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Financial Accounting

Scenario 1

Sources of Finance

There are a number of equity sources of finance. They include help from family and

friends, public stock sale, venture capital, and funds from angel investors. A businessperson can

get money from family to start up a business. The advantage with obtaining funds from family

and friends is that they may be lenient with repayment terms (Leach and Ronald 34). They might

also offer low interest rates and longer repayment duration. The problem is friends and family

members might not have the amount of money one needs. This can make it hard for one to raise

the needed capital. A businessperson can raise money from public stock offerings which involves

selling shares of the stock of the business. This means that one has to register the business as a

public company. Selling of equity shares is a good way of raising capital because it does not

require the business to repay the money to the public investors. The disadvantage, however, is

that this process requires disclosure of some information that might be helpful to competitors.

The owner also losses control of the business, the privacy of the business, and will also be under

pressure to perform.

Venture capital is capital raised from venture companies. Venture capital companies

invest money into businesses for profit. These companies normally put money into businesses

that have a high growth potential. Because of the risk involved, venture companies normally look
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for competent management, a growing industry, and a competitive edge of a company. Venture

companies also do not retain their ownership in a company for long (Stickney 21). After

sometime, they look for an exit strategy to let the business to run on its own. The disadvantage

with venture capital is that the owner loses control of the business because of the involvement of

the company in running the business. The requirements needed to be fulfilled before one is

offered the capital are many and many businesspeople might not be able to meet them.

Venture capital companies also normally invest in industries they have good knowledge

about. This makes it hard for businesspeople who are venturing in new industries unknown to

these companies to get money from them. Just like venture capital companies, angel investors are

private investors who invest their money into starting businesses (Charles 35). Apart from

investing money into the business, they also offer their expertise on how to run the business. In

return for investing into a business, angel investors take ownership of part of the business. The

disadvantage with angel investors is that they do not make huge investments and can therefore

not help a business that requires huge capital. The most secure source of debt financing is funds

from family and friends. This is because family and friends are lenient and are subject to

adjustment of the terms of the agreement depending on the circumstances.

Evaluation of Sources of Finance

Renting out the mansion will enable Lisa to raise part of the capital as well as retain her

mansion. This will enable her to avoid losing her property in case the business fails. However,

renting out the mansion will not raise enough capital to start the business. This is because renting

the mansion for five years will raise 300,000 pounds only. Selling the mansion for 15 million

pounds will provide Lisa with a substantial amount of cash that will help her start the business

(Stickney 51). However, she risks losing everything should the business fail.
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Bringing a partner on board will allow Lisa to raise the needed capital as well as retain

her mansion. Apart from bringing funds to the business, the partner would also be involved in the

management of the business and offer valuable advice that can help in the growth of the

business. However, she will be forced to lose control of the business because decision-making

will also involve the partner. She will also have to share the profit with the partners. However,

bringing a partner on board is the most appropriate source of capital because it will offer security

(Rajasekaran and Lalitha 61). This is because if the business fails, she will not have to pay the

money invested into the business by the partner. In addition, she can gain independence by

dissolving the partnership. Conversely, she can enter into a short-term partnership to help her

stabilize the business. After the end of the term, Lisa can gain full ownership of the business.

This will help her retain her mansion as well as gain enough capital to start the business.

Cost of the Sources of Finance

Renting the mansion for 5000 pounds a month for 5 years will total to 5×12×5000

=300,000 pounds

Bringing a partner on board will bring 30% of capital. This will be equivalent to 30% of 50

million pounds

=15 million pounds. Bringing a partner to the business will therefore bring more value to the

business in terms of cash than renting out the mansion. However, the partner will also have a

share of the profit. A 30% share of profit will be 30/100×120,000

=36,000 pounds

This means that Lisa will get a profit of 120,000-36,000

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=84,000 pounds per month

This will make her lose a portion of the profits made by the business,

Importance of Financial Planning

Financial planning has many benefits to a business. One of them is that financial planning

leads to effective management of income. It helps one to understand how much needs to be spent

on tax payments, savings, and other expenditures (Beyer 47). Financial planning also helps one

to increase their cash flows because it allows for the careful monitoring of spending patterns and

expenses. It helps one to carry out prudent spending, tax planning, and careful budgeting. This

enables one to retain a bigger portion of the earned income. Increased cash flows also lead to

increased capital for added investment.

