TASK 1:

( 1.1, 1.2, 1.3, 2.4)

Sources of finance are the most explore-able area especially for entrepreneurs starting a new
business. It is considered the toughest part of doing a business. There are various sources of
finances that we can classify on the basis of the time period, ownership and control, and source
of generation of finance.

Sources of finance are equity, debt, debentures, retained earnings, term loans, working capital
loans, letter of credit, euro issue, venture funding etc. These sources of funds are used in
different situations. They are classified based on time period, ownership and control, and their
source of generation. It is ideal to evaluate each source of capital before opting it.

Since there are many alternatives for financing a company can choose from, choosing the right
source and the right mix of finance is crucial for every finance manager. This process involves
in-depth investigation of every single source of funding. For analysing and comparing the
sources, we need to understand the characteristics of the financing source. There are many
characteristics on the basis of which sources of finance are classified.

On the basis of time period, sources are classified as long-term, medium term, and short term.
Ownership and control classify sources of finance into owned capital and borrowed capital.
Internal sources and external sources are the two sources of generation of capital. All the sources
of capital have different characteristics to suit different types of requirements.

Failure to use appropriate source of finance may lead to a firm being over-reliant on short term
finance or on long-term debt.

There are two main reasons for raising funds namely:

- Purchase of fixed assets, or the buying out of another firm

- The need for more working capital: for debtors, stocks or cash, i.e. an increase in current
assets.

The sources that are utilized by Gulf Engineering System Solutions Ltd. are
Internal Sources

1. Fixed Assets

2. Current Assets

3. Retained Earnings

4. Equity

External Sources

A. Short Term

1. Debt Financing

2. Bank over Drafts

3. Trade Creditors

4. Loans
B. Long Term

1. Lease

2. Mortgage

3. Debenture

4. Sharing

Internal Sources of Finance

Sources within the business firm that can be used as internal source of financing which the
business can manage its needed fund. The best advantage of internal sources of finance is there is
no dependency on outsider factors for collecting required money. The internal financial sources
utilized by Gulf Engineering System Solutions Ltd. are according to the balance sheet are
discussed below:

1. Fixed Assets

Fixed assets are the tangible assets that a company owns for a long time and uses for the income
of the company and these assets are not easily exchangeable into cash. Fixed assets include
property, plant and equipment, working capital and share investments.

Advantages of fixed assets are:

- If fixed assets are utilized efficiently for a long time then the depreciation burden and
repair costs may become less compared to income of using those assets.
- Unused assets like machineries, space, land etc. can be given in rent or sold for raising
fund for the business.
- No interest is needed for fixed assets.

Disadvantages of fixed assets are:

- Repairing and maintenance cost of machineries can be very high with time period.
- As the above cost become higher the depreciation would also become higher.

2. Current Assets

Current assets are the properties or cash equivalents of a company that can be converted into
cash easily and conversion period is within a year.

Current assets are important to businesses because they can be used to fund day-to-day
operations and pay ongoing expenses. Depending on the nature of the business, current assets
can range from barrels of crude oil, to baked goods, to foreign currency. On a balance sheet,
current assets will normally be displayed in order of liquidity, that is, the ease with which they
can be turned into cash.

Assets that cannot feasibly be turned into cash in the space of a year – or a business' operating
cycle, if it is longer – are not included in this category and are instead considered long-term
assets. These also depend on the nature of the business, but generally include land, facilities,
equipment, copyrights, and other illiquid investments.

3. Retained Earnings

Retained earnings are the profits or earnings that are left to a company after deducting all
dividends to shareholders.

Advantages of retained earnings are:

- Easy source as it is liquid assets.

- Increase stock value
- Assure corporate stability
- Provide funds for research and expansion without increasing corporate debt
- No interests are added on the use of retained earnings.

Disadvantages of retained earnings:

- Opportunity costs are involved in using retained earnings.

- This source is available only to those businesses that have performed for year at least.
- Availing this financial resource requires successful and profitable business performance
for long period of time.

4. Equity

Equity shares were earlier known as ordinary shares. The holders of these shares are the real
owners of the company. They have a voting right in the meetings of holders of the company.
They have a control over the working of the company. Equity shareholders are paid dividend
after paying it to the preference shareholders.

The rate of dividend on these shares depends upon the profits of the company. They may be paid
a higher rate of dividend or they may not get anything. These shareholders take more risk as
compared to preference shareholders.

Equity capital is paid after meeting all other claims including that of preference shareholders.
They take risk both regarding dividend and return of capital. Equity share capital cannot be
redeemed during the life time of the company.

Advantages of Equity Shares:

1. Equity shares do not create any obligation to pay a fixed rate of dividend.

2. Equity shares can be issued without creating any charge over the assets of the company

3. It is a permanent source of capital and the company has to repay it except under liquidation.

4. Equity shareholders are the real owners of the company who have the voting rights.

5. In case of profits, equity shareholders are the real gainers by way of increased dividends and
appreciation in the value of shares.

Disadvantages of Equity Shares:

1. If only equity shares are issued, the company cannot take the advantage of trading on equity.

2. As equity capital cannot be redeemed, there is a danger of over capitalization.

3. Equity shareholders can put obstacles for management by manipulation and organizing
themselves.

4. During prosperous periods higher dividends have to be paid leading to increase in the value of
shares in the market and it leads to speculation.

