Sources Of Finance And Impact On Financial Statements Finance Essay

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This brief report highlights the financial performance of the Trevors PLC using ration
analysis and decisions on new projects that the company is going to be invested.
Firstly it will focus on the financial statements of a company and the formats of
financial statements.
Secondly ration analysis performs on the basis of the information given about
Trevors Plc. This explains under the main headings of Profitability, asset efficiency,
liquidity, working capital management, solvency and Investors ratios. In addition to
that it discusses the insufficient information to raise accurate comments on ratio
analysis.
Thirdly the emphasis will be given to the results obtained from net present value and
Payback period calculations.
Fourthly it identifies sources of finance. It involves details analysis of each financing
methods and tax, ownership and controlling implication of each source.
Finally the attention will be given towards the importance of financial planning and
information need of the decision makers. Recommendation and conclusion of this
report included in the latter part of this report.

Financial statements
Financial statements form a basis for understanding the financial performance,
position and liquidity of a firm. As per the IAS Financial statement refers to,
Balance sheet
Income statement
Statement of changes in equity

Cash flow statement

Accounting policies and notes
An annual report includes following in general,
Financial statements
Auditors report
05 year summary of key financial data
Stock prices(High or low)
Management discussion and analysis
Financial statements give good direction to achieve the objectives of a user. Fr
example a lender to a firm in deciding whether or not to lend may refer to the cash
flow statement. Financial health of a firm could be better understood by means of
cash flow statement. Therefore this information collection can be viewed as a map,
which provides a good direction.
Often financial statements contain a large amount of information. Further the
accounting policies, reporting environment, accounting practices are complex and
constancy changing. The man can hide or omit key information, create the picture
they require. Though the accounting standard limits variability, still financial
reporting in different firms and industries has considerable deviations.
The balance sheet is the snap shot of the firm. It is a convenient means of organizing
and summarizing what a firm owns and what firm owes and the difference between
the two at a given time (Equity). The structure of assets for a firm reflects line of
business that the firm is in and also marginal decisions about how much cash and
inventory to have and about credit policy, fixed assets acquisition and so on.
Income statement measures a performance over some period of time, usually a
quarter, or year. If you think balance sheet as a snap shot, then you can think of the
income statement as a video recording covering the period between a before and an
after picture.
Information about the cash flows of an enterprise is useful in providing users of
financial statements with a basis to assess the ability of the enterprise to generate

cash and cash equivalents and the needs of the enterprise to utilize those cash flows.
The economic decisions that are taken by users require an evaluation of the ability of
an enterprise to generate cash and cash equivalents and the timing and certainty of
their generation.
A cash flow statement, when used in conjunction with the rest of the financial
statements, provides information that enables users to evaluate the changes in net
assets of an enterprise, its financial structure (including its liquidity and solvency)
and its ability to affect the amounts and timing of cash flows in order to adapt to
changing circumstances and opportunities. Cash flow information is useful in
assessing the ability of the enterprise to generate cash and cash equivalents and
enables users to develop models to assess and compare the present value of the
future cash flows of different enterprises. It also enhances the comparability of the
reporting of operating performance by different enterprises because it eliminates the
effects of using different accounting treatments for the same transactions and events.
As discussed in above lenders can evaluates the secure of their lending using g the
information reflects on the cash flow statement. On the basis of that, if a company's
cash flow statement reflects the well management of their cash and cash equitant
that company is in position to raise fund easily from external sources.
Various tools can be used in financial analysis. The derivative financial statements,
(Cash flow statement, fond flow statement) Common size financial statement
(Common size balance sheet and common size income statement), trend statement
and Financial ratio analysis are the most commonly used tolls in financial analysis.
These can be used as techniques of analyzing financial information for a more
meaningful understanding of the financial position and performance of a firm.

Formats of financial statements

There are three basic forms of business organizations. Sole proprietorship,
Partnership and limited liability companies. Sole proprietorship is a business form
for which there is one owner, in a partnership two or more individuals act as owners
and a limited liability company is a separate legal entity from its owners. When
shares of a public limited company are listed, the company is known as quoted
company, whose financial statements publication is compulsory. Therefore the
annual reports of quoted companies are a major source of financial information.
However most of the time, the financial information of sole proprietorships,

partnerships and private limited liability companies are not readily publically
available as there are no volunteers in financial statements publication.

