A-Level Business - Theme 2.1

Finance

The money the business needs to start and to operate

What is Working Capital

The capital (money) of a business which is used in its day to day trading operations (expenses)

Working Capital Formula

Working Capital = Current Assets - Current Liabilities (short term debts/expenses)

Process of Working Capital

-> Cash -> Purchase Raw Materials -> Manufacture the Product -> Finished Goods -> Sale of Goods -> Receive Payment of Goods (cash) -> Repeat

3 Internal Sources of Raising Finance

• Owner’s Capital

• Retained Profit

• Sale Of Assets

What is Owner’s Capital

The funds/assets the business owner invests into the business

Advantages of Owner’s Capital (2)

• No interest

• You don’t need to pay the money back

Disadvantages of Owner’s Capital (3)

• Not easily Replaceable

• Likely to be a one-off '

• Only limited capital, might not have enough

What is Retained Profit

Profit made by the business that is kept and re-invested back into the business

Advantages of Retained Profit (2)

• No interest

• You don’t need to pay the money back

Disadvantages of Retained Profit (2)

P, R

• Pay corporation tax on profits

• Relies on having to make a profit (needs to be successful)

What is Sale of Assets

Selling of possessions or resources (owned by the business) to raise capital (e.g: Equipment, Premises, vehicles)

Advantages of Sale Of Assets (2)

• Provides a quick injection of cash

• If asset appreciates, you can make more than how much it was bought for

Disadvantages of Sale Of Assets (4)

• If asset depreciates, you will make less money than how much it was bought for

• Can only sell what you own

• One time option

• Can’t use the possessions anymore once sold

Appreciation

An increase in value of an asset overtime

Depreciation

A decrease in the value of an asset overtime

Expansion

If successful, businesses will want to expand. Additional finance will be needed to invest in this expansion

Venture Capital

Long term funding by a specialist investor (e.g Dragon’s Den, in return for a proportion of the companies shares)

Advantages of Venture Capital (2)

• Given Advice and Finance

• Opens up a network in the industry

Disadvantages of Venture Capital (3)

L, L, P

• Loss of ownership

• Loss of control

• Potential conflict

Angel Investors

People who invest in start-ups / entrepreneurs. Often entrepreneur’s family or friends

Advantages of Angel investors (2)

• No interest

• Can agree on repayment terms (if any)

Disadvantages of Angel Investors (3)

• May lose some ownership

• Is a One-off

• Potential conflict / damage to personal life

Trade Credit

Offered by suppliers, giving time to pay an invoice (30-60 days)

Advantages of trade credit (4)

I, A, N, P

• Improves cash flow (dependant on trust/ good relationship)

• Agreed Limit '

• No Interest

• Prevent negative closing balance - sell products first and pay supplier

Disadvantages of trade credit (2)

S, N

• Stuck with one supplier (may increase prices)

• Not suitable for large amounts

Overdraft

Allowing to spend more than a business has in its bank account up to an agreed limit

Advantages of Overdraft (3)

I, A, F

• Improves cash flow

• Agreed limit

• Flexible arrangement

Disadvantages of overdraft (2)

• High interest rates

• Banks can demand it be repaid with very little notice

Loans

A fixed amount which is borrowed typically from a bank - repaid with an agreed rate of interest

Advantages of loans (2)

B, G

• Better interest rates if a business is established (low risk)

• Get a large sum at once

Disadvantages of loans (2)

I, L

• Paid back with interest

• Little flexibility - fixed repayments (increased monthly outgoings)

Leasing

A long term rental agreement with a supplier - allows business to use machinery & equipment w/o buying it upright

Advantages of Leasing (2)

• Instant access to the purchase

• Helps with budgeting

Disadvantages of leasing (3)

O, V, H

• Often more expensive than one time purchase

• Value can depreciate but still paying the same

• It has to go back

Hire Purchase

A method of buying goods through making instalment payments overtime

Advantages of Hire purchase (3)

I, H, E

• Instant access to the purchase

• - Helps budgeting

• - End up with ownership to the good

Disadvantages of hire purchase (3)

O, V, C

• Often more expensive than one time purchase

• - Value can depreciate but still paying the same amount

• - Can be recalled until the final payment is made

Grant and Soft loans

Soft loans - loans with favourable credit terms, less than commercial rates Grants - Free loans made to a firm (from government)

Advantages of grants and soft loans (3)

(grants) - D, N, (SL) - L

• Does not have to be repaid, no interest (grants)

• - No share of business given up (grants)

