Introduction

This assignment was given by Miss. Sana Naseem teacher for the subject Managing Financial Resources (HND business semester 1) to our group, which comprises of Sayed Muhammad Ali, Shah Awais and Muhammad Haris on 18th December, 2008. We were assigned to submit a report on the analysis of different financial sources, their cost and evaluation of the financial performance of a business. 15th January, 2009 was given a last date for submission of report. For this purpose, we selected Cherat Cement Company, which is one of the national and international level Company.Cherat cement is the leading company in the field of cement manufacturing and introduced in 1981. It is located near Nowshera, N.W.FP and is built on land bordering the Cherat hills. There are different companies in Pakistan, which is listed at Karachi stock exchange but Cherat Cement Company is listed in Karachi as well as Lahore and Islamabad stock exchanges. Cherat cement belongs to Ghulam Faruque group of industries. They are well known industrialist in Pakistan running their business nationally and internationally in various fields. Their head office is situated at Karachi, Pakistan. Besides Cherat cement they have sugar mills at Mirpur khas, Sindh. Similarly Ghulam Faruque textile industry is situated at Faisalabad, Greaves cotton air conditioned plant for manufacturing of heavy air condition plant for industry. Moreover they are manufacturing CNG heavy duty generators. They are installing CNG filling stations throughout Pakistan. They also have another factory for the manufacturing of auto spare parts. Thus they are involved in various fields of industries contributing to the prosperity of Pakistan.Cherat Cement Company is one of the leading producers and suppliers of cement in N.W.F.P and Punjab. Moreover, they have ISO 9001:2000 certification, which enables them to export their cement throughout the world. The company is currently expanding their production and business. Now days through their export, they are the leading brand and first choice in Afghanistan.In order to get clearer concepts regarding managing financial resources over there. Interview was conducted of the higher management of Cherat Cement Company, which helped us a lot to come up with comprehensive analysis and preparing our report.

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Sources of Finance:Finance means money; every business organization needs finance (funds) to start, expand and grow & operate a business whether it is a small shop, big organization or multi-national company. Without finance, business organization would not be able to survive nor can work. It depends on the mind of the business individuals to select an appropriate source of finance for their business. Business organization has to choose the source of finance which suits them and makes them more successful in the long run. So every organization selects the most appropriate source of finance for their business.

There are two major sources of finance.1) Internal Sources2) External Sources

Internal sources:Internal sources of finance are those sources which come from the business assets or activities. Such types of funds are mostly generated from internal sources within the company. Profits, sale of assets, reducing stock and extended payment terms etc are some of the internal sources.Profits: If business organization is financially strong, and makes every year successful trading and some profit after paying all its costs, then the company could use some of its profit to finance future activities. This is very useful source to generate funds.Sale of Assets: The Companies or business organizations may choose or be forced to sell-off assets in order to raise finance. These assets may be property, fixtures, machinery, vehicles etc.Reduction in Stock: Reduction in stock is considered as short-term source. Stock is a type of asset and can be sold to raise finance. Stock includes the business holdings of raw materials, semi-finished products and finished products that it has not been sold yet.

External Sources:Internal sources of finance are not sufficient to fund the current and future planned expenditure of a business; therefore the business organization must look externally for potential sources of finance. External sources are those sources which come from outside the business. Total dependence on these external sources for an organization is not recommendable but big organizations which are self sufficient in their finance, can better utilize the external sources of finance. External sources include family and friends, commercial banks, limited partnerships, leasing & hire purchase, shares, government loan programs and grants etc.Bank Loans: Mostly the business of bank is running on lending money to the persons or companies on interest basis. The lower the rate of interest of a bank, the more customers are attracted towards them. But the banks have also fixed policies; they do not lend money to every person. Before lending money they have to check many things, which makes them capable of loans e.g. they check the character and honesty of the borrower and their pay back capability.Investment from Outside Parties (Franchising): Getting finance from outside parties in the form of appointment of franchisers to their product is another external source. This

