Good management of finances and investments is crucial to the success of any organisation. Therefore, the essay reports different ways of funding a business, their costs and effects on the financial statements. The various roles of the budgetary process in companies are also highlighted in the paper. In addition, the use of the Net Present Value to differentiate between viable and non-viable is included in the essay. The article concludes with the analysis of the British Airways financial statements and their significance.
Financing a company is one of the most vital decisions that managers are supposed to make from time to time. As such, it is of great importance for any manager to be aware of various ways of raising finance. Since different funds are utilised in a business venture over varying lengths of time, they can be classified into three types. The first category that consists of funds available to a company within only one year is the short-term financing. An enterprise like the Financial Consulting Firm can support its current assets through trade credit, overdrafts, bill discounting, lease finance, and short-term loans among others. Through an overdraft, it is possible to get more money from the bank than the company has in its account. The firm can also receive short-term loans from commercial banks and repay them in one year with interest. Moreover, the firm can access lease finance by acquiring an asset from another company; then, the ownership will be passed to the firm after all the payments are made. The other short-term finance is the invoice discounting through which the company can give discounting companies the authority to gather debts from its debtors. Finally, the firm can still use products from the suppliers but pay after three months or so (Pride, Hughes, Kappor 2012).
The other category of funding the activities of the company is the medium-term finances. Sometimes it is hard to secure long-term investments for a corporation in such instances; it is practical to use funds that last between three to five years. Lease finance, hire purchase funds, debentures as well as preference capital are some of the examples in this group. Minaxi (2010, p.167) describes debentures as debt instruments that corporations can use to get money over the years. The firm is obliged to pay the debenture holders an interest every year and reimburse them the full amount of the debentures after the lapse of a particular period. Hire purchase is another means of acquiring assets even with inadequate funds, but the firm has to make monthly payments to the hire purchase company. Moreover, the consulting corporation can issue preference shares to its shareholders as a way of gaining capital. On the other hand, the preference shareholders will earn dividends from the firm. In addition, a financial consulting firm can opt to borrow loans from commercial banks and other financial institutions or even from the government.
According to Pride, Hughes, Kappor (2012, p.577), acquiring or maintaining fixed assets can only be done through long-term funding. As a result, this type of financing lasts for a very long time, from 5 to 20 years or even more. Most of the examples in this category are similar to those in the medium-term group, only they last longer like the debentures, preference shares and term loans. The firm can also use international financing, asset securitisation, retained earnings, venture funding or the ordinary share capital as part of lasting finances. One of the most efficient sources of funding is the retained earnings since there is no cost to the company when using it. They are the profits that a firm has saved over the time it has been operating. The second source is the equity shares bought by the shareholders of a business enterprise. Additionally, external investors provide financial support to companies that have the potential for real returns in the future. Lastly, asset securitisation involves issuing securities that are backed by a pool of illiquid assets owned by the firm. Examples include collateralised debt obligations, asset-backed as well as mortgage-backed securities.
Subhash (2013, p.820) suggests the need to understand how various finance sources affect the work of a company. For instance, if a financial consulting firm requires shielding itself from risky lending, it can opt for a short-term funding as it is easy to repay it quickly. Moreover, sometimes a company may aim at investing in real opportunities but does not have adequate funds. Therefore, it can use short-term funds to support such emerging opportunities. Nevertheless, most of the projects in business cannot be supported by this source of finance as it is available for a few months only. A long-term financing also has its share of implications such as high costs, restrictions on the business and call for thorough credit appraisal. Furthermore, the risks are very high because it can put a corporation in financial distress if it defaults on repayments. Despite all the negative effects of the finance, it has some advantages for any business. Firstly, the firm will be able to expand its working capacity such as if it uses the funding to buy office equipment or new office buildings. Secondly, compared to other forms of financing like the short-term funds, these finances are more stable due to the formal contracts. In terms of negative and positive implications, the medium-term funding is similar to the long-term investments (Minaxi 2010).
A financial consulting firm needs to take into consideration a variety of factors before selecting an individual source of funding. The first factor is the urgency of the funds; the firm has the advantage of getting funds from cheap sources if the finances are not required in a short time. However, if it is urgent, it does not have an option not incurring high costs for accessing the funds. Secondly, the cost that the company is likely to sustain for obtaining the resources also plays a key role in choosing the source. In the same way, it is better to use funds that have lower risks to reduce negative implications for the firm. Organisations also require utilising money over different periods of time. As such, it is significant to identify the time to eliminate unsuitable sources. Equally, some sources like the venture capital and the issuance of shares are influenced by the control of the organisation. As Subhash (2013, p.822) observes, the gearing ratio is an important issue to consider in the determination of ways of raising funds. High geared companies will find it hard to borrow from commercial lenders. Apart from the above factors, the total funds that the firm needs also have an effect on the source of the finances.