Tryor Plc presented their financial statements in accordance with the IAS'S since it
get affects from legal requirements such as listing rules governed in the stock
exchange. The main reason is the Tryor Plcs shared are listed on the stack exchange.

Ratio Analysis
Financial performance of the company can explain using a variety of measures. In
particular, in this report, principally discuss the Trevor's results by using ratio
analysis. Ratio analysis can be regarded as a technique used in the financial
statement analysis. It gives an insight in to the performance of an enterprise.
Ratios could primarily be divided in to following areas:
Profitability
Asset Efficiency
Liquidity
Working Capital Management
Gearing/ Leverage
Investors Ratio

Profitability
This ratio reveals the efficiency of a business in terms of profitability and Assets
utilization.
Gross profit ratio of the company is recorded as 28.95%. This ratio is said to be
favorable but in order to make accurate comment this has to be compared with the
last year figures or industry averages. Net profit ratio of Trevor's is 6.37%. Net profit
ratio is also said to be favorable to the company since company earning profits from
their operations. Trevor Plc was able to achieve significant turnover for the period. In
addition to that management of the company was able to manage their cost of

operations efficiently. However accurate comment on both rations will depend on the
results of the last years and industry averages. (Refer Appendix 01 Profitability
ratios)

Asset Efficiency
It assesses the efficiency of the company in terms of assets utilization. It is concerned
on the areas of utilization of fixed assets and working capital. The detail analysis
these ratios will reveal whether there are any idle assets or underutilized assets.
Assets turnover is recorded at 0.73 (Refer Appendix 01 Asset efficiency ratio). This
ratio indicates the 1 of assets generates 2.38 sales to the company. Therefore
available information for the company is not sufficient since it has to be compared
with industry averages or past year's results.

Liquidity
This ratio assesses the liquidity position of the company.
Liquidity is the amount of cash a company can put its hand to settle its debt and
possibility to meet other unforeseen demands for cash payments too. A company can
obtain liquid assets other the sales such as issue of shares for cash new loan or the
sale of long term assets. But a company cannot rely on these at all times, and in
general obtaining liquid funds depends on making sales and profits.
Company's Current ratio is 2.16. Further Quick assets ratio is recorded as 1.50. (Refer
Appendix 01). In theoretical view these two ratios are expected to be within a given
range of 2:1 and 1:1 respectively. Trevor's current ratio and quick assets ratio are lie
within that given range. As a result of that company's liquidity position is held at
good position. Therefore management of the company has to adopt on current
strategies to continue this position in future also. However these ratios also
compared with last year results or industry averages to raise an accurate comment on
liquidity position of the company.

Working Capital Management

This assesses the efficiency of the working capital management of the company.
Finished goods turnover ratio is recorded as 12 times. (Refer Appendix 01) Further
this led to finished goods residence period to 30 days. In addition to that Creditor's

turnover ratio of the Trevor's PLC is recorded as 8 times. Further company creditors'
period from suppliers is 45 days.
Factors such as stock policies, policies on credit period allowed to debtors and those
obtained from suppliers helps to determine the working capital management of the
company. Comment on those rations cannot be raised due to unavailability of
information. However Company would concentrate on increasing the rapidity of cash
cycle, because each cycle can enhance the profitability of the company.

Solvency
Gearing ratios are concerned with a company's long term stability. How much the
company owes in relation its size, whether it's getting in to heavier debt or improving
situation, and weather its debt burden seems heavy or light.
Debt to equity ratio recorded as 3.94. It means 01 of equity carries 3.94 of debt.
(Refer Appendix 01 gearing ratio) By just seeing the ratio it's fair to say that Trevors
uses significant amount of debt and can be identified as a geared company.

Debt generally carries a fixed rate of interest; hence there is a given amount to be
paid out from profits to holders of debt before arriving at residue available for
distribution to the holders of the equity. The highly gearing situation creates greater
risk to the equity holders. This means that there will be a grater volatility of amounts
available for ordinary shareholders and presumably therefore greater volatility in
dividends paid to share holders. Dividend payment in year 2009 is 50,000.

