Btec L3 Business 2010 (Qcf) Unit 2 P4 - Sources of Finance
Business and Management
Submitted By reynedd
ESS Products LLP
ESS are a ventilation and electrical contracting business. Based in Liphook the business operates in London and throughout the South East. The main focus of the business is installing ventilation equipment into domestic properties. 70% of business turnover comes from working for Housing Associations in the London area. The company employs 16 people with the 2013/2014 turnover forecast at £750,000 which is 20% increase over the previous financial year.
Internal sources of finance.
Retained Profit: This is the cheapest form of finance and is a short-term source. This profit retained in the business at the end of the previous year’s trading can be used to grow the company organically – e.g. by spending on new equipment, staff and resources to grow their operations. This may mean potentially slower growth than taking out a loan to grow rapidly but more stable finances. It can also lead to higher long term profit as there is no debt to pay interest on for the business.
As the business had a 20% rise in turnover this year it is likely to have increased its retained profit, which should enable them to fund further growth in the future.
A way of boosting the retained profit is by reducing the owner’s salaries to retain profit in the business to fund growth. This may cause problems in the short term as the owners are not drawing enough salary, but in the medium term it can be highly beneficial for the company as a cheap way of funding growth.
Sale of assets: Because ESS owns a load of assets – i.e. things like the mechanical equipment, tools and vans. Iy would be possible for them to raise some money by selling some of this if they needed to. It wouldn’t be the most likely way to do it as they may end up selling some equipment or machines that they might need again in future and when they’ve gone, they’re gone. If they then had to replace them it would probably cost more money. Buts if it was equipment they didn’t use at all they would be better off with the cash to spend on something else. Generally Sale of Assets is not the first source of finance a business like ESS would use, but if they were short of money or unable to borrow any then it could be considered.
External sources of finance.
Bank Loan: A long-term source which could be used to help expand the business, for example funding a specific project to help grow the business such as a marketing campaign or employing extra staff.
It shouldn’t be used for funding for the day-today running of the business for example office lease salaries etc.
Bank loans can be are relatively cheap and easily managed form of external finance as they allow the owners to retain control of the business for a relatively low price.
Bank loans provide a risk to the owner/managed business as they have to be secured by an asset such as a building or the goods they were used to purchase. If there is a fall in demand for the service provided by ESS, such as might happen in a recession hit they can be very challenging times for the owners as the loan still needs to be repaid, even if they have less revenue coming in. If the business were to fail to keep up loan repayments they could lose the assets the loan is secured on and in extreme circumstances this could affect the chances of the business surviving. Because ESS is a type of business called an LLP (Limited Liability Partnership), they have Limited Liability, which means that any debts run up by the company only affect the finances of the company and not the personal assets of the owners such as their own property as well.
When the business was first started, it was just one person who was a Sole Trader who did have Unlimited Liability. Luckily this wasn’t ever a problem. As the company grew they chose to change to Limited Liability to be safer.
Overdraft: A short-term source. This is an essential shorter term finance requirement. It is for expenses that were not foreseen such as if you have to buy some extra materials before customers pay you, which helps unexpected cash flow issues but is a more expensive form of external finance because you have to pay higher interest rates than for loans, and sometimes fees to the bank too.
Overdrafts don’t have to be secured by an asset, but if the bank thinks there is a problem with the company in an emergency it can cancel the overdraft. It is a very good idea for all businesses to make sure they have an overdraft facility form their bank, even if they don’t use it.
Because ESS have had good cash-flow and are profitable they don’t often need to use their overdraft, except when they are doing big contracts where the customer doesn’t pay for a couple of months and ESS may have had to buy loads of materials and equipment to do the work.
Leasing: This can be a Short and long term source. Most of the equipment in the office is leased for example the computers, printers and vans. Leasing allows companies to invest in equipment without a large capital outlay. The leasing deals for the different equipment are normally for between 3 and 5 years, with the company paying a fixed amount each month. At the end of the lease the equipment goes back to the leasing companies. This is good for things that need replacing every few years like the vans as they just get new ones. If they want to they can buy them from the finance company at the end of the lease quite cheaply as they have depreciated in value a lot.
ESS don’t normally lease equipment such as the tools they use for the installations as they will always need these and they last a long time.
Shares: Long-term source because it changes the overall size of the company. This is the type of finance you see on Dragons’ Den. A business would use it for long-term expansion such as taking over another company or buying new equipment to expand into new areas.
A friend of the owner of ESS has offered to invest in the business without taking any ownership but on agreed profit share. Although this is a cheap and effective source of finance the owner has decided not to go down this route at the moment because they want to keep all of the ownership in the business and not have other shareholders controlling the decision making.
Trade Credit: Short term source. This is a very useful source of finance that most businesses can get and should take advantage of. To make it easier when they buy supplies form the same supplier every day or every week, they just get one bill at the end of the month, rather than making loads of separate payments. This means they get some goods for at least a month before having to pay for them, so the money can just sit in ESS’s bank account and gain interest.
ESS have to make the payments for these bills at the end of the month or else the suppliers would send them threatening letters that they might take them to court. They might also refuses to sell any more goods to ESS if they don’t pay the bills, so ESS might not get any supplies. It is very important to keep a good relationship with your suppliers because of this.
Obviously, because ESS get credit from their trade suppliers they also have to give credit to their trade customers, so it works both ways. If their customers don’t pay their bills ESS could run short of money.
Uses of funds.
The main things that the company has needed to spend money on this year have been the expansion to meet rising demand. A mixture of the different sources has been use for different items.
For example, the two new vans that have been acquired were not purchased by the company, but are on a three year leasing contract from the local Ford garage. The other way they thought about doing this was a credit loan provided by Lloyds Bank motor finance, but this would have been more expensive.
However a lot of the equipment used by the workers that is kept in the vans is purchased directly by ESS. Most of this comes from specialist suppliers and manufacturers, as there aren’t many places form which you can buy this sort of thing. To help spread the cost of the purchases ESS take advantage of trade credit from the suppliers, so they don’t have to pay cash up front.
The 4 extra employees that were taken on to use all of the equipment I have mentioned will need to be paid every month and also needed to be trained. The funds for this would have just come from the day-to-day money that ESS have. This basically means from the retained profit they have built up over the years and also the bank loan they took out. The money they have for things like this is called working capital. It is calculated by taking away the money you owe from the money you have. You need to make sure you have got some working capital all the time so you can pay for things in an emergency, it is like money in the till or piggy bank.
ESS get their finance from loads of different sources. This is because they need different types of money at different times and for different purposes. Some is needed quickly, other times it is over a long period. The most important thing for them is to make sure they can pay their bills otherwise they may go bust. So they need flexibility and to be able to get finance from different places. It is always very important for them to plan ahead and make forecasts so they can plan how much money they need and when they need it. This is the job of the accountant and managers.