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Assess How The Source Of Finance Impacts A Businesses Ability To Achieve Its Financial Objectives

1247 words - 5 pages

Assess how the source of finance impacts a businesses ability to achieve its financial objectives (20 marks)

There are five financial objectives, which are influenced by internal and external sources of finance. These five financial objectives are: liquidity, solvency, efficiency, profitability and growth. Internal sources of finance come from within the business and include retained profits. External sources of finance can be classified into two forms. Debt or equity. Debt is categorised as short term or long term. Short-term debts include; overdrafts, commercial bills and factoring, whereas long-term debts include; mortgages, debentures, unsecured notes and leasing. Equity can be issued ...view middle of the document...

In order to improve the quick ratio a business should use factoring. Factoring is the selling of accounts receivable to a specialised debt- collecting agency. The debt now becomes the factoring company’s problem, not the problem of the business. However, factoring will improve the quick ratio but will hinder the current ratio as current assets will reduce. A business will sell its accounts receivable to a specialist factoring company for less than what it is worth. For example a business has an accounts receivable of $100, and sells it to a debt-collecting agency for $90. The business loses $10 in the sale, however the issue of collecting the debt is no longer their problem. In conclusion selling a non-current asset, adding to a mortgage and factoring are adequate ways for a business to improve its financial objective- liquidity.

Solvency is the ability of a business to cover total liabilities with owners-equity. Solvency is the long-term financial viability of a business. The ratio used to measure the solvency of a business is the gearing ratio (total liabilities over owners equity). An accepted ratio is 100% or above. To improve the gearing ratio, a business should not draw out any capital and retain all profits in the business to maintain the owners equity. To decrease liabilities a business should find a cheaper mortgage broker to reduce the amount of interest being paid on the mortgage. New issues of shares is when a business becomes public and lists itself on the stock exchange. Issuing shares is an ideal way to generate cash without having to pay it back. Individuals who buy the shares become part owners of the business. Issuing shares will improve the owner’s equity of a business and will consequently improve the gearing ratio. A positive factor of issuing shares is that the business does not have to pay back the funds.

Efficiency is a measure of output per input. It is the ability of a business to use its resources effectively in ensuring financial stability and profitability. Two ratios are used to measure the efficiency of a business. There are the accounts receivable turnover ratio (sales divided accounts receivable, divided by 365 to get the average number of days for debt to be collected) and the expense ratio (expenses divided by sales). In order to improve the accounts receivable turnover ratio factoring should be used. Factoring would decrease accounts receivable because selling the debt reduces the days for it to be collected. However, there is a draw back to factoring, as the business that sells its debt does not receive the full accounts receivable amount. Factoring decreases the current ratio, but improves the quick ratio and improves the efficiency of the business. To improve the expense ratio a business can use the sale and lease back strategy. Sales would increase dramatically from selling a...

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