Financial planning also makes one to make high profits in business. Careful expenditure

helps one to avoid unnecessary spending. This reduces the cost of production which increases the

amount of profit from sales. Financial planning also helps in investment. Financial planning acts

as a guide that helps one to choose the right investments which are in line with one’s goals and

needs.

Another benefit of financial planning is increased savings. Financial planning helps one

to increase savings by engaging in investments that have a high liquidity level. This can guard

one against emergencies. Financial planning also helps one to know the real value of their assets.

In business, many assets normally come with liabilities (Beyer 37). Financial planning therefore

enables one to calculate the amount of liabilities and assets in the business. This helps one to

determine the net amount of assets in the business. In this regard, one is able to determine the

level of security in the business.

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Information Needs

Different stakeholders need different information in the Lisa scenario. For shareholders,

the information needed is the viability and profitability of the business. Shareholders need to

know whether the business will survive in the industry and whether it is profitable. This is to

ensure that they can gain dividends from their investments. Banks need a certain level of security

on their loan (Rajasekaran and Lalitha 21). They normally need the loaned to have enough

security to ensure that if they default on their loans, the loan can be recovered from the sale of

the property of the loaned. They also need information on the ability of the business to pay the

interest on the loan taken. The business partners need to know all the information about the

operations of the business. This includes the stock value, information about suppliers, and

information about employees in the business. This is because business partners are part of the

business and need to know everything the business.

Impact of Finance on Financial Statements

Financial activities have different effects on financial statements. For instance, bank

borrowing increases the asset cash as well as the liability of the bank loan on the balance sheet. It

also increases the total on the balance sheet (Beyer 67). Paying dividends reduces the net cash on

the cash flow statement. It also affects the amount of retained earnings on the statement of

changes in equity. Paying interest affects cash flow statement and statement of retained earnings.

Paying interest reduces retained earnings and the net cash on the statements.

Scenario 2

Variance in the budget

Variance in the turnover in unit

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Actual –budgeted

=2000-3000

=-1000 units

The turnover in unit was 1000 units less than the budgeted amount. This is an adverse

variance because the targeted turnover was 3000 while the achieved turnover was 2000.

However, this can be attributed to the price (Finkler and Mary 25). The actual price was 12 per

unit while the budgeted price was 9 per unit. The increased price could have led to reduced

demand for the product leading to reduced sales. This means that for the targeted turnover to be

achieved, there is need to reduce the price for each unit.

Variance in revenue from sales

Actual-budgeted

24,000-27,000

=-3000

The revenue from sales was 3000 pounds less than the targeted amount. This is an

adverse variance. The adverse variance could have occurred due to the fewer number of units

sold. Therefore, there is need for the company to come up with strategies to increase the turnover

in unit to achieve the desired revenue (Carey, Mary, Cathy and Jane 39). This can be through

price reduction, increased marketing, and increasing the awareness about the product among

customers through advertisement.

Variance on cost of direct materials

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Actual-budgeted

=8000-8800

=-800

The actual cost of direct materials was 800 pounds less than the budgeted cost. This is a

favorable variance because it means that the actual cost of production was less than the budgeted

cost of production. This means that the business needs to reduce the amount set aside for

production.

Variance on direct labor

Actual-budgeted

7000-6550

=450

The actual cost of direct labor was 450 pounds more than the budgeted cost. This is an

adverse variance because increased cost of direct labor increases the cost of production. This

means that the company needs to look for ways to reduce the cost of direct labor (Finkler and

Mary 45). This can be through reduction of wages payable to workers or reducing the number of

workers.

Variance in overhead cost

Actual-budgeted

9600-9400
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=200

The actual overhead cost was 200 pounds more than the budgeted overhead cost. This is

an adverse variance because increased actual overhead cost increases the overall cost of

production. Therefore, the company needs to look for ways in which it can reduce the overhead

cost (Fridson and Fernando 38). This can be done through reducing some miscellaneous

expenditure such as the amount of office stationery. Conversely, the company can increase the

price of its products to cover for the increased overhead cost.

