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7/27/2019 Foundation Accounting.docx
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Foundation Accounting
Task 1
Using your text book, other books, journals and/or internet resources explain the key
advantages of one key source of finance for a company.
The source of finance to be discussed is equity finance, according to Needles et al. (2010),
equity financing is achieved through the issuance of shares to investors in exchange for assets
which is usually cash, and investors are then issued a share certificate which they can transfer
at any time by selling it for cash in the stock market. By issuing such shares in exchange for
cash, the company is selling part of its interests to the investors, and this makes them part
owners and partners in the business with full rights as shareholders as prescribed by the law
(Gowthorpe, 2005). There are several advantages of equity financing and these are discussed
accordingly:
According to Needles et al. (2010), equity financing is less risky than most of the other types
of financing sources because the company does not pay interest on it, and will only pay
dividends when the board of directors decide to pay them, whereas in other sources that the
company has to pay interest, if it does not pay, it can be forced to pay the interest or be forced
to close down, if it cannot pay. Shareholders are only interested in returns on their investment
in the form of dividends or increase in the market value of the shares they have been issued
by the company which they can sell for a profit (Porter and Norton, 2010). Also, the
company can decide to divert the unpaid dividends into the business’ operations to finance
projects that need cash in order to improve the company’s profit making capabilities (Needles
et al., 2010).
The payment of dividends is flexible because it can be increased during the period of
profitable performance, and then be reduced when the company is less profitable, and they
still always have access to raise more funds whenever there is need for it (Porter and Norton,
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2010). The share certificates have no expiry dates except when the shareholder sells the
shares, and the funds provided to the company by the investors does not have to be returned,
so they are a good source of long term funding for the company (Fleming, 2004).
Task 2
a) Explain the long and short-term sources of finance utilised by each company in two
consecutive years.
Molins PLC and Povair Plc
Long term sources of finance:
Equity:
Issued share capital which shows that the company has collected cash from its shareholders,
in return for share certificates which they can sell in the stock market either at a profit or loss,
depending of the value of the company’s stock on the stock market (Needles et al., 2010).
Share premium is the amount of money received over and above the actual value of the
shares.
Reserves represents extra cash that has been set aside by the company to meet some
obligations in the future which may either be expected or unexpected, but which is currently
available for the company to finance its operations.
Retained Earnings represents the part of the company’s net income which is set aside, and
not paid as dividends, but to be re-invested into the company’s main business in future.
Interest-bearing loans and borrowings are funds that have been borrowed for specific
investment purposes at fixed interest rate, and which must be repaid at the agreed date.
Employee Benefits refer to the benefit pension scheme run on workers behalf and from
which pension payments are made when the employee retires, and the company is responsible
for its maintenance.
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Cumulative translation reserves represent the gains that result from varying exchange rates
in the previous years.
Task 2
Companies
Mollins Plc Povair Plc
Year
Ratios
2012 2011 2012 2011
Gearing Ratio(See Appendix A)
16.21% 11.26% 19.44% 19.50%
Dividend Cover (See Appendix B)
7.60 times 7.1 times 4.23 times 3.18 times
Dividend Yield(See Appendix C)
0.02% 0.00008%
Interest Cover (See Appendix D)
0.343 times 0.310 times 7.95 times 6.58 times
b. From the above analysis, the gearing ratio for Mollins Plc was 11.26% in 2011, it increased
to 16.21% in 2012, this shows that the company’s debt increased in 2012 and is likely to
continue to rise, Povair Plc’s gearing ratio reduced from 19.50% in 2011 to 19.44%.
Although, the two companies borrow to finance their activities while they both have enough
stock of cash in their share premium account to pay back the debts.
c. Risks and Rewards
Risk is the uncertainty attached to a specific investment which makes it impossible to confirm
that the investment has a positive or negative reward or that the reward is high or low, the
reasonableness of risk is measured in terms of the relationship between risk and reward,
hence, the higher the risk, the higher the reward, also, the lower the risk the lower the reward
(McMenamin, 1999). From the reports of the activities of both companies, we can see that
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both are exposed to different types of risks based on their line of business as well as the
global economic and market cycles, but they have both tried to reduce the effect of such risks
by engaging in several range of business operations such that if one fails, the other can make
up for the losses from other sections. But because both companies declare dividends
progressively on a yearly basis, and the yearly increase in the earnings per share, the risks are
worth taking and this will keep shareholders happy, since it will increase the value of the
companies’ shares on the stock market.
d. How would the return to both (shareholders and loan providers) vary if the ‘Profit
before Interest and Tax’ rises or falls? (A sensitivity analysis is required by simulatingdata within a reasonable range).
The returns to both shareholders and loan providers can be affected by the performance of the
organisations regarding the amount of sales declared, and within its cost of sales, the
efficiency in the company’s inventory turnover as well as the management of administrative
expenses. A sensitivity analysis is provided below to show this:
Povair Plc Adjusted Consolidated Income Statement as at 30 November 2012
2012 2012
Adjusted Actual
£ ‘000 £’000
Revenue 53,518 76,455
(Assuming a 30% reduction in stock value in 2012 from
fire outbreak in the stores which also leads to a 30% reduction in sales)
Less: Cost of sales (51,231) (51,231)
Gross Profit 2,287 25,224
Less:
Distribution costs 500 990
(Distribution costs would also reduce since sales has reduced)
Administrative expenses (17,029) (17,029)
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(Administrative expenses are assumed to be fixed costs)
Operating Profit/(Loss) (15,242) 7,205
From this big loss, the company would not be able to declare dividends and it would have
been unable to pay the interest on its loans for the year, and this leads to a default in
payments.
