Managing financial resources and decisions assignment 1

The report contains six main parts: Available sources of finance to business and the implications of different sources, appropriate sources of finance for a business project, costs of di

Prepare for: Mr Jun Bathan

Unit 2: Managing financial resources and decisions

Banking Academy, Hanoi

BTEC HND in Business (Finance)

Executive Summary

Financial sources are very important to a business Knowledge about managing financial sourceswill help a business to select appropriate sources and use them wisely There are various types offinancial sources, and each one has advantages and disadvantages A business has to assess theadvantages, disadvantages and has to calculate and compare the costs of different sources inorder to choose suitable sources This report will show understanding about the issues thatrelevant to sources of finance

The report contains six main parts: Available sources of finance to business and the implications

of different sources, appropriate sources of finance for a business project, costs of differentsources of finance, the important of financial planning, the information needs of differentdecision makers and the impact of finance on financial statements

First part will indentify the available sources of finance to General Electric (GE) and assess theimplications of different sources

Second part will indentify appropriate sources of finance for a GE’s project

Third part will assess and compare the costs of different sources of finance

Fourth part explains the important of financial planning

The fifth part describes the information needs of different decision makers

The sixth part shows the impacts of finance on financial statements

Table of Contents

INTRODUCTION 5

Aims, Purposes/ Scopes 5

Sources of information 5

Limitation of the report 5

1 Available sources of finance for General Electric and the implications assessment of each source 6

1.1 Overview of GE 6

1.2 Debt Financing 6

1.3 Equity Financing 10

2 Appropriate sources of finance for a business project 13

3 Costs of Different Sources of Finance 15

3.1 Share Capital 15

3.2 Borrowed Funds 16

3.3 Retained Earnings 17

4 The Important of Financial Planning 17

4.1 Sales Budget 17

4.2 Purchase Budget 18

4.3 Personal Debt 18

4.4 Capital Expenditure Budget 19

4.5 Cash Budget 20

4.6 Comment 20

4.7 Profit & Loss budget from Jan-Apr 21

4.8 Budgeted Balanced Sheet 21

5 The Information Needs of Different Decision Makers 22

5.1 Types of Information 22

5.2 Classification of Information User 24

6 The Impact of Finance on the Financial Statement 25

6.1 Control operations and earnings 25

6.2 Assess Vendors, Customers and Business Partners 26

6.3 Stability of Vendors, Customers, and Business Partners 26

6.4 Assess Appearance to Investors and Creditors 26

CONCLUSION 27

References 28

Appendix I - WACC Calculation 29

Aims, Purposes/ Scopes

The aim of this report is the practice of identifying available sources of finance andassessing the implications of each source, thus calculating and comparing the costs of eachsource in order to choose the suitable sources for a business The scopes of the report are:

Available sources of finance identification and implications assessment

Appropriate sources of finance for a business project

Costs of different sources of finance

The important of financial planning

The information needs of different decision makers

Impacts of finance on financial statement

Sources of information

This report uses the information from reliable sources: course book (BPP ProfessionalEducation), websites like: BusinessFinance.com, Oxford dictionaries, and personal knowledgeand experiences

Limitation of the report

Due to the limitation of the number of words, the report might not cover enough allknowledge that relevant to sources of finance Unimportant mistakes might occur

1 Available sources of finance for General Electric and the implications assessment of each source.

1.1 Overview of GE

General Electric (GE) is one of the largest industrial firms in the world GE’s productsare diverse, from light bulb to air craft engine With over 300,000 employees worldwide, GE’sannual sale is over $180 billion To a huge company like GE, finances are very importantbecause it needs a lot of money to keep the work going

Financing is the backbone of a business, especially to a giant like GE Finances aredivided into three types: Long and short term finance; external and internal; equity and debt Tomake it easy to identify available sources and asset them, debt and equity finances will beanalyzed

1.2 Debt Financing

Debt financing is financing a company by selling the bonds, notes or mortgages held

by the business Basically it is borrowing money to keep your business running [ CITATION Bus12 \l 1033 ]

Advantages:

Initiative: A company will pay the interest and loan in a proactive way because

the interest rate is set at first

Maintain ownership: The obligation of the company is to pay the debt fully on

time The lenders cannot interrupt the company’s operation Maintaining ownership is the key

factor to large companies, included GE The dilution in control is not good in a big organization;the company might turn into chaos.