Variance in total cost

Actual-budgeted

24,600-24,750

=-150

The actual total cost was 150 pounds less than the budgeted total cost. This is a favorable

variance because the actual cost of production is less than the budgeted cost of production.

Variance in profit

600-2250

-1650

The actual profit was 1650 pounds less than the budgeted profits. This means that the

company made less profit than the projected level. This could have been due to reduced amount

of units sold, increased cost of production, or increased overhead costs. To increase profits, the
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company needs to come up with ways to reduce the overall cost of production and overhead

costs. The company also needs to look for ways to increase its sales in order to increase its

profits.

Scenario 3

The cost per unit is normally calculated by adding the fixed cost and the variable cost and

dividing the total by the number of units produced. That is, fixed cost+ variable cost/number of

units. The cost of production determines how much a product will be sold. This is because the

selling price has to cover the production cost and the targeted profit. The error Lisa has made in

calculating her cost of production per unit is that she has not included the transport cost

(Rajasekaran and Lalitha 71). Transport cost should be included in the cost of production to

enable proper calculation of cost per unit. For instance, if the transport cost was 0.1 pounds per

unit, then the cost of production would have been 1.2+0.1. This would have made the production

cost per unit to be 1.3 pounds. The pricing strategy used by Lisa was the use of different price

levels in different markets. This could have been motivated by the level of demand and

purchasing power of people in these markets. This ensured that she makes maximum sales in

each market.

Scenario 4

Project 1

For five years, the income will be 500,000×5

=2.5 million pounds

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Total at the end of five years will be 22+2.5

=24.5 million pounds

Project 2

0.9×5

=4.5 million pounds

=22×80/100

17.6 million pounds

Total

=17.6+4.5

=22.1 million pounds

Capital cost is 10/100×22

=2.2 million pounds

22.1-2.2

=19.9 million pounds

From the two projects, the first project is viable. This is because after five years, the total

amount Lisa will have accrued will be 24.5 million pounds while in the second project; the total

amount accrued will be 19.9 million pounds. This means that for the second project Lisa would

have made fewer returns than she would have made in the first project.
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Financial Statements

There are four types of financial statements. They include the balance sheet, also known as

statement of financial position, income statement or the profit and loss statement, cash flow

statement, and statement of retained earnings or statement of changes in equity. The balance

sheet shows the financial position of an organization. It comprises of three elements including

the assets, liabilities, and equity. Assets are things owned by a business. They include cash,

machinery, and inventory (Carey, Mary, Cathy and Jane 67). Liabilities are things a business

owes to other people or organizations. They include bank loans and goods taken on credit.

Equity is what the business owes the owner. The balance sheet has two sides, the debit and the

credit side. The liabilities and capital are normally on the credit side while assets and equity are

on the debit side.

The profit and loss statement shows the financial performance of a company over a

specified period of time. It shows the net profit or loss made by a business. The profit and loss

statement comprises of two elements. They are income and expenses. The net profit or loss is

arrived at by subtracting expenses from income.

The cash flow statement shows the movement of bank and cash balances over a specified

period of time. The cash flows in a cash flow statement are categorized into the following

sections: operating activities, investing activities, and financing activities. Operating activities

represent the cash flows derived from primary activities (Fridson and Fernando 78). Investing

activities are cash flows from the sale and purchase of assets which are not inventory. Statement

of retained earnings shows the movement of owners’ equity in a specified period of time. It

comprises of the following components: net profit or loss, share capital repaid or issued during

the period, dividend payments, and gains or losses in equity.

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Formats of Financial Statements

Different businesses have different formats of financial statements. For instance, the

format of financial statements for a sole trader is different from the format of financial

statements of a limited company. The financial statements of a sole trader are simple while those

of a limited company are complex. For example, the income statement of a sole trader has the

single step format while that of a limited company has the multistep format.

