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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 Sources
2) 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.
Implications:
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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