5. Investors who desire to invest in safe securities with a fixed income have no attraction for such
shares.

External Sources of Finance

External sources of finance are sources from where a business can gather its desired fund.
External sources are from outside the business. The best advantage of using external sources is a
company can get necessary fund from a variety of sources as there are different types of
institutions, banks who provide money for business to a company. The external financial sources
utilized by Gulf Engineering System Solutions Ltd. listen in balance sheet are discussed below:

External Sources

A. Short Term

1. Debt Financing

Borrowing money for the purpose of financing the operations and growth of a business can be
the right decision under correct circumstances. The owner doesn't have to give up control of his
business, but too much debt can inhibit the growth of the company.
Advantages of Debt
 Control: Taking out a loan is temporary. The relationship ends when the debt is repaid. The
lender does not have any say in how the owner runs his business.
 Taxes: Loan interest is tax deductible, whereas dividends paid to shareholders are not.
 Predictability: Principal and interest payments are stated in advance, so it is easier to work
these into the company's cash flow. Loans can be short, medium or long term.
Disadvantages of Debt
 Qualification: The Company and the owner must have acceptable credit ratings to qualify.
 Fixed payments: Principal and interest payments must be made on specified dates without
fail. Businesses that have unpredictable cash flows might have difficulties making loan
payments. Declines in sales can create serious problems in meeting loan payment dates.
 Cash flow: Taking on too much debt makes the business more likely to have problems
meeting loan payments if cash flow declines. Investors will also see the company as a higher
risk and be reluctant to make additional equity investments.
 Collateral: Lenders will typically demand that certain assets of the company be held as
collateral, and the owner is often required to guarantee the loan personally.

When looking for funds to finance the business, an owner has to carefully consider the
advantages and disadvantages of taking out loans or seeking additional investors. The decision
involves weighing and prioritizing numerous factors to decide which method will be most
beneficial in the long-term.
2. Bank Overdrafts

Bank overdraft is source of finance in which banks provide short term fund to a business firm
against the account of the company. This is very useful to manage short term financial
requirements. A business can take higher amount of money than the company account holds
from bank overdraft.

Advantages of bank overdraft are:

- It is helpful for business where cash flow changes rapidly.

- It helps to maintain proper history of financial transactions.
- It consists less paperwork compared to other sources like loans.
- It is very quick to arrange in time of need.
- It is very flexible so a firm can arrange whenever it needs.

Disadvantages of bank overdraft are:

- There is a certain limit of taking bank overdrafts.

- Bank charges higher rate of interest for overdrafts compared to other loans.
- Overdrafts can only be obtained from banks where company has its account.
- Interest rate against overdrafts fluctuates with time it becomes difficult for company to
calculate the return the amount

3. Trade creditors
Trade creditors are person or entities who allow a business to buy its necessary materials
instantly by providing credit. A company can avail materials it needs for the production but pay
later on. In case of Gulf Engineering System Solutions Ltd. the suppliers of dye, yarn, etc. are
trade creditors.

Advantages of trade credit:

- It is a quick process to avail short term fund for business.

- It is free from heavy formal boundaries.
- It involves very low cost to avail working capital and it includes no interests if repaid
within duration.
- If payback is done earlier than given time then company may get a discount.
- There is no legal or banking botheration in getting trade credits.

Disadvantages of trade credit:

- New business finds it difficult to manage trade credits.

- If not repaid in due time then it can be very costly.
- It is available for those companies that have good reputation of repaying in the past.

4. Loans

Loans can be defined as the activity of giving cash, property or other materials to a person or
company in return for future payback of the main amount with interests and other charges.
Advantages of loans are:

- The interest rate is fixed in bank loans so it is easier for business firms to avail it and plan
company budget accordingly.
- Bank loans are highly flexible compared to other types of loans. After the approval a
company can easily get the money which they can use in its operational purpose. Unlike
other loans bank provide loans with more flexible terms.

Disadvantages of loans are:

- Bank loans involve complex legal procedures which may cause sufferings for the
company in long term.
- Security has to be given to banks over an asset or property of business organization so
that in case of any failure of business the bank has the first authority on left property.
- Higher rate of interests need to be paid even for a small amount of loan.
- Bank loans must be paid back within due date.

B. Long Term

1. Venture Capital
 Venture capital is financing that investors provide to startup companies and small
businesses that are believed to have long-term growth potential. Venture capital generally
comes from well-off investors, investment banks and any other financial institutions.
However, it does not always take just a monetary form; it can be provided in the form of
technical or managerial expertise.

Though it can be risky for the investors who put up the funds, the potential for above-
average returns is an attractive payoff. For new companies or ventures that have a limited
operating history (under two years), venture capital funding is increasingly becoming a
popular – even essential – source for raising capital, especially if they lack access to
capital markets, bank loans or other debt instruments. The main downside is that the
investors usually get equity in the company, and thus a say in company decisions.

2. Mortgage

A legal contract by which a loan is granted by a bank or a lender to a person with his or
her property as security is called mortgage. The loan is to be repaid along with interest
and other costs. Once this is done, the contract ends. If the loan is not repaid, the bank or
the lender can sell the property to cover the debts. This process is known as foreclosure
which negatively affects your scope of taking loans in the future. Let us see what are the
advantages and disadvantages of mortgage.

Advantages of mortgage
- Buying capacity
The cost of property has increased like anything in the last couple of years. With lesser hike in
people’s salaries, it is impossible to think of buying land or house. That is where mortgage
comes to help. A mortgage loan definitely helps increase the buying capacity of people

- Cost effective
The mortgage loan is granted with your property as security. So, the lender need not worry about
the loan not being repaid. If anything goes wrong, the lender still has a valuable property to rely
upon. It can be sold to cover the debts. Due to this option, the interest rate on mortgage loans is
lower.

- Easy to repay
When you take a loan, you do not have to repay the amount in one go. It can be paid as monthly
installments. For example, you can avail loan over a 25 year term which means that you have 25
years to repay the loan as installments. So, one installment is not as big an amount when
compared to your salary which makes repayment easy.

