Introduction
The preferred name for the company is Kotton and will work with independent firms and factories to create an everyday-clothing essentials line priced to match the quality desired by customers. The demand for cotton products in the United Kingdom is high, and the Egyptian cotton is the best available quality in the market. The Egyptian cotton is the most expensive cotton in the United Kingdom market since it provides comfort, durability and silky softness and possesses the strongest and longest fibers. The Egyptian cotton has managed to beat competition from Pima and Sea Island brands, two major sellers of cotton in the United Kingdom. Kotton aims to provide the longest and strongest cotton while at the same time ensuring customers are able to enjoy the comfort, durability and softness from its cotton products. As we aim to invest in the cotton industry, we seek to secure credit that will significantly enable Kotton to meet its starting operating costs as well as maintaining the operations for a considerable period of time. However, since the demand for longer and stronger fibers is high, we project the possibility of paying back the amount borrowed within the second financial year. Our aim is to ensure that we add the concepts of longer and stronger fibers to comfort and durability desired by customers. The future demand for cotton products is also attractive hence implying that the business is likely to survive for a considerable period of time and fulfill the going concern concept that is expected for most business. We aim to convince creditors and investors to have confidence in our investment through committing ourselves to using the relevant financial documents and investment appraisal techniques to strategically achieve desired profitability.
Sources of Finance for Kotton
The firm seeks for financial assistance from a local bank for starting up the business. The choice for the local bank was due to the ability to advance the amount required as well as giving the loan at favorable rates. The other key advantage of seeking a loan from the local bank is the fact that the payment period will be spread depending on the terms agreed with the company. However, there are terms and conditions that the firm is aware of when entering into a contract with the local bank. The terms include the penalties for breach of payment which include legal actions in case there are no reasonable explanations for the breach of contract. The other term include payment of the amount borrowed with the interest rates suggested by the company.
Kotton is looking for a local bank that will be able to advance the loan at favorable borrowing rate that will in turn make it possible to repay it on time. The alternatives of acquiring the startup finances include partnership but it is unlikely that the partnership will raise the amount required to get the business going. We also chose the option of local commercial banks since we believed it is critical in providing the necessary investment advice before we engage the market. This implies that the bank will be able to advise Kotton on the various aspects of financial management such as determining the appropriate ratios and cash flows to maintain for a healthy business. Kotton seeks for funds to enable it successfully penetrate the United Kingdom market where the company seeks for £ 200000 from the local bank to help supplement the £ 50000 we already have as cash in hand for the start up. With the initial set up amount of £ 250000, we believe that we shall be able to move the company to a forecasted annual net profit of £ 480065 by the end of the first year, £ 550000 for the second year, £750000 for the third year and £ 1200000 by the fourth financial year.
The consequences of failing to acquire the funds is that we may be forced to sell the idea to other investors which in this case is not a desirable decision considering the ambitions and the plans we already have to fulfill the needs and expectations of the target market. The other consequences for failing to acquire the loan is that we may be forced to withdraw from investing in the cotton market which means that the gap in the market will remain unfilled in the long run. We look forward to accessing the loan at friendly rates to be able to pay back without much struggles. The preferred interest rates is 5% and we hope to be able to return the credit plus the interest within two years.
