Financial Analysis and Funding Strategies Case Study

Acme's Product Ltd: Growth Strategies

Part 1: Comprehensive Analysis of Financial Statements

Section 1.1 Balance sheet

Section 1.2 Profit and Loss Statement

Section 1.3 Statement of Cash Flow

Section 1.4 Ratio analyses

• Quick ratio

• Operating profit market ratio

• Return on equity

• Debt to equity ratio

• Interest Coverage Ratio

Section 1.5 Analyses the financial statement of Acme's product ltd

A. Ratio analysis

For analyses the financial statement ratio analysis techniques have been used which will help in determining the short-term and long-term position of the company. Financial statements for the years July 2021 to Sept 2022 have been taken and further calculations have been upon them.

• Liquidity position: The current ratio and quick ratio have been determined to identify the liquidity position of the company. The current ratio of the company is 1.12 and the quick ratio is 0.68 which are both less than the ideal ratio (Financial statement of Acme's Product Ltd 2023). This shows the company will not be able to pay its short-term obligation by selling its current assets and quick assets. This means that the company's liquidity position is not good and the company should invest more in current assets.
• Solvency position: To identify and analyse the company's solvency position debt debt-to-asset and debt-to-equity ratios have been calculated. The debt-to-asset ratio is 0.5 which is regarded as the safe ratio a for company. The debt to equity ratio is 1 which means the company's debt liability and shareholders are equal This shows that the company will able to cover its long-term liability as the company has sufficient cash flow.
• Profitability position: Gross profit and net profit ratio have been calculated to determine the profitability position of Acme's product Ltd. Gross profit is 40% and net profit is 9% which is lower than the ideal ratio (Husain, and Sunardi, 2020). This indicates that the company should focus on increasing profit by decreasing the cost of the product or operating expenses.
• Efficiency position: Efficiency position is determined by identifying the company's capability to generate income by utilizing its assets. The inventory turnover ratio and total assets to sales ratio have been calculated to determine the position. The inventory turnover ratio is 0.7 which indicates that the company is selling its whole inventory in 7 months which indicates the company is not having effective control over inventory. The total asset-to-sales ratio is 6.7 which is a high ratio so the company should focus on improving its efficiency.

B. Strategies for better performance

• From the financial statement, it has been identified that the cost of goods sold has been increasing from the past year so the company should adopt various strategies such as automation, lowering the cost of materials, buying in bulk amount etc to reduce cost.
• The company should focus on investing in current assets and delay any capital purchase. The company's liquidity position is not good so to improve the company could sell off assets that do not generate any return and drawings in the company should reduced.
• Operating expenses of the company should be reduced as it results in a decrease in the gross profit of the company (Gunarathne, Lee, and Hitigala Kaluarachchilage, 2021). The pricing strategy needs to be evaluated so that appropriate costs should be identified for the product which could increase sales.
• Inventory control techniques such as batch tracking, first in first out and ABC analysis should be adopted for effective management of inventory.
• The company should sell out its assets which are not generating returns as this is decreasing the efficiency of the organization.

