Accounting for Business Decision - Essay Example

? ACCOUNTING FOR BUSINESS DECISION Table of Contents Table of Contents 2 a The income ment of TR Ltd. as on 30th September shows that-Sales has increased by ?320,000 (i.e. from ?620,000 in 2011 to ?940,000 in 2012), which signifies expansion, and increase in income. Cost of Sales has increased as additional amount of materials is required for increase in sales, but gross profit has also shown a marked increase of ?188,000. There is an increase in operating profit of the business. The profit has increased from ?161,000 in 2011 to ?201,000 in 2012. Since this profit is calculated before deducting interest and tax, so the company can plan for distribution of profits after deduction is done, i.e. on PAT (Profit after tax). On deduction of interest from the operating profit, there is a marked decrease in the Profit available before tax by ?94,000. This decrease in profit is due to increase in the amount of bank loan and bank overdraft in between September 2011 and September 2012 for the purpose of continuing operations of the business. As a result of decrease in profit after deduction of interest, the profit for the year has also decreased from ?107,000 in 2011 to ?64,000 in 2012. Reduction in profit would have an adverse effect on the business, such as, the company fail to pay the dues of its creditors, would not be able to pay appropriate dividends to its shareholders, as well the company would face problems in expansion as it would face shortage of funds. The ongoing activities of the business entity would also be affected with such decrease in profits. The financial position as per the balance sheet of TR Ltd. as at 30th September 2012, depicts the following- Though the value of non-current assets are shown in terms of written down value in the balance sheet, the market value of land and buildings as on 30th September 2012 in much more than its written down value. All the non-current tangible assets show an in increase in value on 30th September 2012. This depicts that the company has purchased new assets in the period of 1year. Current assets have also shown an increase from 2011 to 2012, but the balance of cash as on 30th September 2012 shows a reduction of ?13,000 from the closing balance of 2011. As a result of this the company may face liquidity problems in the short run due to shortage of available cash. An increase in retained profit as on 30th September 2012 depicts that the business entity has retained a part of the profit earned. From the income statement it is found that the business has earned a profit of ?64,000 as on 30th September 2012. As the extra profit retained in the year 2012 amounts to ?34,000, so it can be concluded that the company has drawn an amount of ?34,000 from the profit of ?64,000 and added it to the balance of retained profit. The remaining ?30,000 out of the profit is declared as to be distributed as dividend for the year 2012. An increase in Bank Loan has increased the debt of the firm. Though bank loan is a long term debt but still the company would face problems in meeting its debt if the profit does not increase in the long run. As the profit has decreased in the year 2012 so the company would face problem in meeting its timely payments as agreed upon with the bank. The amount of current liabilities has in the year 2012 but as the profit in the year 2012 has decreased the company would face problems in meeting the liabilities on time as it will face a shortage of funds. Though the current assets are more than the current liabilities to be met in the year 2012, but still the company would face problems in meeting its liabilities as because the balance of liquid cash available is not sufficient to meet the liabilities and Inventory is not a liquid asset and Trade receivables is yet to be realized. From the above, it can be concluded that the business is at a crucial stage in the year 2012. Though there has been improvement and increase in operations undertaken and performed for the growth and expansion of the business, still the marked decrease in profit and the liquid cash status of the business would not encourage the business to grow as the reduction will lead to increase in the liabilities. The liabilities of the business have already increased in the year 2012 as compared to the year 2011, non-payment of liabilities and dues on time would increase in debt further, which if not treated properly may lead to serious consequences in the long run (Knight and Bertoneche, 2000, pp.3-8). 2. Working Capital Management is considered to be the life blood and the controlling nerve centre of the business. Efficient management of working capital not only influences the profit earning capacity of the business but largely determines the scope and content of operation of the business and influences the rate of growth. (Mathur, 2007, pp. 3-5). An efficient working capital management by the finance manager of a company must ensure the following- An optimal amount of cash balance must be maintained Any amount of excess liquid funds available must be invested in marketable securities that provide best return considering default risk or liquidity constraints. Accounts receivable must be managed properly An well-organized inventory management system must be maintained An appropriate level of short term financing is to be maintained in the most flexible and least expensive way. A business entity faces working capital problems if it is unable to fulfill the above requirements and ensure the necessities on time. On analyzing the balance sheet of TR Ltd. as per the above, it is found that the company is facing working capital problems. The problems faced by the company in terms of working capital management is mentioned below- i. One of the greatest challenges faced by the financial manager of a company is the management of cash flows since exhaustion of liquid resources can leave the firm unable to meet its maturing obligations as they become due. TR Ltd. is at this stage in the year 2012, as the decrease in the balance of cash in the