Unit 3 - Finance and accounts

Internal Sources of Finance examples

• Personal Funds

• Retained Profit - Reinvested Earnings

• Sale of Assets

Personal Funds (Owners own money)

An internal source of finance where there is:

• No interest / repayment

• A limited amount of personal risk

Retained Profit

Reinvested earnings

• Cheap, no dilution of control

• Only profitable if, lower dividends

Sale of Assets (Sell unused assets for cash)

An internal source of finance which is:

• Quick Capital, no debt

• Not sustainable; may affect operations

External Sources of Finance

• Share capital

• Loan Capital

• Overdrafts

• Trade Credit

• Leasing

• Crowdfunding

• Microfinance Providers

• Business Angels

• Debentures

Share Capital

Money raised from selling shares - produces a large sum of finance

Loan Capital and +s -s

• Borrowed from banks; repaid interest

• Long-term finance for expansion/assets

+ Big sums, spread costs

- Interest, must pay

Overdrafts and +s -s

• Short term bank borrowing; flexible limit.

+ Quick and pay interest only on use.

- Expensive, can be withdrawn by the bank at anytime

Trade Credit and +s -s

• Buy now, pay later (30-90 days)

+ Aids cash flow.

- Lose discounts, risk supplier issues.

Leasing and +s -s

• Rent assets, don’t own.

+ Spreads cost, maintenance often covered by suppliers.

- Higher long term cost.

Crowdfunding and +s -s

• Online funding from many small investors / donors.

+ Promotes business and raises capital.

- Unreliable, ideas exposed.

Microfinance and +s -s

• Gives small loans to poor entrepreneurs/ small business.

+ Accessibility, microfinance helps those in poverty become independent, whereas commercial banks don’t lend such amounts and to this particular demographic.

+ Job creation, the effective use of microfinance can help to create new job opportunities, with beneficial effects on society as a whole.

- Immorality, critics argue that microfinance is unethical as the providers are for-profit organisations, as they profit from the poor and unemployed.

- Limited eligibility - not all poor individuals qualify for it. As for-profit organisations microfinance providers have to minimise their own risk.

Business angels and +s -s

• Extremely wealthy individuals who choose to invest their own money. They consider ROI - whether it is worthwhile and also the business plan and their track record.

+ Provide capital and experience.

+ Close relationships to the entrepreneur.

- May intefere too much, pressure to perform.

- Owner loses some control to business angels

Debentures and +s -s

• Long term fixed interest loan issued by another business or individual to raise finance for a business, at the end of the loan interest is payed.

+ Interest rate is fixed which can help with budgeting and planning.

- Not flexible as it is a long term loan.

Short term sources of finance

• Available for less than a year.

• Used to pay for the daily routine operations of the business.

• Anything has to be repaid to the creditors within the current fiscal year or the next 12 months.

Examples: Trade Credit, Overdrafts, Crowdfunding, Retained profits and Sale of Assets.

Long term sources of finance

• Available for more than 12 months from the accounting period.

• Used for the purchase of fixed assets or to finance the expansion of a business.

Examples: Debentures, Share capital, leasing, microfinance, business angels and loan capital.

Key factors in Financial Decisions

• Size and status of a firm - larger, established firms, generally have more options and can secure cheaper finance.

• Purpose of finance - the use determines the type of finance needed e.g. buying a factory requires long term finance such as debentures, but covering a short term cash shortfall requires a short term finance e.g. an overdraft.

• Amount required - small amount might be covered by an overdraft or retained profit’s. Large amounts often require share capital or long term loans.

Profit

Total revenue - Total cost

What is Total cost made up of?

Fixed Cost and Variable Cost

Fixed Cost

Costs that don’t vary with the output in the short run e.g. rent, lighting, heating, marketing.

Variable Cost

Costs that vary directly to the output in the short run(e.g raw materials)

Semi-variable costs

Costs that combine elements of fixed and variable costs. E.g. labour costs may comprise of a salary(fixed cost) plus a bonus or wage(variable)

Cash flow

The amounts of money flowing into and out of a business over a period of time.

Difference between profit and cashflow

Profit is the financial gain a business makes when revenue is greater than costs whereas cashflow is the movement of money in and out of a business.

Cash inflow

Receipts of cash coming into the firm, typically from loans received, rent charged, sale of assets and interest received.

Cash outflow 

Payments of cash going out of the firm, typically from the purchase of items, loans repaid, rental payments, purchase of assets and interest payments. 

How do you comment on cashflows?

• Talk about closing balance an why they are positive or negative .

• If the company has negative closing balances for long periods of time then you can say “something must be done about this, if it continues the company may go bankrupt”.

How can Cashflow problems arise?

• Overtrading

• Over-borrowing

• Poor credit control

• Unforeseen changes

Overtrading

Expanding too quickly without enough cash to cover increased costs such as materials, labour and investment in assets.

Over-borrowing

Heavy dependence on loans increases interest payments and risk when interest rates rise.

Poor credit control

Extending too much credit or offering long payment periods to customers which delays cash inflows. It can also lead to debts and customers failing to pay.

Unforeseen Changes

Unexpected events like machinery breakdowns or sudden shifts in demand can disrupt cash flow.

Reducing cash outflows?

Cutting unnecessary costs or delaying expenditures.

Improving cash inflows?

By encouraging faster customer payments or increasing sales revenue

How can you reduce cash outflows?

• Delaying payments to creditors - negotiate longer payment terms, but be careful not to damage supplier relationships

• Reduce/eliminate nonessential spending; cut back on unnecessary fixed and variable costs

• Seem alternative, cheaper suppliers; find suppliers offering lower prices, which reduces the costs of goods sold.

• Leasing instead of buying equipment, it spreads the costs over time and avoids a large initial cash outflow.

How can you improve cash inflows?

• Credit control, limiting the time period customers have to pay or offer discounts for early payment to speed up cash collection.

• Reduce customer credit limits, limit the amount of credit a customer can use or stop offering it entirely to customers with poor payment history.

• Sale and leaseback, sell a fixed asset to raise a large sum of cash, then lease it back to continue using it.

Cash Flow Advantages and Disadvantages

Advantages:

• Identifies potential cash-flow problems in advance e.g. inability to meet payment obligations.

• Guides the firm towards appropriate action e.g. change plans.

• Helps secure finance, banks and investors often require a forecast to see if the business can apply for loans.

Disadvantages:

• Based on estimate, predictions may be wrong due to unexpected changes - late payments.

• Changes in consumer tastes e.g. fashion and technology

• Unexpected events aren’t included, things like economic downturns or sudden cost increases can make forecasts unreliable.