Introduction to Finance

Introduction to Finance

Task 1: Start-up Capital

In scenario one, a florist has saved £10,000 and is eager to start a venture that requires a minimum of £30,000. He will need to evaluate the possible sources of finance that will enable him to raise the deficit of £20,000. The florist, an entrepreneur, can choose from either internal or external sources of funding. Internal sources of finance include the owner’s capital and retained earnings, which are appropriate for short-term financing. External sources of funding include debt and equity, which are suitable for long-term financing. The choice of funding has implications on the control as well as financial costs to the business. Each source of capital, either short or long-term funding, has its advantages and disadvantages. As a budding entrepreneur, understanding the various implications is vital before committing to any particular funding offer.

Owner’s Capital

The owner’s capital includes the personal finances of the sole proprietor and other business partners. Personal finances include cash on hand, savings, and money in the bank, and also less liquid funds such as retirement accounts and stock holdings. As a business owner, accrued personal savings can be used to cover immediate and short-term business expenses. Other alternatives to short-term finances include taking out credit on personal belonging, cashing out retirement plans such as 401k accounts, and lastly borrowing funds from relatives and friends.

Personal financing, as a means of financing, has its pros and cons. The upside of using the owner’s capital is that there are no accompanying strings attached. The use of personal funds is advantageous because there is no interest accrued and no definite repayment schedule (Keythman, 2019). Personal finance is the easiest and fastest source of funding since the business owner does not require to convene lengthy meetings convincing strangers to fund their ventures. The repayment schedule and options are flexible in instances of paying back relatives and friends. These advantages of personal finances bestow more control over the business management to the proprietor.

Conversely, the use of personal financing to fund the business venture has significant disadvantages. Firstly, the proprietor puts his capital at immense risk (Sarokin, 2018). One stands the risk of losing their entire savings in case the business fails to pick up. In instances where the proprietor has cashed out their retirement plans, there is a risk of jeopardizing their future financial plans. These risks are also bound to happen for other business partners if it is a partnership business structure. Secondly, there is an apparent risk of severing the personal relationships with close relatives and friends (Sarokin, 2018). Resorting to relatives and friends allows fast access to finances to cover short-term business expenses. However, in case the start-up venture fails to succeed, there can be reproach from close relatives and friends who feel that their resources were not effectively used.

Funds from Investors

Business owners can seek financing from external sources such as investors, banks, and other financial institutions. Entrepreneurs have the option of seeking funds from venture capital firms and angel investors. It can be advantageous for budding entrepreneurs to cooperate with angel investors since they have access to enough capital reserves required to fund the business needs from inception and throughout the initial stages of growth and development. Venture capital firms and angel investors can bankroll the business expenses in one fell swoop, thus allowing the entrepreneur more time to concentrate on executing the core business objectives (Sarokin, 2018). Start-up entrepreneurs who seek out investors are relieved off the pressure of staking their finances in the business venture.

There are downsides to securing sources from venture capital firms and angel investors alike. The main disadvantage of securing funds from investors is the challenge of finding the right fit for the business. Convincing Angel investors can be a daunting task for many start-up entrepreneurs as it takes a lot of effort. Besides, angel investors expect to exert substantial control over the business management owing to their significant financial commitment to supporting the start-up venture (Sarokin, 2018). Entrepreneurs face the danger of loss of independence and control when making critical decisions for their business. The lack of control over the decision-making process can inhibit the entrepreneur’s impetus for growth and expansion.

Bank Loans

Financial institutions, such as banks, are other conventional sources of funding. Banks, like venture capital firms and angel investors, can fund the long-term growth of a start-up. Finding the right bank to discuss a loan plan is quite easier than identifying potential investors. Banks require a detailed loan proposal that must indicate the company’s history, the competitors, and the purpose of the funds (Williams, n.d). The loan proposal must detail the explanations of the business venture or project that the entrepreneur intends to pursue.

