Finance for a Business Project Assignment
The discussion as provided below throws light upon the necessity and benefits provided by funding to an organization. The discussion also states about the cost of utilizing various sources of finance and at the same time it provides idea relating to the usefulness of the financial planning. The assignment also covers a discussion relating to budgeting, investment appraisal and ratio analysis.
Sources of fund are considered as the most important elements of an organization. Organizations need some sources from which the required amount of funds can be raised or generated in order to satisfy their financial needs. The sources of raising funds can be of these types:
The retained earnings are the funds which are retained back from the earned profits of the organization in order to meet the future financial needs. The organizations used to reserve a certain portion of profit without paying dividend to the stakeholders (Tarca, Morris and Moy, 2012).
This is a long term source of fund which are generated out of the owner’s wallet. The owner’s contribution is considered as the starting capital of a business organization. The owner of the organization invests fund from his personal savings in order to run the operational activities of the organization on a regular basis.
Sale of fixed assets:
The sale of fixed assets are the internal sources of raising funds where an organization used to sale its unused fixed assets. The sale of fixed assets are considered as favourable for the organization in terms of liquefying the fixed assets and at the same time the production process also gets hampered.
The bank loans are the external sources of raising optimum amount of funds which can be availed on a long term basis (Tarca, Morris and Moy, 2012). The bank provides loans for a particular time period according to the needs of the organizations with an agreement of paying it back with certain rate of interest.
This is a long term external sauce on which the organizations are allowed to draw lucrative amount of funds from the bank account without having the amount on account. Alike bank loans this source also involves repayment of the loan at a fixed rate of interest for a particular period of time.
Leasing is also considered as a source of raising fund for a particular time period especially on a short term basis. The organizations provide machineries and other tangible properties as rent to other concerns.
Trade credit also used by the organizations as the source of fund where the organization purchases goods or commodities without paying the amount immediately. The creditors allow a credit limit period within which the organization has to pay for the purchase. The credit limit period usually last for a time span of around 30 days.
Issue of shares:
One of the most reliable and stable source which can be used on a long term basis is the issuance of equity shares. The organizations issue equity shares in the market and the potential shareholders are invited to invest funds and in turn the shareholders enjoy the rights of ownership over the business.
The implications of the source of finance over the organization are as follows:
Retained earnings: this source does not includes the repayment of principal amount as it has been retained back from the earned profits of the organizations. The organizations might face retention which may occur due to the decreasing share value but any risk of insolvency or dilution of control is not involved (Haas and Haas, n.d.). The cost of this source is considered to be the same as cost of equity.
Alike retained earnings, this source does not deals with any repayment options as the investment is done out of the personal savings of the owner. This source involves a chance of insolvency if majority of the owner’s funds gets drained out in the business. However for the organization there is no risk of bankruptcy but the control in the concern is impacted.
Sale of fixed assets:
Like the other internal sources, this source also comes as a repayment free source as the organization is generating fund by selling its fixed assets. The only drawback of this source is the production process of the organizations may get hampered due to the sale of fixed assets. This is considered to be an internal source of finance and generally does not have a cost associated with it. The same also does not impact the control of the organization.
This source is an external source and almost every external source involves the repayment of the principal amount. Dilution of control over the business is not possible but a risk of insolvency exists if the organization fails to repay (Haas and Haas, n.d.). A cheap source of finance considering the impact of taxation, it is also easier to obtain as compared to equity or raising funds through debentures.
The bank overdraft includes repayment of loan and also involves a chance of insolvency during the failure of an organization in terms of repaying the amount. Bank overdraft because of the presence of the tax shield is considered to be less expensive and is easier to procure as compare to other sources (Smart, Megginson and Gitman, 2004).
Only a chance of forfeiture is involved if the lessee fails to pay the amount within the agreed time. Leasing has no impact on the control in the organization and is relatively a cheap source of finance due to the presence of the tax shield. However, where the organization fails to make the lease payment the asset can be repossessed by the lessor.
The trade credit becomes a cost free source if the purchase amount can be paid within the credit purchase limit (Smart, Megginson and Gitman, 2004). If the credit purchase limit exceeds then the calculation of interest comes into existence. No dilution of control is possible and no risk of insolvency is involved.
Issue of shares:
The organization has to encounter some costs in terms of paying dividends to all the stakeholders. As the stakeholders are provided with ownership rights, dilution of control over the business is involved but risk of insolvency is not possible.
The organization have to encounter some costs in order to use the sources of funds needed for satisfying their regular operational activities. The costs can be of:
No such costs are involved in this source as the funds are generated out of the earned profits of the organization.
The owners fund also does not include any cost as the funds are generated out of the personal savings of the owner (Kaliski, 2001). The same has an opportunity cost had the funds been invested somewhere.
Sale of fixed assets:
The sale of fixed assets also does not involve any costs as the organizations is selling its own fixed assets. The only cost is the associated selling expense.
The bank loans include the repayment of the principal amount along with a certain rate of interest for a particular period of time. The payment of interest is the cost of availing bank loans as a source of funds. The cost of debt can be explained with the help of the formula below:
‘I’ is the interest paid by the organization and (1-T) is to consider the impact of taxation.
Just like the bank loans, the bank overdraft also includes the repayment of the loan amount along with a fixed rate of interest for a particular period of time. The payments of interests involved in this source is considered as the cost which an organization has to incur in order to avail bank overdraft as a source of financing the operational activities.
Leasing is the external source of raising funds which comes with a cost free benefit as the organization is providing an owned property as rent.