Leeds Professional College

Pgd In Strategic Business Management And Leadership

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TITLE OF DEGREE: Pgd In Strategic Business Management And Leadership

MODULE TITLE: Financial Management

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ContentsIntroduction.................................................................................................................................2

Question1.....................................................................................................................................2

Task 1........................................................................................................................................2

1.1.1 Different Sources of Financing.........................................................................2

1.1.2 Internal and external financing:......................................................................................4

Task2..........................................................................................................................................5

1.2 Factors in choosing between long-term loan and ordinary share capital as appropriate source of finance......................................................................................................................5

Task 3........................................................................................................................................6

1.3 Major factors which a lender should take into account when deciding whether to grant a long-term loan to the company....................................................................................................6

Question 2........................................................................................................................................7

Task 1...........................................................................................................................................7

2.1 Discuss with your finance director (or the equivalent) how and when finance fits into your strategic planning process. Summarise your discussion and make some recommendations in the future. Summarise your discussion with recommendations for improvements..........................................................................................................................7

Task 2........................................................................................................................................8

2.2 Grants and funding are seen as ways of mitigating risk or overcoming lack of funding in risk ventures. What impact would grant or government protected funding have on your business and would this change given economic growth or recession?......................................8

Task 3........................................................................................................................................8

2.3 How do interest rates and exchange rate fluctuations impact on any aspects of shareholder wealth in your organisation................................................8

Question 3....................................................................................................................................9

3.1 Analysis of financial statement of two companies from FTSE250 Index............................9

3.1.1 Thomas Cook Group plc.................................................................................................9

3.1.2 Highlights.......................................................................................................................9

Gearing ratios:..................................................................................................................10

3.2.1 AVEVA Group plc.......................................................................................................10

3.2.2 Highlights.....................................................................................................................10

Question 4..................................................................................................................................11

Financial performance of your business would respond to a recession.....................................11

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Question 5..................................................................................................................................12

(a) Calculate the net present value - for each of the projects, and comment briefly on the factors that should be considered, if the company will only have sufficient funds to undertake one of the proposed projects only. Assume a cost of capital of 10%........................................................................12

(b) In addition to figures worked out by the accountant, there are also non-financial factors that may need to be considered before a final decision to go ahead is taken. Identify and discuss these non-financial factors.....................................................................................................................................12

(c) Explain the action which could be taken if the limiting factor for a project is the availability of skilled or un-skilled labour.....................................13

Conclusion..................................................................................................................................14

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Introduction

This report discusses with the sources of financing, their long term and short term effects on the organizations and financial analysis. Traditionally, investors need money for capital asset acquirement - new machinery or the construction of a new building or depot. Also, its costly to develop new products and here again capital may be required. Normally, such developments are financed internally, whereas capital for the acquisition of machinery may come from external sources. But many organizations have to look for short term capital in the way of overdraft or loans in order to provide a cash flow cushion as the availability of the total liquidity is tight. Interest rates can vary from organization to organization and also according to purpose

Question1

Task 1

1.1.1 Different Sources of Financing A company might raise new funds from the following sources:

The capital markets:i) By issuing share, for example, by companies acquiring a stock

market listing for the first timeii) rights issues Loan stock Retained earnings Bank borrowing Government sources Business expansion scheme funds Venture capital Franchising.

The brief description of each category is given belowThe capital MarketOrdinary shares are issued to the owners of a company. They have a nominal or 'face' value. The market value of a quoted company's shares bears no relationship to their nominal value, except that when ordinary shares are issued for cash, the issue price must be equal to or be more than the nominal value of the shares.

Loan stock

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Loan stock is long-term debt capital raised by a company for which interest is paid, usually half yearly and at a fixed rate. Holders of loan stock are therefore long-term creditors of the company.

Loan stock has a nominal value, which is the debt owed by the company, and interest is paid at a stated "coupon yield" on this amount. For example, if a company issues 10% loan stocky the coupon yield will be 10% of the nominal value of the stock, so that ₤100 of stock will receive ₤10 interest each year. The rate quoted is the gross rate, before tax.

