Financial Management
Hope PLC
Q1 a) Concept of valid & reliable Financial Data: Internal and External Business Environment Internal Business Environment: Internal environment of business normally consists of the following. i. Finance ii. Marketing iii. Human Resources iv. Operations (Production, Manufacturing) v. Technology vi. Other Functions (Logistics, Communications)
External Business Environment: The following business environment factors outside an organization have a profound effect on the functions and operations of an organization.
i. Customers ii. Suppliers iii. Competitors iv. Government/Legal Agencies & Regulations v. Macro Economy/Markets: vi. Technological Revolution Financial Data can also be validated using an analysis which is used in a business is called SWOT Analysis. SWOT is an acronym where S stands for Strengths W stands for Weaknesses O stands for Opportunities T stands for Threats Strengths and weaknesses are within an organization, i.e., they pertain to the internal environment of the organization. Opportunities and threats, on the other hand, pertain to the external environment, i.e., outside the organization.
How Hope PLC can gather these valid & reliable financial data from internal and external sources:
b) Liability: The liabilities that your company has are the amounts that it owes its creditors. These could be the bank for loans or overdraft. It could be credit card companies. And it is frequently your suppliers. It could also be anyone else you have borrowed money from, such as friends or relatives who helped you get your business going. The financial records of a company are contained in its accounts or financial statements. These come in three basic forms, which firms trading as limited companies in the United Kingdom are required to publish: • the balance sheet • the income statement (or profit and loss statement), and • the cash flow statement Liabilities (Right Hand Side): The right hand side of the balance sheet represents liabilities. – Liabilities are sources which are use to acquire the resources or liabilities are obligations of two types: 1) Obligations to outside creditors and 2) Obligations to shareholders known as Equity. – Liabilities can be short term debts, long term debt, equity, retained earnings, contingent, unrealized gain on holding of marketable securities – Current Liabilities = Account Payables + Short Term Loans + Accrued Expenses – Net Working Capital = Current Assets – Current Liabilities – Total Equity = Common Equity + Paid In Capital + Retained Earnings (Retained
Earnings is NOT cash always) – Total Equity represents the residual excess value of Assets over Liabilities: Assets – Liabilities = Equity = Net Worth – Only cash account represents real cash which can be used to pay Hope Plc bills Why Track Your Business Liabilities?
There are some who don’t really bother tracking business liabilities, especially loans to friends or relatives. This is a poor business practice and gives a false picture of your business. It is always a good idea to track all of your liabilities, not only to give an accurate picture of the business, but also to protect those people who are your creditors. Imagine if anything happened to you or your company and your friend or relative had no record themselves of the loan, but your company books did. Say you were in a fatal accident and had no heirs. In this case your company would be liquidated. If you have the loan on your books, at least those close to you are protected and can get some of their money back (assuming there is any after paying back the other higher priority loans). In Balance sheet, a liability is an obligation to pay a sum of money at a specified date. The payment can be one time -- in a lump sum -- or in a series of periodic installments. Examples includes commercial paper, accounts payable, bonds payable and taxes due.