Interpretation of Accounting Ratios

Accounting ratios determine the financial performance and position of a business. A net

profit margin of 0.19% for AVIVA Insurance means that the company made a net profit of

0.19% on its sales. This is the profit made after deduction of all expenses. A net profit margin of

0.19% shows that the company is not very profitable. A gross profit margin of 4.18% means that

the company made a gross profit of 4.18% on its sales (Charles 56). That means that on every

dollar of sales the company made, it made a gross profit of 0.0418 of a dollar. A current ratio of

2.69 means that for every one dollar of current liabilities, there are 2.69 dollars of current assets

that can be used to repay them. This shows that the company is in a position to settle all its

current liabilities without having to sell any of its long-term assets.

A quick ratio of 0.9 means that the company has 0.9 of a dollar in cash for every one

dollar of current liabilities. This means that the company has enough cash to settle its urgent

obligations. This also reflects the financial security in the company. The company has a good

financial base that can cushion it from any financial obligation. Return on capital employed of

20% shows that the company made a profit of 20 percent on its capital. This shows that the

company is efficient in the use of its assets.

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A net profit margin of 2.64% for the Admiral Insurance shows that the company made a

profit of 2.64% after all the expenses had been deducted from the gross profit. A net profit of

2.64 shows that for every dollar of sales made by the company, 0.0264 of a dollar was made in

profit. A gross profit margin of 3.79% means that company made a gross profit of 3.79% on its

sales. A current ratio of 1.96 indicates that the company has enough current assets to pay off its

current liabilities (Bull 154). This also reflects the financial position of the company. The

company has high liquidity. A quick ratio of 1.2 indicates that the company has enough assets in

form of cash to settle its current liabilities. However, this could also indicate the inefficiency in

the company in terms of investment. The company is keeping too much assets in terms of cash.

A return on capital employed of 32% shows that the company made a profit of 32% in the use of

its assets. This indicates a high efficiency in the company.

A net profit of 2.2% for Industry Standard indicates that after settling all its expenses, the

company managed to make a profit of 2.2%. A gross profit margin of 4% indicates that the

company made a profit of 4% on its sales before subtracting the expenses. A current ratio of 3

shows that the company has three times current assets as compared to current liabilities

(Bhattacharyya 126). This shows a strong financial position of the company. A quick ratio of 1.5

indicates that the company has enough cash to pay off its short-term liabilities. A return on

capital employed of 25% indicates that the company made a profit of 25% in the use of its assets.

This shows that the company is very efficient in the use of its assets.
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Works Cited

Bull, Richard. Financial Ratios: How to Use Financial Ratios to Maximise Value and Success

for Your Business. Amsterdam: Elsevier/CIMA Pub, 2008. Print

Leach, J C, and Ronald W. Melicher. Entrepreneurial Finance. Mason: South-Western

Cengage Learning, 2009. Print.

Charles, Gibson. Financial Reporting and Analysis + Thomsonone Printed Access Card.

Nashville: South-Western Pub, 2012. Print.

Beyer, Swen. International Corporate Finance - Impact of Financial Ratios on Long Term

Credit Ratings: Using the Automotive Examples of Bmw Group, Daimler Group and

Ford Motor Company. München: GRIN Verlag GmbH, 2010. Print

Finkler, Steven A, and Mary L. McHugh. Budgeting Concepts for Nurse Managers. St. Louis:

Saunders/Elsevier, 2008. Print.

Fridson, Martin S, and Fernando Alvarez. Financial Statement Analysis: A Practitioner's Guide,

Fourth Edition. Hoboken: John Wiley & Sons, 2011. Print

Bhattacharyya, Debarshi. Management Accounting. Delhi: Pearson, 2011. Print.

Carey, Mary, Cathy Knowles, and Jane Towers-Clark. Accounting: A Smart Approach. Oxford:

Oxford University Press, 2011. Print.

Stickney, Clyde P. Financial Accounting: An Introduction to Concepts, Methods, and Uses.

Mason: South-Western/Cengage Learning, 2010. Print.

Rajasekaran, V, and R Lalitha. Financial Accounting. New Delhi: Dorling Kindersley, 2011.

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