Task 3
Based on the comparable results of the ratio analysis and from other reports in both
companies’ annual accounts, Povair Plc has a lower risk profile and hence lower returns
while Molins Plc has higher risk and higher returns. This is because of the amount of debt
that Molins Plc shows in its report which increase it gearing ratio by 5%, and although it is
owing more, its returns are higher and is shown in its earnings per share for 2012 which is
40.0p per while Povair Plc which is less risky reported earnings per share of 10.1p. The
dividend cover for the two companies also shows that Molins Plc in 2012 is 7.6 while Povair
Plc is 4.23, the dividend yield for Molins is also higher at 0.02% while Povair is 0.00008%.
Although the closing share price for Povair Plc was 270p on 24th of May while that of Molins
was 155.5, the higher value of Poviar’s shares can be explained that investors are more risk -
shy, therefore very few of Molins shares are traded on the market because its shares are not as
attractive because of its level of risk.
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Appendix
Gearing ratio refers to the measure of a company’s debt compared to its equity, which means
the extent is a company financing its operations with borrowed funds compared with the
owners’ funds (McMenamin, 1999). The higher the gearing ratio, the more the company isconsidered risky, and it is calculated as
Appendix A
Gearing or Leverage Ratio =
...%100Fundsrs'ShareholdeEquityCapitalDebtTotal
CapitalDebtTotal
(McMenamin, 1999)
Molins Plc
Gearing Ratio:
Total debt capital = £5,900,000 million, and Shareholders’ funds = £30,500,000
Therefore, gearing ratio for 2012 = %21.16000,500,30000,900,5£
000,900,5£
Gearing ratio for 2011 = %26.11100000,000,41000,200,5
000,200,5
Povair Plc
Gearing ratio for 2012
Total debt capital = Bank overdrafts and loans of £1,000,000
Bank loans £10,145,000
Total debt £11,145,000
2012 = 19.44%100000,174,46000,145,11
000,145,11
Gearing ratio for 2011
Total debt capital = Bank overdrafts and loans of £865,000
Bank loans £9,331,000
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£10,196,000
2011 = %50.19100000,091,42000,196,10£
000,196,10£
The gearing ratio for Molins Plc for 2012 is 16.21%, and that for 2011 is 11.26%,also, for Povair Plc, the gearing ratio for 2012 is 19.44%, and that for 2011 is 19.50%.
While Povair Plc has tried to stabilise its borrowings during the year, Molins Plc’s
borrowings have increased during the year by almost 5% while that of Povair Plc has
reduced by 0.06%, from this analysis, Molins Plc’s long term gearing is riskier than
Povair Plc.
Appendix B
d) Calculate the dividend cover, dividend yield and interest cover ratios for both
companies for two consecutive financial years. Based on your calculations and other
relevant information, explain the risks and reward for shareholders and loan providers
for both companies.
Dividend Cover = times... payableDividends
(PAIT)taxandinterestafter Profit (McMenamin,
1999)
For Molins Plc, 2012 Dividend cover is = times60.7000,000,1
000,600,7
2011 Dividend cover is = times1.7000,000,1
000,100,7
For Povair Plc, 2012 Dividend cover is = times23.4000,023,1
000,282,4
2011Dividend Cover is = times3.18000,976
000,099,3
Appendix C
Dividend Yield = ...%shareordinary per priceMarket
shareordinary per Dividend (McMenamin, 1999)
Molins Plc
Market price as at Friday 24 May 2013: 155.5 pence (See attached screen print below)
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Molins Plc: Ordinary Share Price as at Friday 24 May 2013
Dividend yield as at 13 May 2013 = %02.0 pence5.155
pence0.3
Povair Plc
Market price as at Friday 24 May 2013: 270 pence (See attached screen print below)
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Povair Plc: Ordinary Share Price as at Friday 24 May 2013
Therefore, dividend yield as at 24 May 2013 = %00008.0 pence270
pence024.0
Appendix D
Interest Cover = times... payableinterestTotal
(PBIT)taxandinterest beforeProfit (McMenamin, 1999)
Molins Plc, for 2012, Interest cover is = times0.343000,700,15
000,400,5
2011, Interest cover is = times0.310000,700,17
000,500,5
Povair Plc, for 2012, Interest cover is = times95.7000,906
000,205,7
2011, Interest cover is = times6.58000,806
000,307,5
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REFERENCES
FLEMING, L. 2004. HSC Business Studies, Glebe, NSW, Pascal Press.
GOWTHORPE, C. 2005. Business Accounting and Finance: For Non-specialists, Bedford Row, London,
Thomson Learning.
MCMENAMIN, J. 1999. Financial Management: An Introduction, London, Routledge.
NEEDLES, B. E., POWERS, M. & CROSSON, S. V. 2010. Financial and Managerial Accounting, Mason,
OH, USA, South-Western Cengage Learning.
PORTER, G. A. & NORTON, C. L. 2010. Financial Accounting: The Impact on Decision Makers, Mason,
OH, South-Western Cengage Learning.
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