Financial documents to be used by Kotton
Financial documents play a critical role in enhancing organization’s success. Documents such as profit and loss accounts are relied upon since they provide a clear description of the incomes and expenses of the firm. From the incomes and expenses, it is possible to determine the projected net profits which in turn affects the ability to attract investors and lenders. The projected income statement for the business is shown below:
Profit and Loss Account for Kotton
For the First Financial Year
Sales 1882330
Cost of goods sold
Purchases (559340)
Net sales 822990
Less: Expenses
Wages and salaries 76000
Rent 220000
Advertising 8000
Utilities 1200
General expenses 10000
Business rates 10965
Insurance 7000
Repairs and maintenance 9760
Net profit before taxation 480065
Kotton
Cash Flow Statement
Cash at beginning of year (0)
Operations
Cash receipts from customers 563900
Cash paid for
Wage expenses 76000
Inventory services 32500
General operating & administrative expenses 54200
Income taxes 15200
Interest 7050
Net Cash Flow from Operations (378950)
Financial Activities
Cash input from issuance of Stock
Borrowing 70000
Cash paid for
Repayment of loans 20000
Repurchase of stock 200000
Net Cash flow from financing Activities (-150000)
Net increase in cash 228950
Investors are always interested in analyzing the trends in income and expenses to determine the viability of the business such that in the event where the business has low profit margins or encounters losses, then the investors and lenders may decide to opt out of the possibility to risk their finances on the business. Expenses such as salaries, overhead costs and equipment need to be accurately recorded to provide a clear description of the firm’s outflows.
Balance sheets on the other hand provide a description of the assets and liabilities of the business. This implies that the balance sheets provide a way in which it is possible to read and interpret the assets and liabilities of the firm to be able to keep the owners informed on the financial standing of the business. A clear outlook of the balance sheets is able to show owners in case the business is in trouble to enable appropriate strategies to be used to correct the situation. Lenders and investors rely on the balance sheets to determine the owner’s equity to be able to decide on whether to fund the business or avoid risking their funds in the business. This then implies that there is need to ensure that the assets and liabilities of the company are updated and that there are less liabilities for the business since more liabilities put the business into greater risks of lower profits. Below is a representation of Kotton’s balance sheet:
Kotton Company Balance Sheet
Accumulated Funds
Profits 480065
Capital 250000
Total funds 730065
Non-current assets
Furniture and fittings 1000
Equipment and Com 5000
Machinery 225000
Current assets
Stock 559 340
Cash in hand 50000
Total Assets 790340
Non-current liability
Current liability
Creditors (60275)
Net Assets 730065
Cash budgets are also useful documents used by the business to determine the flow of receipts and payments. Monitoring the cash flows is desirable for business to e babel to avoid insolvency issues due to little cash in the business. Little cash also implies that lenders and investors will be unwilling to risk their money in the business since they are certain with the firm’s failure to pay back the amount plus the interest attached to the borrowed amount.
Evaluating the Financial Performance of the Business
Investment appraisal techniques are important since they help in identifying the long term viability of the business. Appraisal techniques such as return on capital employed and the payback back period reflect the ability of business to stick to its priorities and enhance long term success of the venture. Return on capital employed is key to measuring the efficiency of the capital investment such that the levels of expected returns is evaluated against the expenditures made. The return on capital employed by Kotton is shown below:
ROCE=Earnings before interest and tax/capital employed
480065/250000
+1.92 (The positive ROCE implies that the venture is worth investing in)
There is therefore need to ensure that the expenditures on non-current assets are regulated to ensure the firm does not incur huge expenses on assets that could undermine potential returns. This implies that the targeted return on capital employed need to be less than the return on capital employed achieved to be sure of long term viability of the venture. Payback period is also the other key investment appraisal technique which considers the period of time taken for the business to pay back the costs involved in its start up. The earlier the payback period, the more viable the business may seem to be and the possibility of obtaining more credit for expansion purposes becomes easier. Investors and creditors are always looking for the ability of business to pay its borrowed funds in time. Current ratios are useful for the business as they measure the firm’s ability to pay short term and long term obligations. The current ratios consider the total assets of a company both cash and non-cash assets to determine the firm’s ability to pay its liabilities as well as maintain its financial stability.
Current ratio=Current assets /current liabilities
609340/60275
+10. 11 (The ratio proves that Kotton is able to maintain a higher current ratio)
Gearing ratios are also key to comparing the owner’s equity to the borrowed funds. The business is therefore able to determine the degree to which it is dependent on the funds provided by creditors.
