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Managing financial resources and desicions

Executive Summary

How to start a business, develop & expand without source of funds?

This is the 1st question which you will get to your mind when you going to startup a business, develop or expand, as business management student we have to identify what are the source of finance to start up, develop or expand a business.

Then the 2nd step would be to recognize the method of obtaining them & identify what source of finance should use on what purposes.

Introduction

In terms of market capitalisation, John Keells Holdings PLC is the largest listed conglomerate on the Colombo Stock Exchange. Other measures tell a similar tale; our group companies manage the largest number of hotel rooms in Sri Lanka, own the country's largest privately-owned transportation business and hold leading positions in Sri Lanka's key industries: tea, food and beverage manufacture and distribution, logistics, real estate, banking and information technology. Our investment in Sri Lanka is so deep and widely diversified that our stock price is sometimes used by international financial analysts as a benchmark of the country's economy.

For over 130 years, we have remained proudly independent, forcefully committed to private ownership and private dividends, and relying on foresight, expertise and integrity for success and growth. Having a significant portion of our shares held by foreign investors, our Group has also partnered with some of the world's finest business establishments, from DHL to American Airlines, from IBM to Toshiba, and from Thomas Cook to Kuoni. For emerging-market investors and those seeking a business partner in Sri Lanka, John Keells is an option that simply cannot be ignored.

Corporate Vision

Building businesses that are leaders in the region.

Our Values

We are passionate about :

Source Of Finance

The assets of a business are financed from a variety of sources, which can be categorized into either:

Source of finance is the most crucial point when it's come to the point of starting up a business, development & expansion of the business as I mention above.

Short Term

Short- term finance is finance repayable within 12months.

E.g.: -

Medium Term

Medium-term finance is finance provided for a period of between 1 and about 5years

E.g.: -

Long Term

Long term sources of finance are those that are needed over a longer period of time generally over a year.

Source of Finance

Internal Source of Finance

These are the sources of finance that come from the business assets or activities.

Retained Profit

If I explain it in simple terms it is the profit that the organization kept and not spent, such as use within the business to help with buying new machinery, vehicles, and computers etc, helps us to run the day to day business.

Sale of Assets

Business balance sheets usually have several fixed assets on them. A fixed asset is anything that is not used up in the production of the good or service concerned - land, buildings, fixtures and fittings, machinery, vehicles and so on. At times, one or more of these fixed assets may be surplus to requirements and can be sold.

Alternatively, a business may desperately need to find some cash so it decides to stop offering certain products or services and because of that can sell some of its fixed assets. Hence, by selling fixed assets, business can use them as a source of finance. Selling its fixed assets, therefore, has an effect on the potential capacity of the business - the amount it can produce.

Working Capital

This is the short-term capital or finance that a business keeps. Working capital is the money used to pay for the everyday trading activities carried out by the business - stationery needs, staff salaries and wages, rent, energy bills, payments for supplies and so on. Working capital is defined as:

Working capital = current assets - current liabilities

Where:

Current assets are short term sources of finance such as stocks, debtors and cash - the amount of cash and cash equivalents - the business has at any one time. Cash is cash in hand and deposits payable on demand (e.g. current accounts). Cash equivalents are short term and highly liquid investments which are easily and immediately convertible into cash.

Current liabilities are short term requirements for cash including trade creditors, expense creditors, tax owing, dividends owing - the amount of money the business owes to other people/groups/businesses at any one time that needs to be repaid within the next month or so.

External Source of Finance

This is finance that comes from outside the business. It involves the business owing money to outside individual or institution. There are two main external sources.

  1. Ownership Capital.
  2. Non Ownership Capital.

Ownership Capital

In this context, 'owners' refers to those people/institutions who are shareholders. Sole traders and partnerships do-not have shareholders - the individual or the partners are the owners of the business but do not hold shares. Shares are units of investment in a limited company, whether it is a public or private limited company. Shares are generally broken down into two categories:

Ordinary Shares

Ordinary shares are also known as equity shares and they are the most common form of share. An ordinary share gives the right to its owner to share in the profits of the company (dividends) and to vote at general meetings of the company.

Since the profits of companies can vary wildly from year to year, so can the dividends paid to ordinary shareholders. In bad years, dividends may be nothing whereas in good years they may be substantial. Some businesses may choose to pay out a dividend even if it has had a difficult trading year and has made a loss! (How do you think this is possible and why might a business choose to do this?)

Ordinary shareholders can vote on all of the issues raised at a general meeting of the company including:

  1. Appointment of directors and auditors
  2. Whether to accept the dividend proposed
  3. Changes to the company's constitution (memorandum and articles of association)

Preference Shares

Preference shares offer their owners preferences over ordinary shareholders. There are two major differences between ordinary and preference shares:

Non-Ownership Capital

Whilst the following sources of finance are important, they are not classed as Ownership Capital - Debenture holders are not shareholders, nor are banks who lend money or creditors. Only shareholders are owners of the company.

Debentures

Debentures are loans that are usually secured and are said to have either fixed or floating charges with them.

