Sources Of Finance And Impact On Financial Statements Finance Essay
This brief report highlights the financial performance of the Trevors PLC using ration analysis and decisions on new projects that the company is going to be invested.
Firstly it will focus on the financial statements of a company and the formats of financial statements.
Secondly ration analysis performs on the basis of the information given about Trevors Plc. This explains under the main headings of Profitability, asset efficiency, liquidity, working capital management, solvency and Investors ratios. In addition to that it discusses the insufficient information to raise accurate comments on ratio analysis.
Thirdly the emphasis will be given to the results obtained from net present value and Payback period calculations.
Fourthly it identifies sources of finance. It involves details analysis of each financing methods and tax, ownership and controlling implication of each source.
Finally the attention will be given towards the importance of financial planning and information need of the decision makers. Recommendation and conclusion of this report included in the latter part of this report.
Financial statements form a basis for understanding the financial performance, position and liquidity of a firm. As per the IAS Financial statement refers to,
Statement of changes in equity
Cash flow statement
Accounting policies and notes
An annual report includes following in general,
05 year summary of key financial data
Stock prices(High or low)
Management discussion and analysis
Financial statements give good direction to achieve the objectives of a user. Fr example a lender to a firm in deciding whether or not to lend may refer to the cash flow statement. Financial health of a firm could be better understood by means of cash flow statement. Therefore this information collection can be viewed as a map, which provides a good direction.
Often financial statements contain a large amount of information. Further the accounting policies, reporting environment, accounting practices are complex and constancy changing. The man can hide or omit key information, create the picture they require. Though the accounting standard limits variability, still financial reporting in different firms and industries has considerable deviations.
The balance sheet is the snap shot of the firm. It is a convenient means of organizing and summarizing what a firm owns and what firm owes and the difference between the two at a given time (Equity). The structure of assets for a firm reflects line of business that the firm is in and also marginal decisions about how much cash and inventory to have and about credit policy, fixed assets acquisition and so on.
Income statement measures a performance over some period of time, usually a quarter, or year. If you think balance sheet as a snap shot, then you can think of the income statement as a video recording covering the period between a before and an after picture.
Information about the cash flows of an enterprise is useful in providing users of financial statements with a basis to assess the ability of the enterprise to generate cash and cash equivalents and the needs of the enterprise to utilize those cash flows. The economic decisions that are taken by users require an evaluation of the ability of an enterprise to generate cash and cash equivalents and the timing and certainty of their generation.
A cash flow statement, when used in conjunction with the rest of the financial statements, provides information that enables users to evaluate the changes in net assets of an enterprise, its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities. Cash flow information is useful in assessing the ability of the enterprise to generate cash and cash equivalents and enables users to develop models to assess and compare the present value of the future cash flows of different enterprises. It also enhances the comparability of the reporting of operating performance by different enterprises because it eliminates the effects of using different accounting treatments for the same transactions and events.
As discussed in above lenders can evaluates the secure of their lending using g the information reflects on the cash flow statement. On the basis of that, if a company’s cash flow statement reflects the well management of their cash and cash equitant that company is in position to raise fund easily from external sources.
Various tools can be used in financial analysis. The derivative financial statements, (Cash flow statement, fond flow statement) Common size financial statement (Common size balance sheet and common size income statement), trend statement and Financial ratio analysis are the most commonly used tolls in financial analysis. These can be used as techniques of analyzing financial information for a more meaningful understanding of the financial position and performance of a firm.
Formats of financial statements
There are three basic forms of business organizations. Sole proprietorship, Partnership and limited liability companies. Sole proprietorship is a business form for which there is one owner, in a partnership two or more individuals act as owners and a limited liability company is a separate legal entity from its owners. When shares of a public limited company are listed, the company is known as quoted company, whose financial statements publication is compulsory. Therefore the annual reports of quoted companies are a major source of financial information. However most of the time, the financial information of sole proprietorships, partnerships and private limited liability companies are not readily publically available as there are no volunteers in financial statements publication.