- Better credit score

A good credit score is guaranteed in the credit report if the current status of the mortgage loan is
good. That means if you have correctly paid the installments, it helps you get other loans with
lower interest rates. On-time payment of loans would improve your credibility in the eyes of the
creditors.

- Tax benefits
Availing mortgage loans qualify a person for income tax benefits. They reduce the amount of tax
to be paid to the government. The money you pay as interest may be excluded from the tax. This
is the reason why people take a second loan for a new property or a house when the first one is
paid off.

Disadvantages of mortgage
Let us discuss some disadvantages which are lesser in number than the advantages.

- Paying more than borrowed

Mortgage loans are always accompanied with interests. Ultimately when you pay back, you pay
the principal amount plus the interest. Some lenders charge a high interest rate compared to
others. In situations where you urgently require a loan, you are forced to overlook this and will
have to pay a lot of money as interest.

- Extra charges
In addition to the principal amount and the interest to be paid back, there are other fees which
seem unimportant in the beginning. These charges like legal fees, insurance fees etc will come
upon you as extra burden when you actually start repaying.

- Higher interests for variable rate mortgage

Unlike the fixed rate mortgage, the interest rate in variable rate mortgage changes periodically.
Initially the rate may be lesser than that of the fixed rate mortgage. This largely attracts people to
it. But at the end of the introductory period, the rate either goes up or down depending on the
market interest rates. This means that the rates would be unpredictable and you may end up
paying more interest

- Affected by loss of property value

Any property will not retain the same value forever. It keeps on changing according to the
market fluctuations. As a result, the rates in variable rate mortgages tend to increase. This may
make people unable to pay the installments due to lack of funds and eventually lead to
foreclosure

3. Debenture

If a company needs funds for extension and development purpose without increasing its
share capital, it can borrow from the general public by issuing certificates for a fixed
period of time and at a fixed rate of interest. Such a loan certificate is called a debenture.
Debentures are offered to the public for subscrip-tion in the same way as for issue of
equity shares. Debenture is issued under the common seal of the company acknowledging
the receipt of money.
 Features of Debentures:

The important features of debentures are as follows:

1. Debenture holders are the creditors of the company carrying a fixed rate of interest.

2. Debenture is redeemed after a fixed period of time.

3. Debentures may be either secured or unsecured.

4. Interest payable on a debenture is a charge against profit and hence it is a tax

deductible expenditure.

5. Debenture holders do not enjoy any voting right.

6. Interest on debenture is payable even if there is a loss.

Advantage of Debentures:

(a) Issue of debenture does not result in dilution of interest of equity shareholders as they
do not have right either to vote or take part in the management of the company.

(b) Interest on debenture is tax deductible expenditure and thus it saves income tax.

(c) Cost of debenture is relatively lower than preference shares and equity shares.

(d) Issue of debentures is advantageous during times of inflation.

(e) Interest on debenture is payable even if there is a loss, so debenture holders bear no
risk.

Disadvantages of Debentures:

(a) Payment of interest on debenture is obligatory and hence it becomes burden if the
company incurs loss.

(b) Debentures are issued to trade on equity but too much dependence on debentures
increases the financial risk of the company.

(c) Redemption of debenture involves a larger amount of cash outflow.

(d) During depression, the profit of the company goes on declining and it becomes
difficult for the company to pay interest.

4. Share Capital

Share capital is the source of finance where shareholders invest their money in a company for
ownership and hence company raise funds for its business. This is a long term source of finance.
Shares issued by company include both ordinary share and preferred share. Ordinary
shareholders buy the ownership of the company and enjoy the benefits earned by business along
with bearing the risk of loss. Preferred shareholders are also owners of the company and they get
the dividend before ordinary shareholders but they do not hold any position in decision making
of the company

Advantages of share capital are:

- No payback needed:

Using share capital is free from paying back shareholders their initial investments. Shareholders
only get shares of the profit that the business makes.

- Lower risk:

Company that has more equity compared to debts has lesser risk of bankruptcy. Because in case
of any failure in business, equity investors cannot force it to bankruptcy but to wait for
betterment.

- Very helpful in rising long term finance for a company.

Disadvantages of share capital are:

- Company has to pay fixed rate of dividend to shareholders for a long term before paying
for anything else.
- Share finance managing is costly and time consuming.
- Regular information need to be provided for the shareholders that takes heavy
management of time.
- The fund raising process involves legal issues to deal with.
- Price of shares in the market fluctuates so it may bring losses for the company.

5. Lease

Lease can be defined as the act of making an agreement between more than one persons or
entities where one party give another party the allowance of using its specific properties,
machineries or services for a particular time period. Other party has to pay for using those
properties on periodic basis or according to the terms of agreement.

Advantages of lease are:

- It offers more relax for the company as the payment are paid in same monthly or
according to agreement.
- The lease rate always remains same. It does not increase with the success of the business.
- It is easier to collect lease finance than collecting loans from banks or other commercial
lenders.
Disadvantages of leasing are:

- If lease is taken then rents must be continuously even the business face any downfall.
- Company has to pay all maintenance cost for the property that is taken in lease even the
company is not the owner.
- After the period ends the ownership goes back to the real owner.

2.2 Why financial planning is important?

Financial planning helps you determine your short and long-term financial goals and create a
balanced plan to meet those goals.

Here are ten powerful reasons why financial planning – with the help of an expert financial
advisor – will get you where you want to be.