Hope PLC Liabilities: From Hope PLc Balance sheet, there current liabilities are 1240 which is divided into trade payables and other creditors and accruals. Non-current liabilities are Hope Plc 6% debenturs 1400
d) Equity Defination: Equity Shares also known as ordinary shares, which means, other than preference shares. Equity shareholders are the real owners of the company. They have a control over the management of the company. Equity shareholders are eligible to get dividend if the company earns profit. Equity share capital cannot be redeemed during the lifetime of the company. The liability of the equity shareholders is the value of unpaid value of shares. Features of Equity Shares
Equity shares consist of the following important features: 1. Maturity of the shares: Equity shares have permanent nature of capital, which has no maturity period. It cannot be redeemed during the lifetime of the company. 2. Residual claim on income: Equity shareholders have the right to get income
left after paying fixed rate of dividend to preference shareholder. The earnings or the income available to the shareholders is equal to the profit after tax minus preference dividend. 3. Residual claims on assets: If the company wound up, the ordinary or equity shareholders have the right to get the claims on assets. These rights are only available to the equity shareholders. 4. Right to control: Equity shareholders are the real owners of the company. Hence, they have power to control the management of the company and they have power to take any decision regarding the business operation. 5. Voting rights: Equity shareholders have voting rights in the meeting of the company with the help of voting right power; they can change or remove any decision of the business concern. Equity shareholders only have voting rights in the company meeting and also they can nominate proxy to participate and vote in the meeting instead of the shareholder. 6. Pre-emptive right: Equity shareholder pre-emptive rights. The pre-emptive right is the legal right of the existing shareholders. It is attested b y the company in the first opportunity to purchase additional equity shares in proportion to their current holding capacity. 7. Limited liability: Equity shareholders are having only limited liability to the value of shares they have purchased. If the shareholders are having fully paid up shares, they have no liability. For example: If the shareholder purchased 100 shares with the face value of Rs. 10 each. He paid only Rs. 900. His liability is only Rs. 100. Total number of shares 100 Face value of shares Rs. 10 Total value of shares 100 × 10 = 1,000 Paid up value of shares 900 Unpaid value/liability 100 Liability of the shareholders is only unpaid value of the share (that is Rs. 100). Advantages of Equity Shares
Equity shares are the most common and universally used shares to mobilize finance for the company. It consists of the following advantages. 1. Permanent sources of finance: Equity share capital is belonging to long-term permanent nature of sources of finance, hence, it can be used for long-term or fixed capital requirement of the business concern. 2. Voting rights: Equity shareholders are the real owners of the company who have voting rights. This type of advantage is available only to the equity shareholders. 3. No fixed dividend: Equity shares do not create any obligation to pay a fixed rate of dividend. If the company earns profit, equity shareholders are eligible for profit, they are eligible to get dividend otherwise, and they cannot claim any dividend from the company. 4. Less cost of capital: Cost of capital is the major factor, which affects the value of the company. If the company wants to increase the value of the company,
they have to use more share capital because, it consists of less cost of capital (Ke) while compared to other sources of finance. 5. Retained earnings: When the company have more share capital, it will be suitable for retained earnings which is the less cost sources of finance while compared to other sources of finance. Disadvantages of Equity Shares 1. Irredeemable: Equity shares cannot be redeemed during the lifetime of the business concern. It is the most dangerous thing of over capitalization. 2. Obstacles in management: Equity shareholder can put obstacles in management by manipulation and organizing themselves. Because, they have power to contrast any decision which are against the wealth of the shareholders. 3. Leads to speculation: Equity shares dealings in share market lead to secularism during prosperous periods. 4. Limited income to investor: The Investors who desire to invest in safe securities with a fixed income have no attraction for equity shares. 5. No trading on equity:When the company raises capital only with the help o f equity, the company cannot take the advantage of trading on equity.
Retained Earnings: Retained earnings are another method of internal sources of finance. Actually is not a method of raising finance, but it is called as accumulation of profits by a company for its expansion and diversification activities. Retained earnings are called under different names such as; self finance, inter finance, and plugging back of profits. According to the Companies Act 1956 certain percentage, as prescribed by the central government (not exceeding 10%) of the net profits after tax of a financial year have to be compulsorily transferred to reserve by a company before declaring dividends for the year. Under the retained earnings sources of finance, a part of the total profits is transferred to various reserves such as general reserve, replacement fund, reserve for repairs and renewals, reserve funds and secrete reserves, etc. Advantages of Retained Earnings
Retained earnings consist of the following important advantages: 1. Useful for expansion and diversification: Retained earnings are most useful to expansion and diversification of the business activities. 2. Economical sources of finance: Retained earnings are one of the least costly sources of finance since it does not involve any floatation cost as in the case of raising of funds by issuing different types of securities. 3. No fixed obligation: If the companies use equity finance they have to pay dividend and if the companies use debt finance, they have to pay interest. But if the company uses retained earnings as sources of finance, they need not pay
any fixed obligation regarding the payment of dividend or interest. 4. Flexible sources: Retained earnings allow the financial structure to remain completely flexible. The company need not raise loans for further requirements, if it has retained earnings. 5. Increase the share value: When the company uses the retained earnings as the sources of finance for their financial requirements, the co st of capital is very cheaper than the other sources of finance; Hence the value of the share will increase. 6. Avoid excessive tax: Retained earnings provide opportunities for evasion of excessive tax in a company when it has small number of shareholders. 7. Increase earning capacity: Retained earnings consist of least cost of capital and also it is most suitable to those companies which go for diversification and expansion. Disadvantages of Retained Earnings
Retained earnings also have certain disadvantages: 1. Misuses: The management by manipulating the value of the shares in the stock market can misuse the retained earnings. 2. Leads to monopolies: Excessive use of retained earnings leads to monopolistic attitude of the company. 3. Over capitalization: Retained earnings lead to over capitalization, because if the company uses more and more retained earnings, it leads to insufficient source of finance. 4. Tax evasion: Retained earnings lead to tax evasion. Since, the company reduces tax burden through the retained earnings. 5. Dissatisfaction: If the company uses retained earnings as sources of finance, the shareholder can’t get more dividends. So, the shareholder does not like to use the retained earnings as source of finance in all situations.
