T/617/1213

15 CREDITS
LEVEL 5
LO1 Understand the sources of finance available to organisations.
1.1 Describe the sources of finance available to different types of
organisations.

The sources of finance that will be discussed below are; internal, external, short
term, medium term and long-term sources of finance. These sources are used in a
lot of circumstances. They are categorized according to their period of time,
ownership rights, the current capital gearing of the company and the state of equity
markets. It would be less speculative if financial managers assess each source
before determining which one is more fitting for their company.

Internal source of finance: Internal finance is the least expensive method of finance
because a corporation will not be required to pay interest on the sum of money as it’s
the firm’s own earned finance and not borrowed from an external party.
Nevertheless, this might not be capable of initiating a good amount of money needed
by the company, particularly if its large sums. Examples of internal sources of
finance include, working capital, retained profit, sales of the asset, reducing
inventory, owner’s capital and so on. This source enables a business to sustain
absolute control, and when using this form of financing they may not have similar
refunding obligations as when relying on external debts.

External source of finance: Financing is provided by companies/ individuals who

don’t do business personally with the company. So, they might rely financial sources
through an overdraft, a loan from a bank, stock dividend selling of new shares.
External finance sources release equity, contributes emergency relief, assist
irregular cash flows and boost potential growth in the business. External sources of
finance are needed if companies require additional funding for R&D expenses,
expanding into new markets and so on.

Short term sources of finance: A company requires cash immediately for urgent and
short-term purposes. It is being used to transcend short-term financial shortfalls, to
get by in times of poor cash inflow, and to hide short term financial requirements due
to unforeseen issues and challenges. Secured loans, trade credit, loans from co-
operatives, customer advances and so on. When immediate business requirements
are at stake, short term source of finances help bridge that gap during times of
temporary shortfall.

Medium term sources of finance: This form of finance is utilised for larger amounts of
money that are required but not as large as long-term finance. It is typically used to
fund the acquisition of assets with a tenure of 2 to 5 years. Examples of this type of
financing includes, hire purchase finance, debentures, borrowing from commercial
banks, leasing, income funds and so on.

Long term source of finance: Long term finance is primarily used by businesses that
require a substantial amount of finance that will be hard to repay. This can used to
supply start-up earnings to fund the company for its entire duration, funding the
capital asset with a long-term life, such as buildings, issuing expensive capital for
major projects, such as constructing a new plant or acquiring other enterprises.
This form of finance is beneficial for those which investment is made for a prolonged
period, usually over 5 years. It’s essential for corporate development,
industrialization, growth and advancement, as well as diversification.

1.2 Evaluate the costs and benefits of different sources of finance.

Of course, the latter sources of finance are not without their pros and cons, and
financial managers need to be decided accordingly when to use each sources of
finance.
Internal source of finance: Internal sources have no legal obligations, meaning they
don’t need to be paid to a second party, cases where debt providers are involved
interest need to be paid and not abiding by these laws can result in lawsuits. Hence,
internal funding is a safe option for many organisations. Internal sources also boost
the company’s credit rating and its value generated through these sources of
finance. Henceforth, improving the firm’s gearing ratio and aids in driving more
investors into their firm.
However, the downside to this type of funding is that it’s not appropriate for large
project investments, and if firms do use this form of funding in long term projects,
without close surveillance, the company may go bankrupt and end up shutting down.

External source of financing: Larger economies of sales, funding long term and other
investment projects and an opportunity to obtain several other financing solutions are
some of the advantages of using external sources of financing.
Evidently, interest rates are a financial burden for many companies who desperately
need money for projects. Securing the funding is painstaking to begin with, not every
fund you’re seeking are guaranteed to be in your hands.

Bank loan: Instead of waiting to reach your budget for expansion or other investment
plans, bank loans provide quick ways to attain extra finance. Cash flow injection
without ultimately losing any control of your company is another great advantage of
using bank loans, and many cost-effective options to choose from (more favourable
interest rates).
The downside however is banks strict lending criteria and may be wary when lending
to businesses. Surprisingly, banks don’t give the entire amount and it may also not
be befitting for ongoing expenses.