 Income: It's possible to manage income more effectively through planning. Managing
income helps you understand how much money you'll need for tax payments, other
monthly expenditures and savings.
 Cash Flow: Increase cash flows by carefully monitoring your spending patterns and
expenses. Tax planning, prudent spending and careful budgeting will help you keep more
of your hard earned cash.
 Capital: An increase in cash flow, can lead to an increase in capital. Allowing you to
consider investments to improve your overall financial well-being.
 Family Security: Providing for your family's financial security is an important part of the
financial planning process. Having the proper insurance coverage and policies in place
can provide peace of mind for you and your loved ones.
 Investment: A proper financial plan considers your personal circumstances, objectives
and risk tolerance. It acts as a guide in helping choose the right types of investments to fit
your needs, personality, and goals.
 Standard of Living: The savings created from good planning can prove beneficial in
difficult times. For example, you can make sure there is enough insurance coverage to
replace any lost income should a family bread winner become unable to work.
 Financial Understanding: Better financial understanding can be achieved when
measurable financial goals are set, the effects of decisions understood, and results
reviewed. Giving you a whole new approach to your budget and improving control over
your financial lifestyle.
 Assets: A nice 'cushion' in the form of assets is desirable. But many assets come with
liabilities attached. So, it becomes important to determine the real value of an asset. The
knowledge of settling or cancelling the liabilities comes with the understanding of your
finances. The overall process helps build assets that don't become a burden in the future.
  Savings: It used to be called saving for a rainy day. But sudden financial changes can still
throw you off track. It is good to have some investments with high liquidity. These
investments can be utilized in times of emergency or for educational purposes.
 Ongoing Advice: Establishing a relationship with a financial advisor you can trust is
critical to achieving your goals. Your financial advisor will meet with you to assess your
current financial circumstances and develop a comprehensive plan customized for you.

The first step in developing your financial plan is to meet with an advisor. At BlueShore
Financial, we use our unique discovery and assessment process called lifespring®. This
complimentary process begins with a review of your current financial circumstances, anticipated
changes, future goals, and results in your customized plan. Call us today to book your
assessment.

2.3 Assess the information needs of different decision makers

Decision makers in terms of financial planning require different details about their organization
in order to take final decision in respect of capital source and financial planning. Some of the
most important information needs of eventual decision makers are listed as follows:

1) Size of the organization: Size of the organization is important factor whilst planning. When
the size of the organization is huge, they require large amount of money and usually the project
duration is also longer.

2) Nature of projects: Project management is also important for financial planning. When the
organization plans to invest in different projects which have definite life and objectives, it can
plan for its finances with considerable amount of ease. However when the nature and size of the
project along with its objectives is unknown, planning process becomes relatively difficult.

3) Cost of capital and opportunity cost: The manager must be aware about expected rate of return
from the project. He should also consider the opportunity cost of the project because eventually
every administrator wants to earn return from invested capital. This could be done only when
proper analysis in this respect has been made.

2.4 The Impact of Financial Statements

A company's annual report is its communication to shareholders about its financial performance
and company developments.

Businesses regularly put out financial statements such as the income statement, balance sheet and
statement of cash flows. When these financial statements are released, they can have large
impacts on the business and on the investors of the company. Therefore, it is critical for the
business to ensure that the information the statements present is correct.

Impact on Stock Price

 Balance Sheet as at May, 2015

Financial statements can have a drastic effect on the stock price of a company. Many investors
look at the financial statements when making investment decisions. If information is presented in
a financial statement that is better or worse than expected, it can send the stock price up or down.
Investors often use financial ratios based on information from the financial statements to make
assumptions. Because of this, the financial statements can have a drastic effect on the investors
of a business.

Financing Decisions

Financial statements can also have an impact on how easy it is for a business to get financing. If
a company is trying to take out a business loan, the lender will typically want to look at the
financial statements of that company. If the information on the financial statements is not
flattering, it may negatively impact the ability of the company to borrow money. Lenders usually
only want to invest in companies that have good financial numbers.

Attract New Investors

Financial statements also affect attracting new investors. When a company issues new shares of
stock, it will most likely distribute financial statements to potential investors. The potential
investors will examine the financial statements to determine if they want to put money into the
company. Low earnings numbers could negatively impact the number of investors willing to put
money into the company.

Other Companies

In some cases, financial statements can even affect other businesses. For example, a leading
company in a particular industry releasing financial statements can influence that industry as a
whole. Bad numbers by a leading company can sometimes lead to a negative outlook on other
companies. This may drive down the stock prices on other companies in the same industry or
sector of the market.

Gulf Engineering System Solutions Ltd

Adjustments 1:

Obtaining a 2-year interest free loan of 4000 from the A Alex Ltd.
 Particulars $ in AED $ in AED
Fixed Assets 7,850
Current Assets 32,910
Add: Cash 4,000
Less: Current liabilities (7,100)
Net Current Assets 37,660
Less: Long-term liabilities (4,000)
Net Assets 33,660
Financed by
Capital
Share Capital 12,400
Add: Net profit 21,260
33,660

Adjustments 2:

Obtaining a 5-year loan of 12000 at 10% interest per annum.

Balance Sheet as at May, 2015

Particulars $ in AED $ in AED

Fixed Assets 7,850
Current Assets 32,910
Add: Cash 12,000
Less: Current liabilities (8,300)
Net Current Assets 44,460
Less: Long-term liabilities (12,000)
Net Assets 32,460
Financed by
Capital
Share Capital 12,400
Add: Net profit 21,260
Less: Interest payable (1,200)
32,460

Adjustments 3:
Obtaining a 1-year credit with a major supplier for purchase amounting 2000

Balance Sheet as at May, 2015

Particulars $ in AED $ in AED

Fixed Assets 7,850
Current Assets 32,910
Less: Current liabilities (7,100)
Add: Creditors (2,000)
Total current liabilities (9,100)
Net Current Assets 31,660
Less: Long-term liabilities
Net Assets 31,660
Financed by
Capital
Share Capital 12,400
Add: Net profit 21,260
Less: Purchases (2,000)
31,660
Adjustments 4:
Issuing additional 1,000 shares at 3.50 per share.