There are critical challenges associated with seeking bank loans. Firstly, the bank has full discretion of determining the details of the loan, such as the grace period, interest payable, and the repayment duration. Secondly, banks require detailed financial information regarding cash flow projections before they consider the possibility of advancing a loan to start-up entrepreneurs. Lack of elaborate cash flow projections can reduce the chances of securing a bank loan. Additionally, banks and other financial institutions will charge interest on the loan and thus increasing the burden to the budding business owners (Sarokin, 2018). The fixed and timely repayment schedule can be another stumbling block for fledgling businesses in their initial stages of growth. Start-up entrepreneurs need to pay attention to the loan details and negotiate for a fixed interest rate. Otherwise, a non-fixed interest rate fluctuates with time, and thus the company can end up paying more than what was initially negotiated.

Pros and Cons of Financial Sources

Recommendations

The sources of finance are crucial in financing a business start-up. Each source has its pros and cons, as well as implications for business management. It is imperative to make an informed decision on the alternative to choose from. The most appropriate source of funding for a start-up venture would be personal finances and venture capital firms and angel investors. In the scenario presented, the suitable method to fund the florist business would be the use of personal finances. The proprietor has ready cash on hand-drawn from his savings of £10,000. The additional £20,000 can be sourced from family and friends.

I would recommend that the florist engage relatives and friends to top-up his savings and realize the minimum required capital of £30,000. Securing funding from family and friends is a faster and easier method to finance the deficit. The florist will retain control of the business and will have substantial independence over the decision-making process. Retaining control and having powers to make significant decisions can be an additional motivation to the proprietor. The personal financing route does not require numerous formalities, and thus the business is not held by several constraints and strings such as interest rates.

Additionally, the repayment plan can be re-negotiated depending on the prevailing business circumstances. Should the business experience difficulties in its initial stages, then the repayment duration can easily be extended up until the period when the venture picks up. However, the entrepreneur should be diligent in ensuring that he maintains the trust bestowed upon him by his family and friends and thus ensure that all the resources and funds acquired are utilized effectively and efficiently.

Task 2: Decision Making Exercise

Scenario description: Mr. Neil Down, a sole proprietor, wants to incorporate a new partner who will help him raise £20,000.

1. Discuss types of business budgets

A budget is a financial plan that covers a predefined period, usually one year. Strict adherence to budgets is essential as it portrays proper planning and management of revenues and expenses. An ideal budget covers all the costs and allocates a little surplus for unforeseen expenses (Bhasin, 2019). There are several budgets that entrepreneurs prepare for their business operations. These budgets include:

Cash flow budgets, which tracks the inflow and outflow of cash in the business for a specific period, usually a year. It is used to evaluate whether the business has enough cash flow to fund its operations.

Operating budget-forecasts the projected revenues and expenses for a specific period. The costs cover production, labor, and other overhead expenses.

Financial budget- manages the financial aspects such as assets income, and expenses. A strong financial budget defines the stability of the company.

Sales budget- gives the projected sales income and selling expenses of a company. This is the backbone of the firm’s operations.

Production budget- it forecasts the required stock levels and the associated costs of production. It is adjusted depending on the sales and market demand.

These budgets are essential in informing the investment decision of new partners and investors. Potential investors will have a clear picture of the financial position and the production capacity of the firm before making an investment decision.

2. Methods of calculating the unit cost of the wooden toys

The unit cost is calculated by dividing the total production costs and expenditure by the quantity produced. The total production expenses are a summation of variable and fixed costs. Variable costs change as the volume of production changes (Shpak, 2018). Such costs include labor costs and raw materials. Fixed costs remain constant regardless of the changes in production. Such costs include rent and utilities. In this scenario, Mr. Neil Down would calculate the unit costs of the wooden toys using the following formula:

Unit cost of a wooden toy = (variable costs + fixed costs)/ total output

3. Compare financial statements for a sole proprietorship and a partnership business.

Financial statements are records of the position of a business. They are structured in a formal format depending on the type of business establishment. The format of the financial statements for a sole proprietorship varies from that of a partnership. The financial statement of a sole proprietorship has a single capital account, while that of a partnership has multiple capital accounts, depending on the number of partners. In a sole proprietorship, the profit belongs to the business owner, and thus there is no schedule of profit/loss distribution (Roberts, 2020). In a partnership, the financial statement indicates changes in equity of each partner, unlike in a sole proprietorship.