year 2012 to such an extent that it would not be able to even pay of its current liabilities, i.e. the liquid resources of the company has exhausted. ii. The company has run-out of liquid financial resources. This is said because the company’s has only one liquid financial resource i.e. cash, (since the other financial resources i.e. inventory and trade receivables is illiquid and is yet to be received), and cash has reduced in the financial year 2012 to an extent that it is unable to meet the dues arising out of its current liabilities. iii. A rapid growth in production and sales is an indicator of increase in income, but it can also cause a firm to use up all its cash pursuing growth and investing the cash in illiquid assets such as inventory, trade receivables, and fixed assets. TR Ltd. is also facing this problem. The income statement of the company as on 30th September 2012 shows an increase in sales whereas the profit earned by the company has decreased as compared to the previous year in which the sales was much lower. The Balance Sheet of the company as at 30th September 2012 also shows an increase in fixed assets and other illiquid assets whereas the cash balance has decreased as compared to the previous year. This clearly states that with the rapid rise in sales, the company has used up a major part of its liquid cash in the illiquid assets which has reduced the liquidity position of the business. iv. Inspite of having positive working capital, (i.e. when current assets is more than current liabilities and the company is considered to be in a condition to meet its short term dues properly) the company is unable to meet its current liabilities or short-term dues on time because of unavailability of liquid cash as most of the investment is locked into the illiquid assets (such as inventory and trade receivables) which shall generate cash in future. v. The company made investments in inventory even when the revenue generated (i.e. profit for the year) and cash balance for the year 2012 was decreasing. Recommendations to solve the above problems are as follows- i. The knowledge of the cash flow cycle must be acquired by the finance manager of the company which will aware the manager about the dynamics involved in working capital management. The cash flow cycle shall also help the manager to visualize the impact of changes in variables on the cash account. ii. Steps must be taken by the management to collect the money invested in illiquid assets (such as inventory and trade receivables), which shall increase the value of liquid cash so as to allow smooth flow of operations. Taking short term loan for increasing the cash balance and continuing operations is not recommended since in such a case the debt of the company will increase, and the company is in a situation of increased debt due to nonpayment of timely dues. iii. For increasing the cash balance the company can decide upon to increase the long term debt and equity and decrease some portion of the fixed assets after proper analysis. iv. The company may decide upon to convert the inventory into saleable products which shall generate revenue. v. The finance manager must adapt to some common ratios (such as, current ratio, quick ratio, receivable turnover ratio, average collection period, inventory turnover, average days sales in inventory, payable turnover, average days of sales in payables) so as to assess a firm’s overall approach to Working Capital Management, since ratios helps to summarize a firms working capital management. vi. A cash budget is forecasts the timing and magnitude of expected cash surpluses and deficits, so that, in the verge of taking investment or financing or operating decisions the manager can arrange for suitable financing or plan an suitable investment strategy. b) Ventura plc, the venture capitalist, has entered into a venture capital business with TR Ltd. so as to finance the new possibilities. Venture capital is a way to supply finance for new business in which the venture capital pool investors’ cash and loan it to start small businesses with a perceived long term growth potential. Venture capital business involves high risk for the investors with potentially higher returns. This form of business is popular among companies with a limited operating capacity and cannot raise capital for the venture through equity offering or a debt issue (Cumming, 2010, p.9). The Objectives of the venture capitalist (Ventura plc) behind entering into venture capital business with an existing business entity (TR Ltd) and investing as per the proposal are- i. The venture capitalist takes large equity positions of the existing business entity in exchange for funding the venture. In the venture capital business entered into by TR Ltd. it is noticed that that the directors of TR Ltd. have proposed that the venture capitalist would be given 65% of the ordinary share capital in exchange of their investment. ii. Despite of being aware of the enormous risks to be faced, a venture capitalist invests into the business proposed by the established company, with a hope to earn high reward and growth potential in the long term. Ventura plc shall invest into the venture capital business with an expectation to earn high return and growth in the long term and TR Ltd is an established company. iii. Management is an important factor which the venture capitalist looks into before making an investment. The venture capitalist looks whether the executives of the established company are successful in running the business and generating high return for their investors. The executives TR Ltd. has been successful in running the business and has expanded the business since its incorporation. The company though was unable to generate increased profit as compared to the previous years but tries to satisfy its investors by giving them return from the profit earned. In the year 2012 the profit of the company is ?64,000, which is quite lower than the previous year; still the company has declared a dividend of ?30,000 out of the profit for its investors. Therefore