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MANAII

MANAGEMENTII
SCHEDULEBLOCK4

Task

Classtopic

DueDateIIB

DueDateIIA

Class
*ARTICLE#1:SourcesofFinance
Participation

October12

October15

Class
*ReadARTICLE#1:SourcesofFinance
Participation

October14

October16

Homework

ReadARTICLE#2:InvestmentAppraisal
Homeworkis
PRESENTHOMEWORK:
Answerthefollowingquestions:
dueOctober19
1)Statethreeexamplesofbusinesssituationsthatrequire
additionalfinance.
2)Outlinetwowaysinwhichbusinessescanraisefinance
frominternalsources.
3)Explainthedifferencebetweenlongandshorttermfinance.
4)Whymightanewbusinessfinditdifficulttoraiseexternal
finance?

Homeworkis
dueOctober22

Class
*ReadARTICLE#2:WorkingCapital
Participation

October21

October23

Class
*ReadARTICLE#3:FinancialStatements(BalanceSheet)
Participation

October26

October29

Homework

Group
Activity

*ReadARTICLE#4:FinancialStatements(Profit&Loss
Homeworkis
Statement.)
dueOctober28
PRESENTHOMEWORK:Investmentappraisal.
1) Ifaprojectcosts$20millionandisexpectedtopay
back$5000000peryear.Calculatethepayback
period.
2) Ifaprojectcosts$3millionandisexpectedtopayback
$300000peryear.Calculatethepaybackperiod.
3) CalculateARRandshowallyourcalculations
Year0:initialinvestmentof3millions,Year1:profitof2
millions,Year2:profitof4millions,Year3profitof6millions
4) CalculateARRandshowallyourcalculations
Year0:initialinvestmentof3millions,Year1:profitof2
millions,Year2:profitof4millions,Year3profitof6millions

ReviewExercises

Nov4

Homeworkis
dueOctober30

Nov5

Resources:
http://abdurs.yolasite.com/resources/b%26m%20ebook.pdf

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ARTICLE#1:SourceofFinance

Financeisrequiredformanybusinessactivities.Belowaresomeexamples:

Settingupabusiness
willrequirestartupcapitalofcashinjectionsfromtheowner(s)topurchaseessential
capitalequipmentand,possibly,premises.
Businessesneedto
financetheirworkingcapital
thedaytodayfinanceneededtopaybillsandexpenses
andtobuildupstocks.
Business
expansionneedsfinancetoincreasethecapitalassets
heldbythefirmand,often,expansion
willinvolvehigherworkingcapitalneeds.
Expansioncanbeachievedbytakingoverotherbusinesses.Financeisthenneededto
buyouttheownersofthe
otherfirm.
Apartfrompurchasingfixedassets,financeisoftenusedtopayfor
researchanddevelopment
intonewproductsor
toinvestinnewmarketingstrategies,suchasopeningupoverseasmarkets.

Sourcesoffinance

INTERNALSOURCESOFFINANCE
Profitsretainedinthebusiness
Ifacompanyistradingprofitably,someoftheseprofitswillbetakenintaxbythegovernment
(corporationtax)andsomeisnearlyalwayspaidouttotheownersorshareholders(dividends).If
anyprofitremains,itiskeptinthebusinessandthisretainedprofitbecomesasourceoffinance
forfutureactivities.
Saleofassets
Establishedcompaniesoftenfindthattheyhaveassetsthatarenolongerfullyemployed.These
couldbesoldtoraisecash.Inaddition,somebusinesseswillsellassetsthattheystillintendto
use,butwhichtheydonotneedtoown.
Managingworkingcapitalmoreefficiently
Whenbusinessesincreasestocklevelsorsellgoodsoncredittocustomers(debtors),theyusea
sourceoffinance.Whencompaniesreducetheseassetsbyreducingtheirworkingcapital
capitalisreleased,whichactsasasourceoffinanceforotheruses.

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EXTERNALSOURCESOFFINANCE
Shorttermfinance
bankoverdrafts
Abankoverdraftisthemostflexibleofallsourcesoffinance.Theamountoffinancecanvary
fromdaytoday,dependingontheneedsofthebusiness.Thebank
allowsthebusinesstooverdrawonitsaccountatthebankbywritingchequestoagreatervalue
thanthebalanceintheaccount.Thisoverdrawnamountshouldalwaysbeagreedinadvanceand
alwayshasalimitbeyondwhichthefirmshouldnotgo
tradecredit
Bydelayingthepaymentofbillsforgoodsorservicesreceived,abusinessis,ineffect,obtaining
finance.Itssuppliers,orcreditors,areprovidinggoodsandserviceswithoutreceivingimmediate
payment.

Mediumtermfinance
hirepurchaseandleasing
Thesemethodsareoftenusedtoobtainfixedassetswithamediumlifespanonetofiveyears.
Hirepurchaseisaformofcreditforpurchasinganassetoveraperiodoftime.Thisavoidsmaking
alargeinitialcashpaymenttobuytheasset.
Leasinginvolvesacontractwithaleasingorfinancecompanytoacquire,butnotnecessarilyto
purchase,assetsoverthemediumterm.