Gearing ratios=interest bearing debt/share capital + retained earnings
480065/200000
2.4 (The ratio shows that in the long run, the venture will be able to support most of its operating expenses)
There is need to ensure the firm does not get into debts that will eventually limit its net earnings. Avoiding the financial risk of excessive debt is important since investors are always keen to analyze the trends in the debts ratios to make decisions on whether to engage with the business. The other important investment appraisal technique is the net present value which determines the present value cash flows measured against the present value of the cash outflows, this then makes it possible to estimate the viability of the business for a given period of time. While relying on a given interests rate, the NPV makes it possible to assess the ability to pay the borrowed amount while still managing to maintain desirable profits.
NPV=-C0+C1/1+r+C2/ (1+r)2
=-250000+480065/1.05+550000/(1.05)2+750000/(1.05)3+1200000/(1.05)4
-250000+457204.76+498866.21+647878.20+987242.97
NPV =+£2341192.14 (A positive NPV means the venture is worth launching).
The key aspect is to consider the net profit margins which measures the percentage of revenues after expense are deducted from the sales. This is key to determining the profitability of the firm in the long run since it acts as a major measure of the ability of the firm to meet its operating expenses in the long run.
Reason why the Business will succeed
The business will succeed in the long run considering the effectiveness with which it studies its financial ratios. The current ratios enable the business to consider its ability to pay the short term and long term financial obligations. This means that from the current ratio, it is possible to determine the appropriate, measures to take to ensure that the firm avoids incurring higher expenses that could limit its ability to pay back amounts borrowed. While analyzing the ratios, the business is keen on its cash and non-cash assets since they are likely to determining whether the firm is able to maintain its financial solvency. The gearing ratios are key to estimating future success because they take into account the measure of owner’s equity to the funds borrowed. What this means is that there is need to ensure that the owner’s equity is always higher than the borrowed finds in the long run to ensure that the business is safer in terms of settling its financial liabilities. While assessing the gearing ratios, the business is able to understand the extent to which it needs to rely on creditors funds to be able to sustain its operations. The net present margins are important since they determine the percentage of revenue after expenses are deducted. Positive net margins are desirable for business since they indicate that the future is likely to be worthwhile for the business, taking issues such as economic situations and political factors to be stable. As shown in the balance sheets, the income statement and the ratios, the business will in the long run be able to achieve higher profit margins which are key to growth and stability.
Conclusion
The chances of the business achieving its long term goals is high considering it aims at taking advantage of the need for longest and strongest fibers which many of the competitors lack. While considering the investment appraisal techniques and strategically incorporating them into the business, it is possible for the firm to be able to pay its debt in real time and avoid issues such as breach of contract or request for more time to pay the loans. Positive net margins are desired throughout the life of the business since this implies that the operating costs of the company will be optimal and hence ability to attract investors and lenders. While relying on the appraisal techniques, there is need to ensure the financial documents are used in their appropriate manner such that it is possible to interpret the results depicted by the documents. Income statements, cash budgets and balance sheets are key documents that will significantly help Kotton achieve its long term growth and stability in the industry. With the credit provide, we believe that we shall successfully penetrate the cotton industry and be able to convince customers of the need to adopt Kotton as their preferred retailer.
References
Beest, F., Braam, G. & Boelens, S., 2009. Quality of Financial Reporting: measuring qualitative characteristics. Nijmegen, Nijmegen Center for Economics, pp. 1-10.
Čalopa, M., Horvat, J. & Lalić, M., 2014. Analysis of Financiong Sources for Start-up Companies. Journal of Management, pp. 19-26.
Kerr, W. & Nanda, R., 2009. Financing Constraints and Entrepreneurship. Harvard Business Review, pp. 1-10.
Olawale, F., Olumuyiwa, O. & George, H., 2010. An investigation into the impact of investment appraisal techniques on the profitability of small manufacturing firms in the Nelson Mandela Bay Metropolitan Area, South Africa. African Journal of Business Management, pp. 1274-1280.
Riedl, E., 2008. Signaling Firm Performance Through Financial Statement Presentation: An Analysis Using Special Items. Harvard Business Review, pp. 1-10.
