Implications Of Different Sources Of Finance Finance Essay
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Published: Mon, 5 Dec 2016
This assignment will look at the different sources of finance that are available to a small business or a big company. With each source of finance listed the report will assess the implications that can arise and along with this the report will look at the cost to the business to taking a curtain source of finance. All businesses need short-term finance from the very beginning to start up the business and to cover day-to-day running costs. This provides the business with working capital. However businesses also need long-term capital to help them to grow and expand, and this is paid back over a number of years. Without finance a business would find it difficult to accomplish anything.
For my assignment purpose I have chosen two companys they are sainsbury and tesco respectly, source of finance can be define into two ways such as internal source of finance and external source of finance.
Source of Internal finace fro both company are as follows:
Personal savings: This is most often an option for small businesses where the owner has some savings available to use as they wish. Practically both sainsbury and tesco depends on their savings for source of finance.
Retained profit: This is profit already made that has been set aside to reinvest in the business. It could be used for new machinery, marketing and advertising, vehicles or a new IT system.
Working capital: This is short-term money that is reserved for day-to-day expenses such as stationery, salaries, rent, bills and invoice payments.
Sales of assets: There may be surplus fixed assets, such as buildings and machinery that could be sold to generate money for new areas. Decisions to sell items that are still used should be made carefully as it could affect capacity to deliver existing products and services.
External Source of financing:
Shares: Limited companies could look to sell additional shares, to new or existing shareholders, in exchange for a return on their investment.
Loans: There are debenture loans, with fixed or variable interest, which are usually secured against the asset being invested in, so the loan company will have a legal shared interest in the investment. This means that the company would not be able to sell the asset without the lender’s prior agreement. In addition the lender will take priority over the owners and shareholders if the business should fail and the cost will have to be repaid even if a loss is made.
There are other types of loan for fixed amounts with fixed repayment schedules. These may be considered a little more flexible than debenture loans.
Overdraft: A bank overdraft may be a good source of short-term finance to help a business flatten seasonal dips in cash-flow, which would not justify or need a long-term solution. The advantage here is that interest is calculated daily and an overdraft is therefore cheaper than a loan.
Hire purchase: Hire purchase arrangements enable a firm to acquire an asset quickly without paying the full-price for it. The company will have exclusive use of the item for a set period of time and then have the option to either return it or buy it at a reduced price. This is often used to fund purchases of vehicles, machinery and printers.
Credit from suppliers: Many invoices have payment terms of 30 days or longer. A company can take the maximum amount of time to pay and use the money in the interim period to finance other things. This method should be treated with caution to ensure that the invoice is still paid on time or else the firm might risk upsetting the supplier and jeopardise the future working relationship and terms of business. It should also be remembered that it’s not ‘found’ money but rather a careful balancing act of cash-flow.
Grants: Grants are often available from councils and other Government bodies for specific issues. For example there may be a council priority to regenerate a particular area of a town and who are happy to help fund refurbishment of buildings. Alternatively there may be an organisation that specialises in helping young entrepreneurs to launch new businesses. Assessment for grants can be very competitive, is very individual and not automatic.
Venture capital: This source is most often used in the early stages of developing a new business. There may be a huge risk of failure but the potential returns may also be big. This is a high risk source as the venture capitalist will be looking for a share in the firm’s equity and a strong return on their investment. However the significant experience these investors have in running businesses could prove valuable to the company. This is what the TV programme ‘Dragon’s Den’ is all about!
Factoring: This involves a company outsourcing its invoicing arrangements to an external organisation. It immediately allows the company to receive money based on the value of its outstanding invoices as well as to receive payment of future invoices more quickly. It works by the firm making a sale, sending the invoice to the customer, copying the invoice to the factoring company and the factoring company paying an agreed percentage of that invoice, usually 80% within 24 hours. There are fees involved to cover credit management, administration charges, interest and credit protection charges. This must be weighed up against the benefit gained in maximising cash flow, a reduction in the time spent chasing payments and access to a more sophisticated credit control system. The downside is that customers may prefer to deal direct with the company selling the goods or services. In addition ending the relationship could be tricky as the sales ledger would have to be repurchased.
Money is a scarce resource and each source has its own advantages and disadvantages. Lenders will be looking for a return on investment, the size of the risk and the flexibility with which they can get their money back when they want or need it. For the company seeking money, the decision as to the best source will ultimately depend on what the money is for, how long the money is needed for, the cost of borrowing and whether the firm can afford the repayments.
