Managing Financial Resources & Decisions

Scenario

Case Study :Softwood Ltd

Softwood Ltd is a medium-sized limited liability company producing furniture for the retail sector and private homes for the last 6 years, mainly

catering for domestic market.

The business was initially set up by 3 young carpenters.  They have shown the exceptional understanding with each other as a result the business has

been growing steadily over the years.  Given the past business successes, growing brand name and the loyal customer base the promoters have realized

that it is the best time to go for expansion. Their intention to go for expansion is also backed by a growing enquiry for their furniture from some

overseas buyers as well.  Whilst their ability and skills to design and produce the furniture is largely undiminished, other business functions such

as marketing, administration and sourcing materials at the best prices are not well integrated as neither are particularly skilled in the

professional business processes.

Recently, they have appointed a young and energetic John Mathew as the Managing Director (MD) to study and manage the business as it expands. He has

several year experience managing a fast moving consumer goods manufacturing business.

Their preliminary study has suggested that for the proposed expansion and to attract foreign buyers they need to modernize their operation and invest

some money in new equipment and tools. While the successful businesses have increased the company’s capital base and satisfaction to promoters, the

company at present need much more capital to expand as per the plan.

John was excited to learn the range of finance available in the market to his company which has a good track record.  He already had a preliminary

talk with a bank manager who was encouraging and even suggested to prepare a detailed financial plan and forecast in order to apply for a bank loan.

He did receive some leaflets, with outline headings for various information that are required for a reliable forecast. He also recommended for a

reliable and user friendly financial planning software which could save time and money. However, John was aware that Softwood Ltd. could also explore

for other internal as well as external sources of finances available. Many equipment suppliers in the market have tie ups with financing companies

and  offer  very flexible financing options like lease, hire purchase etc.  As such, each source of finances bear different borrowing costs, so it is

the duty of MD to highlight them to the promoters so the most prudent decisions could be taken. Following the meeting with the bank manager John also

felt the need to collect the right information to prepare the realistic financial forecast.

Section A

A part of the expansion plan of Softwood Ltd included setting up a separate production unit for contemporary designed furniture for exports which is

expected to start production in January 2015.  John wanted to ensure a good cash management for this unit as he did not want any hiccups for the

company’s first ever export venture. So he gathered information to prepare a cash budget for the future as follows:

Forecast of income and expenses for the year 2015 are as follows:

Jan    Feb    Mar    Apr    May    Jun    Jul    Aug    Sep    Oct    Nov    Dec
Sales    350    350    350    500    500    700    700    900    900    800    900    900
Purchase    140    140    140    200    200    280    280    360    360    320    360    360
Labour    105    105    105    150    150    210    210    270    270    240    270    270
Other variable
Expenses    35    35    35    50    50    70    70    90    90    80    90    90

(Note all the figures in the table above are in £ 000)

1.    Half of the Sales are on 2 months credit.
2.    Purchases are paid after 2 months.
3.    Labour costs are paid in the same month as they incur.
4.    Other variable costs are paid in the following month.
5.    Fixed expenses of £75,000 per month are paid the next month.
6.    Annual repayment for the machines is £400,000 being made in June.
7.    Other financial information are:
a.    ing cash balance is £50,000.
b.    ing stock is £450,000; closing stock is valued at £ 425,000.
c.    Annual Depreciation of£400,000 is not included in the Fixed Expenses above.

Section B

The proposed expansion and the modernization of the current operation entailed purchase of a new modern plant for seasoning of wood. The following

two suppliers were shortlisted based on their quotations and future cash-flows:

ABC Ltd- Cost of machine is£ 2,000, 000 and the scrap value at the end of 5th year is estimated at £200,000.

XYZ Ltd- Cost of machine is £1,700,000.

Cost of finance is estimated at 10% p.a. The life of machines is 5 years in both cases.
Their cash-flow from the operation for the next 5 years are forecasted as follows:

Years    ABC Ltd
( £ 000)
XYZ Ltd
( £ 000)

1    600    600
2    700    700
3    800    500
4    600    400
5    100    150

Section C
Analysing historical financial statements gives the insight of the company’s financial standings through the information about the existing

profitability, liquidity and the financial leverages.  This also provides the platform for drawing up any future plan for the company. John realized

the limited financial knowledge of the promoters so he decided to explain the basics before analysing the company’s financial statements.
He had past two years ‘Income Statement and Balance Sheets available to analyse.
Income Statements        £000

2013    2012
Sales                           Cost of sales
Gross profit

Operating expenses
Profit before interest and tax
Interest
Net profit before tax

Income tax
Profit after tax

Retained profit brought forward
Retained profit carried forward
3590
(2010)
1580

(1105)
475

(155)
320

(68)
252

608
860    2,217
(1,201)
1016

(732)
284

(86)
198

(50)
148

460
608

Balance Sheet                                          £ 000

2013    2012
Non Current Assets:
Freehold property €“ cost
Equipment €“ cost
Depreciation