Balance Sheet as at May, 2015

Particulars $ in AED $ in AED

Fixed Assets 7,850
Current Assets 32,910
Add: Cash 3,500
Total Current Assets 36,410
Less: Current liabilities (7,100)
Net Current Assets 37,160
Less: Long-term liabilities
Net Assets 37,160
Financed by
Capital
Share Capital 12,400
Add: Additional Share Capital 3,500
Add: Net profit 21,260
37,160

Adjustments 5:

Selling some office furniture worth 2,000 at their net realizable value, with no profit
made on disposal.
Balance Sheet as at May, 2015

Particulars $ in AED $ in AED

Fixed Assets 7,850
Less: Sale of Fixed Assets (2,000)
Total Fixed Assets 5,850
Current Assets 32,910
Add: Cash 2,000
Less: Current liabilities (7,100)
Net Current Assets 33,660
Less: Long-term liabilities
Net Assets 33,660
Financed by
Capital
Share Capital 12,400
Add: Net profit 21,260
33,660

TASK 2

3.1 Analyse budgets and make appropriate decisions

Every small business owner should have a budget that lays out the future course of the
company's activities. A budget shows where the sales will come from and how the money will be
spent, with the ultimate goal to produce a profit. While budgets are great for planning, they are
also a valuable management tool to keep the business on track to meet its objective. The way to
accomplish this goal is known as budget variance analysis.

Putting together a budget at the start of the year is a valuable exercise for any business. It gathers
input from all the departments and gets everyone on the same page. A budget is an excellent
form of communication that tells everyone where the company is going and how it intends to get
there. But it's after the year gets going and you start comparing actual results to the budgeted
numbers that things get really interesting. This is the part where deviations, or variances, from
the budget are identified, and you have to dig into the problem to find out why this happened.

Calculation of Variances

Types of Budgets

Master budget:

The master budget is the aggregation of all lower-level budgets produced by a company's various
functional areas, and also includes budgeted financial statements, cash forecast, and a financing
plan. The master budget is typically presented in either a monthly or quarterly format, or usually
covers a company's entire fiscal year. An explanatory text may be included with the master
budget, which explains the company's strategic direction, how the master budget will assist in
accomplishing specific goals, and the management actions needed to achieve the budget. There
may also be a discussion of the headcount changes that are required to achieve the budget.

A master budget is the central planning tool that a management team uses to direct the activities
of a corporation, as well as to judge the performance of its various responsibility centers. It is
customary for the senior management team to review a number of iterations of the master budget
and incorporate modifications until it arrives at a budget that allocates funds to achieve the
desired results. Hopefully, a company uses participative budgeting to arrive at this final budget,
but it may also be imposed on the organization by senior management, with little input from
other employees.

Operating budget:

An operating budget shows the company's projected revenue and associated expenses for an
upcoming period -- usually the next year -- and is often presented in an income statement format.
Usually, management goes through the process of compiling the budget before the start of each
year, and then makes ongoing updates each month. An operating budget might consist of a high-
level summary schedule, supported by detail to back up each line item in the budget.
An operating budget starts with revenue, and then shows each expense type. This includes
variable costs, or the costs that vary with sales, such as the cost of raw materials and production
labor. The operating budget includes fixed costs, such as the monthly rent on office space or the
monthly payment for a photocopier lease. The budget also includes operating expenses, such as
interest on business loans, and the non-cash expense of depreciation. These items enable the
company to compute its projected net income and net profit percentage.

Financial budget:

A financial budget in budgeting is predicting the incomes and expenses of the business on long-
term and short-term basis. Right projections of the cash flow help the business to achieve its
targets in the right way.

The organizations prepare the financial budget to manage the cash flows in a better way. This
budget gives the business a better control and efficient planning mechanism to manage the
inflows and outflows. To prepare a financial budget, it is important to prepare the operating
budget first. It is with the help of operating budget that the organization can predict the sales and
the production expenses. Therefore, the financial budget is prepared only after the different
financing activities are known in the operating budget.

DIFFERENT SECTIONS OF FINANCIAL BUDGET

CASH BUDGET

The cash budget tells about the inflows and outflows of the business. On the other hand, the cash
flow of the business keeps on changing and with that, the cash budget should also change.
Making cash budget is a dynamic process and not a static process. Any change in the cash flow
should be immediately reflected in the cash budget of the business.

BUDGETED BALANCE SHEET

The budgeted balance sheet comprises of many other budgets. The major component of this
budget includes production budget and its associated budgets.

CAPITAL EXPENDITURE BUDGET

As the name suggests, the capital expenditure budget is about expenses related to plant and
machinery or any capital asset of the business. This budget determines the expenses that would
be incurred if an existing plant is replaced or any new machinery is bought. Factors like
depreciation, cost of the plant, life of the machinery, etc. are taken into account while preparing
the capital expenditure budget.

FINANCIAL BUDGET PLAN

The financial budget plan comprises of following steps:

 Calculate the expected inflow

 Calculate the expected outflow
 Set the targets
 Divide the expenses into different categories
 Keep the track of components in budget
 Set up the ledger

The above points give an idea of how financial budget plan is set. Different organizations may
take different factors in considering while preparing the budget. However, the above points shall
form part of any budget plan.

Variances

Variances are like alarm bells and they come in two types: favorable and unfavorable.

For example, let's say the original budget for Hasty Rabbit Corporation's projected sales of blue
sneakers would be $100,000 per month. After a few months into the year, the owner finds that
blue sneaker sales are averaging $115,000 per month. That positive difference in sales of
$15,000 per month and is a favorable variance. That's a good omen for the year.

