Business Finance, Cash Flow, and Financial Analysis

Capital expenditure

Spending on non-current assets.

Short-term finance

Finance needed for less than $1$ year, often used to manage cash flow.

Long-term finance

Finance invested over several years, often to purchase non-current assets.

Credit terms

An agreement between buyer and seller about when payment is made for goods bought on credit.

Trade receivables

The amount owed to the business by customers who bought on credit.

Liquidity

A business's access to cash and its ability to pay short-term debts.

Working capital

The finance required to fund day-to-day trading expenses, calculated as:$\text{Current assets} - \text{current liabilities}$

Bank overdraft

A flexible short-term borrowing facility that enables a business to withdraw more funds than its bank balance contains.

Trade credit

A short-term financing arrangement where a supplier permits a business to receive items and pay at a later agreed date.

Venture capital

Long-term finance provided to innovative start-ups with high growth potential in exchange for an ownership stake and expertise.

Hire purchase

A financing method where an asset is paid for in regular installments over time, transferring legal ownership only after the final payment.

Cash flow forecast

A forward-looking estimate that predicts the size and timing of expected cash inflows and outflows to anticipate potential deficits.

Net cash flow

The overall difference between cash entering and cash leaving a business across a specific period:$\text{Total cash inflows} - \text{total cash outflows}$

Gross profit

The profit earned directly from trading before operating expenses are deducted:$\text{Revenue} - \text{cost of sales}$

Statement of financial position

A formal financial summary showing a company's assets, liabilities, and owner's equity at a specific date.

Current ratio

A liquidity metric that evaluates the ability to cover short-term debts:$\frac{\text{Current assets}}{\text{Current liabilities}}$

Acid test ratio

A stringent measure of immediate liquidity that excludes inventory from liquid assets before comparing against short-term obligations.

Capital employed

The total long-term funding invested in a firm, calculated as:$\text{Shareholders' equity} + \text{non-current liabilities}$

Reasons businesses need finance

To provide start-up capital, fund working capital for day-to-day operations, purchase or replace non-current assets, invest in modern technology, finance business expansion, and conduct research into new products and markets.

Internal sources of finance

Capital generated directly from within an existing enterprise, consisting of owner's personal savings, retained profits reinvested into operations, working capital adjustments, and proceeds from selling redundant non-current assets.

Methods to improve working capital

Lowering inventory holding levels to release tied-up cash, negotiating extended credit terms with suppliers to delay payables, and enforcing shorter payment windows for credit customers.

Bank overdraft: advantages and disadvantages

Advantages: Provides flexible short-term liquidity where interest is only paid on borrowed funds, making it suitable for sudden deficits. Disadvantages: Carries higher interest rates than long-term loans and can be demanded back by the lender at short notice.

Trade credit: advantages and disadvantages

Advantages: Obtains necessary trading supplies immediately while postponing cash settlement, offering an interest-free form of short-term financing. Disadvantages: Businesses forfeit prompt-payment cash discounts and risk damaged supplier relations or disrupted supply if debts are delayed past agreed terms.

Bank loan

A medium- to long-term borrowing arrangement where an agreed capital sum is supplied upfront and repaid in regular installments alongside fixed or variable interest.

Bank loans: advantages and disadvantages

Advantages: Capital is accessed quickly once approved, structured repayments simplify cash flow forecasting, and ownership equity is retained. Disadvantages: Interest and principal must be repaid regardless of performance, small firms often struggle to qualify, and business or personal collateral is typically required.

Fixed vs variable interest rates

A fixed interest rate remains unchanged across the borrowing duration for predictable repayments, whereas a variable interest rate alters according to prevailing economic conditions.

Leasing

A contract where a firm pays periodic rental fees to utilize an asset owned by an external finance company, avoiding purchase costs.

Leasing: advantages and disadvantages

Advantages: Assets can be utilized without an initial capital outlay, the provider handles maintenance and repairs, technology can be upgraded easily, and expenses are spread over time. Disadvantages: Periodic payments include financing charges, cumulative costs can exceed the purchase price, and the business never gains legal ownership.

Hire purchase: advantages and disadvantages

Advantages: Spreads payments across regular installments to avoid a large upfront cost, and legal ownership transfers to the business upon final settlement. Disadvantages: Overall expenditure exceeds the initial cash purchase price due to interest, and the business bears full responsibility for servicing and repairs.

Share issue

The method used by incorporated companies to raise permanent capital by offering shares of ownership to private investors or the public.

Share issue: advantages and disadvantages

Advantages: The raised funds never need to be repaid during the company's existence, dividend payouts are not legally compulsory during lean years, and substantial capital sums can be acquired. Disadvantages: Equity ownership and voting control become diluted, a public firm risks hostile takeover, and drafting a formal prospectus incurs substantial administrative expense.

Government grants

Non-repayable financial assistance distributed by state bodies to support start-up creation, regional employment, or economic development.

Government grants: advantages and disadvantages

Advantages: The capital does not require repayment and avoids interest charges or equity dilution for qualifying small enterprises. Disadvantages: Requires compliance with rigorous eligibility requirements and involves extensive, time-consuming administrative paperwork.

Crowdfunding

The practice of funding a project or venture by raising small contributions from a large network of individuals, typically via web-based platforms.

Crowdfunding: advantages and disadvantages

Advantages: Unlocks capital for entrepreneurs lacking collateral, tests customer demand for new concepts, accesses an extensive backer base, and can raise funds rapidly. Disadvantages: Public exposure risks concept imitation by competitors, and all gathered pledges must be returned if the predetermined funding target is not achieved.

Venture capital: advantages and disadvantages

Advantages: Makes large financing sums accessible to high-risk start-ups without regular debt service payments, while providing professional managerial guidance. Disadvantages: Highly selective and competitive to acquire, requiring founders to surrender a substantial equity percentage and managerial autonomy.