• - Lower interest rates (soft loans)

Disadvantages of grants and soft loans (3)

H, L, L

• Have to meet a certain criteria to qualify

• - Likely a one-off (grants) '

• - Long and time-consuming application process (grants)

Share Capital

Finance raised from investors buying shares in a company. At the end of the year a dividend is paid to the shareholder if a profit is made

Advantages of share capital (3)

L, N, C

• Large injections of capital

• - No interest

• - Can bring additional expertise

Disadvantages of share capital (3)

L, D, M

• Loss of ownership - give a % of the business

• - Dividends have to be paid to shareholders

• - May want a say on how the business is run

Online Collaborative Funding

Bypassing traditional finance institutions (banks), gain funding via social media/specialised websites

Advantages of OCF (1)

• Easy to access a world of investors (so more money can be made easily)

Crowdfunding

Funding a new project or venture by raising many small amounts of money from people (online via social media/websites)

Advantages of crowdfunding (3)

P, C, I

• Potential to raise large amounts

• - Can give smaller returns to investors

• - Increase brand awareness - increase sales

Disadvantages of Crowdfunding (3)

M -> H, C, M

• Might not raise the amount needed, target not reached = have to give money back

• Could damage brand/reputation if business fails

• May be copied before it being up and running

Peer to Peer Lending

Lending money to existing individuals/businesses through online services, matches lenders and borrowers directly

Advantages of P2PL (3)

L, M, H

• Lower rate of interest (from greater competition between lenders)

• More accessible funding source

• High returns to investors

Disadvantages of P2PL (3)

L, N, C

• Legislations - may not be accessible to all

• No insurance/protection from gov - last resort, risky

• Credit risks

Creditor

An entity or person that lends money or extends credit to another party

Debtor

An entity or person that owes money to another party

Unlimited liability

The owner and business are seen as one entity; if the business has debts, the owner is responsible - even if it means selling personal possessions

Examples of unlimited liability (2)

Sole trader, Partnership

Limited liability

The owner and business have separate legal identities; the owners can only lose the amount they invest in the business, often has shareholders

Examples of limited liabilities (2)

Public limited companies (Plc) , Private limited companies (Ltd)

Private Limited Company (Ltd)

Owned by shareholders who are known to the company, often family & friends Can only sell shares on to other shareholders

Public Limited Company (Plc)

Can sell shares openly on stock exchange, accessible to anyone

Contents of a Business Plan (7)

• Executive Summary

• The Product/Service

• The Market

• Marketing Plan

• Operational Plan

• Financial Plan

• Conclusion

Why are Business Plans important? (5)

Secure…, Ensure…, Identify…, Provide…, Set…

• To secure external funding

• Ensure firm develops a healthy financial structure

• To help identify problem areas

• Provides realistic expectations of what can be achieved

• Sets targets to check on firm's development

Cash Flow

Money moving in and out of a business over a specific period

Receipts

Documents showing money received by the business for goods/services

Payments

Transactions in which a business pays another for goods/services

Net Cash Flow

Net result of cash Inflows and Outflows each month

Net Cash Flow formula

Net Cash Flow = Cash Inflows - Cash Outflows

Opening Balance

How much a business starts with each month

Closing Balance

How much a business has at the end of each month

"Opening Balance ""formula"""

Opening Balance = Closing balance of the month before

Cash Flow Forecast

A forward-looking statement (12 months) predicting the cash inflows and outflows of a business

Importance of Cash Flow

Needs to ensure a positive cash balance to meet day to day expenses (employees, suppliers, loans etc.)

Cash Flow Statement

A backward looking statement showing what happened with previous cash inflows and outflows

Advantages/Uses of Cash Flow Forecasts (4)

Make sure…, Can identify…, Find p…, Makes it…

• Make sure you have enough to pay employees & suppliers

• Can identify negative cash flow months & inject a source of finance

• Find problems before they happen (keep up with loan payments)

• Makes it easier to get a loan

Disadvantages of Cash Flow Forecasts (3)

Based on… Doesn't… Biased…

• Based on estimates

• Doesn't account for external factors that may affect cash flow (e.g recession)

• Biased figures used for loans

How to Improve Cash Flows (2)

Speed… Slow…

• Speed up inflows

• Slow down outflows

How can we speed up inflows? (5)

D, R, D, L/O, I

• Discount for early payments

• Reduce trade credit length

• Destock

• Loans / Overdrafts

• Increased revenues

How can we slow down outflows? (2)

D, R

• Delay paying debtors (trade credit)

• Reduced costs