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Understanding Finance

Assessment brief:

You are required to produce a budget report, complete with analysis and commentary, on a given scenario. The report consists of THREE compulsory parts.

Budget Report

Introduction

Hamble Ltd is a renowned food packing and distribution company. The company provides services all across London and the south east of England. The company is planning expansion over the next one year via acquisition of an existing business operating in east England and the midlands (Hamble Heating Services, 2021).

In this assignment, we will produce a budget report consisting of cash budget, different sources of funding, possible JV options and their ratio comparison, sales budget and factors affecting demand. Our analysis will help the directors to decide future course of action.

 Part 1

2. Analysing Cash Flow

The cash flows statement is referred to as the primary financial statements, depicting the operating, investing and financing cash flow need of an organisation (Ilkhechi and Khatibi, 2020).

Hamble Ltd performance and cash flows are gradually improving. In the month of May, company is in need of short-term funding to meet the shortage of -2990 in operating activities. March Credit sales is the lowest at 6000 affecting the May cash flows. However, company performance has substantially improved and enough cash flows are generated from June without any external funding support. Considering the short-term fluctuating cash flow, company should plan to keep credit limit/Overdraft limit or other short-term borrowing with bank to mitigate any negative cash flows.

Payables are high in the initial months showing directors have mis-planned the cash flows and built un-necessary inventory in the beginning. However, post June, payables have reduced and the cash from credit sales has surged favourably. Post July, excess cash is lying, so co. should plan to divert for future expansion.

3. Hamble Ltd. Can consider raising funds from following sources.

SourceAdvantagesDisadvantages
Internal FinancingFastest and easiest.No external borrowing.Neither regular interest payments nor stringent re-payment schedules.No dilution of ownership and control, no approval.Cheapest option (Rokhmawati, 2017).Unavailability of enough personal savings by owners.No tax deduction on interest expenses.Risk of bankruptcy for owners (Rokhmawati, 2017).
Equity IssueLess burden as no loan to repay.Good tool to build initial credit-worthiness (Liu, 2018).  Ownership diluted with new equity shareholders.Additional cost of market regulator compliances and fees (Liu, 2018).  
Bank LoanQuick access & easy availability in the market.Substantial amount available at one go depending on the collateral size (Choi, 2018).Regular interest paymentNew business face slight challenges to access (Choi, 2018).
Venture CapitalGain more quickly.Potential to raise huge amount of moneyThey offer business advisory, bring expertise and networking to business.Investors are willing to take risk as they believe in the company (Harding, 2000).Business rights diluted for owners.VCs. prioritize capital gains over business vision. Conflicting business visions.VCs’ may redeem when high capital gains are there.Long and complicated process(Harding, 2000)
Debt FundingPopular among growth companies.Benefit of tax deductions for the interest payments (Wenger, 2010).  Need to offer some collateral,Legal obligation to payHaving bearing on gearing ratio, need to be raised with caution.Excess credit having adverse effect on ratings (Wenger, 2010)..

Hamble should go with the venture capital.  Venture Capital (VC) is a type of Private Equity (Metrick and Yasuda, 2011). PE is a professionally run investment firm that invest in un-listed companies. They are known to undertake risky investments known as growth capital in the early-stage start-ups/companies.

  • VCs invest growth capital in the young companies.
  • VC firms has a specific amount for specific period spread across different companies.
  • It brings faster growth as compared to organic growth due to volume and easy availability. Further, they usually repeat funding rounds for the same company.
  • They bring in external knowledge and networking.
  • There are no fixed payment schedule and interest obligations like debt funding. So, it is advisable for growth companies (Metrick and Yasuda, 2011).

4. Equity finance is among the most popular funding options. Capital is raised through the sale of shares of a business on the stock exchange (Medina, Castaño and Tiu, 2018). In some cases, it is more preferable than any other funding alternative.