Opening balance (cash flow forecast)

The initial cash reserve available at the start of a budget cycle, equal to the closing balance of the preceding period.

Closing balance (cash flow forecast)

The projected monetary balance at the end of an operating cycle, calculated as: $\text{Net cash flow} + \text{opening balance}$

Short-term cash shortage solutions

Delaying supplier disbursements (reduces cash outflows but sacrifices early-settlement discounts), shortening customer credit periods (hastens cash inflows but risks customer dissatisfaction), utilizing an overdraft (provides immediate liquidity but incurs interest), and postponing capital equipment purchases (protects immediate cash reserves but may slow long-term efficiency).

Cash vs profit

Cash is readily expendable currency and bank deposits needed to cover immediate debts, whereas profit is the accounting surplus remaining when total costs are deducted from sales revenue. A profitable business can still collapse if it exhausts its cash reserves.

Statement of profit or loss

A formal financial statement prepared at least annually that records total sales revenue, costs incurred, and the resulting financial gain or loss over a trading period.

Revenue

The total gross earnings generated from the sale of goods or services, calculated as: $\text{Selling price per unit} \times \text{number of units sold}$

Cost of sales

The direct costs incurred to manufacture or purchase the products sold by a business during an accounting period.

Expenses (overheads)

Indirect costs incurred to operate a business that do not relate directly to production, such as administrative salaries, marketing, insurance, loan interest, and transport.

Profit (net profit)

The remaining earnings of a business once all production and operating costs have been deducted: $\text{Revenue} - \text{total costs}\quad\text{or}\quad\text{Gross profit} - \text{expenses}$

Retained profit

The cumulative surplus earnings retained within a business after tax and dividends, reinvested to finance non-current assets and future operations.

Current assets

Liquid resources and short-term holdings expected to be converted into cash or consumed within $12\,\text{months}$, such as inventory, trade receivables, and bank balances.

Non-current assets

Long-term resources owned by a business expected to be retained and utilized for more than $1\,\text{year}$, including machinery, land, and vehicles.

Current liabilities

Short-term debts and financial obligations that fall due for settlement within $12\,\text{months}$, such as trade payables and bank overdrafts.

Non-current liabilities

Long-term debts and obligations that are not due for complete repayment within $12\,\text{months}$, such as mortgages and debentures.

Owner's equity

The total capital provided by the owners plus accumulated retained profit, representing the owners' financial claim on the assets of the business.

Gross profit margin

A profitability ratio that measures gross profit as a percentage of total revenue: $\frac{\text{Gross profit}}{\text{Revenue}} \times 100$

Profit margin

A ratio assessing the proportion of revenue retained as profit after deducting all expenses, reflecting how well overheads are managed: $\frac{\text{Profit}}{\text{Revenue}} \times 100$

Current ratio benchmark

A standard liquidity comparison where current assets should exceed current liabilities (ideally above $1:1$), but generally not exceed $2:1$, as a figure above $2:1$ suggests excessive idle cash or unsold inventory.

Uses of financial statements

To assess profitability and liquidity, evaluate progress against financial goals, assist lenders and investors in making funding decisions, analyse performance trends across years, and benchmark operations against rivals.

Limitations of ratio analysis

Calculations rely on historical figures that may not indicate future trends, non-financial factors such as employee expertise are omitted, varying accounting policies between companies prevent direct comparison, and macroeconomic fluctuations are ignored.

External sources of finance

Capital acquired from outside the enterprise, categorized into short-term options (such as bank overdrafts and trade credit) and long-term options (such as bank loans, hire purchase, leasing, crowdfunding, share issues, venture capital, and government grants).

Cash

Physical currency and readily accessible bank deposits required to settle immediate operational obligations such as wages, supplier invoices, and premises costs.

Cash flow management

The active process of monitoring and controlling incoming and outgoing monetary flows to ensure that a business consistently holds sufficient liquid funds to meet obligations.

Cash inflows

Total monetary funds received by a business across a trading period, originating from sources including sales revenue, owner or share capital injections, and borrowed funds.

Cash outflows

Total monetary funds paid out by a business across a trading period, including disbursements for supplier invoices, staff wages, utilities, loan repayments, and rent.

Positive cash flow

A financial condition occurring when total cash inflows exceed total cash outflows across a given time interval.

Importance of profit

Functions as a metric of commercial success, acts as an internal source of finance to purchase non-current assets and fund expansion, and provides a financial return to reward risk-taking by founders and investors.

Total cost

The complete expenditure incurred to produce goods and operate an enterprise, calculated as: $\text{Cost of sales} + \text{expenses}$

Assets

Resources and property of financial value owned by an enterprise, classified into short-term holdings and long-term productive investments.

Liabilities

Debts and financial commitments owed by an enterprise to external entities, such as trade suppliers and lending institutions.

Total assets

The aggregate financial worth of all holdings owned by an enterprise, calculated as: $\text{Non-current assets} + \text{current assets}$

Total liabilities

The combined financial value of all short-term and long-term obligations owed by an enterprise, calculated as: $\text{Non-current liabilities} + \text{current liabilities}$

Reasons to measure business performance

To pinpoint operational strengths and weaknesses, evaluate progress toward strategic targets, and inform decisions that enhance future operating outcomes.

Return on capital employed

A primary profitability ratio measuring how efficiently long-term capital and equity are deployed to generate operating returns.

Methods to improve profit margin

Actions focused on either increasing the gross profit margin (by raising selling prices or lowering cost of sales) or reducing operating expenses and overheads.

Implications of changes in current ratio

An increasing ratio signifies an enhanced ability to satisfy short-term debts, whereas a declining ratio signals deteriorating liquidity and greater financial strain.