A secured debenture is one that is specifically tied to the financing of a particular asset such as a building or a machine. Then, just like a mortgage for a private house, the debenture holder has a legal interest in that asset and the company cannot dispose of it unless the debenture holder agrees. If the debenture is for land and/or buildings it can be called a mortgage debenture.

Debenture holders have the right to receive their interest payments before any dividend is payable to shareholders and, most importantly, even if a company makes a loss, it still has to pay its interest charges.

If the business fails, the debenture holders will be preferential creditors and will be entitled to the repayment of some or all of their money before the shareholders receives anything.

Other Loans

The term debenture is a strictly legal term but there are other forms of loan or loan stock. A loan is for a fixed amount with a fixed repayment schedule and may appear on a balance sheet with a specific name telling the reader exactly what the loan is and its main details.

Overdraft Facilities

Many companies have the need for external finance but not necessarily on a long-term basis. A company might have small cash flow problems from time to time but such problems don't call for the need for a formal long-term loan. Under these circumstances, a company will often go to its bank and arrange an overdraft. Bank overdrafts are given on current accounts and the good point is that the interest payable on them is calculated on a daily basis. So if the company borrows only a small amount, it only pays a little bit of interest.

Hire Purchase

Hire Purchase is a method of acquiring assets without having to invest the full amount in buying them. Typically, a hire purchase agreement allows the hire purchaser sole use of an asset for a period after which they have the right to buy them, often for a small or nominal amount. The benefit of this system is that companies gain immediate use of the asset without having to pay a large amount for it or without having to borrow a large amount.

Lines of Credit from Creditors

This source of finance really belongs under the heading of working capital management since it refers to short term credit. By a 'line of credit' we mean that a creditor, such as a supplier of raw materials, will allow us to buy goods now and pay for them later. Why do we include lines of credit as a source of finance? Well, if we manage our creditors carefully we can use the line of credit they provide for us to finance other parts of our business

Grants

Grants can be an attractive aspect of a company's financing structure. If a company has a specific issue that it wants or needs to deal with then it could find that there are grants available from local councils and other bodies that will help to pay for it.

Factoring

Factoring allows you to raise finance based on the value of your outstanding invoices. Factoring also gives you the opportunity to outsource your sales ledger operations and to use more sophisticated credit rating systems. Once you have set up a factoring arrangement with a Factor, it works this way:

Once you make a sale, you invoice your customer and send a copy of the invoice to the factor and most factoring arrangements require you to factor all your sales. The factor pays you a set proportion of the invoice value within a pre-arranged time - typically, most factors offer you 80-85% of an invoice's value within 24 hours.

The major advantage of factoring is that you receive the majority of the cash from debtors within 24 hours rather than a week, three weeks or even longer

Leasing

Leasing is a contract between the leasing company, the lesser, and the customer (the lessee). The leasing company buys and owns the asset that the lessee requires. The customer hires the asset from the leasing company and pays rental over a pre-determined period for the use of the asset. There are two types of leases:

Identify the monetary policy and the financial market

Monetary Policy

Core objective of the monetary policy is economic & price stability of a country, which is managed by central bank of a country. , i.e. actions to influence cost and availability of money, to attain this objective. The Monetary Law Act (MLA), the legislation under which the Central Bank has been established and operates, has provided a wide range of instruments for monetary management. At present, the monetary policy framework of the country places greater reliance on market based policy instruments and the use of market forces to achieve the desired objectives.

Financial Market

Financial market is a mechanism that allows people to buy and sell financial securities such as stokes & bonds

John Keells - Source of Finance 2008/2009

The Sources of finance statistically for Financial Year 2008/2009

Analyze the Statistical data of John Keells Holdings 2008/2009.

Internal Source of Finance

Internal Source of Finance 2008

Internal Source of Finance 2009

Evaluation of Internal Source of Finance in 2008/2009

External Source of Finance

External Source of Finance 2008

External Source of Finance 2009

Evaluation of External Source of Finance

Appropriate Source of Finance for a Business Project

The relationship between risk & return this concept states that an investor or a company takes on more risk only if a high return is offered in compensation. Return refers to the financial rewards gained as a result making investment.

The time value of money - is a concept in corporate finance & it's relevant to both companies & investors. In a wider context it is relevant to anyone expecting to pay or receive money over a period of time.

The Role of a Financial Manager

The role of the financial manager as the person central to a company financing, investment decisions.

Corporate Objectives

How is Shareholder Wealth Maximized?

NPV = Net Present Value

SHW = Shareholder Wealth Maximized

Agency Theory

While managers should make decisions that consistent with the objectives of maximizing

The Concept of capital structure, which is the rate of return required on invested funds, plays an important role in corporate finance theory and practice. A companies cost of capital used as the discount rate in the investment appraisal process when using techniques such as net present value and internal rate of return refers to financial rewards gained as a result of making an investment.

Key points for cost of capital.