Unfortunately, the owner also received a disturbing report about the material costs to make each
pair of blue sneakers. The budget assumed that the materials cost per pair would be $8.25.
However, the most recent report from manufacturing showed that material costs were actually
$9.10 per pair, a difference of $0.85. That's an unfavorable variance, and definitely not a good
sign.

Types of Variances

The cause of a variance can generally be traced to either of two types: changes in prices or
quantities.

The sales department of Hasty Rabbit reported that they had kept the prices the same but were
able to sell more sneakers. In this case, the favorable variance of improved sales was due to an
increase in the quantity sold.

However, manufacturing might be having a problem. The owner wanted to know why the
material costs had gone up by $0.85. His production supervisor told him that an increase in the
price of rubber was responsible. So, in this case, the unfavorable variance was supposedly due to
an increase in the cost of materials. But the owner wasn't sure this was the complete source of the
problem.

Cause of a Variance
The real value of a budget variance analysis is the investigation and determination of the cause of
a variance. Digging into the "why" may reveal important opportunities or flaws in a company's
operations. Here are several scenarios to consider:

Is the variance a long-term or short-term problem? If it's a problem expected to continue, then a
more permanent solution may be needed.

Is it possible to increase prices to make up for an unfavorable cost variance?

Is the problem due to inefficiencies in the company's processes? In the case of the increase in
manufacturing costs of blue sneakers for Hasty Rabbit, this could be the result of inefficiencies
in production because of increased sales volume.

Have conditions changed? Economic conditions can affect consumer demand, and costs of
operations can increase. For example, a jump in oil prices can increase delivery costs, which
cannot be passed on to the customer.

Taking Corrective Action

Once the owner has identified the type of variance and its cause, he can start to take corrective
actions. If sales of blue sneakers are increasing, he might want to spend more on advertising to
seize on this unexpected popularity.

Unfavorable variances require more serious solutions. If a process has become inefficient,
managers have to find ways to improve. It might be necessary to find substitute materials that are
cheaper. New machines might be needed to replace obsolete equipment. The exercise of
analyzing budget variances is an ongoing management function. Over time, identifying
variances, determining the causes and taking corrective actions will lead to a healthier and more
profitable business.

3.2 Explain the calculation of unit costs and make pricing decisions using relevant
information

- Unit cost: It is a summation of all the expenses incurred in the entire process of producing,
storing and selling one unit of a product or service. It includes all fixed costs, variable costs,
overhead costs, direct material and labor costs and all the other costs incurred in production.

- Price: Price is the amount which is paid by one party for purchasing the given goods or services
to the other party. In other words price is the cost of obtaining something.

Pricing methods can be broadly classified in two categories:

- Cost oriented pricing method

- Market oriented pricing method
Cost oriented pricing method- cost of production is considered as the base method to calculate
price of final product or goods.

Differential pricing-

Differential pricing- It is the strategy of selling the same product at different prices to different
customers. It is adopted to maximize the profit of the organization. Differential pricing can be
charged considering various bases:

Customer segment – depending on the segmentation of customer’s different prices can be

charged on the same product. For instance, fees in various colleges are different for Indians and
NRI’s (Schneider, et. al 2012).

Image pricing- the image that a product or good has in the market can be the factor for charging
different prices. Cosmetics and clothing brand fall in this category.

Product form pricing- slight variation leads to charging of different prices.For instance the price
of iPhone in rose gold is higher than black.

Location pricing- prices are determined considering the location. For instance, the same bottle of
cold drink is sold at a higher price in theatres than usual.

Time pricing- the same product is sold at a higher price depending upon the time such as off-
season. For instance, woolens are sold at high price in winters than in summers (Schneider, et. al
2012).

Particulars AED AED

Alex 10 hours to work 100

$ 10 paid per hour

10*10= 100

Will 20 hours to work 100

$ 5 paid per hour

20*5= 100

Direct Unit Cost 200

Production overheads and 2 hours 110

machine utilization
At $ 55 per hour
 2*55=110

Total Production Cost 310

National insurance, pension 200 Direct unit cost 40

contributions and holiday pay
20% on Direct unit cost

200*20%

Selling, distribution and 20 per hour 40

administration overheads
For 2 hours

20*2=40

Total cost 390

Mark up on selling price 39

Selling price 390*110/100 429

Adjustment 4: Re-estimate the price that the company must quote if the budgeted
number of hour that the job requires is readjusted to 2.5 hours

Particulars AED AED

Alex 10 hours to work 100

$ 10 paid per hour

10*10= 100

Will 20 hours to work 100

$ 5 paid per hour

20*5= 100

Direct Unit Cost 200

Production overheads and 2.5 hours 137.5

machine utilization
At $ 55 per hour

2.5*55=110
Total Production Cost 337.5

National insurance, pension 200 Direct unit cost 40

contributions and holiday
pay 20% on Direct unit cost

200*20%

Selling, distribution and 20 per hour 50

administration overheads
For 2.5 hours

20*2.5=40

Total cost 427.5

Mark up on selling price 42.75

Selling price 390*110/100 470.25

Adjustment 5: Re-estimate the price that the company must quote if the budgeted
number of hour that the job requires is readjusted to 1.5 hours

Particulars AED AED

Alex 10 hours to work 100

$ 10 paid per hour

10*10= 100

Will 20 hours to work 100

$ 5 paid per hour

20*5= 100

Direct Unit Cost 200

Production overheads and 1.5 hours 82.5

machine utilization
At $ 55 per hour

1.5*55=82.5
Total Production Cost 282.5

National insurance, pension 200 Direct unit cost 40

contributions and holiday
pay 20% on Direct unit cost

200*20%

Selling, distribution and 20 per hour 30

administration overheads
For 1.5 hours

20*1.5=40

Total cost 352.5

Mark up on selling price 35.25

Selling price 390*110/100 387.75

3.3 Assess the viability of a project using investment appraisal techniques

Investment appraisal is a collection of techniques used to identify the attractiveness of an

investment.