Bonds and debentures: Debentures can stimulate long term financing to aid in
business growth. They are inexpensive compared to other sources of lending,
secured investment, and during times of inflation they are beneficial.
However, they are limitations in borrowing capacities and the investors interest are
not refunded by the debtor.
Bonds are less risky and volatile and creates a leverage for managers but has high
interest rates and may provide risks.

Share issues: Issuing shares is an essential way of increasing cash in order to

finance expansion without levying far too much debt, repayment is also not required
when issuing shares.
Disadvantages include losing control, surrendering partial control of the company to
shareholders, asset disclosure, and getting the voting right is also another
challenging experience.
Leasing: Benefits of leasing is lower monthly payments compared to other sources,
lesser risk of obsolescence, flexible and easier ways of funding fixed assets and are
also highly profitable.
The drawbacks of leasing are that the consensus is backed up by the asset and
overpriced in the long term.

Retained earnings: This form of finance eliminates the expense of disbursing equity
and eradicates shortfalls. Say the company is dependent on retained profits, then
there will be no signs of management and authority subsiding.
Capital amassed through retained profits stimulates leadership to overspend. It is
only possible if there are huge amount of finance to begin with.

Trade credits: Trade credits boosts cash flow and fuels business growth, can focus
on areas like research and development, marketing and so on. However, extending it
can increase risks in getting into debt, and delayed repayments may obtain poor
credit history.

1.3 Compare and contrast sources of finance for a specific project

Tesco’s main products are household goods, grocery items, financial services and
telecoms. In 2010, the overall value of Tesco was nearly 57 billion pounds and a net
revenue of 3.457 billion pounds. Why is assessing the current financial stance of
Tesco important when opting for an appropriate source of finance for investment
projects? Capital gearing of a company can prove many indications of a firm’s
financial health. For instance, Tesco is a highly geared firm with a 73.08% gross
gearing percentage. With a higher leverage, Tesco is more susceptible to downfalls
in the economy with high gearing ratio. It is commonly used to gauge a company’s
borrowings, and firms should verify that it will not exceed the usual limit by becoming
too excessive.

Tesco’s objective in expanding in Asia requires nearly 3 billion pounds.

Tesco’s technological prowess stock management and checkout framework
prompted to the organization’s growth and augmentation over competing companies.
So, on deciding a means of finance, managers should come to a rational conclusion.
The judgement to use some assets should be made with three main components in
mind: cost efficiency, fewer constraints and less challenging. After assembling all the
sources and their essential aspects, it is evident that the fund yielded by investors in
the form of equity, which is more appropriate for large firms like Tesco.

Acknowledging a loan from commercial banks will be beneficial to, since its less
costly form if financing where interest rates can be nontaxable. However, credit risks
hold Tesco back from taking such a risky financial decision. Not meeting the legal
obligations can lead to a downfall, including foreign exchange risks ‘loans to non-UK
subsidiaries in currencies other than in the Group’s functional currency’
(https://www.tescoplc.com/investors/debt-investors/financial-risks/)

Tesco is a public limited company, so this indicates that it can sell common or
favoured equity to entities, it can also elevate funds to finance working and
development capital requirements by raising capital through the use of stock
disbursement. It is less risky and cost effective providing numerous advantageous
benefits and helps dodges many consequences for the future of the business.

Tesco also utilises retained profits too, where they pay dividends to shareholders
later, and according to their latest disclosure, Tesco has 75 million retained in their
account. This can be beneficial when expanding overseas, and exploiting it for
research and development, inventory management systems and so on.