Tryor Plc presented their financial statements in accordance with the IAS’S since it get affects from legal requirements such as listing rules governed in the stock exchange. The main reason is the Tryor Plcs shared are listed on the stack exchange.
Financial performance of the company can explain using a variety of measures. In particular, in this report, principally discuss the Trevor’s results by using ratio analysis. Ratio analysis can be regarded as a technique used in the financial statement analysis. It gives an insight in to the performance of an enterprise.
Ratios could primarily be divided in to following areas:
Working Capital Management
This ratio reveals the efficiency of a business in terms of profitability and Assets utilization.
Gross profit ratio of the company is recorded as 28.95%. This ratio is said to be favorable but in order to make accurate comment this has to be compared with the last year figures or industry averages. Net profit ratio of Trevor’s is 6.37%. Net profit ratio is also said to be favorable to the company since company earning profits from their operations. Trevor Plc was able to achieve significant turnover for the period. In addition to that management of the company was able to manage their cost of operations efficiently. However accurate comment on both rations will depend on the results of the last years and industry averages. (Refer Appendix 01 Profitability ratios)
It assesses the efficiency of the company in terms of assets utilization. It is concerned on the areas of utilization of fixed assets and working capital. The detail analysis these ratios will reveal whether there are any idle assets or underutilized assets.
Assets turnover is recorded at 0.73 (Refer Appendix 01 Asset efficiency ratio). This ratio indicates the £1 of assets generates £ 2.38 sales to the company. Therefore available information for the company is not sufficient since it has to be compared with industry averages or past year’s results.
This ratio assesses the liquidity position of the company.
Liquidity is the amount of cash a company can put its hand to settle its debt and possibility to meet other unforeseen demands for cash payments too. A company can obtain liquid assets other the sales such as issue of shares for cash new loan or the sale of long term assets. But a company cannot rely on these at all times, and in general obtaining liquid funds depends on making sales and profits.
Company’s Current ratio is 2.16. Further Quick assets ratio is recorded as 1.50. (Refer Appendix 01). In theoretical view these two ratios are expected to be within a given range of 2:1 and 1:1 respectively. Trevor’s current ratio and quick assets ratio are lie within that given range. As a result of that company’s liquidity position is held at good position. Therefore management of the company has to adopt on current strategies to continue this position in future also. However these ratios also compared with last year results or industry averages to raise an accurate comment on liquidity position of the company.
Working Capital Management
This assesses the efficiency of the working capital management of the company. Finished goods turnover ratio is recorded as 12 times. (Refer Appendix 01) Further this led to finished goods residence period to 30 days. In addition to that Creditor’s turnover ratio of the Trevor’s PLC is recorded as 8 times. Further company creditors’ period from suppliers is 45 days.
Factors such as stock policies, policies on credit period allowed to debtors and those obtained from suppliers helps to determine the working capital management of the company. Comment on those rations cannot be raised due to unavailability of information. However Company would concentrate on increasing the rapidity of cash cycle, because each cycle can enhance the profitability of the company.
Gearing ratios are concerned with a company’s long term stability. How much the company owes in relation its size, whether it’s getting in to heavier debt or improving situation, and weather its debt burden seems heavy or light.
Debt to equity ratio recorded as 3.94. It means £ 01 of equity carries £ 3.94 of debt. (Refer Appendix 01 gearing ratio) By just seeing the ratio it’s fair to say that Trevors uses significant amount of debt and can be identified as a geared company.
Debt generally carries a fixed rate of interest; hence there is a given amount to be paid out from profits to holders of debt before arriving at residue available for distribution to the holders of the equity. The highly gearing situation creates greater risk to the equity holders. This means that there will be a grater volatility of amounts available for ordinary shareholders and presumably therefore greater volatility in dividends paid to share holders. Dividend payment in year 2009 is £ 50,000.
