Identify the Sources of Finance Available To Living Wood
Living Wood is in a quagmire about how to source some funding for the purchase of two machines that will enhance the performance of the firm. The firm may source these funds from borrowing loans from commercial banks. This will require them to offer some sort of security for the money loaned out to them. The firm may use the assets of the firm as security, although this is potentially risky.
Alternatively, the firm may enter into a lease agreement with the sellers of these two machines such that the firm will just be making monthly payments to the seller as part of the annual premiums payable. They may even agree on an initial down-payment. However, the firm will incur extra costs in leasing the machines as opposed to borrowing a loan to purchase the machines. The firm may also borrow from local and state organizations that seek at helping local industries to grow. These institutions offer loans at fairly affordable interest rates, lower than the market value. This means that the firm may incur lower costs in using this option of financing. The firm may also decide to become a public company, and hence seek capital from the shareholders. This will be easier and safer than borrowing from a commercial lending institution. The government may also offer grants especially where economic development of a certain region is likely to be improved by the growth of London Wood (Peterson and Fabozzi, 1999).
Assess the Impact of the Sources of Finance You Have Identified In To Living
If Living Wood decides to source the machines through a lease agreement, they stand to gain profits that may then be used to pay the necessary lease obligations. However, the firm ties itself to annual payments that may last for many years, even after the machine collapses or ceases to be relevant. The firm stands to incur lower interest costs if it sources its funding from governmental and international development institutions. The grants from such institutions also stand to provide extra capital to the firm hence reducing its capital expenditure. Borrowing from banks may prove to be risky in case the firm is unable to raise the monthly or annual installments due to the repossession of security due to non-payment.
Evaluate the Appropriate Sources That Living Wood Limited Might Consider When
Purchasing Production Machines
This helps to rid the firm of older equipment and to acquire new and more efficient equipment for increased performance in the production process. Production machines usually become cumbersome once they start experiencing breakdowns. Therefore, the firm must make sure the equipment purchased are of high quality. This may mean a higher leasing or hire purchase cost. However, these are some of the quality versus cost decisions that the firm must decide on. Low quality machinery may eventually result in higher costs in terms of maintenance and inconveniences caused by such machines (Wahlen, 2011).
The lease agreements must also have a provision for training on how to operate the machines. This helps to ensure the technicians do not mishandle these machines. Alternatively, the machines should have well elaborated operation manuals that provide appropriate guidelines on the effective operation of the machines. The government and other non-profit organizations may, through the grants, provide for customization of machines to the specific needs of the firm through communication with the manufacturers of the machinery.
Analyze the Costs of Different Sources of Finance Living Wood Might Be Using
The costs of the various sources of finance vary depending on the contractual agreements between the buyer and the seller of the equipment. The cost of leasing, though high, is rather fair considering that the firm stands to gain from the use of the equipment prior to full payment of the amount payable. The same case applies to a hire purchase system of acquiring the required equipment. Finances sourced from commercial lending institutions such as banks usually have high interest rates that may significantly affect the firm’s net profits. The firm also risks losing some of its assets that have been placed as security in case it defaults in payment.
The hire purchase system is especially costly due to the fact that the hirer may repossess the goods in case the buyer defaults in payment of installments. Furthermore, in such a case any installments previously paid are also considered null and void. The finances obtained from government and other NGOs are the cheapest because of the low interest rates that are attached to these finances. Grants attract no cost since there is no repayment of the amounts forwarded to the firm (Needles and Powers, 2010).
Explain the Importance of Financial Planning To Living Wood Limited
Financial planning helps to improve the budgeting of the firm’s finances. This helps in the analysis of the risks involved in the investments made by the firm. A close analysis of the risks available is crucial in ensuring the firm avoids incurring unforeseen losses that are easily avoidable. Financial planning helps in managing of the firm’s income. This means a determination of the appropriation of funds to the various costs that the firm must meet. This will provide a follow up on the firm’s cash flows (Gitman and McDaniel, 2009). This may act as an internal control mechanism to enable the audit team to detect any fraudulent activities occurring within the firm. This may also help to safeguard against draining of the firm’s capital base on irrelevant business activities. A control of the firm’s capital also ensures that the firm does not run the risk of going bankrupt due to overinvestment. This is through the control of capital expenditures that the firm incurs.
Financial planning helps in the determination of a firm’s capital requirements, either short term or long term. This means striking a balance between the recurrent expenditures and the acquisition of assets. Financial planning also plays a crucial role in framing of London Wood’s financial policies such as lending, cash expenditures and even further borrowing. Financial managers also use information on financial planning to determine how the scarce resources will be used to obtain maximum returns on the investments made (Brigham and Ehrhardt, 2008b).