Retained earningsThe amount of earnings retained within the business has a direct impact on the amount of dividends for any company. Retained earnings are profit that is reinvested, which could have been paid as a dividend. The major reasons for using retained earnings to finance new investments are as follows:a) Although, this is not true, the management of many companies considers that retained earnings are funds which do not cost anything,. However, it is true that the use of retained earnings as a source of funds does not lead to a payment of cash.

b) The dividend policy of the company is in practice determined by the directors. From their standpoint, retained earnings are an attractive source of finance because investment projects can be undertaken without involving either the shareholders or any outsiders.

c) The use of retained earnings as opposed to new shares or debentures avoids issue costs.

d) The use of retained earnings avoids the possibility of a change in control resulting from an issue of new shares.

Bank lending Borrowings from banks are an important source of finance to companies. It is still mainly short term, although medium-term lending is quite common these days.

A short-term loan is given for three/five years. Medium-term loans are loans for a period of from five to ten years. A loan may have a fixed rate of interest or a variable interest rate, so that the rate of interest charged will be adjusted every three, six, nine or twelve months in line with recent movements in the Base Lending Rate.

LeasingA lease is an agreement between two parties, the "lessor" and the "lessee". The lessor owns a capital asset, but allows the lessee to use it. Leasing is, however, a form of rental. Leased assets have usually been plant and

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machinery, cars and commercial vehicles, but might also be computers and office equipment. There are two basic forms of lease: "operating leases" and "finance leases".

Hire purchaseHire purchase is a form of installment credit. Hire purchase is similar to leasing, with the exception that ownership of the goods passes to the hire purchase customer on payment of the final credit installment, whereas a lessee never becomes the owner of the goods.

Hire purchase agreements usually involve a finance house.

Government assistanceAs part of its policy of helping to develop the national economy, the government provides finance to companies in cash grants and other forms of direct assistance. It happens especially in high technology industries and in areas of high unemployment.

Venture capitalVenture capital is money put into an enterprise which may all be lost if the enterprise fails. A businessman starting up a new business will invest venture capital of his own, but he will probably need extra funding from a source other than his own pocket. However, the term 'venture capital' is more specifically associated with putting money, usually in return for an equity stake, into a new business, a management buy-out or a major expansion scheme.Franchising

Franchising is a method of expanding business on less capital than would otherwise be needed. For suitable businesses, it is an alternative to raising extra capital for growth. Franchisors include Budget Rent-a-Car, Wimpy, Nando's Chicken and Chicken Inn.

Under a franchising arrangement, a franchisee pays a franchisor for the right to operate a local business, under the franchisor's trade name. The franchisor must bear certain costs (possibly for architect's work, establishment costs, legal costs, marketing costs and the cost of other support services) and will charge the franchisee an initial franchise fee to cover set-up costs, relying on the subsequent regular payments by the franchisee for an operating profit. These regular payments will usually be a percentage of the franchisee's turnover

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1.1.2 Internal and external financing:

We call it internal financing when a firm uses its profits as a source of capital for new investment, rather than distributing them to firm's owners or other investors and obtaining capital elsewhere.

External financing is the term used to describe funds that firms obtain from outside of the firm. There are many kinds of external financing. The two main ones are equity issues, (IPOs or SEOs), but trade credit is also considered external financing as are accounts payable, and taxes owed to the government.

Task2

1.2 Factors in choosing between long-term loan and ordinary share capital as appropriate source of finance.

1.2.1 Factors for choosing long term loans

Repayment TermsOne has to consider how long the financing arrangement is structured to last. Longer loans can build up a significant amount of interest over time, but loans with shorter terms can require larger periodic payments. A business, must consider the amount of the periodic payment and how often it is required to pay.

Interest and Fee StructuresA borrower should add up all of the costs associated with each financing method before making a decision. Common costs for loans include interest rates, origination fees and brokers' fees. Financing through investment can carry much different costs. Money from venture capitalists, for example, may not require repayment for years, at which time the investor may expect to be repaid at a steep premium all at once. Financing through stock offerings can lead to a change in management and a shifting in strategic focus.

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Financing RequirementsBorrower must consider the personal requirements each lender and investor places on applicants. Pursue financing from sources whose requirements the company meet in full. Common financing requirements include credit score requirements and specific financial ratio tests, such as the debt-to-equity or interest coverage ratios.

Additional RequirementsVenture capitalists often require an ownership stake in the company, which they expect someone to buy back at a premium after a period of rapid growth. Before a company buy the ownership stake back, however, the investor may assert a great deal of influence on managerial and strategic decisions. Selling shares of stock to finance a business has its own set of vital considerations, including the possibility of losing managerial control in the future and falling victim to a takeover from a larger company.

