Studied by 18 peopleFinance
Necessary for all businesses, from starting up a new business to upgrading its capital equipment or to funding its expansion plans
How is the role of finance characterised?
capital expenditure or revenue expenditure
What is the finance department responsible for?
Overseeing its financial management
Role of Finance
Businesses need to have various sources to pay for their operational / daily cost, such as: purchasing of raw materials, components and inventory, and payments of wages, salaries, ent, insurance and utility, and bills.
Capital Expenditure
Refers to business spending on non-current assets / equipment of a business. Results in an increase in the earning capacity of the business
Capital Expenditure Examples
Buildings, tools and equipment, computers, printers, photocopiers, machinery, vehicles, research and development, factories, etc.
Revenue Expenditure
Refers to business spending on its everyday and regular operations. There expenses have to be paid in order to jeep the business operational, including routine expenditure on maintaining the firm’s non-current assets.
Revenue Expenditure Examples
Stocks of raw materials, delivery costs, utility bills, wages and salaries of employees, rental payments for the premises, monthly repayments on bank loans and mortgages, insurance premiums, etc
Summary of Capital Expenditures
Long-term tenure, Adds value to the non-current assets, non-recurring (one time), provide long-term benefits, represents significant investments of the firm, expenditure reflected in the balance sheet, improves operational efficiency
Summary of Revenue Expenditures
Short-term tenure, does not add value to the non-current assets, recurrings (ongoing), provides short-term benefits, includes low cost expenditures, does not improve operational efficiency; sometimes known as operating costs
Are advertising costs revenue or capital expenditures?
Revenue Expenditures
Are bank charges/interest payments revenue or capital expenditures?
Revenue Expenditures
Is computer software/hardware revenue or capital expenditures?
Capital Expenditures
Financing
Obtaining resources to fund business activities; initial establishment of a business, expansion of a business, and/or day-to-day operations
Internal Financing
Comes from within the business
External Financing
Comes from outside the business
Personal Funds
Sole traders and partners, as types of business entities, usually rely on personal funds from their own savings to finance their start-up businesses
Personal Funds Advantages
Do not need to be repaids, there is not interest charges incurred, and it shows greater commitment to the business venture opening up possible future borrowing
Personal Funds Disadvantages
Rarely sufficient for most small businesses, lack of sufficient funds can lead to higher risks of sustainability for a business, and many entrepreneurs risk their entire life savings in a business venture
Retained Profit
An internal source of finance that comes from having a financial surplus. These funds are reinvested in the business.
Retained Profit Advantages
Does not incur any interest charges, as the money belongs to the business and is already in hand if a business project fails the use of retained profit does not necessarily pull the organisation into debt (“house money”), and the business can use this for any purpose within the business (By contact, bank loans are approved for specific uses only)
Retained Profit Disadvantages
Start-up business don’t have any, is rarely enough as a sole source of finance for most businesses in their pursuit of growth and evolution, and using the funds for use to grow the businesses means there is less dividends paid out to shareholders and owners of a business
Sale of Assets
Items a business owns, that can be used repeatedly, and that can generate income. When a business is in need of cash, it can sell off some of its fixed assets
Sale of Assets Advantages
Large sum of money can be raised and there are no costs in borrowing involved or interest repayments to make
Sale of Assets Disadvantages
The sale of certain fixed assets can hinds a firm’s productivity, it can be time consuming to find a suitable buyer, and the purchase will most likely be very low.
Share Capital
The money raised from the sale of shares of a limited company and is also known as equity capital
Loan Capital
Money sourced from financial institutions such as banks, with interest charged on the loan to be paid
Crowdfunding
Company funded by a large amount of people, each contributing a small share of money
Overdrafts
When a business uses more money then it has
Trade Credit
Business-to-Business agreement where a customer can buy goods without paying cash up front, instead organising paying the supplier at a later date
Leasing
A source of finance that allows a firm to use an asset without having to purchase it with cash
Microfiance
A small loan which is given to a ground of people with a low income towards starting a business
Business Angels
A private individual with a high net-worth, and usually with business experience, who directly invests part of their assets in a new and growing private businesses. In exchange, they usually seek equity in the business.
Short-Term Financing
Refers to sources of finance needed for the day-to-day running of a business, i.e its revenue expenditures. Funds that do not last longer than one year from the balance sheet date.
Short-Term Financing Examples
Personal funds, sale of assets, overdrafts, and trade credit
Long-Term Financing
Refers to sources of finance for more than one year from the balance sheet date
Long-Term Financing Examples
Share capital, loan capital (mortgages), leasing, business angels, microfinance providers, and crowdfunding
[SPACED] Size of the Business
The larger the size of a business, the greater the choice of finance there tends to be
[SPACED] Purpose of Funds
Refers to what the finance is specifically to be used for
[SPACED] Amount Required
If a business only needs a small amount of finance, it is likely to consider short-term sources of finance, such as bank overdrafts
[SPACED] Cost
Have an implication on all business decisions, such as the choice of sources of finance. So, businesses need to consider the costs associated with obtaining a certain source of finance
[SPACED] External Environment
Refers to factors that affect a business but which it has not control
[SPACED] Duratior
The longer the finance is needed, the more likely the firm will need to provide a guarantee (collateral or security) to the lender, in case the borrower defaults on the loan
Fixed Costs
Costs that do not change with the amount of goods or services produced
Note
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