PART 2: Key Considerations and Sources of Business Financing

Section 2.1 factor affecting the choice of source of fund

• Risk: It is an important factor which needs to be evaluated before raising funds from various sources. Some sources include higher risk and some have low risk. Raising funds from equity shareholders leads to higher risk than debt. Equity involves the risk of paying higher returns and if not pay they may disinvest their funds. Raising funds through debentures or loans includes risk as regular interest needs to be paid and the principal amount needs to be reimbursed after a particular period. Evaluating risk helps in identifying whether to raise funds from a particular source or not.
• Control: Each company want to possess full control of the working of the organization but raising some sources includes dilution of power. If a company do not want to have full control and wants to dilute its power then it should opt for equity. Equity shareholders are the owners of the company and have voting rights (Putra, 2019). Each source should be evaluated on this factor to know how many rights a company can dilute. If a company focuses on keeping the power with them only then borrowing should be opt.
• Cost: The cost of raising funds involves the money which the owner needs to pay to raise that fund. Internafundsnd or retaining earnings are cheaper sources of raising funds as they do not createan obligation for repayment. Debt creates an obligation for payment of interest and the principal amount thereon. Debt sources are cheaper than equity as interest on debt is a tax-deductible expense. Whereas equity dividends do not follow such rules which make it costlier than debt.
• Period: The organization should identify the duration for which funds need to be raised according to the sources that could be identified. For raising funds for short periods commercial paper, treasury bills, trade credit, commercial bills etc should be used which do not create long-term obligations. Where debentures and equity shares should be issued when the nford of funds is for a long period. Long-period loans are generally raised when a company is at an expansion level as they need funda s on regular basis. Rate on the short-term, loans is less than on long-term loans.
• Financial strength and stability of operation: Every fund if sourced from outside needs to be repaid at any point in time. So the company should analyse and evaluate its financial strength before raising funds. The flow of cash in the organization should be evaluated so that the source and be identified whether equity or debt. Debt includes regular payment of interest, if regular inflow is not there then the company should not opt for debt sources of funds. The company should identify its market value so that when the company need funds it can easily issue shares (Gompers, et.al, 2020). If the business is not stable in its operation then debentures and preference shares which create obligation should not be acquired.

Section 2.2 Sources of Financing at a start-up level

• Venture capitalists: It is the type of financing which is aimed at providing funds to start-ups. They usually invest in companies which have the potential to survive for a long duration and growth potential. They just do not provide funds but also provide their expert opinion to the entrepreneur. Venture capitalized have long connections in the industry which could be useful for the young entrepreneur to grow their business. This also helps in gaining potential customers and suppliers easily. Venture capitalisation helps improve the position of the company in the minds of the customers and the industry.

Start-ups can gain trust in the market as they have been got funds through VC which invest only after properly analyzing the company's potential growth. This type of funding helps in protecting from the obligation of regular payment of interest and principal amount. They usually take equity rights in the company which make returns in the form of dividends which are not compulsory (Coakley, and Lazos, 2021). The disadvantage that startups could face is that they are expert individuals who need to evaluate every aspect before investment which leads to delay in decision making. They also want the company to grow at a faster rate which something creates pressure on entrepreneurs which could lead to wrong decision-making.

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• Angle investors: These are the individuals who provide funds for starting stage of the organizations in return for a stake or ownership in the company. They are like venture capitalist, but they provide funds at the very first stage i.e. seed financing whereas venture capitalists only provide for companies which show some growth potential and are already established. They do not pool money from different investors but rather invest their own money into business. They also perform advisory roles by sharing their experience and applying their expertise in the organization. They also help provide assistance in management decisions and help in expanding connections with other organizations. The disadvantage that occurs due to angel investing is that they take 10% to 50 % of the company's ownership in exchange for their fund which leads to dilution of control by the owner.
• Crowdfunding: It is a type of funding which aims at collecting a small amount of funds from various investors without diluting the ownership of the company. It is a type of funding which raises funds from online sources where investment opportunity is provided to various individuals. The company mainly opts for this funding when they don't get loans from banks they include the financial risk to them(Cumming, and Zhang, 2019.). Startup Companies raise funds from these sources for various reasons as they can test the market.

The idea and objective of the organization are conveyed to individuals before asking them to invest; this makes entrepreneurs understand the market. Various channels such as emails, phone calls, and in-person meetings need to be used to gain funds through this centralized communication system could be used. This also helps in gaining potential customers as this company is pursuing various individual which lead to marketing our company and its product.

Section 2.3 Sources of finance for expanding companies

• Issue of debentures and bonds: Debenture is a debt instrument which could be used to raise funds. It includes creating an obligation on the firm as it includes regular payment of the interest and the redemption of the debenture at particular periods. Expanding and growing organizations could easily raise funds from these sources they have regular cash inflows which help in the timely payment of the interest. Raising funds through the issue of debenture is cheaper as interest on debenture is tax deductible expense which helps in increasing the per share value of the share.

Firms which are expanding sometimes do not want to dilute the control and include more voters so they opt for debenture. They usually have an inflow of funds so when the company do not need debentures they can easily redeem it any time whichsavese them from paying interest thereon. These are generally issued to rais funds and for the long-term duration which helps in the availability of funds for the completion of long-term objective of the firm (Cumming, Vanacker and Zahra, 2021). They are less costly than getting loans from banks as their interest rate is lower than the bank rate and issued with less formality.