The purpose of investment appraisal is to assess the viability of project, programme or portfolio
decisions and the value they generate. In the context of a business case, the primary objective of
investment appraisal is to place a value on benefits so that the costs are justified.

There are many factors that can form part of an appraisal. These include:

Financial – this is the most commonly assessed factor;

Legal – the value of an investment may be in it enabling an organization to meet current or future
legislation;

Environmental – the impact of the work on the environment is increasingly a factor when
considering an investment;

Social – for charitable organizations, return on investment could be measured in terms of ‘quality
of life’ or even ‘lives saved’;

Operational – benefits may be expressed in terms of ‘increased customer satisfaction’, ‘higher

staff morale’ or ‘competitive advantage’;
Risk – all organizations are subject to business and operational risk. An investment decision may
be justified because it reduces risk.

A financial appraisal is the most easily quantifiable approach but it can only be applied to
benefits that produce financial returns.

The simplest financial appraisal technique is the payback method. The payback period is the time
it takes for net cash inflow to equal the cash investment. This is a relatively crude assessment and
is often used simply as an initial screening process.

A better way of comparing alternative investments is the accounting rate of return (ARR) which
expresses the ‘profit’ as a percentage of the costs. However, this has the disadvantage of not
taking into account the timing of income and expenditure. This makes a significant difference on
all but the shortest and most capital-intensive of projects.

In most cases, discounted cash flow techniques such as net present value (NPV) or internal rate
of return (IRR) are appropriate to evaluate the value of benefits and alternative ways of
delivering them. NPV calculates the present value of cash flows associated with an investment;
the higher the NPV the better. This calculation uses a discount rate to show how the value of
money decreases with time. The discount rate that gives an investment a NPV value of zero is
called the IRR. NPV and IRR can be compared for a number of options.

Appraisal of capital-intensive projects should take into account the whole-life costs across the
complete product life cycle as there may be significant termination costs. In the case of the
public sector, where income is usually zero, it is common practice to identify the option with the
lowest whole-life cost as the option that offers the best value for money.

The appraisal on less tangible and non-financial factors is more subjective. In some cases, a
financial value may be calculated by applying a series of assumptions. For example, work that
improved staff morale may lead to lower staff turnover and reduce recruitment costs. A financial
appraisal of this benefit would have to include assumptions about the numerical impact of
increased morale on staff turnover and the estimated costs of recruitment.

Where benefits cannot be quantified then scoring methods may be used to compare the
subjective value of benefits.

Stand-alone projects will use investment appraisal to compare alternative approaches to

achieving the required benefits. Wherever possible, the project should use techniques that are the
organizational, programme or portfolio standard approach.

Where a project is part of a programme, the initial investment appraisal may be performed by the
programme management team. That does not exempt the project management team from being
familiar with the content of the appraisal or the techniques used to perform it. It will still be
responsible for keeping the business case up to date and this will involve repeating the
investment calculations to account for changing circumstances.

Where a project is undertaken by a contracting organization, the financial appraisal is relatively

straightforward as it will simply be a comparison of costs with the fee paid by the client,
probably using a discounted cash flow technique.

4.1 Discuss the main financial statements

Financial statements are a formal record of the financial position of a business, entity or an
enterprise.

Financial information is thus represented by:

Balance sheet – it represents the statement of assets, liabilities, and capital of a business at a
given point of time,

Income statement- It provides a report of the company’s financial performance over a specific
accounting period. It takes into consideration all the operating and non-operating activities thus
helps in assessing the financial position of the company. It provides the details of incomes and
expenses over the preceding period.

Income statement is divided into two parts; operating and no- operating. The operating portion
discloses the incomes and expenses that are earned or incurred from regular business operations
(Pompian, 2012).

Income statement is used to calculate ratios as return of equity, return on assets, gross profit,
operating profit, earnings before interest and tax and earnings after interest and tax.

Therefore it provides two to three year data for historical comparison.

Cash flow statement- it is a financial statement that affects cash and cash equivalents due to
changes in balance sheet and income statement. Cash flow statement comprises of three parts:

Operating activities- it includes activities that are conducted in the operations of the business
(Johnson, 2014).

Investing activities- it includes activities that are conducted for making investments.

Financial activities- it includes a summary of financial activities such as inflow from banks,
investors and customers and outflow in the form of distribution of dividends.

4.2 Compare appropriate formats of financial statements for different types of business

Financial statements are formatted four ways: The statement of financial position (balance
sheet), the statement of comprehensive income (income sheet), the statement of changes in
equity (equity statement), and the statement of cash flow. The difference between them is what
they report. A balance sheet reports on assets and liabilities; an income sheet reports on income,
expenses and profits; an equity statement reports on equity changes; and a cash flow statement
reports on operational, investment and financial cash flow activities. Of these, only the balance
sheet applies to a single time point. The other statements detail periods of time. Balance sheets
are typically divided into two sections -- one for assets, the other for liabilities and net worth --
with the two sections working together to show how the company's financial income and output
balanced against each other. Balance sheets often vary in complexity depending on the size of
the business they detail. Income sheets are used to show the transformation of revenue into net
income and have the simple purpose of showing company managers and investors whether the
business made or lost money during a specific fiscal period. There are generally two types of
income sheet -- single and multi-step -- with the latter being more detailed than the former as it
offers a lengthier breakdown of finances. Equity statements present a company's changes in
retained earnings, which is the portion of net income that the corporation does not distribute and
keeps hold of it. It includes information on dividends, operational profits and losses, and all other
charges or credits to these earnings. Finally, the cash flow statement indicates the effect of the
information contained within the above on the company's overall flow of cash, as determined
through operational, investment and financial perspectives. This information is most useful to
bankers, accounting staff, investors and potential employees.