4. Discount pricing

A wholesaler has to consider several factors before offering a discount to a retailer. Mr. Neil Down will have to evaluate different factors before granting the discounting request from a large retailer. Essential factors to consider include order quantity, total order value, strategic customer, and keeping customers (Thomsen, 2019). A discount can be offered if the order quantity exceeds a given number as this will increase the number of breaks. The wholesaler can offer a discount if the total order value exceeds a specified amount. Giving discounts to strategic customers can be crucial in gaining or sustaining them.

In summary, the large retailer can prove to be strategic for Mr. Neil Down as there is a high probability of a higher purchase in the future. Also, the large retailer can offer Mr. Neil Down a crucial marketing advantage due to their influence in the market. The business will gain brand recognition and thus improving its market position. In case the retailer agrees to a cash purchase, then Mr. Neil Down will get money immediately to finance short-term purchases.

5. a) Payback

• Payback for Toy Store A arises past four years. So the payback period is beyond four years.
• Payback for Toy Store B arises £225000/£250000 through year 4, which is approximately 49 weeks. The Payback period is 3 years + 49 weeks

1. b) Net Present Value

I would recommend that Mr. Neil Down purchases Toy Store B since it has a shorter payback period of 3 years + 49 weeks and also because it has a higher net present value (NPV).

Last Task: Preparing a Business Report

1. The published accounts of Hamley’s Group Limited meet the criteria for structure, format, and requirements. Published accounts must include statements of financial position, profit & loss, cash flows, changes in equity, and cash flow statements. The structure of the published accounts must identify the financial statements and their accompanying notes. Additionally, the name of the entity, the currency, and the reporting period must be identified. The financial statements must identify the current and non-current classifications. Current assets are projected to be received in the standard accounting period. Current liabilities are expected to be settled within 122 months. Otherwise, the non-current assets and liabilities extend after 12 months. The format of the financial statements requires that assets and liabilities be presented as current, followed by non-current. A standard financial statement must have assets then liabilities, then equity. Besides, a net asset value (assets minus liabilities) is also allowed.
2. Hamley’s Group Limited and its stakeholders rely on financial ratios to assess the position of the company. Firstly, Profitability ratios are used to evaluate the capacity of the business to use its assets to generate profits. Liquidity ratios determine the ability of the company to settle debt obligations without the need for external capital. Efficiency ratios indicate the ability of the firm to manage its short term liabilities using its assets.   Capital ratios measure the value of funds in reverse against the risk-weighted credit.  Lastly, investor ratios evaluate the expected return to the business owner.

References

Keythman, B. (2019).  Advantages & Disadvantages of Equity Capital. Retrieved from https://smallbusiness.chron.com/advantage-disadvantage-equity-capital-58005.html

Sarokin, D. (2018). Sources of Finance and Their Advantages & Disadvantages. Retrieved from https://smallbusiness.chron.com/sources-finance-advantages-disadvantages-14407.html

Williams, M. (n.d.). What Banks Look for When Reviewing a Loan Application? Retrieved from https://www.bizfilings.com/toolkit/research-topics/finance/business-finance/what-banks-look-for-when-reviewing-a-loan-application

Thomsen, R. B. (2019). Nine Discount Strategies You Can Use Today (Without Hurting Sales). Retrieved from https://sleeknote.com/blog/discount-strategy

Roberts, S. (2020). Financial Statements of a Sole Proprietorship. Retrieved from https://smallbusiness.chron.com/financial-statements-sole-proprietorship-14717.html

Shpak, S. (2018). How to Determine the Unit Costs of Production. Retrieved from https://smallbusiness.chron.com/determine-unit-costs-production-80184.html

Bhasin, H. (2019). 10 Types of Budget that exist for Businesses. Retrieved from https://www.marketing91.com/10-types-of-budget/