FHS Selecting Financial Strategies

FHS Some ways to raise finance Internal External

FHS Some ways to raise finance Internal External Retained profits Working capital Asset disposals Sale & leaseback Issue shares Bank loan / overdraft Debentures

FHS Retained profits The most important and significant source of finance for an established, profitable business

Retained profits – main advantages Cheap (though not free) – The “cost of capital” of retained profits is the opportunity cost for shareholders of leaving profits in the business Very flexible – Management control how they are reinvested – Shareholders control the proportion retained Does not dilute the ownership of the company FHS

Possible downsides of retained profits Danger of hoarding cash Shareholders may prefer dividends if the business is not earning a sufficient ROCE High profits and cash flows would suggest the business could afford debt (higher gearing) FHS

Working capital as a source of finance Reducing working capital – A one-off benefit from lower working capital – The question – can it be sustained? Finance often wasted in excess stocks and trade debtors Look for very low stock turnover ratio or high debtor days FHS

Asset disposals Potentially another one-off boost to finance Good examples: spare land, surplus equipment Note – not all businesses have spare assets Often occurs after acquisitions FHS

Example of assets sale Retailer JJB Sports has said it may be heading for a full-year loss of up to £10m after seeing sales fall in "extremely difficult" trading JJB is looking to sell its Fitness Clubs business FHS

Sale and leaseback Specialist method of raising cash Involves selling fixed assets and then leasing them back from new owner Tends to involve business properties (e.g. hotels, supermarkets, offices – popular when property market was booming Note: can only be done once!

Example of sale & lease back Sorry – another football link! Leeds football club are trying to raise funds by selling off Elland Road football ground for £6m and then lease back. They are trying to sell to Leeds council. The negotiations are still underway. FHS

Issuing shares Company issues new shares 1 1 Shareholders buy the new shares 2 2 Company has: More cash More shareholders Company has: More cash More shareholders 3 3

FHS Examples of issuing share rights Working lunch great visual example of what share rights involve… HSBC bank share rights issue

FHS Methods of issuing shares for a plc Flotation Share issued on Stock Exchange for the first time Opportunity for existing shareholders to realise profits on their investment Costly + time-consuming process Aims to raise at least £25-50million + of new capital Rights issue Fresh issue of new shares to existing shareholders Shareholders have the “right” to subscribe for the new shares, usually at a significant discount to the existing share price

FHS Share issues – benefits and drawbacks BenefitsDrawbacks Able to raise substantial funds if the business has good prospects Can be costly and time- consuming (particularly flotations) Broader base of shareholdersExisting shareholders’ holdings may be diluted Equity rather than debt = lower risk finance structure Equity has a cost of capital that is higher than debt

FHS Raising Loan Capital Bank overdraft Bank loan Debentures Covered in BUSS2

FHS Debentures A debenture is a form of bond or long-term loan which is issued by the company, usually with a fixed rate of interest

Debentures – key features Long-term: often years Issued by the company (not a bank) Fixed rate of interest Usually secured against the assets of the company (provides some protection for debenture holders) Can be traded

FHS Cost Minimisation Strategies Cost minimisation aims to achieve the most cost-effective way of delivering goods and services to the require level of quality

FHS Cost minimisation What strategies can a business take to minimise costs? (although this is a financial question the answer could come from any functional area or even a corporate solution) – Marketing Low cost strategy – Operations Management Relocation Lean production – Human Resources Changing organisational structure Workforce plans – Corporate Close unprofitable branches Cost minimisation is a recurring theme in BUSS3 What financial strategies has Ryanair taken to achieve its objective of growth? What other factors have influenced these strategies ?

Possible sources of cost reductions Eliminating waste & avoiding duplication (lean production) Simplifying processes and procedures Outsourcing non-core activities (e.g. transaction processing, payroll administration, call handling) Negotiating better pricing with suppliers Improving communication Pruning product ranges and customer accounts to eliminate unprofitable business Using the most effective methods of training and recruitment Introducing flexible working practices Aggressive control over non-essential overheads (e.g. banning first or business class travel unless essential)

Potential problems with cost minimisation Business left with insufficient capacity to handle unexpected or short-term increases in demand Cost reductions by one department may surprise and/or annoy other functions if they are not properly communicated and coordinated

Your go… FHS

Textbook – p 55 Sainsburys - mini activity VW - mini activity Q 1&2 FHS

Profit Centres A profit centre is a separately- identifiable part of a business for which it is possible to identify revenues and costs (i.e. calculate profit)

Examples of profit centres Individual shops in a retail chain Local branches in a regional or nationwide distribution business A geographical region – e.g. a country (for multinationals) or county A team or individual (e.g. a sales team, a team of installers)

FHS Benefits and drawbacks of profit centres AdvantagesDisadvantages Useful insights into where profit is earned within a complex business Can be time-consuming to both set-up and monitor Supports budgetary control at a detailed level, including setting profit objectives Difficulties in allocating costs (particularly) and revenues (occasionally) Can improve motivation of those responsible for the profit centre May lead to conflict and competition rather than cooperation within the business Comparisons can be made between similar profit centres (e.g. shops in a chain) Potentially de-motivating if profit centre targets are too tough, or if unfair cost allocations are made Improves decision-making at a local level (likely to be closer to customer needs) Profit centres may pursue their own objectives rather than those of the broader business Finance can be allocated more efficiently – where it makes the best return

FHS Plenary Q’s Why might a car manufacturer need to raise large sums of money? What options are available internally & externally to raise such sums to a car manufacturer in today’s economic climate? What are the benefits of using retained profit for a major investment? What are the opportunity costs of using your retained profits too? (consider the ratios that will be effected)

FHS Hwk Textbook – read info on Profit centres – p56 to 58 Make key revision notes: What is a profit centre? Benefits & limitations of profit centres. Implications of profit centres.