Equity Capital

Capital raised from owners. Equity capial goes under long-term source of finance, This is different from debt capital which is money raised by incurring debt through the issuance of debentures & other types of bonds. Owners can choose to sell equity in the company, in the form of stocks, to investors. This is usually done through a direct offering to the public through an underwriter like an investment bank. Equity capital is used to get companies off the ground.

Debt Capital

Capital issued through the issuance of bonds. Although most of the time the capital raised is money, it could be could be other values as well. The capital raised must be paid back to those who finance the debt. Both private companies and government can raise debt capital this way.

If we assume that a company is rational, it will seek raise capital by the cheapest & most efficient methods, thereby minimizing its average cost of capital. This will have the effects of increasing the net present value of the companies projects & hence its market value. For a company to try to minimize its average cost of capital, it's first requires information on the cost associated with the different sources of finance available to it.

We consider the impact of gearing on the cost capital of a company. The advantage to equity holders of using debt arises from tax shield on debt, that is, the benefit to share holders deriving from the treatment of debt for tax as being deductible in arriving at an entity's taxable profits. High gearing means that debt represents a high proportion of the financing of entities assets.

Second, It needs to know how to combine these different sources of finance in order to reach its optimal capital structure.

The main disadvantage of increasing debt is that additional intrest payable reduces the earnings available to share holders, thereby increasing the risk of their investment & consequently increasing the cost of capital, as new investors to compensate for the increased financial risk.

If you are still doubtful as to why increasing debt increase risk, you must appreciate that debt has priority & also that coupon ratesv of debt must be met. Thus if an entity hits bad times & profits fall significantly losses ensure, there may be little if any return for shareholders. Clearly, therefore, the level of an entities gearing can affect both earnings per share & dividend policy decisions.

Capital Gearing

Capital gearing is concerned with the level of debt in a companies capital structure.

Weighted Average Cost of Capital

The WACC assumes that when a company raises finance, the cash raised is added in to a pool of funds when a potential investment project is identified, the project is assumed to be financed from the pool, rather than from any specific fund raising operation. If the mix of equity, debt & preference shares within the pool of funds is assumed to remain constant over time, the discount rate to apply in appraising the project would be the cost of the pool of funds, that is, the weighted average cost of capital. The WACC can be found by calculating the cost of each long term source of finance weighted by the proportions of finance used.

Finance as Resource

Cost of different source of finance

Share capital (Dividends in cash)

Borrowed Funds

Government Grants

Government grants may appear to be without cost. However there may be well opportunity cost associated with eligibility for a grant. Being based in a certain region for example, may deprive a business of certain sales opportunities. There will also be certain administrative costs to cover applying for the grant & filling in forms on a regular basis to reassure the grant giving authority that the business is still eligible to receive it.

Retained Earnings

Importance of Financial Planning

Over trading

Overtrading happens when a business tries to do too much too quickly with too little long term capital, so that it is trying to support too large a volume of trade with the capital resources as its disposal. Even if an overtrading business operates at a profit, it could easily run into series trouble because it is short of money. Such liquidity troubles stem from the fact that it does not have enough capital to provide the cash to pay its debts as they fall due.

Other causes of overtrading are as follows

Symptoms of Overtrading

Management of Debtors

The Management of Creditors

Management of Stocks

The Management of Cash

Cash Flow Problems

Methods of Easing Cash Shortages

Postponing capital expenditure.

Treasury Management

The Value of Having a Specialist Treasury Department

The following are advantages of having a centralized specialist

Avoids having a mix of cash surpluses & overdrafts in different localized bank accounts.

Information Needs of Different Decision Makers

What is Decision Making?

The Decision Making Process

The Importance of Financial Information

E.g. Buying a new machine replacing an old machine to improve capacity -it needs funds.

Sources of Financial Information

Impact on The Finance on Finance Statement

The impact of financial are mainly forced through the double entry system of the changes made in assets, liabilities, profit loss and equity.

These transactions would effect on the financial statements as trade proft & loss account balance sheet, cash flow statement etc,

E.g.: -

Conclusion

Cost of Capital

  1. http://www.teachnet-uk.org.uk/2007%20Projects/Biz-GCSE%20Finance/sources/internal.htm
  2. http://images.google.lk/imgres?imgurl=http://www.decal-orations.com/images/graphics/j/jo/john_keells_holdings.png&imgrefurl=http://www.decal-orations.com/search-apparel.php%3Fs%3D1%26c%3D30%26f%3Djohn%26p%3D2&usg=__CNSYlDwhMCKpfSdXxA2k1cRJ5-w=&h=567&w=365&sz=41&hl=en&start=5&um=1&itbs=1&tbnid=ob6izLqSiMYwJM:&tbnh=134&tbnw=86&prev=/images%3Fq%3Djohn%2Bkeells%2Blogo%26um%3D1%26hl%3Den%26sa%3DN%26tbs%3Disch:1
  3. http://www.investorwords.com/1727/equity_capital.html
  4. http://www.businessfinance.com/equity-capital.htm
  5. http://www.wisegeek.com/what-is-debt-capital.htm
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