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 companys 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,

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 companys 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 companys net income which is set aside, and not paid as dividends, but to be re-invested into the companys 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.

Cumulative translation reserves represent the gains that result from varying exchange rates in the previous years. Task 2 Companies Povair Plc 2012

Year Ratios Gearing Ratio

(See Appendix A)

Mollins Plc 2012

2011

2011

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 companys debt increased in 2012 and is likely to continue to rise, Povair Plcs 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

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 simulating data 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 companys 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 Adjusted 000 Revenue 53,518 2012 Actual 000 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 Gross Profit Less: Distribution costs 500 (Distribution costs would also reduce since sales has reduced) Administrative expenses (17,029) 990 (17,029) (51,231) 2,287 (51,231) 25,224

(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 Poviars shares can be explained that investors are more riskshy, therefore very few of Molins shares are traded on the market because its shares are not as attractive because of its level of risk.

Appendix Gearing ratio refers to the measure of a companys 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 is considered risky, and it is calculated as Appendix A Gearing or Leverage Ratio = Total Debt Capital 100 ...% (McMenamin, 1999) Total Debt Capital Equity Shareholde rs' Funds

Molins Plc Gearing Ratio: Total debt capital = 5,900,000 million, and Shareholders funds = 30,500,000 Therefore, gearing ratio for 2012 =
5,900 ,000 16 .21 % 5,900 ,000 30 ,500 ,000

Gearing ratio for 2011 =

5,200 ,000 100 11 .26 % 5,200 ,000 41,000 ,000

Povair Plc Gearing ratio for 2012 Total debt capital = Bank overdrafts and loans of 1,000,000 Bank loans 10,145,000 Total debt 2012 =
11,145 ,000 100 19.44% 11,145 ,000 46 ,174 ,000

11,145,000

Gearing ratio for 2011 Total debt capital = Bank overdrafts and loans of 865,000 Bank loans 9,331,000

10,196,000 2011 =
10 ,196 ,000 100 19 .50 % 10 ,196 ,000 42 ,091,000

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 Plcs borrowings have increased during the year by almost 5% while that of Povair Plc has reduced by 0.06%, from this analysis, Molins Plcs 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 = 1999)

Profit after interest and tax (PAIT) ...times (McMenamin, Dividends payable

For Molins Plc, 2012 Dividend cover is = 2011 Dividend cover is =

7,600 ,000 7.60 times 1,000 ,000

7,100 ,000 7.1 times 1,000 ,000 4,282 ,000 4.23 times 1,023 ,000

For Povair Plc, 2012 Dividend cover is =

2011Dividend Cover is = Appendix C Dividend Yield =

3,099 ,000 3.18 times 976 ,000

Dividend per ordinary share ...% (McMenamin, 1999) Market price per ordinary share

Molins Plc Market price as at Friday 24 May 2013: 155.5 pence (See attached screen print below)

Molins Plc: Ordinary Share Price as at Friday 24 May 2013

Dividend yield as at 13 May 2013 =

3.0 pence 0.02 % 155 .5 pence

Povair Plc Market price as at Friday 24 May 2013: 270 pence (See attached screen print below)

Povair Plc: Ordinary Share Price as at Friday 24 May 2013 0.024 pence 0.00008 % Therefore, dividend yield as at 24 May 2013 = 270 pence Appendix D

Interest Cover =

Profit before interest and tax (PBIT) ...times (McMenamin, 1999) Total interest payable

Molins Plc, for 2012, Interest cover is =

5,400 ,000 0.343 times 15,700 ,000

2011, Interest cover is =

5,500 ,000 0.310 times 17 ,700 ,000

Povair Plc, for 2012, Interest cover is =

7,205 ,000 7.95 times 906 ,000

2011, Interest cover is =

5,307 ,000 6.58 times 806 ,000

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.