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is a better way of business and raising funds to the company in large amount. Although it is unreliable and risky way because the products of the company goes to other hands, but there is also some positive points. As the franchiser borrow your expertise and goodwill by providing money in lump sum.Shares: It is a long-term source of finance and important for limited companies. Issuing new shares can raise a lot of capital that can be utilized for expansion i.e. buying more fixed assets etc. But the business organization will also have to pay dividends on the shares.Lease: Expensive equipments and their parts can be leased to the leasing company and continue to use it by paying its rent to the lessor (Leasing Company) for a fixed or indefinite period of time.Hire Purchase: Hire Purchase is an alternative source of purchasing items. For which down payment is made in the first instant and then the rest of payment is made in easy installments. Ultimately the purchaser becomes the owner on completion of the agreed price, which includes its original price along with its profit.

Sources of Finance Used by Cherat Cement Company : Before selecting any source of finance, business organization must keep some of the factors in their mind.Duration: For the business organization, it is must that finance is guaranteed as long as it is needed. On the other hand the investor would like to ensure that adequate security is available for the duration of the loan - as in the case of a 15-year loan secured against a property that will continue to have value for all the 15 years.Cost: Every business organization look for the cheapest source of finance. The simple and easiest way to compare the cost of finance is to express the annual payment to lenders as a percentage (profit) of the amount of finance provided.Repayment: A business should not get into a position where all of its profits are being swallowed up in interest payments. There is a real danger of borrowing too much.

Internal Sources for Cherat Cement Company:

As Ghulam Farooq group of industries belongs to Ghulam Farooq and his family, who are big industrialist of Pakistan and are the owners of the many other industries beside Cherat cement (as mentioned in the introduction). So they are well off and each industry is supported by other industry. They are not facing any problem regarding finance.

Cherat cement is well established organization from the very beginning and it has progressed throughout from the growth till maturity. That is why the graph of balance sheet has always shown in the ascending order.

Cherat cement generates high revenues every year. A high margin of the profit earned by the business is invested again and again, causing smooth operation of the business.

Cherat cement has always introduced new technology in their organization, which has proved to be very useful and giving them distinctive position among the competitors.

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External Sources for Cherat Cement Company:1) Borrowing from Banks: Borrowing from bank is an external source of finance for

Cherat Cement Company. It has a reputable name in the market because of their strong financial position and all the banks know that they have good capability of returning loans. So every bank wants to have business with them. There is no risk involved on either sides because the terms and conditions are fixed so one does not has to worry about any change in its contract and thus it is very predictable.

2) Share Issue: Share issue is another external source for Cherat Cement Company. Some times they sales out some part of shares in the open market to generate funds and because of their strong financial position, the investors like to purchase their shares.

I mplications: We will now consider the implications of sources of finance, that why we selected some sources of finance and why we rejected the others.

Accepted Sources of Finance:1) All the internal sources of finance:All the internal sources of finance are applicable to those business organizations which are well established and financially strong. As far as Cherat cement is concerned, they are financially strong because they are the owners of the many other industries beside Cherat cement and each industry is supported by other industry.2) Borrowing from Bank: This source of finance is selected because now a days the terms and conditions of borrowing from any commercial bank are very flexible, as the interest rate is not too high. Besides this, Cherat Cement Company has a reputable name in the market and all the banks know that they have good capability of returning loans because of the financial position of the company. 3) Share Issue: As mentioned earlier, Cherat cement is financially strong company and also shares are suited to those companies which are well established. So, this is an easy way for Cherat Cement Company to get investment from outside or external source.

Rejected sources of finance:1) Government grants:This source of finance is not available to Cherat Cement Company because of the fact that neither it is a government organization nor it comes under small industries. For the financial support of small industries or enterprises, Government of Pakistan has developed PICIC (Pakistan Industrial Credit and Investment Corporation), which gives them loan for their establishment.2) Sale of Assets & Reduction in Stock:To organization of such a stature like Cherat Cement Company, Sales of assets and reduction in stock is not applicable, because there is always an increasing demand of their products from the customers.

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Outcome: 2

2.1) Cost associated with sources of finance: Cost of finance includes, cost of obtaining the finance and cost of managing finance e.g.