These ratios are considered to be external ratios and are used in evaluating the stability and investment potential of a company.
Basic Earnings per share of the Trevor Plc was £2.03 in 2009, reflecting the profitability in 2009. (Refer Appendix 01 Investors ratio). Trevor’s Plc can be considered as a well performing company in the industry since company maintains favorable investor’s ratios attracting potential investors. However this comment will not be accurate due to unavailability of comparison information about the past results of the company or the industry averages.
Net Present Value (NPV) and Discounted Pay Back Period
NPV = £ 484,750.89 (Refer Appendix 02)
Discounted Pay Back Period = 02 years and Nine Months (Refer Appendix 02)
This project gives positive NPV of £ 484,750.89. Further this project enables to recover its initial investment with in the period of 02 years Nine months. In order to make a decision based on the discounted payback period it has to be compared with target payback period. However project recovers its cost during its life time. Meanwhile positive NPV value gives a favorable indication that project is worthwhile. Therefore according the calculation it’s profitable to accept the project.
Sources of Financing
Offer for sales
Tax Impact, Control and Ownership of Sources of finance
Term Loans, Higher purchases, Debentures, Leases and venture capital can be identified as the debt financing methods.
In the case of term loans, higher purchases, debentures and leases, existing ownership of the company may not be diluted. Voting rights to Control the company lies with the equity holders even though the company raise finance through above mentioned sources. Interest payments on debentures and term loans are tax deductible and debt holders do not have any controlling power in the company. However in the case of venture capital there is a risk associates with controlling power of the company, since controlling and planning of the business will be held in the newly acquired management.
Rising of equity financing is much easier for a public company whose shares are traded on a stock exchange then it’s for a private company. Offer for sales and right issue can be identified as sources of Equity financing. Right issues are cheaper than offer for sales to the general public since it does not require the prospectus and less cost of underwriting. Right issues are more beneficial to existing shares holders than new shareholders. New shares are issued at discount to the current market price to the existing shareholders. In the case of right issues controlling power and ownership of the existing shareholders may not be diluted. However offer sales will lead to dilute the controlling power of the existing share holders. Dividend payments to existing shareholders and new shareholders are not tax deductible.
Long term loans are available from lending institutions and the commercial banks. It can be obtained to cover specific projects for restructuring as well as for equipment financing. Term loans are granted mainly on the strengths of cash generation of the project. This type of term loan facilitates grace period and easy repayment schedule at the early stage of projects operations.
This is defined as procedure of purchasing goods under which the purchaser pays a deposit on the receipt of the goods followed by a number of installments until the debt is cleared. The goods do not become the property of the purchaser until the last installment has been paid.
Debenture is direct from of borrowing by a company from the investors. In this case the interest rate and maturity period are fixed. The company is not required to pay the value of the debt before maturity although in some instances companies may prefer to redeem them before maturity by buying them back in the market.
It refers to participation by way of equality or co- financing through long term convertible debt in business. Venture capital means risk capital. This type of capital is sought to assisting product development, market research and acquisition of plant and equipment. Risk associates with this are venture capital involves control of management and planning of the business.
It’s a form of lending which enables a firm to use an asset without owing it. The owner of the assets grants another party the right to use the asset usually for a specific period in return of a series of specific rental payments. The risk is that lessee is not the owner of the asset for which he cannot claim capital allowances.
Offer for sale
Offer for sales is method of issuing shares to the public, which have already been bought by an investor as a block. Therefore it’s not considered as a primary issue but a secondary sale. A financial institution buys blocks of shares usually when the companies are formed and offer to the public at a later date.
Is a new issue of shares but subscription is limited to existing shareholders. Companies in need of additional capital usually go right issue unless the funds requirement is very large. The issue price will be determined usually at a level lower than the market price.