Equity & Retained Earnings for Hope PLC:
e) Basic form of accounting equation from Hope PLC: Ratio analysis is a commonly used tool of financial statement analysis. Ratio is a mathematical relationship between one number to another number. Ratio is used as an index for evaluating the financial performance of the business concern. An accounting ratio shows the mathematical relationship between two figures, which have meaningful relation with each other. Ratio can be classified into various types. Classification from the point of view of financial management is as follows:
● Liquidity Ratio ● Activity Ratio ● Solvency Ratio ● Profitability Ratio
Liquidity Ratio It is also called as short-term ratio. This ratio helps to understand the liquidity in a business which is the potential ability to meet current obligations. This ratio expresses the relationship between current assets and current assets of the business concern during a particular period. The following are the major liquidity ratio:
Activity Ratio It is also called as turnover ratio. This ratio measures the efficiency of the current assets and liabilities in the business concern during a particular period. This ratio is helpful to understand the performance of the business concern. Some of the activity ratios are given below:
Solvency Ratio It is also called as leverage ratio, which measures the long-term obligation of the business concern. This ratio helps to understand, how the long-term funds are used in the business concern. Some of the solvency ratios are given below:
Profitability Ratio Profitability ratio helps to measure the profitability position of the business concern. Some of the major profitability ratios are given below.
Q2 a) Hope PLC Stakeholders and their financial information needs: Principals and Agents In the early days of the industrial revolution, the firm was usually managed by those who owned it, much like the small family-run business of today. Because the modern corporation tends to be a large, complex organisation, a divorce has arisen between those who own the firm (shareholders) and those who run it (managers, typically the Board of Directors). In the modern corporation, it is the task of management—the agents—to administer the firm on behalf of its owners—the principals. This is known as an agency relationship. In the past, it was often assumed that there was no divergence of interests between the firm’s owners and managers, but increasingly this does not seem to be the case. A conflict of interest between those who own the firm and those who manage it appears to be the norm rather than the exception. There is a tendency for managers to make
decisions that may be in their own interest but not in the interest of shareholders or consistent with the risks bondholders accepted when they purchased their stake in the company. Such conflicts give rise to additional costs, known as agency costs. These costs, which are not easily measured in monetary terms, represent opportunities which have been foregone as a result. For example, while management might consider a corporate aircraft useful, it might not be in the shareholders’ interest. One way of minimising these costs is to turn agents into principals. This can occur when the directors of a company are also shareholders (a primary aim of the use of employee share options). There are four key areas of agency cost:
• Costs of minimising the incentives for management to act contrary to the interests of shareholders • Costs of monitoring the actions of management • Bonding costs to protect shareholders from managerial dishonesty • Opportunity costs of lost profits due to complex organisational structures, which limit managerial decisionmaking flexibility Further, there may be a conflict of interest between the firm’s managers and its labour force. Thus within the firm’s operations there may be a three-way conflict of interest. Further conflicts of interest may arise as a result of the firm’s sources of financing. Investors can provide funds to a firm via debt or via equity. Bondholders—a shorthand term including any providers of debt to the firm—are likely to be affected in a different way by the firm’s decisions than shareholders, leading to a conflict of interest between these groups. The key area of conflict concerns the appetite of these groups for risk. Because shareholders wish to see their wealth maximised ceteris paribus (other things being equal), they would prefer management to leverage their returns via prudent risk taking. Alternatively, bondholders are primarily interested in the company doing enoug h to ensure that they receive their payments of interest (and repayment of principal in the longer run), which may involve a lower risk strategy. It may also be the case that conflicts of interest occur between groups of shareholders, or between groups of bondholders. In recent years, an expanding body of literature has developed, investigating the various issues pertaining to conflicts of interest between a firm’s various constituents or stakeholders. The seminal work in this area is probably the 1976 paper by M. C. Jensen and W. H. Meckling, which gave rise to the distinction between maximising behaviour and satisficing behaviour: the former indicating behaviour with the objective of maximising the value of the firm (or shareholder wealth), the latter indicating behaviour whereby management does “just enough” to keep shareholders content.
