Studied by 6 peopleCapital Expenditure (source of finance)
Money spent on fixed assets (things you have for a year or longer)
Revenue Expenditure (source of finance)
Money spent on daily operations (wages, rent, insurance, etc.)
Internal Finance (source of finance)
Money obtained within the business
Personal funds
Family and friends
Working capital
Sale of goods and services
Retained profits
Part of profits kept by businesses (internal profits)
Selling assets
Selling unused assets such as equipment (dormant assets)
Investing extra cash
making money through investments
Advantage and Disadvantage of Selling Assets
Advantage = No interest or borrowing costs
Disadvantage = Can be time-consuming to find a buyer
Advantage and Disadvantage of Retained Profits
Advantage = a permanent source of finance that doesn’t have to be repaid
Disadvantage = If retained profit is too low, it may not be enough for business growth/expansion
Advantage and Disadvantage of Personal Funds
Advantage = Provides sole trader with more control over the finances
Disadvantage = Large risk since they are investing their own life savings
External Finance (source of finance)
Money obtained outside the business
Share capital
money raised from selling shares of the company
Preference shares
owners get fixed amount of company profits
low risk
Ordinary shares
AKA. equity capital
Returns are based on level of profit by the company
Higher risk
Company profit is not affected by the sale of a shareholders stock
Loan capital
Long term
mortgage
Business development loan
Overdraft
taking out more money than the company has in its bank account for short term
Trade credit
buy now, pay later
Government grants/subsidies
Debt factoring
Advantage and Disadvantage of Share Capital
Advantage = No interest payments and this relieves the business from additional expenses
Disadvantage = Shareholders will expect to be paid dividends when the business makes profit
Advantage and Disadvantage of Loan Capital
Advantage = Repayment is spread out over a predetermined time, reducing burden on the business
Disadvantage = If loan isn’t repaid in time, it could lead to seizure of firm’s assets
Advantage and Disadvantage of Overdrafts
Advantage = It’s a flexible form of finance since the demand depends on the business’s needs
Disadvantage = Banks can request for the overdraft to be paid back at very short notice
Advantage and Disadvantage of Trade Credit
Advantage = It’s an interest-free means of raising funds for the length of the credit period
Disadvantage = Debtors lose out on the possibility of getting discounts if they’d paid in cash
Factors that influence a company’s choice of finance
Purpose
long-term assets or short term credit?
Cost
Will you have to pay interest payments?
Status & Size
Public Ltd company’s are less risky than sole traders
Amount Requires
For small amounts companies will choose short term use
State of external environment
What are the interest rates? Inflation rates?
Flexibility
Can the company switch between sources when needs arise? e.g. seasonal changes
Gearing
Amount of money in other people’s firms
The relationship between share and loan capital
Large proportion of loan capital to share capital = high geared
Small proportion of loan capital to share capital = low geared
High-geared companies are risky to invest in. So, organisations may be reluctant to invest
Costs
Expenses that the business has to make to supply the good or service
Fixed Cost
Remain constant no matter how much production changes. Will stay constant for usually 1 year.
e.g. rent, licenses, insurance, mortgage payments, etc.
Variable Cost
Change as production increases or decreases
e.g. raw material, shipping, packaging, environmental license, etc.
Direct Cost
Costs that can be identified when clearly attributed to the production of a specific good/service. They can be linked to a particular product, department or process.
e.g. flour making in a bakery
Indirect Cost
Costs that are not clearly identified. They are also known as overheads. Expenses that are not traceable to a cost center
e.g. rent, audit fees, ect.
Revenue
The income earned or generated from the sale of goods and services.
Total cost = Price x Quantity
Profit
Total amount of money you make after costs. Calculated from subtracting costs from revenue.
Profit = Total Revenue - Total Costs
Final Accounts
Gives an idea about the profitability and financial position of a business to its management, public and others.