The launch of Clubcard in Thailand in August this year extends Tesco’s loyalty cards operation further across the globe, and belatedly brings Thailand’s biggest retailer into a loyalty card market which already contains offers from Carrefour, Tops and Big C. It will clearly be big: in its first three weeks Clubcard gained more members (two million) than competitor Carrefour’s I-Wish card has accumulated since its launch in 2007. The recent launch in Malaysia has resulted in 70% of scanned transactions being covered by Clubcard.
The benefits to Tesco are clear. Their dominance of the UK market has been underpinned by Clubcard, and whilst their latest campaign to double points has yet to prove effective (Tesco growth in the period still lags Asda*, a competitor which does not use a loyalty card), there is a consensus amongst industry observers that it has historically been a critical part of their marketing mix. The benefits to manufacturers are less clear; and one suspects criticism of one’s biggest customer would naturally be muted. So what are the implications for Tesco’s suppliers and how should they respond to Clubcard?
Clubcard is a loyalty card, and is designed to encourage shoppers to use a particular chain more. In its simplest incarnation a loyalty card gives rewards, usually in the form of discounts against future purchases, based on how much is spent. Because Clubcard registers who did the shopping, it is possible for Tesco (through their partners Dunnhumby, majority-owned by Tesco), to analyze who buys what, which should enable activities such as promotions to be better targeted. So, for example, a coffee supplier could target their next promotion only at shoppers who bought the competitor product. The targeting of promotions offers a theoretical improvement in effectiveness, but the real boon is the potential to effectively evaluate activities – knowing which shoppers bought adds useful data to a promotion evaluation which is currently limited to whether sales went up or not.
Clubcard promises suppliers much: Insight into shoppers, more efficient promotions, and unprecedented access to new in-store media opportunities. Suppliers will need to evaluate the potential benefits of the Clubcard offer against the inevitable associated costs. Yet it clearly has limitations: Clubcard in Thailand has two million card holders, yet with Tesco enjoying 25% of the Thai retail market, their total number of shoppers must be significantly higher than this. So how skewed is the sample, how representative, and what is missing?
Choosing the Right Source of Finance
A business needs to assess the different types of finance based on the following criteria:
Amount of money required – a large amount of money is not available through some sources and the other sources of finance may not offer enough flexibility for a smaller amount.
How quickly the money is needed – the longer a business can spend trying to raise the money, normally the cheaper it is. However it may need the money very quickly (say if had to pay a big wage bill which if not paid would mean the factory would close down). The business would then have to accept a higher cost.
The cheapest option available – the cost of finance is normally measured in terms of the extra money that needs to be paid to secure the initial amount – the typical cost is the interest that has to be paid on the borrowed amount. The cheapest form of money to a business comes from its trading profits.
The amount of risk involved in the reason for the cash – a project which has less chance of leading to a profit is deemed more risky than one that does. Potential sources of finance (especially external sources) take this into account and may not lend money to higher risk business projects, unless there is some sort of guarantee that their money will be returned.
The length of time of the requirement for finance – a good entrepreneur will judge whether the finance needed is for a long-term project or short term and therefore decide what type of finance they wish to use.
Short Term and Long Term Finance
Short-term finance is needed to cover the day to day running of the business. It will be paid back in a short period of time, so less risky for lenders.
Long-term finance tends to be spent on large projects that will pay back over a longer period of time. More risky so lenders tend to ask for some form of insurance or security if the company is unable to repay the loan. A mortgage is an example of secured long-term finance.
The main types of short-term finance are:
The main types of long-term finance that are available for to a business are:
Internal and External Finance
Internal finance comes from the trading of the business.
External finance comes from individuals or organisations that do not trade directly with the business e.g. banks.
Internal finance tends to be the cheapest form of finance since a business does not need to pay interest on the money. However it may not be able to generate the sums of money the business is looking for, especially for larger uses of finance.
Examples of internal finance are:
Day to day cash from sales to customers.
Money loaned from trade suppliers through extended credit.
Reductions in the amount of stock held by the business.
Disposal (sale) of any surplus assets no longer needed (e.g. selling a company car).
Examples of external finance are:
An overdraft from the bank.
A loan from a bank or building society.
The sale of new shares through a share issue.
All lenders charge interest on their loans and this is the major element in the cost of the finance. Building societies and banks have variable interest rates which may vary according to the size of the loan.
However, there are other charges that are normally involved in arraning a mortgage:
Banks and building societies do not always charge arrangement or setup fees, but many lenders do charge them, particularly for some of the specialist mortgages described later in this guide. Arrangement fees are typically in the range of £100 – £400.
In order to protect its security, the lender will want to be sure that the house is worth the sale price, so will alwas insist on a valuation for mortgage purposes. This will be carried out by a qualified surveyor, who will charge a survey fee, paid by the borrower.