Longtermfinance
longtermloansfrombanks
Thesemaybeofferedateitheravariableorafixedinterestrate.Fixedratesprovidemore
certainty,buttheycanturnouttobeexpensiveiftheloanisagreedatatimeofhighinterestrates.
Companiesborrowingfrombankswilloftenhavetoprovidesecurityorcollateralfortheloan
thismeanstherighttosellanassetisgiventothebank,ifthecompanycannotrepaythedebt.
debentures(alsoknownasloanstockorcorporatebonds).
bondsissuedbycompaniestoraisedebtfinance,oftenwithafixedrateofinterest

ARTICLE#2:
InvestmentAppraisal

Investmentappraisalisundertakenbyusingquantitativetechniquesthatassessthefinancialfeasibilityof
theproject.Nonfinancialissuescanalsobesignificantandthereforequalitativeappraisalofaprojectmight
alsobeveryimportant.Insomebusinesses,especiallythosedominatedbythefoundingentrepreneur,formal
investmentappraisalmaynotbeapplied.Instead,theownermaydevelopafeelforwhatislikelytobemost
successfulandgoaheadwiththatprojecteventhoughnoformalanalysishasbeenundertaken.Theuseofsuch
intuitiveorhunchmethodsoftakinginvestmentdecisionscannotbeeasilyexplainedorjustifieddunlessthey
turnouttobeverysuccessful.

3Methodsofquantitativeinvestmentappraisalare:
paybackperiod
averagerateofreturn(ARR)

paybackperiod:
lengthoftimeittakesforthenetcashinflowstopaybacktheoriginalcapitalcostoftheinvestment
Example:Ifaprojectcosts$2millionandisexpectedtopayback$500000peryear,thepaybackperiodwillbe
fouryears.
3

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averagerateofreturn(ARR)
measurestheannualprofitabilityofaninvestmentasapercentageoftheinitial
investment.Thismayalsobereferredtoastheaccountingrateofreturn.IfitcanbeshownthatProjectAreturns,on
average,8%peryearwhileProjectBreturns12%peryear,thenthedecisionbetweenthealternativeinvestmentswillbe
aneasieronetomake.Forsimplicity,wewillassumethatthenetcashflowsequaltheannualprofitability.Formulato
calculateARR:

Example:
Table19.3showstheexpectedcashflowsfromabusiness
investmentintoafleetofnewfuelefficientvehicles.
Theinflowsforyears1to3aretheannualcostsavingsmade.
In
year4,theexpectedproceedsfromsellingthe
vehiclesareincluded.

ThefourstagesincalculatingARR:
1Addupallpositivecashflows
=$9million
2Subtractcostofinvestment
=$9million$5million=$4million(thisistotalprofit)
3Dividebylifespan
=$4million/4=$1million
(thisisannualprofit)
4Calculatethe%returntofindtheARR
($1million/$5million)100=20%

Whatdoesthisresultmean?Itindicatestothebusinessthat,onaverageoverthelifespanoftheinvestment,itcan
expectanannualreturnof20%onitsinvestment.Thiscouldbecomparedwith:theARRonotherprojectstodetermine
whichonetochoose

WorkingCapital

Workingcapitalisoftendescribedasthelifebloodofabusiness.Allbusinessesneedfinancetopayforeveryday
expensessuchaswagesandthepurchaseofstock.Withoutsufficientworkingcapitalabusinesswillbeilliquidunable
topayitsimmediateorshorttermdebts.Eitherthebusinessraisesfinancequicklysuchas
abankloanoritmaybeforcedintoliquidationbyitscreditors,thefirmsitowesmoneyto.

Wheredoesworkingcapitalcomefrom?
Thesimplecalculationforworkingcapitalis:currentassetslesscurrentliabilities.Currentassetsarestocks,debtors
andcash.Virtuallynobusinesscouldsurvivewithoutthesethreeassets,althoughsomebusinessownersrefuse
tosellanyproductsoncreditsotherewillbenodebtors.
Thisisveryrareforbusinessesbeyondacertainsize.Wheredoesthecapitalcomefromtopurchaseandhold
thesecurrentassets?Mostbusinesseswillobtainsomeofthisfinanceintheformofcurrentliabilitiesoverdraftsand
creditorsarethemainforms.However,itwouldbeunwisetoobtainallofthefundsneededfromthesesources.First,they
mayhavetoberepaidatveryshortnotice,meaningthefirmisagainleftwithaliquidityproblem.Secondly,itwillleave
noworkingcapitalforbuyingadditionalstocksorextendingfurthercredittocustomerswhenrequired.

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ARTICLE#3:FinancialStatements

BALANCESHEET

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INCOMESTATEMENT