Investor's ratio
These ratios are considered to be external ratios and are used in evaluating the
stability and investment potential of a company.
Basic Earnings per share of the Trevor Plc was 2.03 in 2009, reflecting the
profitability in 2009. (Refer Appendix 01 Investors ratio). Trevor's Plc can be
considered as a well performing company in the industry since company maintains
favorable investor's ratios attracting potential investors. However this comment will
not be accurate due to unavailability of comparison information about the past
results of the company or the industry averages.

Net Present Value (NPV) and Discounted Pay

Back Period
NPV = 484,750.89 (Refer Appendix 02)
Discounted Pay Back Period = 02 years and Nine Months (Refer Appendix 02)
This project gives positive NPV of 484,750.89. Further this project enables to
recover its initial investment with in the period of 02 years Nine months. In order to
make a decision based on the discounted payback period it has to be compared with
target payback period. However project recovers its cost during its life time.
Meanwhile positive NPV value gives a favorable indication that project is worthwhile.
Therefore according the calculation it's profitable to accept the project.

Sources of Financing
Term Loans
Higher Purchases
Debentures
Venture Capital
Leases
Offer for sales
Right Issue

Tax Impact, Control and Ownership of Sources

of finance
Term Loans, Higher purchases, Debentures, Leases and venture capital can be
identified as the debt financing methods.
In the case of term loans, higher purchases, debentures and leases, existing
ownership of the company may not be diluted. Voting rights to Control the company
lies with the equity holders even though the company raise finance through above
mentioned sources. Interest payments on debentures and term loans are tax
deductible and debt holders do not have any controlling power in the company.

However in the case of venture capital there is a risk associates with controlling
power of the company, since controlling and planning of the business will be held in
the newly acquired management.
Rising of equity financing is much easier for a public company whose shares are
traded on a stock exchange then it's for a private company. Offer for sales and right
issue can be identified as sources of Equity financing. Right issues are cheaper than
offer for sales to the general public since it does not require the prospectus and less
cost of underwriting. Right issues are more beneficial to existing shares holders than
new shareholders. New shares are issued at discount to the current market price to
the existing shareholders. In the case of right issues controlling power and ownership
of the existing shareholders may not be diluted. However offer sales will lead to
dilute the controlling power of the existing share holders. Dividend payments to
existing shareholders and new shareholders are not tax deductible.
Term Loans
Long term loans are available from lending institutions and the commercial banks. It
can be obtained to cover specific projects for restructuring as well as for equipment
financing. Term loans are granted mainly on the strengths of cash generation of the
project. This type of term loan facilitates grace period and easy repayment schedule
at the early stage of projects operations.
High purchases
This is defined as procedure of purchasing goods under which the purchaser pays a
deposit on the receipt of the goods followed by a number of installments until the
debt is cleared. The goods do not become the property of the purchaser until the last
installment has been paid.
Debentures
Debenture is direct from of borrowing by a company from the investors. In this case
the interest rate and maturity period are fixed. The company is not required to pay
the value of the debt before maturity although in some instances companies may
prefer to redeem them before maturity by buying them back in the market.
Venture Capital

It refers to participation by way of equality or co- financing through long term

convertible debt in business. Venture capital means risk capital. This type of capital
is sought to assisting product development, market research and acquisition of plant
and equipment. Risk associates with this are venture capital involves control of
management and planning of the business.
Leases
It's a form of lending which enables a firm to use an asset without owing it. The
owner of the assets grants another party the right to use the asset usually for a
specific period in return of a series of specific rental payments. The risk is that lessee
is not the owner of the asset for which he cannot claim capital allowances.
Offer for sale
Offer for sales is method of issuing shares to the public, which have already been
bought by an investor as a block. Therefore it's not considered as a primary issue but
a secondary sale. A financial institution buys blocks of shares usually when the
companies are formed and offer to the public at a later date.
Right Issue
Is a new issue of shares but subscription is limited to existing shareholders.
Companies in need of additional capital usually go right issue unless the funds
requirement is very large. The issue price will be determined usually at a level lower
than the market price.