• Issue of equity and preference share: Raising funds by issuing equity and preference shares include in the owners‘s equity or shareholder funds. At expansion phases company could opt for this source as their shares will easily purchases by others. They are well established company so people will easily invest in the company without much thought. This do not create obligation of payment on the company as equity shareholders are paid one after all the expense and preference shareholders dividend is paid. They reduce financial risk on the company as company need not to pay regular interest there on.

Issuing equity and preference share don not create charge on the fixed asset as no collateral involvement is needed in this. It is permanent capital raised by company as no obligation on company to pay it back to investors at any point of tine. Issue price of equity share are too small that every class people could invest and in expanding company everyone invest easily. If accompany issue equity it leads to high credit rating eventually help in enhancing creditworthiness of the company.

• Long term loans from banks and other financial institution: Government have made various policies for the organization to raise fund from various bank and other financial institution at lower rate of return. For an expanding organization it is easy to raise fund from banks as they have high credit rating (Mubashar, and Tariq, 2019.). Bank usually needs collateral for providing loans which an expanding firm could conveniently avail to them.

This also does not dilute the control of the management and origination as no ownership and voting rights are availed to lenders. Sometimes financial institutions all play the role of advisory which helps in better and effective management policies of the firms. Raising loans from bank also provides tax benefits to the organization leading toa reduction in the overall cost of raising funds. Loan from banks could be raised for both short-term and long periods leading to flexibility of period.

PART 3: Understanding and Assessing Evaluation Measures in Financial Decision-Making

Section 3.1 evaluation of measures

Various capital budgeting methods have been used to identify the viability and scope of the business or project. This helps us in identify whether to invest in a particular project or not.

• Net Present Value (NPV): Refers to the difference between the net cash outflow and cash inflow. This method includes the concept of the time value of money which helps in identifying results according to the present value of money. After evaluating the project it has been identified that the value is negative. Negative NPV denotes that the return which the project will avail in future will be less than the current cost of the investment. The NPV of this project does not show a positive indicator to invest so the company should not invest in these projects.
• Payback period: It is the type of capital budgeting which indicates the time it would take to recover Investment of the business. The lower the period higher the efficiency of the business. In the project payback period has been calculated which is very high. The company want to invest for 5 years and the initial investment will be recovered after 4.56 years which indicates that the company should not invest in this project (Diana, et.al, 2019). The company will enjoy the profit for only half a year which is a negative indicator as low ROI will be there so the company should avoid such investment.
• Accounting Rate of Return (ARR): This is the measure of capital budgeting which helps in determining the profitability position of an organization in the long term. It also indicates the potential cash inflow that assets or investments could give back. A higher ARR indicate that the company is going to earn huge profits in the long term. In this project, an ARR is 6.755% is not an attractive percentage to invest in business. The company should not invest in the project because of the low ARR.
• Profitability Index (PI): This evaluation method is used to identify which investment is best among others by ranking them according to potential cash inflow. This helps in identifying the cash inflow which could be generated by investing in a particular project. PI if greater than one is considered to be better as it means that the company will earn more than the initial invested amount. In this project, the PI is only 0.85 which means the company should not invest in this as the return on investment is less than the initial amount.
• Internal rate of return: IT is the type of capital budgeting method that indicates the return which could be generated on the investment. The ideal IRR of the company should be 18% to 20% this company should avoid such investment. The IRR of the given project is 4.93% which is a bad indicator of any company to invest in as the company is not going to get the accepted return from the investment. From all the evaluation measures it has been identified that the company should not invest in this project as this will not yield the accepted return from investment.

Section 3.2 Pros and cons of evaluation measures

Net present value

• Advantage: This method takes into consideration for time value of money concept which helps in identifying the actual return according tog the worth of money in future. This also helps in the decision-making process of the manager.
• Disadvantage: The results obtained from NPV are in actual figures and not in percentage which makes it difficult to compare between various projects. This method includes calculation through the required rate of return but no specific guidelines have been provided for the rate of return which can make NPV inaccurate.