1.2.2 Factors for choosing ordinary share capital

The current capital gearing of the business: Although debt is attractive to the borrowers but eventually its interest has to be paid, sometimes it is referred as bankruptcy business model.

Business risk: The risk that a company will not have adequate cash flow to meet its operating expenses is called business risk. Companies that have highly volatile operating profit tend to neglect debt financing as they may find themselves in a position where operating profit falls and they default the interest payment. So, they show inclination to equity financing.

State of equity markets:In a situation when the share prices are declining, many companies will not be interested to sell new shares. They feel the price received will be too low. This will lower the wealth of the existing owners.

Task 3

1.3 Major factors which a lender should take into account when deciding whether to grant a long-term loan to the company.

Longer-term bank loans are available, usually for the purchase of property, where the loan takes the form of a mortgage. When a banker is asked by a

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business customer for a loan or overdraft facility, he will consider several factors, known commonly by the mnemonic PARTS.

- Purpose- Amount- Repayment- Term- Security

P The purpose of the loan. A loan request will be refused if the purpose of the loan is not acceptable to the bank.

A The amount of the loan. The customer must state exactly how much he wants to borrow. The banker must verify, as far as he is able to do so, that the amount required to make the proposed investment has been estimated correctly.

R How will the loan be repaid? Will the customer be able to obtain sufficient income to make the necessary repayments?

T What would be the duration of the loan? Traditionally, banks have offered short-term loans and overdrafts, although medium-term loans are now quite common.

S Does the loan require security? If so, is the proposed security adequate?

Question 2

Task 1

2.1 Discuss with your finance director (or the equivalent) how and when finance fits into your strategic planning process. Summarise your discussion and make some recommendations in the future. Summarise your discussion with recommendations for improvements.

Essentially, when we talk about "strategy", we take a longer term perspective - the big picture. This means making long-term decisions to achieve the longer-term goals. After making decisions on the longer-term goals, decision is taken on the various ways to achieve these goals. That could be described (in a way) as the tactics. Tactics are ways that you use to achieve the immediate and short-term goals.

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In other words, one may know where he/she wants to go financially to achieve financial independence, but probably just don't know exactly how or when to get there. That's where strategic financial planning can help.

Essentially, there are four key stages to to decide and when finance fits into your strategic planning process, all of which must be given equal importance in the planning process:

1. Review the past - Monitor recent trends in demand and expenditure. This is to get an idea of how i manage my expenses.

2. Forecast the future- I will make a forecast of what income and expense items will be like in the next 12 to 36 months, taking into consideration the items that are mentioned in step (1) above.

3. Set strategies and plans- then I will make a decision on what you like to achieve in both the short and long term goals.

4. Set annual budgets- nest step is to make the decision when to invest and make a budget and stick to it.

Finally about taking proper options, I will take into consideration risk tolerance, time horizon, tax considerations and account size. Then work out a custom portfolio solution, which may include individually purchased securities and/or mutual funds. Portfolios may be Balanced, fixed Income or equity oriented. Each portfolio presents different levels of risk, and it should be best to have one which is in line with my "risk appetite".

For future reference, Free Cash Flow is an important measure of the firm’s financial soundness. It represents the net cash available after deducting the investments and working capital increases from the firm’s operating cash flow. (Branch, 1981) It should be measured carefully to decide whether the company needs immediate financing

Task 2

2.2 Grants and funding are seen as ways of mitigating risk or overcoming lack of funding in risk ventures. What impact would grant or government protected funding have on your business and would this change given economic growth or recession?

Grant and government protected funds are always a way of mitigating risk and overcoming lacks of funding in risky ventures. In this business the effect of grant and government protected funds are also same. Grant will reduce interest expenses as generally funding from other sources charges more

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than the government grants. This will reduce the cost of production or services. Providing more to shareholders wealth. Government protected funds also provides additional security in case of default risk. (Myers, 1984)

Task 3

2.3 How do interest rates and exchange rate fluctuations impact on any aspects of shareholder wealth in your organisation

Interest rates fluctuations have considerable impact upon the aspects of shareholders wealth in organizations. Clearly, changes in the Govt. rate affect the behavior of consumers and business, but the stock market is also affected. One of the methods of valuing a company is to take the sum of all the expected future cash flows from that company discounted back to the present. To arrive at a stock's price, sum of the future discounted cash flow is taken and then divided by the number of shares available. This price fluctuates as a result of the different expectations that people have about the company at different times. Because of those differences, they are willing to buy or sell shares at different prices.