Explain Why Living Wood Limited Need Good Information for Its Decision-Making
Living Wood requires access to sufficient information to make good investment and capital expenditure decisions. There is also need to have access to information on prevailing market conditions as far as interest rates and lending rates of commercial banks are concerned. The firm should also be knowledgeable on contractual terms on different modes of accessing funds. This means the company secretary should ensure all contractual terms are understandable and that the firm’s best interests are represented. The firm should also be on the lookout for governmental and other institutional advertisements that may be relaying information on possible grants and low interest rates available to various categories of companies.
Explain the Impact of the Sources of Finance on the Financial Statements of London Wood Limited
The sources of finance available to London woods may significantly affect the expenditures of the firm. This means that the financial statements of the firm, such as the cash flows, income statement and the balance statement will be affected by such sources of finance. Lease agreements will result in the inclusion of a provision to amortize or depreciate this lease as time progresses. This will be included in the balance sheet and also in the income statement as an annual expense. This will lead to reduced net profits for the firm, and hence affecting the capital available to the firm to begin a new financial year (Brigham and Ehrhardt, 2008a).
If the firm is able to secure grants as its source of finance, it will increase its capital base. This means the cost of capital will be non-existent hence resulting in higher profit margins due to the elimination of some costs. Higher interest rates result in higher expenditures hence reduced expenditures. Commercial loans are normally not amortized. Only the repayment premiums are accounted for as expenses in the income statement for that financial year. However, they are included as part of the capital used to finance business operations for that financial year.
Prepare the Cash Budget for London Wood Limited for April – December
A cash budget helps in the evaluation of the firm’s cash flows in line with the firm’s operations. This helps in managing the firm’s capital status hence playing a central role in planning as a part of management.
Calculate the Cost of Production per Chair and State How Cost Affects Pricing Decisions
Production cost per units obtained by dividing the total production cost by the number of units produced. Total cost of production = £26400+£16632=£43032. Cost of production per chair= £43032/ 240= £179.3.
Using The Information Given In (d) And In The Case Study, Assess Whether London Wood Limited Should Purchase The Two Production Machines. Explain Your Decision
Based on the expected net cash flows from acquisition of new production machines, the firm should not acquire the two machines. This is because of the drastic difference between the initial cost of £2000 and the income of £800. There is also a progressive decline in the annual production cash flows for both machines. This is far below the expected increase in production that the machines were expected to bring into the production. The gains from acquisition of the two machines are not commensurate to the cost of financing their acquisition and the opportunity costs forgone in terms of other investment options.
Discuss the Main Financial Statements of a Company
The main financial statements of a company are the income statement and the balance sheet. The balance sheet shows the state of a firm’s financial position at the end of a financial year. It involves a close analysis of the firm’s final year balances in the accounts. The balance sheet compares the firm’s assets and liabilities to determine its financial position. The income statement is a statement that represents the incomes earned and expenses incurred during a financial year. This helps to determine the firm’s net loss or profit for a certain financial year. Other important documents include source documents, prime books of account, ledger accounts the bank reconciliation statement, the statement of cash flows and the trial balance that are used in the preparation of the income statement and the balance sheet.
Compare the Financial Statements of a Company and That One of a Sole Trader
A company usually has more details in its financial statements than a sole proprietorship. This is because the company has more accounts to cater for the many business operations. A good example is the provision for share capital accounts for a public company that sources its finances from shareholders. Companies are also keener on the changes in the balance sheet since they can help to track the movement of the firm’s inventory and hence acts as an internal control mechanism against fraud in the firm. Sole proprietorships do not have comprehensive financial statements due to the fact that it is easy to track the movement of inventory and the cash flows involved.
Net Profit Margin
This is a ratio of the net profit to the total revenue earned in a certain financial year. Net profit = 37, and sales= 499, hence net profit margin=37/499=0.074148. This shows that the firm has a low rate of changing the raw materials into finished goods for sale.
The current ratio is obtained by dividing the current assets by the current liabilities. The current assets= 154, the current liabilities=79, hence the current ratio=154/79=1.9494. This ratio is fairly okay, but it can be improved by increasing the current assets. The firm has a stable working capital as per this current ratio.
The quick ratio is a measure of the ability of the firm to effectively meet its short term liabilities. It is similar to the current ratio, except the inventory is not included in the determination of current assets. Therefore, the quick ratio= 86/ 79=1.08861. This is a measure of the firm’s liquidity. This ratio shows that this firm has rather liquid current assets.
The return on capital employed is a ratio of the operating profit and the capital employed in a certain financial year. This is obtainable as =37/93=0.39785=39.785%.
Asset Turnover Ratio
This is ratio of the net sales to the total assets owned by a business. It is easily determinable as: 499/ (154+110) =1.890. This shows the firm is fairly effective at utilizing its assets for the normal business operations.
Debt Equity Ratio
This is a ratio of the total debt to the total equity (capital) a firm has. This can be calculated as 130/93=1.3978. The firm is not a good situation and is unable to effectively meet its financial obligations.
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