The lender’s survey aims to establish if the value of the house is enough to protect the lender’s security. It does not mean that the property is free from any defects. It is therefore recommended that house buyers obtain a homebuyer’s report or a full survey to ensure that they are aware of any problems. This will increase the cost but could prove to be a wise investment.
Indemnity guarantee fee
Some lenders insist on an indemnity guarantee policy if the loan exceeds 75 percent of the property value. This protects the lender in the event of the borrower defaulting on the mortgage and the sale price of the property not being enough to repay the loan. However, this policy is paid for by the borrower and often, the premium has to be added to the loan. In recent times, the threshold for mortgage indemnity guarantees has increased – many lenders now set the level at 90 percent.
This is a tax charged by the Government on the document transferring ownership of the house, paid by the purchaser. The rates are:
Nil – up to £60,000
1% over £60,000 but not more than £250,000
3% over £250,000 but not more than £500,000
4% over £500,000
There will be legal fees payable to the solicitor or licensed conveyancer handling the transaction. The legal fees will include the local search fees (carried out to reveal matters affecting theproperty) and land registry fees, as well as the lawyer’s own charges.
All mortgage lenders will have a tariff of other charges that you may incur in certain circumstances at various points during the life of your loan. These are not universal charges – lenders will vary in terms of which ones apply, but all should be able to provide details on request.
Importance of Financial Planning
It is important to plan finances in order to reap long term benefits through the assets in hand. The investments that one makes are structured properly and managed by professionals through financial planning. Every decision regarding our finances can be monitored if a proper plan is devised in advance. The following points explain why financial planning is important.
Cash Flow: Financial planning helps in increasing cash flow as well as monitoring the spending pattern. The cash flow is increased by undertaking measures such as tax planning, prudent spending and careful budgeting.
Capital: A strong capital base can be built with the help of efficient financial planning. Thus, one can think about investments and thereby improve his financial position.
Income: It is possible to manage income effectively through planning. Managing income helps in segregating it into tax payments, other monthly expenditures and savings.
Family Security: Financial planning is necessary from the point of view of family security. The various policies available in the market serve the purpose of financially securing the family.
Investment: A proper financial plan that considers the income and expenditure of a person, helps in choosing the right investment policy. It enables the person to reach the set goals.
Standard of Living: The savings created by through planning, come to the rescue in difficult times. Death of the bread winner in a family, affects the standard of living to a great extent. A proper financial plan acts as a guard in such situations and enables the family to survive hard times.
Financial Understanding: The financial planning process helps gain an understanding about the current financial position. Adjustments in an investment plan or evaluating a retirement scheme becomes easy for an individual with financial understanding.
Assets: A nice ‘cushion’ in the form of assets is what many of us desire for. But many assets come with liabilities attached. Thus, it becomes important to determine the true value of an asset. The knowledge of settling or canceling the liabilities, comes with the understanding of our finances. The overall process helps us build assets that don’t become a burden in the future.
Savings: It is good to have investments with high liquidity. These investments, owing to their liquidity, can be utilized in times of emergency and for educational purposes.
The argument made by people from low income groups is that they don’t need to plan their finances due to the less money they possess. However, no matter how much one earns, better planning of income always helps in the long run.
Defining the problem
Take time to properly define the problem. What is the issue to be covered? What is the problem? What decisions need to be taken? A fish-bone diagram will sometimes help in understanding the complex interlinkages that create a particular ‘problem’. For each of the causes or its effects, make a list of information or data that will be required, and clarify how that information will lead to a better decision.
Finding the information
Determine the sources from where information needed for decision-making can be obtained. What information needs to be taken? Who has that information? Why is that information being collected by the source? Which component of the problem at hand will it help? Evaluate the sources to see which of them can provide the best information, and identify the mode and format in which the information is presented. Keep in mind that different sources provide information in different formats (for different reasons!).
Processing the Knowledge
This where the information gathered is matched with the problem in hand. The relevant information from each source is extracted and information from multiple sources is organized. Which parts of the information collected needs to be used? What additional data or information is needed? How can information be best presented to be able to understand the situation and take decisions? The collected information is evaluated and integrated for its relevance, validity and interconnectedness.
Taking the decision
In an interactive and inclusive process involving all the concerned parties, form an opinion from the information collected for its effectiveness and efficiency. Use it to take the decision. Has the decision taken help in solving the problem at hand? Was the decision satisfactory and took into account all the views of concerned parties? A decision taken may need to be examined closely and refined, and modified to meet differing needs over time.
Impact of finance of financial statement is immence because inorder to prepare financial statememnt some cost is essential such as auditors fee, financial analyst’s fee.
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