Cost of sources of finance and impact on financial statements (FS)
Capital structure decision is very significant since the question arises where her there is an optimal mix of capital and debt which a c company should try to achieve. If company is looking for obtaining debt Capital Company should earn enough profits to cover its interest charges before anything is available for equity. On the other hand if borrowed funds are invested in projects which provides return in excess of cost of debt capital, then the shareholders will enjoy the increased return on their equity. General cost of debt of each source as discussed in above is greater than the cost of equity financing. However tax savings can be enjoyed by the company in the cash of interest payments on debt financing. In the case of issuing shares to the public company has to incur considerable amount of expenses which are not tax deductible. As far as companies are concerned debt capital is potentially attractive sources of finance because interest charges reduce the profits chargeable only to corporate tax.
Shares can be issued to the public for the company whose shares are traded on the stock exchanges. In such case financial statements has to be complied with the IASs, listing rules and other regulations governing under the various institutions. Further format of financial statements for those companies are predetermined. But any company can obtain debt financing. In such case if the company is a quoted company, it has to be disclosed the financing sources and their cost and interest payments made during the period.
Best method of raising funds
Initial investment of £ 1 m for the new project can e obtained from the term loan as a source of debt finance.
Term loan has been selected to finance this project since this type of a loan can be easily obtained by Trevor PLC. It’s quoted public company and this loan is obtained as the project oriented loan. Company’s controlling power and the ownership of the existing shareholders will not be diluted. This is a main advantage to the company. In addition to that company does not have to incur any issue cost on issuing shares or debentures to the public. Company should have to incur only the interest payment on the borrowed amount of £ 1m. Further interest payment on such loans is tax deductible and company can enjoy some tax savings. Debt holders do not have any controlling power on the entity. Anyhow company liable to pay interest whether company earn profit or incur loss. But this method is very suitable since this project generates a positioned net present value.
In addition to the above this type of a loan repayment is geared to the specific needs of the project and may include a grace period before repayments commence and easier repayment schedule at the early stages of projects operations. Depending on the nature of the cash flow patterns firms are sometime allowed to capitalize the interest during the start up period.
Finance for a business is provided either by owners or creditors. Finance is categorized by their maturity periods as short term and long term. Short term funds have maturity of on e year or less while long term funds have maturity of more than on e year. Therefore financial planning is very important for a finance manger since he has to match cash inflows from assets with the assets sources of financing. As such medium and long tem fiancé investment in an enterprise should be financed from a medium and long term source. Investment in fixed assets such as land and buildings, plant and equipment generates benefits during their effective economic life. Therefore fund s locked in these assets will be repaid over a longer period. Thus long term assets should not be financed through short term sources. Therefore financial planning is significant without which company may incur heavy losses or possibility to go for bankruptcy.
Information Needs of decision makers
Piece of Information about any company is very essential to the stake holders who are interested in that company. Different stakeholders see the organizations from different angels. As such existing shares holder’s likes very much about the sales, gross profits, expenses incurred and profits earned during the period and any dividend payments. Potential investors are interested about the current earnings per share and new investments that the company is going to be implemented. Employees keen about the bonus payments, incentives, series and wages and potential survival of the company to ensure their job security. Government regulators are looking for information about profits and business operation to collect tax payments and other duties imposing on the nature of the business. As such different king of information about the company serves the stakeholders to make decisions which maximize their value.
Unit Cost and Profit Margin
As per the calculation (Refer Appendix 03) unit cost of a toy is recorded as £ 19.68. Whereas profit margin of a toy (Refer appendix 03) is equal to the £ 0.7179 in accordance with calculation.
Recommendation & Conclusion
It is recommended Trevor’s Plc to undertake the new project of manufacturing and selling brand new toys since it generates positive net present value. It’s fair to say the Trevors Plc perform their operations well. However accurate comments on ratio analysis cannot be raised since unavailability of comparison information about the past results of the Trevors PLC and industry averages.
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