• Fee paid to the financial consultants etc.• Fee or interest paid to the financing companies or banks etc.• Income tax paid to the government.

The list of four different sources of financing and the cost associated with them are given below:

1- Shares Capital or Owner Savings: Cost in the form of Paying of Dividends. Cost in the form of Scrip Dividends (extra shares) to the shareholders when enough

funds are not available in the form of cash. Cost associated in providing Information to the Share Holders, arrangement of

meetings in luxurious places etc. If the funds are not used for a long period of time, it will also cost them some Fees

to the Banks or wherever the money is placed, they will get their Commission.

2- Borrowed Funds: The main cost associated with the borrowed fund by Company is an Interest. The other cost associated with this source is the finance used to fulfill a number of

Formalities i.e. checking references, setting up data etc to get the loan. If the fund is not repaid in time by the Company then Extra Interests or Factoring

Charge Commission will also cost them. Loan itself is the cost for Company, because it also has to be repaid. Most of the creditors are expecting financial information from the company,

because they have interest associated with the company’s profit. So, the Financial & non-financial cost arises from relationship between lender and borrower.

Opportunity Cost, when the retained profit is re-invested with the permission of the lender to earn more profit and to pay extra profit to the investors.

3- Government Aids: Some times aids are provided by the government for establishing industries in

remote places like rural areas, in order to raise the opportunity of employment to the residents of that area. This will also cost the company extra transportation charges. But on the other hand they will get some other benefits e.g. such companies are declared Tax Free for certain period of time.

In order to fulfill the requirements to obtain loan from the Government, some cost is associated which is Formalities and Administrative Cost.

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4- Earnings or Profit: For normal operation of business like Manufacturing and Sales, it is needed that

some expenses should be made by the company in the form of rent, wages, salaries, raw materials, and utility bills etc.

The company will have to pay Income Tax to the Government, which is also a cost.

The re-investment of the retained profit cost Company in the form of extra Dividends to the investors.

If the retained profits are invested for short term in some other business, then Delays or Bad Debts also cost a lot.

2.2) Effects of Interruption in the Flow of Finance:

Cash Flow:“Cash flow (or Finance flow) is the amounts of cash being received and paid by a business during a defined period of time, sometimes tied to a specific project.”Cash flow planning allows company to:

• Assess ability to meet goals.• Project future cash flow needs• Identify opportunities to increase income and/or decrease expenditures.

Cash is the essential ingredient that enables a business to survive and becomes successful. The core objective of any business organization is to gain profit, so for gaining profit the flow of cash is necessary, as it directly affect the profit of a business. A business organization can survive for a short time without sales or profits but without cash they will die. For this reason, cash inflow and cash outflow needs to be carefully monitored and managed.Cash inflow could be money flowing into a business from sales, interest payments received, and any borrowings, while Cash outflow may be money flowing out of a business through, paying for wages, rent, interest owing, paying back loans, buying raw materials etc. Many new business organizations fail because of the poor management of flow of financial resources. That’s why for an ideal or successful business, it is necessary to experience a consistently positive cash flow – i.e. the amount of cash coming into the business (cash inflow) is greater than the cash going out of the business (cash outflows).

Cash Flow Problems:For smooth running of a business, it is imperative that there should be constant flow of cash operating in a cycle. If there is any problem in the flow of cash, whatever the reason may be creates hurdles.Making losses: If an organization is continuously making losses which may be accidental or due to change of policies of government or political un-stability of the country may cause problem in the cash flow.Inflation: Whatever the cause may be for the inflation in the country e.g. devaluation of currency or geo-political instability that adversely affects the cash flow of the company or an organization. A business can be making profit in terms of cash but due to lack of power of purchasing in the currency, the cash flow is automatically disturbed.

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Growth: When business is in the growth stage, it needs many fix assets and stocks etc for which extra financial support is needed. If it is not available from debtors then it will cause problem to the business.Seasonal business: There are some businesses which are seasonal. In certain seasons, there is constant flow of cash because the sales and purchases of stocks are in equilibrium. But at certain period of the year, cash flow is not constant because most of the funds are used in building up the stocks for the next season while the sales of the product are very low rather negligible.One-off items of expenditure:

• Sometimes the funds are used in bulks for payment of purchasing exceptionally expensive items for the company, which create shortage of funds to other important projects.

