business studies - finance

the need for business finance

1. pay startup costs for a new business

2. finance operations before sales are made

3. cash to cover day to day running costs

4. financial expansion or replace old machineary

capital expenditure

money spend on non current assets that are expected to last longer than a year

external finance

money from sources outside the business

internal finance

money from sources within the business

long term finance

any debts or loans repayable after 12 months

short term finance

debts or loans repayable within 12 months

start up capital

money needed by a business to purchase assets before it can start trading

short term sources of finance (internal and external)

internal: manage working capital, reduce inventory, ask customers to pay quicker, pay suppliers slowly

external: bank overdraft, trade credit, debt factoring

long term sources of finance (internal and external)

internal: profit, owners capital, sell non current assets

external: bank loans, mortgages, hire purchasing and leasing , issue shares

(internal SOF) manage working capital

making the best use of current assets (customers pay faster, reducing inventory..)

advantages: no interest, no need to repay, can improve efficiency

disadvantages: upset customers, not enough inventory

(internal SOF) selling non current assets

selling unwanted land or machinery to raise money

advantages: no interest, no need to repay, better use of resources

disadvantages: can take time to sell, might not raise much money, limited number of assets can be sold

(internal SOF) retained profits

money left over from profits made in previous years

advantages: no interest has to be repaid, no need to repay, flexible

disadvantage: takes time to raise funds, might not raise enough money, opportunity cost

(internal SOF) owner’s capital or savings

money put into business by owner at startup

advantages: no interest has to be repaid, no need to repy

disadvantages: risk losing own money, might only raise limited amount

(external SOF) bank overdraft

allowing the business to draw more money than their bank account holds, paid back within 12 months

advantages: flexible, quick

disadvantages: finance costs, security requirements

(external SOF) trade credit

suppliers allow business to buy goods now and pay for them later

advantages: no interest, easy to arrange

disadvantage: if late payment suppliers can stop delivery, loss of discounts

(external SOF) debt factoring

business sells its unpaid bills (invoices) to another company to get money faster. Instead of waiting for customers to pay,

advantages: quick cash access, not responsible for collecting debt owned

disadvantages: do not raise full amount

(external SOF) leasing

pays monthly amount to use or rent building or machinery

advantages: no large initial payment needed, lease company way cover cost of repair, can update or replace when technology improves

disadvantages: the business never owns the asset so cannot sell, overall cost is high

(external SOF) hire purchase

business buys asset in fixed amount and can use it before paying full price

advantage: no large initial payment, business owns item

disadvantage: responsible for maintenance, monthly payments must be made

(external SOF) bank loan

repayable after 12 months

advantages:

• business has a set time need to repay

• large amounts of money can be borrowed

• no risk to ownership

disadvantages:

• finance cost

• security needed

• interest

(external SOF) mortgage and debenture

mortgage: specifically for land and buildings and to act as a security in case the loan cannot be repaid

debenture: limited companies can issue a bond to raise large sums of money

(external SOF) issue shares/ equity

advantages: no need to repay, no interest

disadvantages: risk of takeover if too many shares issued, only option for limited companies

(external SOF) borrow from friends/family

advantages:

• no interest or security

• quick

disadvantages:

• only likely to raise small amounts

• time periods and conditions unsure

alternative sources of captial

microfinance: financial services including small loans for poor people who are not served by traditional banks

factors to consider when making financial choices

• size of business

• cost of finance

• security needed?

• risk involved

• type of business

why must business always have cash on hand?

• prevent suppliers stoping supply

• prevent customer complaints

• prevent demotivation in workers

cash flow forecast

shows the estimated amount of money coming into and out of a business over a period of time

how does cashflow forecast help business

• predict gaps and shortfalls between cash in and out

• give business time to arrange extra funds

• helps loan applications

• helps business planning

cash flow & cash inflow & cash outflow

cashflow: flow of all money in and out of business

cash inflow: money coming into business

cash outflow: money going out of business

net cash flow, closing balance, opening balance

net cash flow: difference between cash inflow and outflow over period

closing balance: amount of cash left at the end of the period

opening balance: the amount of cash at the beginning of the period

ways to solve cashflow problems

• increase cash sales

• short term loan

• reduce amount of inventory held

• customers to pay more quickly

• trade credit

working capital

money to cover day to day running costs

(waves, buy inventory, offer and receive discounts)

liquidity

ability of firm ot meet short term debts

profit

revenue - costs = profit or loss

• the reward for risk taking

• measure of success

• source of internal finance

• needed for long term survival

difference bewteen cash and profit

cash is money that is immediately available to spend, profit is recorded when sale is made

main features of income statement

income statement: records the income and expenditure of business overa. given period of time

• see its performance during a given period

• compare performance with other years

• plan

cost of sales

variable costs of making a product, includes cost of materials and direct labour

gross profit

revenue - cost of sales

expenses

cost direcly linked to producing the product

tax

the amount of tx on a business profit which is payable to government

dividend

share of profit given to shareholders

retained profit

amount of profit kept which can be reinvested back into business

stagement of financial position

value of assets and liabilities of a business at a particular point in time

non current assets and current assets

non current: items owned which are expected to last more than a year

current: short term assets which will last less than a year

trade receivables and trade payables

trade receivables: money owed to a business by customers who have bought items on credit

trade payables: amount a business owes to its suppliers for things bought on credit

current liability

current liability: money owed which has to be paid back in less than one year

non current liabilities

money owed which has to be paid back after 1 year

net current assets & working capital

current assets - current liabilities

net assets

net value of all assets owned by the business

fixed assets+ net current assets

owners equity

total amount owed by the business to owners

share capital

money put into th ebusiness when shares were originally issued

capital employed

total of all long term and permanent capital of business

why stake holders are interest in the businesses’ statement of financial position

• to see what business is worth and how it has been financed

• assess liquidity by calculating ratio

what does financial statements allow business to do

• judge business results

• identify trends in performance overtime

• make comparisons with similar companies

• make decisions

gross profit margin

gross profit/revenue x 100

profit margin

profit/revenue x 100

ways to imporve profit margin

• increase revenue more than expenses

• reduce expenses while maintaining level of sales

ROCE return on capital employed

profit/captial employed x 100

ways to improve ROCE

• make better use of capital employed without reducing profit

• increase profit with same amount of capital employed

current ratio

shows whether a business can pay its current liabilities out of current assets

current assets/current liabilities

acid test ratio

inventory can be difficult to sell quickly to obtain cash → ignoring inventory to provide a more realistic view of liquidity

current assets - inventory/current liabilities

limitations of ratio analysis

ratios only act as a guide to help decision making

• based on past results cannot predict future

• in order to be useful have to compare to previous years

• many ways to measure asset values

• different business different liquidity requirements

liquid assets

assets that can be turned into cash quickly

why are stakeholders interested in analysis of accounts

1. shareholders → how well the business is doing

2. lenders → whether loans will be repaid

3. trade payables → is business able to repay on time

4. employees → level of profit

5. managers → how secure are their jobs

6. customers → supply goods on time?

7. government → profitable business for more tax