b) Defination of Net Asset: Total assets minus total liabilities of an individual or company. For a company, also called owner's equity or shareholders' equity or net worth. Net assets, sometimes referred to as net worth, is the shareholders' equ ity = assets minus liabilities. The term net assets is commonly used with charities or not for profit entities -a measurement of their ability to reinvest profits toward their mission. In "Return On Net Assets" (RONA) it's often fixed assets plus net working capital (current assets minus current liabilities), which may be slightly less than total assets. If net assets are negative, then an entity is balance sheet insolvent.
Net Asset for Hope PLC: For Hope Plc, The net asset was comprise of total 1,400 which was found from total assets less current liabilities less non current liabilities which was in the company’s case 6% debenturs.
c) Revenues: For a company, this is the total amount of money received by the company for goods sold or services provided during a certain time period. It also includes all net sales, exchange of assets; interest and any other increase in owner's equity and is calculated before any expenses are subtracted. Net income can be calculated by subtracting expenses from revenue. In terms of reporting revenue in a company's financial statements, different companies consider revenue to be received, or "recognized", different ways. For example, revenue could be recognized when a deal is signed, when the money is received, when the services are provided, or at other times. There are rules specifying when revenue should be recognized in different situations for companies using different accounting methods, such as cash basis and accrual basis.
Expenses: What Does Expense Mean? 1. The economic costs that a business incurs through its operations to earn revenue. In order to maximize profits, businesses must attempt to reduce expenses without also cutting into revenues. Because expenses are such an important indicator of a business's operations, there are specific accounting rules on expense recognition. 2. Money spent or costs incurred that are tax-deductible and reduce taxable income.
Hope PLC Revenues For Year 4, Hope Plc revenue was 6,200
Hope PLC Expenses: For Year 4, Hope Plc administration and selling expenses was 2,194 So, It can be seen that revenue was greater than administration and selling expenses.
d) Financial Authority through Internal & External Audit in respect with Hope PLC and the needs: a firm’s various constituents or stakeholders. The seminal work in this area is probably the 1976 paper by M. C. Jensen and W. H. Meckling, which gave rise to the distinction between maximising behaviour and satisficing behaviour: the former indicating behaviour with the objective of maximising the value of the firm (or shareholder wealth), the latter indicating behaviour whereby management does “just enough” to keep shareholders content.
Figure: Audit in an organisation
Q3 a) Techniques for measuring performance of an organization: Effective procurement and efficient use of finance lead to proper utilization of the finance by the business concern. It is the essential part of the financial manager. Hence, the financial manager must determine the basic ob jectives of the financial management. Objectives of Financial Management may be broadly divided into two parts such as: 1. Profit maximization 2. Wealth maximization.
c) Identifying all components of annual report that the management of Hope PLC will present at the annual general meeting: Companies present these to shareholders, prospective shareholders and other interested parties in the form of their Annual Report and Accounts. The Annual Report also contains a statement from the Chairman of the Board of Directors as well as a listing of the directors, plus a note from the company’s auditors verifying that the accounts are a “true and fair view of the state of affairs of the company”, “free from material misstatement”. For smaller firms Annual Reports tend to be little more than a basic attempt to meet legal requirements. However, larger firms, especially those with stock exchange listings, often produce glossy brochures that go beyond the legal requirements, appearing to be more the product of the company’s marketing department than its accounting department. The required financial statements normally present little more than an overview, and are supplemented by more detailed “notes to the accounts”.
Obviously, firms in different industries are likely to have different items appearing in their financial statements. This makes it difficult on occasion to compare and contrast firms. It is also the case that firms within the same industry may have different accounting policies, again making it difficult to compare them via their financial statements.
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