• Similarly, repayment of loan at the end of the grace period which was given. At the end of that period, maximum capital is diverted for the payment of loans, which needs more borrowing again.

(BTEC, 2000)

2.3) Financial Information & Decision Making:

Financial statement is about the company’s account, which they produce at the end of every trading year. The balance sheet and income statement (profit and loss accounts) are the main part of financial statements. Financial information provides invaluable statistics and evidence on which company can make decisions and plans for future.The stakeholders have great concern about these financial statements (Stakeholders are all those who are directly or indirectly related to the operations of the organization). These stake holders are tax authority, management, customers, employees, bank, competitors etc. Tax Authority: They are interested in the income of the organization (after payment of interest) in order to charge tax accordingly.Management: The management uses the financial statements for financial assessment of the company. A management responsibility requires to cut costs or to make other finance-related decisions.The Employees: The employees are interested in the financial statement of the company to know about the real profit, so that they may claim for their bonuses and fringe benefits etc from the company.Share Holders: Shareholders are also interested to know about the real earnings from the study of financial statement of the company for their claims of dividends.The Creditors: The Creditors are interested in the financial statements of the company to know about the financial position of the company for their re-payment of loans.

A financial statement provides information that is otherwise not available from the general study of the accounts of a company. This statement must be supplemented with other information also, which includes company’s management, investment advisors and trade associations etc.

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The finance department of a company generates a variety of information that is very useful and help out company as well as stake holders to make decisions, it includes:

• Profit and Loss accounts of the company, information is provided whether the business is making efficient use of financial resources or not.

• Balance Sheet information providing details of business assets and liabilities, as well as the liquidity of the business.

• Sales and purchases information provides details about particular type of trading and accounts with particular customers and suppliers.

• Information about the purchase of assets and liabilities.• Information about the wages paid out by a business.• Information about costs.

By providing a steady and up-to-date flow of information, a business organization is able to make appropriate decisions about how to reduce costs and increase sales, when to raise profitability and purchase new capital assets and which is the best sources of finance and duration etc. and the same is true for stakeholders also. Financial is an important process to help you determine the efficiency, effectiveness, and stability of your organization

2.4) Concept of Assets & Liabilities:

Assets: “Any item of economic value owned by an individual or corporation, especially that which could be converted to cash. (Investorwords, Date Accessed 2/01/2009)

Assets w.r.t Accounting: Accounting equation relates assets, liabilities and owner’s equity. This is the mathematical structure of balance sheet, which can be expresses as:

Assets = Liabilities + Owner’s equity.

Assets include cash, securities, accounts receivable, inventory, equipment, real estate, car, and building or any other property. From an accounting point of view, assets can be classified into the following categories: current assets (cash and other liquid items), long-term assets (real estate, equipment), prepaid and deferred assets (expenditures for future costs i.e. Insurance, interest), and intangible assets (trademarks, copyrights, goodwill). We will now discuss two of the main assets i.e. Current assets and fixed assets.

Current Assets: “A balance sheet item which equals the sum of cash and cash equivalents, accounts receivable, inventory, marketable securities, prepaid expenses, and other assets that could be converted to cash in less than one year.” (Investorwords, Date Accessed 02/01/2009)

The sub classifications of current assets normally found in the balance sheet including cash, marketable securities, accounts receivable, Inventory, and prepaid expenses.

Cash: It is a best liquid asset, which may be currency, deposits account and negotiable instruments e.g. (Money order, checks, and bank drafts).

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Marketable Security: Marketable Securities are temporary investments in stocks, bonds, and other securities which can be sold readily. And management intends to hold only for a relatively short period of time.

Account Receivables: The accounts receivable balance represents the amount which is owed to the business by its customers.

Inventory: Those goods which are owned by a business. It includes raw material, parts, finished and non- finished products. The inventory value reported on the balance sheet is usually the historical cost or fair market value, whichever is lower. This is known as the "lower of cost or market" rule.

