Importance of accurate financial information in decision making
Most business decisions often revolve around financial information. Therefore, it is important for businesses to keep proper books of account and to ensure that the financial statements that are prepared displays the true and fair view of the company. Also, a business needs to ensure that the financial statements are audited periodically and according to law. This will give the necessary assurance that financial information is accurate.
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Further, it is important to carry out further analysis of the financial information. An example is ratio analysis. Accurate financial information will aid the management of Tiny Toes Limited to ascertain whether the two proposed ventures are profitable. In this case, forecasted financial statements will be prepared to ascertain the profits that will arise from both ventures. Also, accurate financial information will aid the company in determining the adequacy of the capital that is required for the two projects. The financial information will reveal the amount of capital that is required for both capital investment and working capital.
This will enable the company to ascertain whether the internally generated capital is adequate or there is a need to look for additional external funding. Further, the use of financial information will enable the management to ascertain whether the performance of the company is improving or deteriorating. This can be achieved by analyzing the trend of performance over time. Also, accurate financial information will enable the management of tiny toes to compare their performance with those of the competitors. This will enable the management to gauge their performance in the industry (Brealey & Myers 2011).
Importance of business plan and cash flow budget forecasts
When starting a new venture or expanding an existing venture, it is important to prepare a business plan. A plan will enable the management to stick to the strategy during the implementation stage. This is based on the fact that all the aspects of a plan are clear and integrated. Secondly, a plan makes it much easier to communicate the objectives and strategies to various stakeholders that the company interacts with.
Some of the stakeholders are bankers, partners, and employees among others. Further, it is important to have a business plan because it will act as a reference point when coming up with different courses of action. A business plan will also assist a company to determine the capital requirements and identify the need for external sources of finance. This allows the company to plan for the future growth of the company. Also, a business plan enables the top management to manage junior employees and to track the results of the company. This will assist the company in managing variances and to ensure that a project does not fail.
Other than a business plan, Tiny Toes Ltd. needs to prepare cash flow forecasts and budgets for the two new projects. The cash flow forecasts will benefit the company in several ways. The first benefit is that it will enable the business to identify possibilities of shortfalls in cash for running the business. For instance, if the budget shows that there is a possibility of a cash deficit, then the company can organize for bank credit facility such as overdraft to cater for the difference. The cash flow forecast also indicates whether the revenues, costs and profits are converted to cash. Further, a cash flow budget also assists in analyzing whether a business is achieving the objectives that are set out in the business plan. This ensures that there is a discipline in financial planning. Finally, cash flow forecasts are important to external capital providers. An example is a bank.
Problems with financial information
In these two projects, the company is yet to prepare a financial report that gives information on the viability of the expansion. The first step for the company is to come up with all the relevant financial information. This should include information such as changes in expenses, the capital costs of the project and the estimated expenses among others. With all the necessary information, the management should first come up with a cash flow forecast and a cash budget for this expansion project. The cash flow forecast will ascertain if there is a need for additional external funding from other sources such as banks.
This should be prepared every month for a period of at least 3 to 5 years. The next step will be constructing a forecasted income statement. This will give information on whether the project will generate profit. The forecasted income statement should also be prepared for a period of 3 to 5 years. Further, there is a need to prepare the forecasted balance sheet for the project. This will profit information on the assets, liabilities, and capital of the project. These three are the key financial statements that are often required by the stakeholders (McLaney & Atrill 2008).
The management of Tiny Toes Ltd. can go further and carry ratio analysis using the forecasted data of the two projects. This will provide further insight into the financial strengths and weaknesses of the project. This information will also be quite vital to the various stakeholders such as creditors, debtors and employees. Apart from carrying out ratio analysis, it will be important to come up with common size income statements, common base year financial statements and combined common size and base year financial statements. This information will be quite significant in analyzing the proportion of various values and to monitor trends of performance. Another aspect that the company needs to focus on is break-even analysis.
This will give the number of children that the company must serve so that the total revenue equals the total costs. This analysis will enable the management to ascertain whether the goal of serving 120 children is achievable given the fee per child and the costs. The break analysis will also assist the management in carrying out sensitivity analysis. Sensitivity analysis will enable the management to know the outcome under different business environment. Considering that the company has competitors, sensitivity analysis can enable the management to know the possible outcome in the best case and the worst-case scenario (Subramanyam 2013). Therefore, these are some of the additional information that the management of Tiny Toe Limited needs to prepare before deciding on whether to invest in the project or not.
Problems with generating funds
Generating funds internally can be achieved by, either through retained earnings, selling assets or reducing the working capital. In this case, the company seeks to raise two-thirds of £17 million from retained earnings. This might not be achievable considering that a lot of pressure is put on the cash flow of the business. This implies that the business is facing a lot of pressure in generating profits that can be retained. Also, the budget that is prepared for the Childcare Centers shows that the company will be making losses in this project.
These losses will consume the already existing retained earnings that were generated by the company before the implementation of the project. Another problem that the company might face is that the resistance of shareholders to approve the use of retained earnings. Therefore, the management might face a problem in convincing the shareholders to approve the use of retained earnings. This might lead to failure during implementation.
External sources of finance are more difficult to raise than an internal source of finance, especially when the company is not performing well financially. The first problem that the company will face is the inability to present appropriate and accurate financial information that can support the viability of the business. In the case study, it is evident that the company does not well-prepared plan for the two proposed ventures. However, external capital providers such as banks often rely on business plans when issuing loans to business. Therefore, the business might face difficulties when dealing with the bank. The second problem that the company might face is the ability to show that the current business is performing well.
In the case of an existing business that intends to expand its operations, the external capital providers will be interested in the financial performance of the existing business. However, as indicated in the case study, the company is experiencing a lot of pressure with the cash flow. This can be an indication that other aspects of finance for Tiny Toes Ltd are also experiencing pressures. Therefore, the banks might find it difficult to issue loans to a business that is not financially sound (Wainwright 2012). Therefore, the expansion program should not only focus on what needs to be done but also on the source of capital for the expansion plan. Besides, the business needs to prepare a proper business plan because it makes the process of raising capital easier (Finnerty 2013).
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Planning for a new business or expanding the current business requires a comprehensive business plan. This facilitates the implementation process of the projects. One important aspect that is missing is a plan for the personnel. The management should come up with a well-structured plan for the additional personnel. Failure to plan for personal might hinder the process of implementation. Also, the managing should analyze some of the risks that the business might face (Brigham & Michael 2009). This should include an analysis of possible ways of mitigating such risks. This will ensure success in the implementation process. Finally, the management needs to comprehensively analyze the market for their new products and come up with an appropriate strategy for penetrating the market.
As a recommendation, Tiny Toes Limited should not continue with the two projects. This can be attributed to the fact that an adequate feasibility study has not been carried out on the two projects. Besides, there are not proper documents that validate the viability of the two projects. Also, the case reveals that the existing business is experiencing pressure financially. Therefore, it is prudent to stop the implementation and plan well for the two expansion projects.
Brealey, R & Myers, S 2011, Principles of corporate finance, Irwin, New York.
Brigham, E & Michael E 2009, Financial management theory and practice, South-Western Cengage Learning, USA.
Finnerty, J 2013, Project financing: asset-based financial engineering, John Wiley & Sons, USA.
McLaney, E & Atrill, P 2008, Financial accounting for decision makers, Financial Times Prentice Hall, London.
Subramanyam, J 2013, Financial statement analysis, McGraw- Hill Education, USA.
Wainwright, S 2012, Principles of accounting, Bridgepoint Education, Inc., San Diego.