Finance and Accounts: 3.1-3.4

What is Capital Expenditure?

What is Capital Expenditure?

investement spending on fixed assets (long term) to sustain business operations

> investement can become long term sources of finance

ex. machinery, equipment, land

Reasons for capital expenditure

- increase productive capacity as business grows

- improve efficency (using latest tech.)

- replace worn out capital equipment and machinery

- comply with changing legislation and regulations

Drawbacks for capital expenditure

- high cost, limited finance

What is Revenue Expenditure?

spending on day-to-day business operations incurred by producing products

ex. wages, utility, insurance, advertising

Capital Expenditure vs Revenue Expenditure

capital expenditure is long term investments vs ongoing operational expenses

Collateral

financial guarentee for securing external loan capital to finance investment expenditure business growth

Fixed Assets

are items of monetary value that have a long-term function for business can be used repeatedly

Internal Sources of Finance

Personal funds, retained profit, sale of assets

Personal Funds

main source of finance for sole traders or partnerships

+ zero cost of finance (unless borrowed from connections expecting interest)

- amount available is limited to size of saving owned by sole traders

Retained Profit

value of finance that the business keeps (after paying tax and dividends) to use within the business

+ zero cost of finance (no interest)

- if business is at loss, source of finance not available

- if shareholders payed high dividends, little retained profit

Sale of Assets

businesses can sell unused assets to raise finance

- capital expenditure

- revenue expenditure (extreme cases, when business facing liquidity)

ex. old machinery, building, equipment

+ zero cost of finance

- if assets are obselete/outdated = no demand = no sale of assets

External Sources of Finance

Share capital

Loan capital

Overdrafts

Trade credits

Crowdfunding

Leasing

Microfinance providers

Business angels

Share Capital

money raised from selling shares of a limited liability company (main finance)

>existing publicly held companies can raise finance by selling more shares

+productive way to raise finance

-time consuming, no guarentees of investors

Initial Public Offering (IPO)

Businesses converting its legal status to a publicly traded company by selling its shares on a stock exchange for the first time

+ raise further finance by selling more shares on stock exchange

- ownership and control of company becomes diluted

Loan Capital

finance obtained from commercial lenders (banks) for medium to long term

+repayment by installments, allowing businesses to ease cash flow problems

- fixed or variable investment

Types of Loan Capital

Mortgages - secured loans for the purchase of real estate. If borrowers fails to repay, lender can repossess the property

Business Development Loans - highly flexible loans to start or expand a business (ex. Purchase specialist equipment) or to improve cash flow

Debentures - Debenture holders receive interest payments before shareholders are paid dividends. Interest can be fixed or variable. No voting rights for debenture holders

Long term finance without losing any control

Overdrafts

Allows businesses to temporarily take more money that it has in its account. For minor cash flow problems (short term)

- high interest (daily basis)

- repayable on demand from the lender

Trade Credit

Allows businesses to buy now and pay later. Creditors are those who offer the credit and debtors are the borrowers. (short term)

Crowdfunding

Is the practice of raising finance for a business venture or project by getting small amounts of money from a large number of people, usually through online platforms

- loss of ownership and control by investors

Microfinance Providers

Type of financial service aimed at entrepreneurs of small businesses providing disadvantaged members of society access to essential financial services to eradicate poverty.

+ accessibility

+ Job creation

+ Social wellbeing (provides opportunities for recipients)

- Immortality (critics argue microfinance is unethical - profiting off the poor)

- Limited finance

- Limited eligibility (microfinance providers have to minimize risks by ensuring loans are repaid)

Business Angels

Wealthy individuals invest in high risk but high reward ventures. Invest in small business that don't attract attention of venture capitalists

Decision Making on Sources of Finance

S - Size and Status of Firm (other sources of finance? (share capital, financial economies of scale)

P - Purpose of Finance (short term or long term)

A - Amount Required (existing debt? Small amount or large?)

C - Cost of Finance (consider assets, capital expenditure can alleviate administrative fees but consider maintenance charges)

E - External Factors - factors beyond the control of a business (economy/consumer attitude), low interest rates can raise investment expenditure because borrowing costs are lower

D - Duration

Fixed Costs

Cost that is independent of output and payable regardless of levels of production

Ex. interest payments on loans, management salaries, rent

Variable costs:

Cost of production that are proportional to output of sales

Direct Costs:

Costs specifically related output of product.

Can be variable or fixed

ex. Fixed: salaries

Variable cost of raw materials

Indirect Costs

costs that cannot be traced to the production or sale of a product

Final Accounts

Financial statements of liabilities and assets that inform stakeholders about the financial profile and performance of a business

Profit and Loss Account

Financial record of a firm's trading activites over the past 12 months, showing revenue and costs at particular trading period

Balance Sheet

Annual financial statements that all limited liability companies document assets, liabilities, equity, retained profits

Intangible Assets

fixed assets that lack physical substance, noncurrent

Revenue Stream Examples

Merchandise, subscriptions, transaction, interest revenue