Companies in the travel and tourism industry utilise funds just like organisations in other sectors. The sources of funding more often than not incur various costs to the organisations acquiring them. For instance, bank overdrafts attract high interests since the banks charge the companies daily. Similarly, loans have interests, although they are fixed for short-term loans and vary for long-term loans. Another source that has interests as the costs of the funds is the invoice discounting. According to Minaxi (2010, p.170), even if retained earns do not have tangible costs, the firms still sustain opportunity costs. For venture capital, the business will have to refund the money, and the investor will earn as well as control the enterprise. Both preference and ordinary shareholders receive dividends annually, and the issuance of shares has administrative costs. An organisation pays floating or fixed interest rates for medium and long-term debentures. What is more, if a company acquires some assets through hire purchase, it will use more money than the cash price of the same asset. Equally, leasing an asset instead of buying one will force the company to pay rental interests (Minaxi 2010).
Every organisation that engages in activities related to tourism and travel needs to adopt proper financial planning to ensure success. Financial planning is a combination of different aspects related to business finances like types of available sources of funding, budgets, long-term and short-term plans, ratio analysis, and pricing policies. The first role of financial planning is suitable cash management for smooth business operations. Secondly, it assists organisations in measuring their progress by using tools such as financial statements. For this reason, organisations will always operate on the right track. In addition, various components of financial planning enable companies to be future-oriented. Some expenses in a business are more important than others; thus, there is a need for financial plans to support the prioritisation process. Besides, funding a business organisation requires a comprehensive financial planning. Therefore, the overall success of a company depends on effective financial planning (Graham, Smart and Meggison 2012, p.478).
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There are various stakeholders in an organisation who include consumers, lenders, management, investors and creditors. The consumers of a company are concerned with the continuity of the business as they receive products from it. The long-term and short-term lenders require the gearing and liquidity ratios of a company respectively. On the other hand, the management must make vital decisions based on the accounting information from the financial statements. Additionally, both the existing and potential investors are interested in the profitability of an organisation because of the returns they earn. Another group of decision makers is the creditors who must consider a company’s credit worthiness before they can work with the organisation. All these stakeholders use information from the financial statements to make decisions that affect the business. Hence, the analysis (ratio, trend, vertical, and horizontal) facilitates the effectiveness of the financial statements as a tool for decision-making (Drury 2007, p. 6).
Both the balance sheet and the income statements reflect different types of finances that the company is using and their respective costs. Bank overdrafts are short-term debts; so, on the balance sheet they fall in the section of the current liabilities. In the income statement, the profit is reduced by the amount of the bank overdraft fees as well as interest charges before charging the tax. Short-term and long-term loans appear in current and long-term liabilities in the balance sheet respectively, while the income statement shows the amount of interest on the loan. As for the bill discounting, only the respective increases in cash balances due to it are displayed in the balance sheet. Moreover, the income statement records any fees and interest rates from bill discounting. The equity capital segment of the balance sheet documents the finances from venture capital, while the appropriation section in the profit and loss account shows the profits earned by venture capitalists. Debentures appear in the long-term liabilities part of the balance sheet, and debenture interest rates are deducted in the income statement prior to tax deduction. Finally, the balance sheet equity capital section records the amount of preference and ordinary shares. Furthermore, the balance sheet documents the share premium, the dividends for preference shares and the exact number of shares. The income statement has an appropriation account that indicates the dividends on the issued shares (Whittington & Delaney 2010).
Compared to large companies, SMEs (Small and Medium-Sized Enterprises) face some unique challenges like inadequate resources, limited managerial skills, unstructured procedure and disciplinary system as well as deficit in human resources department. For this reason, budgets play a significant role in running SMEs. Budgets comprise financial plans and involve budgetary control that uses a process called the variance analysis. Through the variance analysis, an organisation can identify the difference emerging from the actual performance to the budgets. The first role of budgeting is to allocate the inadequate resources in SMEs to different functions of the businesses. Since most organisations in the SMEs category lack adequate procedures, budgets assist in offering the required structure to focus the company in the right direction. Additionally, using budgets in small enterprises that have not been operating for long is a good way of forecasting cash flows from business activities (Adams 2006, p. 126). Another vital budget objective is the measurement of the performance of an enterprise over some period. Being part of the budgeting process, the variance analysis is a single procedure which assists in determining the organisational performance. Adams (2006, p.126) highlights motivation of employees as one of the budget objectives. The workforce will be aiming to achieve the standards set by the management using the budgets. Besides, the monitoring of performance and expenditures of the company through budgetary control enhances efficiency.
It is crucial for a business to determine the unit cost of its products as it defines the total cost incurred for one product. When an organisation is determining the unit cost, it should consider the entire variable and fixed costs. The total costs (both variable and fixed associated with a product) are then divided by the total number of products generated (Drury 2007, p. 120). The variable costs vary according to the changes in the production of products, while the fixed costs do not change. Mostly, due to economies of scale, the unit cost reduces with the increase in the size of the organisation. However, it is evident that the production of large numbers of product units does not result in the change of the unit cost. Important pricing decisions can be made using the knowledge of unit costs. Nonetheless, it is only possible after the determination of the break-even point for the company. The point shows the number of products to be generated making neither a profit nor a loss. After the break-even point, the company can start earning profits with every additional product unit sold. To calculate the break-even point, one needs to subtract the variable costs from the unit sale price, and then use the product to divide the fixed costs. Subsequently, the unit costs as well as the break-even point determine the pricing strategy for a company and prediction of the expected returns (Drury 2007).