Depends on the size of the business
Sole trader: to keep a record of the transactions made
Ltd companies and multinationals: legal requirements
Users of these documents
Shareholders
Managers
Employees
Competitors
Government
Financiers
Every Ltd business must provide…
Trading account
Trading: expenses, taxes and interest paid, net profit and the appropriation of funds
Profit & Loss accounts (income statement)
P/L: Specifically sales revenue, the cost of buying stock and gross profit
Balance sheet
Shows the assets and liabilities at a specific point in time
Covers what it owns (assets), what it owes (liabilities) and how it has funded this situation (the capital employed)
Cash flow statement
Shows the sources of cash inflows and outflows in a business
Net assets
the value of all the non-financial and financial assets owned by a business.
Net assets = Assets - Liabilities
Trading Account
An investment account that allows individuals or entities to trade securities, such as stocks, bonds, etc.
Profit-Loss Account
Summarises the revenues, cost and expenses and shows the net income and provides information about whether a company can generate profit
Balance Sheet
A record of an organisation’s financial position at a specific date, usually the end of a trading year. It shows where the money came from (Capital Employed) and where it has been spent (Assets Employed).
Assets
Fixed assets (>12 months)
Tangible = machines, building, etc.
Intangible = goodwill, patents, etc.
Investments = shares and debentures in other companies
Current assets (<12 months)
Cash or any other asset that is likely to be turned into cash within 12 months (e.g. stocks)
Liabilities
Long-term liabilities
debts to be repaid >12 months
Current liabilities
debts to be repaid <12 months
Working Capital
The capital of a business which is used in its day-to-day trading operations. Shows if a business can pay its bills and shows the short-term financial health of a business
Working Capital = Total Current Assets - Total Current Liabilities
Important to know in a balance sheet
Net Assets = Capital Employed
IB Standard Balance Sheet Format
MUST HAVE TITLE WITH COMPANY NAME AND DATE
Step-By-Step Balance Sheet Process
1) Calculate Equity or Net Asset
Equity = Share Capital + Retained Profit
Net Assets = Total Assets - Total Liabilities
2) Calculate Current Assets
Current Assets = Cash + Stock + Debtors
3) Calculate Current Liabilities
Current Liabilities = Overdraft + Creditors + Other Short-Term Loans
4) Calculate Working Capital
Working Capital = Current Assets - Current Liabilities
5) Calculate Total Assets
Total Assets = Net Fixed Assets - Working Capital
6) Find Value Of Long-Term Liabilities
7) Make Sure Net Assets = Equity
Step-By-Step Profit-Loss Accounts Process
1) Calculate Gross Profit
Gross Profit = Sales Revenue - Cost Of Goods And Services Sold
2) Calculate Net Profit Before Interest And Tax
Net Profit = Gross Profit - Expenses
3) Calculate Net Profit Before Tax
Net Profit Before Tax = Net Profit Before Interest And Tax - Interest
4) Calculate Net Profit After Interest and Tax
Net Profit After Interest and Tax = Net Profit Before Tax - Tax
5) Calculate Retained Profit
Retained Profit = Net Profit After Interest And Tax - Dividends
Advantages of Balance Sheets
Provides information on a company's resources and its sources of capital
Presents all the information of finance in one place
Shows the inflows and outflows of the business
Breaks down company’s finances
Can be used to make business decisions
Disadvantages of Balance Sheets
Only shows the financial condition of a company
Does not tell you the accurate value of a company
Doesn’t show growth over time
Advantages of Profit-Loss Accounts
helps the business understand its operational efficiency and the various expenses required from the business
Shows a company's ability to generate sales, manage expenses, and create profits.
Can be used to measure performance over time
Used when making loan applications
Can attract investors
Disadvantages of Profit-Loss Accounts
Doesn’t predict or guarantee future performance
Companies can manipulate the data to make their account look better
No global format for a Profit-Loss Account
Depreciation
the decrease in the value of a non-current asset over time
Note
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