Ventura plc can invest in the venture capital business. iv. The venture capitalists shall invest into a business that will target a large and addressable market opportunity. This would in turn increase sales and ascertain high return and growth. TR Ltd. has approached for the venture capital business to satisfy the new orders and with a hope to develop further links and encourage expansion. So if Ventura plc invests in the business there shall be a large market opportunity which shall lead to increased return and growth in the future. v. Ventura plc may want to invest with an urge to grab the competitive advantage present in the market and enter the competitive edge that is long lasting. c) Alternative Investment Market (AIM) of London Stock Exchange was launched on 19th June 1995. AIM has raised almost ?24 billion for more than 2,200 companies. Since American firms consider AIM to be an alternative means to raise finance. Alternative Investment Market is not just a market for IPO; it is a market where companies come to raise money. Of the total amount of capital raised on AIM, one third has been raised for secondary issues. The growth company market AIM includes a set of rules that assist growth companies. Regulation of AIM is delegated to broking organizations called Nominated Advisors (NOMADS), a group of advisors, and investment banks. Companies who opt to raise finance through the help of AIM need not to grow back to their investors for raising finance unless they wish to double their size through an acquisition. AIM companies assist in growth through the lack of additional documentation which is required to be supplied in case of listing companies. So for the same acquisition target if an AIM company (i.e. a company which raises finance through AIM) competes against a listed company, the AIM company moves much faster. The essential conditions which a AIM company needs to maintain are as follows- In order to avoid suspension from the market a AIM company must have a NOMAD all the time. Timely disclosure of all price sensitive issues Annual and half-yearly accounts and reports are required to be filed For the AIM Rules all the directors of the company must accept full responsibility, collectively and independently. The company must follow UK Corporate Governance Standards. During closed periods restrictions are imposed on AIM securities for applicable employees and directors. The company raising finance through AIM is placed in an International context. AIM has a professional investor base and is internationally focused. So it is considered to be world’s flourishing growth market. AIM has a more flexible approach towards regulations and covers widespread research for international companies. Therefore, from the above analysis of the Alternative Investment Market (AIM), it can be said that the consideration by the directors of TR Ltd. to raise finance through the AIM for the expansion of their business is a correct and appropriate decision and the directors must take necessary steps so as to accomplish this decision and the plan must be executed. AIM is a place where the company can raise capital for their business through minimum hurdles and compliance rules so as to increase their activities and operations. AIM would also provide expansion opportunities for the company TR Ltd. Raising finance through AIM would not only held the company to recover from the problems the company is facing but would also help in the operations to be undertaken and open up new ways for growth. The venture capital business which the company approached is also to be benefitted through the decision of the directors to raise finance through AIM. Thus the objectives of the company will fertilize. References Tsoutsoura, M., 2004. Corporate Social Responsibility and Financial Performance. [Pdf] Available at: http://responsiblebusiness.haas.berkeley.edu/documents/FinalPaperonCSR_PDFII.pdf. [Accessed on 21 June, 2013]. Dhuyvetter, K. C. and Smith, J. F., 2005. Business Analysis: Which Financial Tools should I Use?. [Pdf]. Available at: http://www.asi.ksu.edu/doc4127.ashx. [Accessed on 21 June, 2013]. Kotane, I. and Merlino, I., 2012. Assessment Of Financial Indicators For Evaluation Of Business Performance. [Pdf]. European Integration Studies. Available at: www.eis.ktu.lt/index.php/EIS/article/download/1554/1597.? [Accessed on 21 June 2013]. Nash, P., 2010. Better Business Reporting: Enhancing Financial Reporting. [Pdf]. Australia: KPMG. Available at: http://www.aicpa.org/interestareas/frc/accountingfinancialreporting/downloadabledocuments/enhanced%20financial%20reporting%20-%20web%20version.pdf. [Accessed on 21 June 2013]. Knight, R. and Bertoneche, M. 2000. Financial Performance. Great Britain: Butterworth-Heinemann. Ogundipe, S. E., Idowu, A. and Ogundipe, L. O., 2012. Working Capital Management, Firms’ Performance and Market Valuation in Nigeria. [Pdf]. Available at: http://www.waset.org/journals/waset/v61/v61-222.pdf. [Accessed on 22 June 2013]. Khanqah, K. T., Khosroshahi, M. A. and Ebrati, M. R., 2012. An Investigation of the Association between Working Capital Management and Corporate Performance. [Pdf] Available at: www.ijmbr.org/?_action=showPDF&article=560&_ob...full....? [Accessed on 22 June 2013]. Mathur, S. B., 2007. Working Capital Management and Control. New Delhi: New Age International. Raina, V. K., No date. Recent Changes in Venture Capital Regulation. [Doc] Available at: www.icsi.edu/icsiweb/works/Schdiary/.../Venture%20Capital%20article.d...?. [Accessed on 22 June 2013]. Cumming, D., 2010. Venture Capital - Investment Strategies, Structures, and Policies. New Jersey: John Wiley and Sons. Kreisel, J., 2001. The Venture Capital Process. [Pdf]. Available at: http://esamultimedia.esa.int/docs/industry/SME/Configuration/Financing/3.1.pdf. [Accessed on 22 June 2013]. Benrud, E., 2010. Trend in Preferences in the market for alternative investments: A summary of recent Deutsche Bank Alternative Investment Surveys. [Pdf] Available at: www.doaj.org/doaj?func=fulltext&aId=1465500?. [Accessed on 22 June 2013]. Read More