned by business through selling of goods from the current and potential customers. Expenses element of statement of income and loss is the cost incurred on a product or service production including labour, material, manufacturing and administrative costs. It is termed as ‘cost of goods sold’. Extent to which operations has performed effectively in order to earn profit is portrayed in this statement (Brigham and Ehrhardt, 2013).
Statement of Cash Flow
Statement of cash flow is another main financial statement that exhibits cash, cash equivalents and inflows/outflow of cash flows. Main elements of this financial statement include operating activities, financing activities and investing activities (Vickerstaff and Johal, 2014).
|Different formats of financial statements as per Generally Acceptable Accounting Practice (GAAP) and International Financial Reporting Standards (IFRS) are demonstrated below in this table|
|Sole proprietorship Business||In this type of business, there are not specific formats of financial statements followed and prepared by the sole proprietor. This signifies that no specific rules defined by GAAP and IFRS are followed in the preparation of financial statements of sole proprietorship business. Under this type of business, simply profit, expenses and working capital is portrayed.|
|Partnership Business||In the type of partnership business, as per the GAAP, partnership capital account is prepared along with balance sheet, income statement and cash flow statement. In this format, shareholders equity statement is not prepared due to involvement of partner’s capital (Brigham and Ehrhardt, 2013).|
|Public Limited Company||In this type of business, three financial statements are prepared as per IFRS, such as balance sheet, profit and loss and cash flow statement. The balance sheet of a public limited company includes information of assets, liabilities and equity account. On the other hand, balance sheets needs to presents information related to shareholder’s net worth along with ordinary shares in accordance to GAAP (Bandy, 2013).|
4.3 Interpret the financial statements of the two restaurants using ratios and comparisons, both internal and external
|Sweet Menu Restaurant||Blue Island Restaurant|
|Return on Assets||43.59%||77.07%|
From the evaluation of liquidity ratio, it has interpreted that position of paying short term obligations on the due date of ‘Sweet Menu Restaurant’ is comparatively better than Blue Island Restaurant. Its current and quick ratio of Sweet Menu Restaurant indicates its sound position; however, as per the standard ratio of 2:1 for current ratio and 1:1 for standard ratio, position of both companies seems unsound (Atrill, 2012). Profitability ratios of Blue Island Restaurant is higher as its net profit ratio and return on assets ratio equals to 31.71% and 77.07% respectively; while, it is 24.29% and 43.59% in case of Sweet Menu Restaurant. This signifies net profit earning efficiency of Blue Island Restaurant is 7.42% higher than Sweet Menu Restaurant and similarly, return on assets is higher by around 33.48%. Solvency position of Blue Island Restaurant seems sound than Sweet Menu Restaurant’ as the computed interest coverage is higher and lower debt to equity. This indicates less financial obligation or burden on the company to pay higher interests to the debt holders. Lower debt to equity shows less personal intervention of the outsiders in the company’s internal affairs (Atrill and McLaney, 2013; Mumba, 2013). The ratios computed under solvency exhibits strong position of Blue Island Restaurant due to its strong capital structure. In particular to the activity ratios category, it is evaluated that receivables and inventory turnover of Blue Island Restaurant indicates its strong position in relative to Sweet Menu Restaurant (Francesco and Dainelli, 2011). Overall, Blue Island Restaurant enjoys efficient position in the market as compared to its direct competitor.
From the overall evaluation, it can be concluded that managing financial resources and decisions are very essential for a business organisations in order to maintain solvency. Finance is the main component of a business that supports in running its operations. Thus, a good knowledge of financial resources, financial statements and financial analysis tools along with capital appraisal techniques are played vital role in managing finance in an efficient manner.
Atrill P. 2012. Financial Management for Decision Makers. 6th Edition. Harlow: Pearson Financial Times/Prentice Hall.
Atrill, P. and McLaney, E. 2013. Accounting and finance for non-specialists.8th ed. Harlow: Financial Times/Prentice Hall.
Bandy, G. 2013. Financial management and accounting in the public sector. Oxon: Routledge.
Brigham, E. and Ehrhardt, M. 2013. Financial Management: Theory & Practice (14th ed.). NY: Cengage Learning
Drake, P. P. and Fabozzi, F. J. 2012. Analysis of Financial Statements. New Jersey: John Wiley & Sons.
Drake, P. P. and Fabozzi, F. J. 2012. Analysis of Financial Statements. New York: John Wiley & Sons.
Fabozzi, F.J. and Peterson, P.P.2013. Financial management and analysis. John Wiley & Sons.
Francesco, L.B., and Dainelli, F. 2011. The Informational Capacity of Financial Performance Indicators in European Annual Reports. Maggioli Editore.
Gibson, C. 2010. Financial Reporting and Analysis: Using Financial Accounting Information (12th ed.). USA: Cengage Learning.
Mumba, C. 2013. Understanding accounting and finance: Theory and practice. USA: Trafford Publishing
Needles, B. and Powers, M. 2013. Principles of financial accounting. 12th ed. Cengage Learning.
Vickerstaff, B. and Johal, P. 2014. Financial accounting. Routledge.
Warren, C.S., Reeve, J.M. and Duchac, J.E. 2011. Financial accounting. Mason: Cengage Learning.
Watson,D. and Head, A. 2012. Corporate Finance Principles and Practice. 6th edition. Harlow: Pearson.
Webster, A. 2014. Introduction to accounting. 2nd ed. Applied Finance.