Payback period

• Advantages; this method does not include compatibility in calculation as it could be calculated by simple formula. This method does not require specialist skills to evaluate the result one could suggest whether to invest in a particular project or not.
• Disadvantage: This only indicates how much time the initial investment could be recovered but actual cash inflow is not considered (ordà, et al.,2019). It also does not take into consideration the time value of money concept which makes it difficult to understand the worth of money in upcoming time.

Accounting rate of return

• Advantage: This is the method which takes into account the profit of the period which helps in identifying the profitability position of the organization in future. This method is easy to calculate because of the simple calculation and formula, evaluation and analysis of the result is also very simple.
• Disadvantage: The time and speed of cash inflow have been ignored while calculating ARR. The actual worth of return generated is not determined as it ignores the concept of the time value of money. ARR does not take into consideration the uncertainty and risk factors associated with business.

Profitability Index

• Advantage:  It takes into consideration the present value of the cash flow which could generated in future which makes it easy to make comparisons between various projects. It all helps in identifying the worth of the money as it takes into account the time value of the money concept. This is an important measure in decision-making as this alone could suggest whether to invest in this project or not.
• Disadvantage: It is evaluated based on the result, if high then profitable and vice versa. However, it does not consider the size of the project which can impact the analysis pattern. It also does not clearly define the investment which could be needed in future rather only initial investment is determined.

Internal rate of return

• Advantages: It is a simple and quick method to identify the best project among various by evaluating based on the return it would generate in future (Kelleher, and MacCormack, 2004). It takes into account the time value of the money concept which helps in identifying the actual significance of money in future.
• Disadvantage: It does not define the cost which entrepreneurs need to incur in future to generate appropriate outcomes. It cannot be used to make comparisons between two projects as they do not take into consideration the sizes of the project while calculating and evaluating IRR.

References

Books and Journals

Coakley, J. and Lazos, A., 2021. New developments in equity crowdfunding: A review. Review of Corporate Finance, 1(3-4), pp.341-405.

Cumming, D. and Zhang, M., 2019. Angel investors around the world. Journal of International Business Studies, 50, pp.692-719.

Cumming, D.J., Vanacker, T. and Zahra, S.A., 2021. Equity crowdfunding and governance: Toward an integrative model and research agenda. Academy of Management Perspectives, 35(1), pp.69-95.

Diana, S.R., Hidayat, A., Rafikasari, A., Ibrahim, I.M. and Farida, F., 2019. Economic Assesstment of Satellite Remote Sensing Data in Indonesia: A Net Present Value Approach. International Journal of Economics and Financial Issues, 9(1), p.140.

Gompers, P.A., Gornall, W., Kaplan, S.N. and Strebulaev, I.A., 2020. How do venture capitalists make decisions?. Journal of Financial Economics, 135(1), pp.169-190.

Gunarathne, A.N., Lee, K.H. and Hitigala Kaluarachchilage, P.K., 2021. Institutional pressures, environmental management strategy, and organizational performance: The role of environmental management accounting. Business Strategy and the Environment, 30(2), pp.825-839.

Husain, T. and Sunardi, N., 2020. Firm's Value Prediction Based on Profitability Ratios and Dividend Policy. Finance & Economics Review, 2(2), pp.13-26.

Kelleher, J.C. and MacCormack, J.J., 2004. Internal rate of return: A cautionary tale. The McKinsey Quarterly, 20, p.2004.

Mubashar, A. and Tariq, Y.B., 2019. Capital budgeting decision-making practices: evidence from Pakistan. Journal of Advances in Management Research, 16(2), pp.142-167.

ordà, Ò., Knoll, K., Kuvshinov, D., Schularick, M. and Taylor, A.M., 2019. The rate of return on everything, 1870–2015. The Quarterly Journal of Economics, 134(3), pp.1225-1298.

Putra, Y.M., 2019. Analysis of factors affecting the interests of SMEs using accounting applications. Journal of Economics and Business, 2(3).

Online

Financial statement of Acme's Product ltd 2023. Online available through <https://www.acmeglobal.com/wp-content/uploads/2022/11/FOR-WEB-Interim-Q1-FS-2022-2023.>