Current Assets:
Inventory (stock)
Trade receivables (debtors)
Bank
Prepayments

Less: Current Liabilities
Trade Payables(creditors)
Other Payables

Net Working Capital

Net Assets

Less: Long Term Liabilities
9% Long term Loan

1170
1015
(450)
565
1735

312
350
78
280
1020

425
125
550
470

2205

925
1280
1170
675
(210)
465
1,635

296
290
65
235
886

241
106
347
539

2174

1146
1028
Equity

420,000 ordinary £1 shares
Retained Profit

420
860
______
1280

420
608
______
1028

Task 1

a)    Identify the different sources of finance available to Softwood Ltd. to finance the proposed expansion plan and   assess their implications

to the business. (Covers Assessment Criteria 1.1 & 1.2)

b)    Analyse the costs associated with each sources identified above and evaluate with recommendation the most appropriate sources of finance for

Softwood Ltd’s expansion plan.(Covers Assessment Criteria 1.3 and 2.1)

To achieve M1 demonstrate that personal judgements are made to recommend appropriate sources of finance  to Softwood Ltd which is effective and

sensible in the given business context.

To achieve D2demonstrate that the importance of interdependence has been recognised and achieved. For example, combinations of a range of finances

recommended recognising their inter-dependence and impacts on the business.
Task 2

a)    Explain why financial planning is necessary to make the proposed expansion venture successful.  And also assess the information that are

necessary for the decision makers to make the financial plan effective and realistic(Covers Assessment Criteria 2.2 & 2.3).

b)    Explain the impact of finance on the financial statements of Softwood Ltd.(Covers Assessment Criteria  2.4).

To achieve M3present business information coherently and logically in a professional way using financial terminology.

To achieve D3 provide evidence of original thinking and presentation of a decision that is appropriately applied in the case study scenario.
Task 3

a)    Prepare the cash budget for Softwood Ltd from January to December 2015 from the information provided in Section A and analyse how you will

manage the cash during this period.(Covers Assessment Criteria 3.1)

b)    From the income and cost information given in section €œA€ above and the annual production estimated at 25,000 units, explain the calculation

of the unit cost of a furniture  and the implications of these costs in pricing decisions.(Covers Assessment Criteria 3.2).

c)    Using investment appraisal methods on the information given in section €œB€ above, assess and recommend the most viable alternative for

Softwood Limited. (Covers Assessment Criteria 3.3)

To achieve M2 demonstrate the use of a range of appropriate methods and techniques like investment appraisal tools, cost and pricing and budgeting to

deal with the problems and get appropriate solutions.

To achieve D1demonstrate that decisions on capital investment,  pricing and cash management are made through in-depth analysis of the information,

merits of  the tools used and well justified on the context of the businesses.

Task 4
a)    Discuss the main financial statements of a business highlighting their structures and significances. And also compare how they differ in a i)

Sole Trader ii) Partnership and iii) Company.(Covers Assessment Criteria 4.1 & 4.2)

b)    Using information provided in section €œC€ above and taking into consideration the industry averages, make a comparative study of the

financial performance of Softwood Ltd for the year 2012 and 2013 with the help of following financial ratios:

Industry Averages
i)Gross Profit Margin                                     40%
ii)Net Profit Margin                                       10%
iii) Return on Capital Employed                   15%
iv) Asset Turnover Ratio                                 3
v) Current Ratio                                               2
vi) Quick Asset Ratio                                    1.5
vii) Stock Days                                                75
viii) Debtors Days                                          30
ix) Debt Equity Ratio.                                  1.0
(Covers Assessment Criteria 4.3)

To achieve M3 present the financial statements and their interpretations coherently and logically in a professional way using financial terminology.

To achieve D3 present reasonable business conclusion made through interpretation of financial statements and effective business recommendation made

based on the conclusion.

LO 1    Understand the sources of finance available to a business

1.1    identify the sources of finance available to a business
1.2
assess the implications of the difference sources.
1.3    evaluate appropriate sources of finance for a business project

LO 2    Understand the implications of finance as a resource within a business
2.1
analyse costs of different sources of finance
2.2
explain the importance of financial planning
2.3
assess the information needs of different decision makers
2.4    explain the impact of finance on the financial statements
LO 3    Be able to make financial decisions based on financial information
3.1    analyse budgets and make appropriate decisions
3.2    explain the calculation of unit costs and make pricing decisions using relevant information
3.3    assess the viability of a project using investment appraisal techniques
LO 4    Be able to evaluate the financial performance of a business
4.1    discuss the main financial statements
4.2    compare appropriate formats of financial statements for different types of business
4.3     interpret financial statements using appropriate ratios and comparisons, both internal and external