Tax deduction: Tax deduction is considered as financial leverage The tax is

counted in the formula: Tax = (sales – costs)* tax rate Higher the costs or debt the lowercompany has to pay for the government With the huge sales amount of GE, the tax they have topay is huge Therefore, this advantage of debt financing must be exploited thorough

Disadvantages:

Risk: Companies have to face risks when they decide to use financing When a

company goes bankrupt, it has to fulfill its obligation to lenders before dividing equity to owners.With huge sum of loans, GE has its own risk This risk must be controlled in order to calm theinvestors

High rate: Company has to face high interest rate even when the burden of tax is

reduced The interest rates will base on the business’s condition, credit rating, history of creditwith banks GE has the advantages because it is a large company with operating experiences soits credit rating is high This advantage helps GE get the loans easier with lower rates compared

to others

Influences credit rating: It seems attractive for the company to keep carrying

debt during operating However, each debt will be marked in the credit rating of the company Inaddition, the amount of the loans is proportional with the risk of the lenders and the interest thatthe company must pay In 2009, due to the global financial crisis, the credit rating of GE has feltfrom AAA to AA+ GE must have solution to react to the unbalance in credit rating

Cash and collateral: A company has to make sure that it has the ability to pay

the interest in the payment term In addition, the company might have to mortgage assets for theloans

Table 1: Some types of Debt financing and its applications to GE

Using for purposes: buyingraw materials, paying wages,funding operation and otheradministrative expenses

Overdraft Short-term, the amount is limited due to the

agreement between banks and businesses

Businesses do not need to report to banksbefore using money and only have to payinterest for the time they use it

To attend to day to dayoperation

Serve the sudden expenseincurred

Factoring Business transfer receivable accounts and

responsibilities to collect from the party whoowes money to banks

When GE need capitalduring operation process

To pay short-term debt

Term loans Long-term (normally 3-10 years) Used to buy

assets or expanding business The amount,term, interest rate depend on the risk profile of

Implementing new projectsBuy assets

Open new branches

Expand product lines

Project

Finance

Project finance are either debt and equityHuge amount, long-term

Using for infrastructure projects

Sensitive to policies, tariffs and regulatory

Implementing infrastructureprojects such as expandinggrids

Debentures Long-term, issued by the company

Negotiate interest rateNot shares

Raise capital for operation

Leasing Agreements between two parties Lessee pay

lessor to use assets which can be equipments

or finances

Two types: Operating and finances leases

Serve the demand forequipments for short-termproject

Serve the demand for capital

1.3 Equity Financing

Equity financing is the act of selling common stock or preferred stock to investors This

is usually done through an underwriter called an investment banker The company will give upownership equity in their business and the underwriter will be responsible for promoting andselling them to the public [ CITATION Bus121 \l 1033 ]

Advantages:

No obligation: The firm does not needs to concern about loans and interests and

their payment terms This helps reduce the risk of bankruptcy to a business, especially to GE

Owner share risk: Larger the number of shareholders, lesser the risk is In case

of bankruptcy, the damages will be shared to all shareholders Risks are problems a companymust solve Equity financing is a way to reduce risks GE might use equity financing to reducerisks as much as it can

Not illegal if unpaid: Because shareholders are owners, they have to accept that

if the company cannot make profit so do them

Disadvantages:

No tax relief: Opposite to debt financing, when a company choose to use equity

financing, it cannot deduct tax Obviously a giant like GE does not want to face thisdisadvantage

Dilution of control: The number of shareholders proportional with the dilution of

control Because owners have rights to take part in the development process of a business,therefore, conflicts might happen between shareholders GE has to make sure that the dilution ofcontrol is under controlled in order to avoid conflicts

Table 2: Types of equity financing and its applications to GE

Types of equity

financing

Retained Profit Obligations to compensate

shareholders for not investing it or

A part of retained profitmight be kept for operation

Risks are shared

Shareholders = owners -> rights tovote(only available to ordinaryshares)

Business can raise a lot of cash

GE issue shares for capital

or cash demands

Ordinary shares

Business can avoid dividendsHigh success rate of issue sharesUnsecured and no legal action ifunpaid

No tax relief Expected interest ishigh

Dividends affect cash flow

To make sure the companyhas enough capital, issuingordinary shares is a must.Helps GE share the burden

of risks

Preferenc

e shares

Fixed rateUnsecuredDividends can be avoidedReduce dilution of control

No legal action if unpaidReturn expected > Debentures

No tax relief

An attractive alternativeform of finance for GE, thecompany can deferdividends without riskingits credit rating

There are three ways for a company to issue shares: Right issues, new issues of shares and bonus issues.

