financial function

sources of fixed capital

 Sell shares and debentures

 Long-term loans with a mortgage bond as security – registered over a fixed property.

 Reserve Funds.

factors affecting the requirement of fixed capital

nature of business, kinds of products, growth prospects, scale of operation, diversification

nature of business

 The nature of business is of two kinds: Manufacturing Business and Trading Business. In case of

manufacturing business, large investment is made in land, building, machinery, etc. Thus, there

is a need for large amount of fixed capital.

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 On the contrary, in case of trading business in which finished goods are bought and sold, less

amount of fixed capital is needed.

types of products

 If the company is engaged in the

manufacture of complicated goods like

refrigerators, T.V. sets, motor vehicles, engines etc., it

may need large amount of fixed capital

 than a business enterprise which produces simple consumer items like soap, toothpaste,

cleaning materials etc.

scale of operations

 The companies which are operating at large scale require more fixed capital as they need more

machines and other assets,

 whereas small scale enterprises need less amount of fixed capital.

growth prospects

 Companies which are expanding and have higher growth plan require

more fixed capital.

 To expand, companies need more plant and machinery; so more fixed

capital.

diversification

 Companies which have plans to diversify their activities by including more range of products,

require more fixed capital.

 To produce more products they require more plants and machineries which means more fixed

capital.

working capital

 Working capital is used to purchase stock or finance debtors. (people or

businesses that owe us money.)

 When the stock is sold, or the debtor pays his account, the money can then be

used to buy more stock.

 Working capital is used to cover the day-to-day running of the business and can therefore also

be used to pay expenses. (current assets)

sources of working capital

trade credit, overdraft facilities at commercial bank, short term loans at commercial bank, lease accounts, installment sale transactions, factoring of debtors, loans on security of warehouse reciepts

trade credit

 Credit allowed by manufacturers and traders to other members in the distribution channel.

 Trade credit is also known as suppliers’ credit or credit on an open account.

overdraft facilities at a commercial bank

 A bank overdraft is when someone is able to spend more money than what is actually in

their bank account.

 Obviously the money doesn't belong to them but belongs to the bank so this money will

need to be paid back; normally automatically done when money goes into the persons

account.

 The overdraft will be limited.

short term loans from a commercial bank

 This is a loan with a repayment period of less than one year.

 A fixed interest rate is charged and the buyer must usually provide some form of security.

lease accounts

 A business pays a monthly instalment for the use of a machine, building etc., but ownership

is never transferred to the business.

 Leasing holds tax advantages for the business.

installment sale transactions

 Instalment sale contracts are usually used to buy machines, equipment or vehicles.

 A monthly instalment is made, which include repayment of the capital and interest.

(finance charges)

 Should the account fall into arrears, the seller has the right to have the article repossessed.

 Ownership is only transferred on settlement of the account.

 The Credit Agreement Act stipulates the percentage deposit that has to be paid and the

maximum repayment period.

factoring of debtors

 If a business sells on instalment sale (credit) and then urgently need cash, he can sell

instalment sale contracts to a bank.

 This will improve its cash flow (more working capital) and reduces the risk of bad debts.

 The bank will not pay the full value of the contract. (to make a profit and to cover its risk of

bad debt)

loans on security of warehouse reciepts

 When storing goods in a warehouse, a receipt is issued as proof that goods are stored in the

warehouse.

 This receipt is negotiable (can be sold) or can be used as security when borrowing money

from the bank.

factors affecting requirement of working capital

nature of business, scale of operations. production cycle, credit allowed, growth prospects, level of competition

level of competition

 High level of competition increases the need for more working capital.

 In order to face competition, more stock is required for quick delivery,

 and credit facility for a long period has to be made available.

growth prospects

 Firms planning to expand their activities will require more working capital,

 for expansion they need to increase the level of production which means more raw materials,

more resources etc. so more working capital also.

credit allowed

 Those enterprises which sell goods on cash payment basis need little working capital

 but those who provide credit facilities to the customers need more working capital.

production cycle

 Production cycle means the time involved in converting raw material

into finished product.

 The longer this period, more capital remains invested in raw material

and semi-manufactured products. Thus, more working capital will be

needed.

 On the contrary, where period of production cycle is little, less working capital will be needed.

scale of operations

 More working capital is required in case of big organisations. They need to maintain more stock,

debtors etc.

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 Whereas less working capital is needed in case of small organisations.

nature of business

 The nature of business is usually of two types: Manufacturing Business and Trading Business.

 In the case of manufacturing business it takes a lot of time in converting raw material into finished

goods. Therefore, capital remains invested for a long time in raw material, semi-finished goods and

the stocking of the finished goods. Therefore, more working capital is required.

 In case of trading business the goods are sold immediately after purchasing. Therefore, very less

working capital is required.

tasks of the financial manager

 He draws up the cash budget (for the short term) as well as a capital budget to plan the long-

term financial needs of the business.

 He helps the general manager to interpret the financial statements. (income statement,

balance sheet and cash flow statement)

 He will make sure that the different departments stay within their budgets.

objectives of financial function

maximise profits by keeping expenses as low as possible, to increase profitability, to make sure business has enough assets to cover expenses, to maintain a good ratio between own and borrowed capital

budgeting

 Budgeting is a

financial tool that estimates expected cash receipts

against estimated cash payments so as to determine

whether the business is expected to make a surplus or a

deficit.

 The financial manager makes these estimates based on historically data, inflationary projections

and predictions of the economy in general.

 It is also common to consider the nature of your business and its strength in the current economic

climate when budgeting.

 Once the budget is completed, the financial manager will then compare the budgeted figures to the

actual figures and make recommendations on how to effectively deal with positive or negative

differences.

 These differences are called variances and the recommendations are called strategies.

income statements

 An Income Statement for a retailer will show the sales and cost-of-sales figures and will be

used to calculate the net profit of the business.

Long-term liability x 100

Total capital (Equity) 1

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 It reflects transactions for a period of time, i.e. a summary of what happened during the

financial year.

balance sheet

 The Balance Sheet reflects the financial position of the business on a specific date, i.e. the last day

of the financial year.

 A balance sheet show how money (capital) was raised (own or borrowed) and how it was applied

(spent) on assets.

cash

 A Business will show how it has generated and utilised its cash flow in a Cash Flow Statement.

 Cash relates to the amount deposited and withdrawn from the current bank account of the

business.

 Cash is generated through the sale of inventory, increase in capital and borrowed funds.

 Cash is utilised through the purchase of fixed assets.

profit

profit

Profit on the other hand is the financial return or reward that entrepreneurs aim to achieve to

reflect the risk that they take.

 Profit is the surplus remaining after total costs (expenditure) are deducted from total revenue,

(income)

 and the basis on which tax is calculated and dividend is paid.

 It is the best known measure of success in an enterprise.

 The profit is shown in the Income Statement.