If a company is seen as cutting back on its growth spending or is making less profit - either through higher debt expenses or less revenue from consumers - then the estimated amount of future cash flows will drop. All else being equal, this will lower the price of the company's stock. If enough companies experience a decline in their stock prices, the whole market, or the indexes that many people equate with the market, will go down.Also, Fluctuations in exchange rate has an effect upon shareholders’ wealth in both ways. If the organization is export oriented then the increase in foreign exchange rate increases the shareholders’ wealth and for importers in has the opposite effect. (Besley, 2010)

Question 3

3.1 Analysis of financial statement of two companies from FTSE250 Index

3.1.1 Thomas Cook Group plc

Thomas Cook Group plc is a travel company created on June 19, 2007 by the merger of Thomas Cook AG and MyTravel Group plc. At flotation on the London Stock Exchange 52%

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of the shares in the new company were held by the German mail order and department store corporation Arcandor (former owners of Thomas Cook AG) and 48% owned by the shareholders of MyTravel. On June 9, 2009 Arcandor filed for bankruptcy. The merger, which was backed by 99.9% of shareholders, took place through the formation of 'NewCo' which effectively purchased MyTravel and Thomas Cook and was then listed on the London Stock Exchange under the name of Thomas Cook Group plc (LSE: TCG). (UK High Court

backs MyTravel, Thomas Cook merger., 2007) It is a constituent of the FTSE 250 Index.

3.1.2 Highlights

30/09/10 30/09/09Turnover

(£m)8890.1 9268.8

Pre-tax Profit (£m)

41.70 45.1

EPS (Norm Dil.) ( p)

16.21 25.93

Dividend (p) 7.00 10.25

NotesFigures from 2006 in accordance with IFRS. EUR to GBP, 2006: 1.49340, 2007:

1.43630, 2008: 1.2632; Change of year end from 31 October 2008 to 30 September 2008

Closing Share Price (p) 165.20Number of Shares in Issue (m) 858.29

Market Capitalisation (£m) 1417.90

Profitability ratios:

• Gross profit margin= 24.11%• Net profit margin= 2.78%• ROCE=6.2%• Asset turnover= 128.83%

Liquidity and working capital ratios:• Current ratio= 0.432• Quick ratio= 0.432• Inventory turnover=0.65• Receivables collection

period=21.53

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• Payables payment period=124.86

Gearing ratios:• Gearing ratio= 0.54• Interest cover=6.37

3.2.1 AVEVA Group plc

AVEVA Group plc(LSE: AVV) is a British Company, providing Engineering IT software and information management solutions for the Plant , Power and Marine industries. It is a

constituent of the FTSE 250 Index. 3.2.2 Highlights

Solid performance in challenging market conditionsfocusing on our core strengths of supplying world classsolutions and services to our customers in the Oil and Gas,Power and Marine markets

Revenue of £148.3 million (2009 – £164.0 million) Recurring revenue up 9% to £102.7 million (2009 – £94.2 million)

representing 69% (2009 – 57%) of total revenue Investment in Research and Development of £20.9 million

(2009 – £27.3 million) Restructuring programme complete at a cost of £1.9 million

and annualised savings of approximately £5.0 million per annum Adjusted profit before tax of £50.7 million

(2009 – £66.4 million)* Profit before tax of £49.6 million (2009 – £59.2 million) Adjusted basic earnings per share of 50.92 pence

(2009 – 69.99 pence)* Basic earnings per share of 49.36 pence (2009 – 62.27 pence) Final dividend increased to 13.9 pence (2009 – 6.5 pence)

resulting in total dividend of 16.9 pence for the year(2009 – 9.36 pence), an increase of 81%

Continued strong cash generation with net cash and depositsat the year end of £149.7 million (2009 – £126.2 million) (Investors Financial Results)

Profitability ratios:

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• Gross profit margin= 79.51%• Net profit margin= 22.5%• ROCE=8.4%• Asset turnover= 62.41%

Liquidity and working capital ratios:• Current ratio= 3.62• Quick ratio= 0.432• Inventory turnover=0.65• Receivables collection

period=60.19• Payables payment period=97.04

Gearing ratios:• Gearing ratio= 0.0789• Interest cover=3.07

 

Question 4

Financial performance of your business would respond to a recession.