LO2 Be able to assess an organisation’s financial performance

2.1 Compare and contrast the financial statements of different types of
organisations.

Sole proprietorship: The balance sheet, also known as the financial statement,
indicates a company’s financial position at a particular time, including a sole trader.
The value of the assets held, debts, and the quantity of the company’s equity show a
sole trader fiscal circumstance. Abiding by the GAAP laws:
When there is an omission of the idea of a corporate entity, whilst also keeping
financial records, the role of corporate entity is abided, which makes the managers
equity a liability for the company. On the other hand, as long as the owner is alive,
the ownership belongs to him, hence no transfer in ownership. Cash flow statement
aren’t mandatory for sole proprietorships.

Partnership: Partnership financial statement are produced the same way as limited
liability company financial statements. These statements are typically arranged with
cash equivalents. (accompanied with liabilities, current and fixed assets and so on)
Evidently, 2 or more individuals make up a partnership where everyone shares the
profit. Business entity concepts is adhered by a company, where the manager’s
equity is appeared on the liability section on balance sheet. Partnerships don’t need
cash flow statements either, just like sole traders and other small businesses.

Public limited company: Cash flow statement must be produced by this type of an
organisation, as well as the statement of changes in equity, profit and loss
statement, cash flow statement, balance sheets and notes to account.

Private limited company: This type of company must disclose statement of financial
position, cash flow, income statement and statement of changes in equity.
However, as per laws, private limited companies aren’t mandated to publicly disclose
these financial statements, hence they don’t need to appeal to their shareholders or
need the incentive to issue these statements.

2.2 Interpret financial statements for a specific organisation.

The finance statement of Tesco will be elucidated below:

Tesco’s share price is £224.20, while its rivals Morrison’s has a share price of £184.5
and Sainsbury’s has a share price of £196.7.
The net impairment reversal of non-current assets consists of a net reversal of £185
(in millions) in estate, property and machinery, and investment portfolio, a gross
charge of £24 in goodwill, operating systems, and other intangibles and a net charge
of a £180 in arduous lease clause.
The gross charge of £24 (m) includes a £34 (m) payment for an upgrade to the IPP
(payment protection insurance) stipulation governing per year, that contributed in the
integration of products that were initially out of bounds for recourse. This has been
partly mitigated by the withdrawal of a £1 (m) CCA (Consumer Credit Act) provision
and a £10 (m) credit earned following completion of bargaining with a third person
regarding preexisting client recompense.
Tesco sold its residual 8.8 percent investor stake in Lazada Group S.A. for a net
cash account of £196 (m), deriving in earnings of £124 (m). The tax cost of £25 (m)
is the result of a capital appreciation on disposable.
Some assets include equipment worth £1752 (m, office equipment worth £316 (m).
£2 (m) in interest capitalised, primarily on land building assets. The capitalisation
percentage of 4.5% has been used to decide the quantity of borrowing costs
capitalised during the fiscal year. Capitalised interest is debited when evaluating
taxable income in the fiscal year where it is imposed A net payment of £189 million
was made in relation to the to the purchase of 7 stores from a joint venture with
British Land, which was a related party contract.

LO3 Be able to use costing methods to make informed organisational

decisions.
3.1 Analyse organisational costs and the impact that they have on
organisational decisions.

Organisational costs can have a direct influence in decision making and how a plan
must be executed in accordance to the monetary data. We will dive deeper into the
various organisational costs firms utilise; fixed, direct and indirect costs, variable and
semi-variable costs, total and unit costs, marginal costs, opportunity costs and
overhead costs.

Fixed costs: Increased production and stock amassing, the accessibility of fixed cost
data regularly encourages strategic decisions that minimize operating leverage. Most
successful companies perform on known fixed costs while also adhering to the
highest turnover of products with minimal amount of overall collected inventory and
the least unit price.

Semi variable and variable costs: Variable costs are those that are directly
proportional to the quantity produced. Semi variable costs that act like fixed costs
until a certain production limit is reached and then become dynamic.
It aides managers to evaluate which goods to provides and which to halt, this costing
systems make estimating product and profitability easier. Instead of data analysis
that is shrouded by expenses that exist whether or not a component is generated,
variables costing enables managers to analyse inspect information depending on the
real cost of manufacture.