Cost of sources of finance and impact on

financial statements (FS)
Capital structure decision is very significant since the question arises where her there
is an optimal mix of capital and debt which a c company should try to achieve. If
company is looking for obtaining debt Capital Company should earn enough profits
to cover its interest charges before anything is available for equity. On the other hand
if borrowed funds are invested in projects which provides return in excess of cost of
debt capital, then the shareholders will enjoy the increased return on their equity.
General cost of debt of each source as discussed in above is greater than the cost of
equity financing. However tax savings can be enjoyed by the company in the cash of
interest payments on debt financing. In the case of issuing shares to the public
company has to incur considerable amount of expenses which are not tax deductible.

As far as companies are concerned debt capital is potentially attractive sources of

finance because interest charges reduce the profits chargeable only to corporate tax.
Shares can be issued to the public for the company whose shares are traded on the
stock exchanges. In such case financial statements has to be complied with the IASs,
listing rules and other regulations governing under the various institutions. Further
format of financial statements for those companies are predetermined. But any
company can obtain debt financing. In such case if the company is a quoted
company, it has to be disclosed the financing sources and their cost and interest
payments made during the period.

Best method of raising funds

Initial investment of 1 m for the new project can e obtained from the term loan as a
source of debt finance.
Term loan has been selected to finance this project since this type of a loan can be
easily obtained by Trevor PLC. It's quoted public company and this loan is obtained
as the project oriented loan. Company's controlling power and the ownership of the
existing shareholders will not be diluted. This is a main advantage to the company. In
addition to that company does not have to incur any issue cost on issuing shares or
debentures to the public. Company should have to incur only the interest payment on
the borrowed amount of 1m. Further interest payment on such loans is tax
deductible and company can enjoy some tax savings. Debt holders do not have any
controlling power on the entity. Anyhow company liable to pay interest whether
company earn profit or incur loss. But this method is very suitable since this project
generates a positioned net present value.
In addition to the above this type of a loan repayment is geared to the specific needs
of the project and may include a grace period before repayments commence and
easier repayment schedule at the early stages of projects operations. Depending on
the nature of the cash flow patterns firms are sometime allowed to capitalize the
interest during the start up period.

Financial Planning
Finance for a business is provided either by owners or creditors. Finance is
categorized by their maturity periods as short term and long term. Short term funds
have maturity of on e year or less while long term funds have maturity of more than
on e year. Therefore financial planning is very important for a finance manger since

he has to match cash inflows from assets with the assets sources of financing. As such
medium and long tem fianc investment in an enterprise should be financed from a
medium and long term source. Investment in fixed assets such as land and buildings,
plant and equipment generates benefits during their effective economic life.
Therefore fund s locked in these assets will be repaid over a longer period. Thus long
term assets should not be financed through short term sources. Therefore financial
planning is significant without which company may incur heavy losses or possibility
to go for bankruptcy.

Information Needs of decision makers

Piece of Information about any company is very essential to the stake holders who
are interested in that company. Different stakeholders see the organizations from
different angels. As such existing shares holder's likes very much about the sales,
gross profits, expenses incurred and profits earned during the period and any
dividend payments. Potential investors are interested about the current earnings per
share and new investments that the company is going to be implemented. Employees
keen about the bonus payments, incentives, series and wages and potential survival
of the company to ensure their job security. Government regulators are looking for
information about profits and business operation to collect tax payments and other
duties imposing on the nature of the business. As such different king of information
about the company serves the stakeholders to make decisions which maximize their
value.

Unit Cost and Profit Margin

As per the calculation (Refer Appendix 03) unit cost of a toy is recorded as 19.68.
Whereas profit margin of a toy (Refer appendix 03) is equal to the 0.7179 in
accordance with calculation.

Recommendation & Conclusion

It is recommended Trevor's Plc to undertake the new project of manufacturing and
selling brand new toys since it generates positive net present value. It's fair to say the
Trevors Plc perform their operations well. However accurate comments on ratio
analysis cannot be raised since unavailability of comparison information about the
past results of the Trevors PLC and industry averages.