Financial Impact of a recession

IncomeThe income of organization will be greatly affected by recession. Generally the income of the organization tends to decline during recession. The severity of it depends on the organization type. Direct costs

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It may be defined as cost that directly can be traced to producing goods and services. However, recession increases the direct cost of products or services.Indirect CostsIndirect costs are those are not directly accountable to the cost of products of services. During recession the indirect cost of production decreasesStockThe investors choose to sell their stocks as they need money, which in turn increases the supply of stocks. Later, transaction of stocks declines, as people are not buys new stocks. Hence, the prices decline gradually.DebtorsThe debtors may become unable to pay interest charges as the profit is minimal. In the worst scenario they may default to pay the principal.CreditorsWithout considerable profit, the lending ability of the lenders declines. They have to shrink their lending limit. In other words borrowers also not interested to borrow in recession period.Operating cash flowOrganizations spend less in the operating activities. As a result operating cash flow of the firm also declines. Capital investmentBanks and investors are not willing to provide lend in recession period. So, raising fund for capital investment becomes difficult. FundingSame things happen in funding condition during recession as happened in capital investment. (Neil Seitz, 2010)

Question 5MAEMM Estates plc is considering investing in a new project, and has identified two possible options, details of which are given below:

Care Home FlatsCash flow Cash flow

£000 £000

Initial outlay 720 650

Net cash flowYear 1 192 120Year 2 200 240

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Year 3 206 200Year 4 208 200Year 5 216 210

Required:

(a) Calculate the net present value - for each of the projects, and comment briefly on the factors that should be considered, if the company will only have sufficient funds to

undertake one of the proposed projects only. Assume a cost of capital of 10%.

NPV for Care home= 770.79- 720=50.79

NPV for Flats= 724. 69- 650=74.7

Management will take into consideration riskiness of the project. (Ross, 2009) Also the NPV of the flats is much higher than the NPV for care home. So, management should take project for flats.

(b) In addition to figures worked out by the accountant, there are also non-financial factors that may need to be considered before a final decision to go ahead is taken. Identify and discuss these non-financial factors.

There are several non financial factors affecting the final decision of selecting the project. Such as

Government rules and regulation is a great influence, since government has the authority of halting some types projects for the sake of the community or greater good.

Govt. may place strict rules and regulations or mandatory CSR activities that may increase the cost of the project and hence make the project non-profitable.

Environmental issue is also matter of great concern. People of the community and other activist group may protest the project if it is harmful to environment in general

Some projects may be profitable in the short run but actually harms the environment more in the long run.

(c) Explain the action which could be taken if the limiting factor for a project is the availability of skilled or un-skilled labor.

Skilled labor is deliberately needed for most of the organizations. Because they can increase the efficiency and decrease the operating cost of the project. Here in for this real estate company both skilled and unskilled

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workers may need, but the need of skilled labor is more important than unskilled labor. In such situations the management can take the following steps

Increase the project time length. So that small number of skilled labors will do the job.

Employ unskilled labors as a considerable proportion of the total labors. Unskilled labors will learn from the skilled labors.

If the project time boundary is short the company may consider bringing in some skilled labors from other places. Obviously then the company has to pay higher salary/compensation.

Conclusion

Though in this report we tried to discuss some methods, factors those are required for financing a project. We took two companies to analyze their financial data and make recommendations on that. Implications of financing upon the organization are also discussed in the report.

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Reference1. Besley, B. (2010). Essentials of Managerial Finance. 2. Branch, B. G. (1981). Cash Flow Analysis: More Important Than Ever. Harvard

Business Review .3. C Mayer, K. S. (2005). Sources of funds and investment activities of venture capital

funds: evidence from Germany, Israel, Japan and the United Kingdom. Journal of Corporate Finance .

4. Christofer D. lttner, D. F. (2003). Coming up short on nonfinancial performance measurement. Harvard Business Review .

5. McNamara, G. (1997). Decision making in an organizational setting: Cognitive and organizational influences on risk assessment in commercial lending. The Academy of Management Journal, .

6. Myers, S. (1984). Finance theory and financial strategy. 7. Neil Seitz, M. E. (2010). Capital budgeting and long term financing decisions. 8. Plc, B. A. (2011). Annual Report 2010. 9. Plc, T. C. (2011). Annual Report and Accounts 2010. 10. Porras, J. C. (1996). Building Your Company’s Vision. Harvard Business Review .11. Ross, W. (2009). Corporate Finance. 12. Van Horne, W. (2010). Fundamentals of financial Management. 13. AVEVA plz(2010). http://www.aveva.com/investors_financial_results.php, retrieved

April 25th

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