Gulf Engineering System Solutions Ltd

Equity Non-current Assets + Current Assets -Less Non-current Liability-

Current liability

CGS Opening Stock + Net Purchases – Closing Stock

It is seen in gulf engineering system solutions Ltd. The straight and simple
CGS is shown and unlike The Appully Engineering Company.

Discount received and Discount allowed is shown in Statement of

comprehensive income.

Indirect Expense is shown in Statement of comprehensive income which

comprises of Rent, Wages and salaries, Van Running Cost, Doubtful debt
provision, Bad debts, Depreciation, Discounts allowed .
 Fixed Assets has not been depreciated in the Statement of financial position
of Gulf Engineering System Solutions Ltd.

The Appully Engineering Company

Total Assets Total Liability + Equity

CGS The direct cost of CGS has not been broken down like Gulf engineering
system solution Ltd.

Discount received is not shown in Statement of comprehensive income

like The Gulf Engineering System Solutions Ltd.

Diverse expenses include Cash Expense, Non-Cash Expense Taxes,

Interest Expense.

4.3 Interpret financial statements using appropriate ratios and comparisons, both internal
and external

Gearing Ratio:
A gearing ratio is a general classification describing a financial ratio that compares
some form of owner equity (or capital) to funds borrowed by the company. Gearing is a
measurement of a company's financial leverage, and the gearing ratio is one of the
most popular methods of evaluating a company's financial fitness.
Though there are several variations, the most common ratio measures how much a
company is funded by debt versus how much is financed by equity, often called the net
gearing ratio. A high gearing ratio means the company has a larger proportion of debt
versus equity. Conversely, a low gearing ratio means the company has a small
proportion of debt versus equity.
An optimal gearing ratio is primarily determined by the individual company relative to
other companies within the same industry. However, here are a few basic guidelines for
good and bad gearing ratios:
 A gearing ratio higher than 50% is typically considered highly levered or geared.
As a result, the company would be at greater financial risk, because during times
 of lower profits and higher interest rates, the company would be more susceptible
to loan default and bankruptcy.
 A gearing ratio lower than 25% is typically considered low-risk by both investors
and lenders.
 A gearing ratio between 25% and 50% is typically considered optimal or normal
for well-established companies.
Typically, a low gearing ratio means a company is financially stable, but not all debt is
bad debt.

It's essential for companies to manage their debt levels. However, it's also important
that companies put their assets on their balance sheets to work, including using debt to
boost earnings and profits for their shareholders.

A safe gearing ratio can vary from company to company and is largely determined by
how a company's debt is managed and how well the company is performing. Many
factors should be considered when analyzing gearing ratios such as earnings growth,
market share, and the cash flow of the company.

It's also worth considering that well-established companies might be able to pay off their
debt by issuing equity if needed. In other words, having debt on their balance sheet
might be a strategic business decision since it might mean less equity financing. Fewer
shares outstanding can result in less share dilution and potentially lead to an elevated
stock price.
Earnings per share:
Earnings per share (EPS) are the portion of a company's profit allocated to each
outstanding share of common stock. Earnings per share serve as an indicator of a
company's profitability. EPS is calculated as:

EPS = (Net Income - Dividends on Preferred Stock) / Average Outstanding Shares

Earnings per share (EPS) are generally considered to be the single most
important variable in determining a share's price. It is also a major component
used to calculate the price-to-earnings (P/E) valuation ratio, where the 'E' in P/E
refers to EPS. By dividing a company's share price by its earnings per share, an
investor can understand the fair market value of a stock in terms of what the
market is willing to pay based on a company's current earnings.

The EPS is an important fundamental used in valuing a company because it

breaks down a firm's profits on a per share basis. This is especially important as
the number of shares outstanding could change, and the total earnings of a
company might not be a real measure of profitability for investors. If Ford's total
earnings were to increase in a subsequent year to $1.8 billion, this might seem
like great news to an investor until they consider the fact that the company's total
shares outstanding increased to 4.5 billion. In this case, EPS would have only
gone up to $0.40.

Dividend per share:

Dividend per share (DPS) is the sum of declared dividends issued by a company
for every ordinary share outstanding. The figure is calculated by dividing the total
dividends paid out by a business, including interim dividends, over a period of
time by the number of outstanding ordinary shares issued. A company's DPS is
often derived using the dividend paid in the most recent quarter, which is also
used to calculate the dividend yield.

Dividend per share is an important metric to investors because the amount a firm pays out in
dividends directly translates to income for the shareholder, and the dividend per share is the most
straightforward figure an investor can use to calculate his or her dividend payments from owning
shares of a stock over time. Meanwhile, a growing DPS over time can also be a sign that a
company's management believes that its earnings growth can be sustained.

DPS can be calculated by using the following formula, where the variables are defined as:

D: Sum of dividends over a period (usually a quarter or year)

SD: Special, one-time dividends in the period

S: Ordinary shares outstanding for the period

Dividend per Share (DPS)

CONCLUSION

On the basis of above discussion it is concluded that firms must be very careful when selecting a
source of finance. These sources must be selected with due care. Company liquidity position and
fundamentals must be kept in mind before selecting any kind of source of finance. In this report,
I have also applied budget evaluation techniques and the best techniques for the company must
be selected the analysts. It is advisable that by merely looking at cash at flows the project must
not be selected. Managers must apply ratio analysis technique in order to evaluate company
performance from various angels. This will help the firm in preparing business strategy on time.
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