F1-short-term finance

Question 1

1.1 investment of surplus cash-profitability

Answer 1

profitability:relates to the return to be gained from the investment
-clearly there is a need to earn as high a return as possible,however high return usually correlates a high risk in an investment, thus, it is important that any considerations regarding return as balanced with considerations about the risk of the investment.
the risk of the investment is linked to both its liquidity and particularly its safety.
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Question 2

1.2 investment of surplus cash-liquidity

Answer 2

liquidity relates to how easily the investment can be converted into cash.

• usually the easier it is to convert, the lower the level of return.
• from our perspective, as long as we are confident that this is surplus cash, then we could invest the funds until they are required for other purposes, for example, expansion of the production facility.

Question 3

1.3. investment of surplus cash-safety

Answer 3

safety relates to how secure the investment is.
usually the safer the investment, the lower its return. Clearly there is a need to protect the capital value of our investment.

Question 4

2.1 suggestions of suitable investments-keep surplus fund in the bank account

Answer 4

1. it keeps the business highly liquid, also a safe form of investment as there is almost no risk of the capital value of the monies in the bank account falling.
2. however, this option gives only a minimum return on the funds and hence is the least profitable option being considered.

Question 5

2.2 suggestions of suitable investments-marketable securities

Answer 5

1. we could invest in short term bonds on the money market, these types of investment are riskier than deposits, especially if the bonds are corporate, however they usually offer the opportunity of a greater return.

Question 6

2.3 suggestions of suitable investments-invest in the stock market

Answer 6

1. investing in the equity shares of other businesses and this is very risky.
2. there is a chance that we could make fantastic returns from buying and then selling shares listed on the stock market, however there is also a chance that we end up losing some of the cash invested.

Question 7

2.4 suggestions of suitable investments-invest in an interest-bearing deposit account

Answer 7

1. this is likely to be a safe investment and would generate a return.
2. the level of return will depend on the amount invested and also whether the funds were tied up for the entire period of deposit or accessible. if the fund were tied up this would usually give a higher return ,although would mean that the investment wasn`t liquid in the event of unforeseen circumstances.

Question 8

3. actions to avoid a cash deficit

Answer 8

1. sell any short term investments that we may hold, although we would need to consider any penalties that may be imposed as a result of early withdrawal/sale.
2. consider the timing of our dividend payment to shareholders or reduce dividend payments.
3. reducing discretionary cash flows by postponing non-essential expenditure.
4. postpone revenue expenditure such as advertising expenditure.
5. bring forward the planned disposal of non-current assets (tested with different budget methods such as rolling budget)
6. consider partly financing the new capital expenditure using long term debt or leasing rather than using all our cash.
7. review our working capital management

Question 9

4. review our working capital management

Answer 9

1. inventory levels should be kept as low as possible whilst avoiding stock-outs.
2. careful management of trade payables may also provide a short-term finance.
   - delaying payments to our suppliers would help us to extend the working capital cycle. however, care is needed with this policy as we may lose settlement discounts and harm our supplier relationships. suppliers may reduce the service they give us, restric supplies, increase price to us in future or even stop our suppliers altogether.
3. we need to ensure that we have an effective collection policy for our trade receivable and that we carry our adequate checks before offering credit to customers.
   - we may also want to consider the possibility of factoring or discounting certain invoices to speed up our cash cycle.

Question 10

5. bank overdraft

Answer 10

1. this has the advantage that it is flexible and that we only pay interest on the amount used which means it is a relative cheap source of finance.,
2. the interest rate is variable which means we are exposed to any changes in bank base rate and makes it more difficult for us to budget for the interest costs.
3. we should however be able to increase our overdraft but would need to check our current security arrangements wiht the bank. thwy will probably require us to provide up to date cash and profti forecasts to support our application for an increase in the facility.

Question 11

6. bank loan

Answer 11

1. agree a short-term loan with the bank to cover the period of the additional cash deficit over and above our overdraft limit.
2. interest however will be payable on the whole sum of the loan for the specified period of the loan.
3. liable to be more expensive than an increase in the overdraft, we may also have to provide further security for the loan.