The Net Present Value (NPV) is among various procedures used when appraising available capital investments in an enterprise. When determining the project to undertake, the NPV method will assist the management in analysing the benefits as well as the costs of the projects. The first step will involve identifying the cash flows expected from the investments, and then calculate their present values. Secondly, the costs associated with the ventures along with their current values are also determined using the NPV formula. The last stage of this method is the evaluation of the gains and costs of each project through subtraction. According to Gotze, Northcott and Schuster (2015, p.50), for a project to be viable, its NPV must be positive. The management should then select the investment with the highest positive NPV. Investing in the selected project shows that the wealth of the shareholders in the company will be maximised. Using the method has the advantage of choosing the best project when a firm has budget constraints. In addition, the criterion used to select a project is absolute since if the NPV is negative, it will make losses in the future. Therefore, the management will be confident of the profitability of the investment before adopting it. The benefits of the process are also evident in its ability to determine the opportunity costs and the risks of the investments using the discount rate (Gotze, Northcott & Schuster 2015).
All companies are required by law to prepare different reports that show their activities annually. Apart from the law, the stakeholders use financial statements to determine the performance and profitability of the enterprises.
The first financial statement prepared is the balance sheet formally identified as the statement of financial position. The balance sheet documents what belongs to the organization (assets), what it has borrowed from other parties (liabilities) and the equity that belongs to the owners of the business. It is an accounting rule that the total equity as well as the liabilities of an enterprise balance with the assets. For this reason, a well-prepared statement of financial position must ensure that the accounting equation is observed (Kurtz & Boone 2011, p. 548).
Secondly, cash flow changes throughout a particular period like a year are recorded in a cash flow statement. Moreover, both the bank balances as well as the cash are included in the cash flows. Nevertheless, there is a slight difference in the way the small and large companies present their cash flow statements. The cash flow statement of a small organisation is simple since it just shows the cash outflows section and the cash flows part. On the other hand, a large corporation has three categories of cash flows. As such, the primary functions undertaken by a company are operating activities, while investing activities are cash flows obtained through acquiring and disposal of assets. Large organisations issue shares, pay dividends, interests and debts (financing activities) (Kurtz & Boone 2011, p. 549).
The owner’s equity is an important part of any organization; therefore, it is the reason for the preparation of financial statement showing the movements of the equity (Statement of Changes in Equity). To prepare this report, information must be acquired from other sources in the company like the dividend payments and net profit/loss. The shares issued in a specified period also affect the owner’s equity. Another change included in the report is any accounting policy alteration influencing the company’s equity (Kurtz & Boone 2011, p. 549).
The tourism sector organisations should also provide an income statement to its stakeholders to show the returns (profit or loss) of a business annually. Expenses and revenues from the company activities are the only components of the income statement. From the two elements, it is possible to derive the profits or even losses of the enterprise. Just like other financial statements, the income statement may look slightly different depending on the size of the business. However, in all the income statements, the expenses and revenues will show the profit or the loss incurred. Apart from indicating the profitability of a business, the income statement also assists in tax returns (Kurtz & Boone 2011, p. 560).
The performance of British Airways can be determined through ratio analysis. From the calculations of liquidity ratios as indicated in the appendix section, the liquidity of British Airways is not enough. The quick, current and cash ratios are 0.61, 0.62 and 0.14 respectively. The value of less than 1 in liquidity ratios shows less liquidity of an organization and thus its inability to fund its liabilities (Gibson 2009, p. 177). However, the airline is still profitable according to the gross profit margin, return on assets and pre-tax profit margin, although the margins are small. It can also cover its operating expenses without borrowing externally. Furthermore, the investors will still be interested in British Airways since the Return on Equity (ROE) is rather high (12.21%). Nevertheless, comparing the ROE ratios with other organisations in the travel and tourism sector would give more information on the profitability of British Airways. British Airways can sell its products quickly from the high Inventory Turnover Ratio of 103. On the other hand, the corporation does not collect money from its debtors more often, which is not good. Moreover, the company seems to have inefficiencies in its management of the assets as both the fixed asset turnover and sales to assets ratios are very low (Gibson 2009, p. 178).
In conclusion, the management of a company must consider the costs involved before selecting certain forms of finances. Moreover, it is also important to evaluate the profitability of a project using a method such as the Net Present Value. Besides, the SMEs companies can overcome most of the challenges that they face by adopting an efficient budgetary control. Lastly, the performance of British Airways is relatively good according to the ratio analysis presented in the essay. However, it should increase its efficiency to promote its profitability in the future.
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