Prepaid expenses: These are expenses paid in cash and recorded as assets before they are used or consumed (a common example is insurance).

Current Assets owned by Cherat Cement Company as shown in Balance Sheet for the year 2006, June 30:

Cash: Cherat Cement Company’s cash and bank balances given in balance sheet of June 30, 2006 are Rs. 383,509,000.Marketable Security: Cherat Cement Company has some short term investments worth of Rs 152,102,000 in the year 2006, June 30.Account Receivables: Cherat Cement Company has Loans & Advances, Trade Deposits, Prepayments and other accounts receivables worth of Rs. 159,446,000, 2,798,000 and 1,989,000 respectively to be paid before 2007.Inventory: Total stock in trade and stores, spares and loose tools for Cherat Cement Company in 2006 are of worth 145,227,000 and 404,237,000 Rs. respectively.Prepaid expenses: Taxation-net at the end of 30th June 2006 is Rs. 18,642,000.

Fixed Assets: “A long-term, tangible asset held for business use and not expected to be converted to cash in the current or upcoming fiscal year, such as manufacturing equipment, real estate, and furniture. also called plant.” (Investorwords, Date Accessed 02/01/2009)

These are assets from which the business expects to receive benefits over a number of future accounting periods. Fixed assets also referred to PPE (property, plant, and equipment), or tangible assets.

Fixed Assets owned by Cherat Cement Company as shown in Balance Sheet for the year 2006:Fixed assets of Cherat Cement Company are its three factories operating in Nowshera, Lahore and Karachi industrial estate. It has modern plants installed in factories, which are the biggest plants installed in any Cement Factory in Pakistan. All the tangible fixed (property, plant and equipment) assets for the year 2006 for Cherat Cement Company are Rs. 2,269,848,000 shown in the Balance sheet. Other fixed assets including derivative financial asset is worth of Rs. 41,478,000 in 2006. Besides this, the company has some

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long term investments, loans and advances and long term security deposits which are worth of Rs. 22,211,000, 8,742,000 and 1,660,000 respectively.

Other Assets: Those assets which are not appropriately classified under either the current or the fixed assets. This may include both tangible and intangible assets. Tangible assets owned by Cherat Cement Company has mentioned above. Intangible asset of Cherat Cement Company is its popularity among customers and well known for their finest quality cement in the market.

Liabilities: “A liability is a financial obligation, debt, claim, or potential loss”. (Investorwords, Date Accessed 02/01/2009)Liabilities include money owing on a loan, money owing on a mortgage etc. Liabilities are reported on a balance sheet and are usually divided into two categories i.e. Current Liabilities and Long-term Liabilities.

Current Liabilities: “A balance sheet item which equals the sum of all money owed by a company and due within one year. also called payables or current debt” (Investorwords, Date Accessed 02/01/2009)

Current liabilities include those obligations which are expected to require the use of current assets and are due within a year. They usually include payables such as accounts payable, notes payable, taxes payable, wages, short-term obligations (e.g. from purchase of equipment), and others.

Current Liabilities of Cherat Cement Company; shown in Balance Sheet for the year 2006:

Accounts Payable: The amount of money which company owes to people or suppliers. As far as Cherat Cement Company is concerned, there are no accounts payables shown in Balance Sheet of 2006. However company has some short term finances worth of Rs.60,000,000. There is some unclaimed and proposed dividends worth of Rs. 11,271,000.Taxes Payable: This liability includes any local, state, and federal taxes which are owed by the business at the end of the accounting period but are payable in the next period. Net taxes that Cherat Cement Company paid in the year 2005, was worth of Rs. 109,045,000.

Long Term Liabilities: A category of debts on a company's balance sheet that do not need to be repaid during the upcoming twelve months, but that instead need to be repaid in a year or more. (Investorwords, Date Accessed 02/01/2009)Long Term Liabilities of Cherat Cement Company; Shown in Balance Sheet for Year 2006:Cherat Cement Company had some long term unsecured deposits of Rs 13,756,000 and there is no and deferred liabilities and some long term liabilities subject to finance leases in the year 2006. There is long term financing of Rs. 650,000,000 for year 2006.

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