Right issues: Company issues further shares, involves offering new shares Price

of new shares is below market value The issuing of new shares will affect on the shareholding ofcurrent shareholder

Disadvantages:

Not suitable for raising a small amount of capitalExisting shareholders might lose some controls due to the rightsselling of other shareholders

To a huge company like GE, right issue is an effective way to raise capital.However, this method might foster dilution of control and unable for raising small amount ofmoney GE must concern about this problem to decide when and how many to issue

New issues of share: For the purpose issuing shares the first time to public.

Therefore, it will not be analyzed because GE had issued their shares the first time in 1907

Bonus issues: an issue of additional shares to shareholders instead of a dividend,

in proportion to the shares already held [ CITATION Oxf122 \l 1033 ]

For GE, instead of dividends, the company can use bonus issues However, bonus issue

is used when the leaders on GE are confident about the future of the company In addition,

bonus issue reduce the market value of share, therefore, its liquidity is high only when market value is high At the moment, the value of GE stock is low so bonus issue is not a sound option.

Debt financing and Equity financing are two sources of finance a company use during

operation They both have pros and cons and each type of finances are used for differenteconomic purpose in different moments GE must consider about what type and when to use toacquire the effective

2 Appropriate sources of finance for a business project

For a giant like GE, choosing appropriate sources of finance for a business project (example: a two billion US Dollar project) is very important There are debt financing and equity financing and both

of them have advantages and disadvantages The mix of debt financing and equity financing will exploit the maximum advantages and decrease the disadvantages for GE However, to find out the appropriate

ratio between debt and equity financing, GE has to calculate WACC

After calculating (Appendix I), there are three options for GE:

Using 16.16% debt financing and 83.84% equity financing

Using 50% debt financing and 50% equity financing

Using 83.84% debt financing and 16.16% equity financing (most suitable)

Huge amount of cash could

be raised in short period oftime

Using 83.84% equity can raise huge amount of cash in short time and alleviate the burden

of paying interests for loans However, this leads to the changes in the proportion of shareswhich will cause dilution of control GE is a huge corporation The dilution of control might lead

to the deviation in the development of the corporation Therefore, using 83.84% equity financing is not an ideal option for GE

Using 50% of each method will create the balance in the advantages and disadvantages.

The increase in the amount of debt financing will increase tax reduction However, the dilution

of control still occurs in this option Therefore, using 50% of each method is not suitable for GE.

The last option: 83.84% debt financing and 16.16% equity financing, which has the smallest WACC (1.004%) In this option, GE will have a huge amount of tax reduction In

addition, they can reduce the dilution of control Besides, GE is a famous corporation so it will

not be hard for them to get loans However, this option is very risky In general, using 83.84%

debt financing and 16.16% equity financing is the most suitable option because it has the lowest WACC and it can reduce the dilution of control, which is the most important factor for

GE in the current situation

3 Costs of Different Sources of Finance

There are three sources of finance that GE needs to assess and compare the cost: Share capital, Borrowed Funds and Retained Earnings.

3.1 Share Capital

Dividends in Cash: A cash dividend is a cash payment that is extended to shareholders

by the issuing company [ CITATION wis12 \l 1033 ] In the case of preference shareholder, theyhave the priority to get the dividend before ordinary shareholder, and the amount of dividendthey get is fixed Preference share will guarantee the safety for investors However, preferenceshareholder cannot receive more when GE makes a lot of profit Investor has to concern aboutthe tax problem because the tax level applied on GE is high (35%)

Scrip Dividend: Instead of paying dividend in cash for shareholders, the organization

can offer more share for them This method will help the business to save cash for furthergrowing

Besides, there are other costs such as consultant fees, stockbrokers or informationproviding fees

3.2 Borrowed Funds

Interest: Loans involve with interest Currently, the interest rate of US is 0.25%

Low interest rate will encourage businesses to borrow This brings