Advantages

  • No interest or payment schedules.
  • Outside investors expect the business to deliver value, they will help in exploring & executing growth ideas.
  • Some large sized equity partners bring invaluable knowledge, expertise, skills and contacts to the business. They provide strategy consultation and decision-making support.
  • Investors have a vested interest in the growth, profitability and valuation of the company.
  • Investors often provide round funding as the business grows (Metrick and Yasuda, 2011).

Disadvantages

  • Equity finance is costly in terms of money and time due to initial formalities and stock exchange fees, consulting charges etc.
  • Sometimes, it diverts management focus to non-core business activities.
  • Promoters are prone to lose power in management decisions due presence of external investors.
  • Stringent regulatory compliances (Medina, Castaño and Tiu, 2018).

Part 2

Hamble should purchase the Norwich Ltd. It is doing better in terms of profitability.

ProfitabilityNorwich LtdSalford Ltd
Gross profit margin (%)27.6%19.7%
Operating profit margin (%)15.0%6.1%
Return on capital employed (%)62.8%20.2%
Asset turnover4.173.31

Further, it will be a able to cover 4 working capital cycles in the financial year (Vs 3 for Salford Ltd.) thereby cash-to-cash movement is better.

EfficiencyNorwichSalford
Inventory turnover (days)7899
Receivables collection period (days)3265
Payables payment period (days)2634
Operating cycle (days)84129

In terms of liquidity, both are doing good as current ratio and acid test are better than 2:1 and 1:1.

LiquidityNorwich LtdSalford Ltd
Current ratio3.8:13.6:1
Acid test1.4:11.6:1

Norwich is majorly funded by equity showcased by a lower gearing and high interest cover ratio.

GearingNorwich LtdSalford Ltd
 Gearing3.3% 42.7% 
Interest cover62.6times9.8times

So, we will advise Hamble Ltd. to purchase Norwich Ltd.

Part 3

 Hamble Ltd. is dealing in food packaging and distribution. The demand has fluctuated after covid-19 due to multiple reasons.

As schools, colleges and hospitality sector are not operating at 100% capacity due to lockdowns and covid restrictions, the demand has slowed down for items like seasonal boxes.

On the other hand, rapid covid cases and hospitalisation along with instant household demands due to sudden lockdown announcements have caused a surge in the demand for food items.

Reference

Choi, S., 2018. Bank Lending Standards, Loan Demand, and the Macroeconomy: Evidence from the Emerging Market Bank Loan Officer Survey. SSRN Electronic Journal,.

Hamble Heating Services, 2021. Hamble Heating Services Ltd – Health and safety. [online] Hambleheating.com. Available at: <http://www.hambleheating.com/index.php?option=com_content&view=article&id=81&Itemid=589> [Accessed 1 September 2021].

Harding, R., 2000. Venture capital and regional development: Towards a venture capital ‘system’. Venture Capital, 2(4), pp.287-311.

Ilkhechi, O. and Khatibi, S., 2020. The Impact of Earnings Persistence on the Operating Cash Flows with Emphasis on Financial Constraints. International Journal of Business and Administrative Studies, 6(5).

Liu, H., 2018. Why Do Banks Issue Equity?. SSRN Electronic Journal,.

Medina, P., Castaño, M. and Tiu, T., 2018. Equity Analysis in Buying Company Shares on the Philippine Stock Exchange. Journal of Finance and Banking Review Vol. 3 (4) Oct-Dec 2018, 3(4), pp.60-66.

Metrick, A. and Yasuda, A., 2011. Venture Capital and Other Private Equity: a Survey. European Financial Management, 17(4), pp.619-654.

Rokhmawati, A., 2017. Do Financial Constraints Moderate the Impact of Financing Decisions From Internal-financing Sources on Investment?. Jurnal Keuangan dan Perbankan, 21(3).

Wenger, T., 2010. Subordinated Debt in Bank Funding and Financial Market Stability. SSRN Electronic Journal,.

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