Direct and indirect costs: Direct costs assist you in marginal critical product pricing.
By establishing the direct costs of a product, you can specify the required price at
which the product should be sold could also alert you when your prices are going up
despite no changes in your good or services.
Indirect costs are those incurred during the manufacturing process that are not
specifically linked to the goods or service. Acknowledging direct and indirect costs is
necessary to guarantee that expenses are effectively recorded.

Total and unit cost: Total unit costs can also assist a firm in determining its break
even point. Unit cost assists us in making the choices required at every facility to
achieve that our resources are utilized proficiently. For correlating contrasting
activities, unit cost guarantees a standardized principle that apply.

Marginal cost: This cost is an immensely beneficial decision-making tool. It assists

management in setting prices, comparing substitute manufacturing methods,
determining production levels of activity, closing manufacturing lines, and deciding
which range of alternative products to produce.

Opportunity costs: The significance or gain of an alternative in relation to the value of

what is chosen is referred to as opportunity cost. The principle of opportunity cost
has been wielded in decision-making to assist organisations in making better
choices, predominantly by considering the substitutes.

Overhead costs: Overhead costs are assigned to goods in order to gather

information for internal decision making and to enhance operational efficiencies.
Budgetary control, but also determining how a business must cover the expenses or
service in order to maximise profits.

3.2 Apply break-even calculations to specific organisational data.

The break-even is the position at which the income and expenditure are equivalent,
resulting in no gain and losses. The fixed overhead costs are divided by the
contribution for every unit to determine the break-even point. The contribution is the
difference between total sales and variable costs.
In this case we’ll discuss the break-even of Dyson and their vacuum cleaners.

Units sold 200,00

Price/unit $400.00
Variable cost $125.00
Fixed costs $4,000,000.00
Profit BE in units 14500

Dyson’s break-even is at 14500 units, it is at its break-even point. The break-even

analysis demonstrates how income increases as an activity of purchases. The break-
even point is located at which the total sales equals the total costs. This evaluation is
critical for developing the liquidity scheme. If the firm has not attained this point of
intersection, it will lose leverage and may become illiquid in the long term. This
necessitates the generation of crucial income.
In general, whenever an organisation intends contributing costs, it should conduct a
break-even assessment. These extra costs might result from opening a company,
eliminating unnecessary goods from the product mix, acquiring another company,
merging, introducing staff and venues.
The break-even analysis relies on economic forecasts and has some constraints to
consider. This is not always capable of predicting what might occur on the industry.
Many businesses offer more than one service/ product, which can have an effect on
the allocation of fixed costs, that may become subjective.
The break-even analysis is internal, and it does not contemplate competitive
pressure or market demand, implying that the company should conduct additional
research to monitor what is occurring in the industry and what technique rivals are
employing.

3.3 Use break-even charts to present decision-making information.

The diagram above provides a visual representation of how break-even analysis

demonstrates key indications in decision making.
Price changes are the responsibility of marketing. Any price increases whether
positive or negative, will have a significant effect on the break-even number. We will
presume that despite price changes, the volume sold will be produced. As a result,
greater prices will rise revenue, requiring fewer products to reach that point of break-
even.
Effective and coherent machinery can substitute staff members and significantly
reduce production variable costs.
Establishing a break-even analysis would be important for constructing a new plant
or shifting into a new headquarters due to commercial growth or rationalization.
Before releasing a new product, a break-even analysis can assist in determining the
anticipated break-even quantity if managers discover that the predicted sales of a
product are less than the break-even point and have a negative margin of safety,
they will most likely revoke the launch. Conversely, if business managers know that
projected revenue from the new product are greater than the break-even point and
have a favourable margin of safety, they will more likely proceed with the product’s
release. As a result, break-even evaluation assists businesses in managing their
products portfolios.