business 3.1 3.2 3.3

What is finance

The financial resources used by business organisations to cover their financial needs (without money business cannot operate)

What are the main uses of finance?

1. Capital expenditure

2. Revenue expenditure

Capital expenditure

The money used to buy fixed assets

What are fixed assets

Durable, physical assets that belong to a business ( they are used to generate future revenues e.g. buildings, factories and machines)

Revenue expenditure

The money used to cover day-to-day to short-term activities (e.g. rent, property taxes, utilities, and employee salaries)

What are sources of finance? And what types?

Methods or ways through which business organisations can acquire financial resources

1. Internal sources of finance

2. External sources of finance

Types of internal sources of finance

includes the sources of finance that exist within the business itself

1. Personal funds

2. Retained profits

3. Sale of assets

What are personal funds

An internal source of finance where the owners use their personal savings to cover the business financial needs

Advantages and disadvantages of personal funds

Advantages:

• permanent - the owner should not replay the money

• Cheap - it does not incur any interest charges

• Flexible - the owner identifies how much funds to withdraw and when to withdraw them (high power is maintained)

Disadvantages:

• limited - the funds might not be sufficient to cover all of the business financial needs.

• Risky - for the owners to use their own funds in the business as they might lose their money

• Opportunity cost - the owner could benefit from using their savings on other activities

What are retained profits?

referred to as ploughed-back profits, there are profits accumulated over time after the business covers all of its expenses

Retained profits advantages and disadvantages

Advantages:

• expansion - an internal sources of finance that can be used to expand the business operations

• Cheap sources of finance - it does not incur any interest changes

• Safe - reduces the business risks as the money should not repaid the business

Disadvantages:

• shareholders dissatisfaction - high retained profits lead to lower dividends paid to shareholders

• Less flexibility - reduces the business ability to face emergency cases

• Not viable for all - not available for all business - mostly available for large businesses

Sale of assets

When the business organisation sells its unused and obsolete physical resources to acquire funds

Sale of assets advantages and disadvantages

Advantages:

• enhances the business liquidity position - turning physical resources into cash provides the business with money that is ready to be spent straight away

• Cheap sources of finance that can- does not incur any interest changes

• Update financial resources - after selling outdated assets, businesses can replace them with newer ones

Disadvantages:

• time-consuming- fixed assets take a lot of time to be sold at convenient prices

• Loss of market value - business organisations might suffer from losses as most buyers bargain to buy at lower prices

• Production capacity - sale of assets affects the business productivity negatively as they have fewer resources to operate with

External sources of finance

The sources of finance that exists outside the business

1. Share capital

2. Loan capital

3. Overdraft

4. Trade credit

5. Crowdfunding

6. Leasing

7. Business angels

Share capital

A long term type of finance where the business organisation sells shares to external investors to acquire funds

Advantages and disadvantages of Share capital

Advantages:

• permanent - share capital is a permanet

• Cheap source of finance

• Provides needed financial resources

disadvantages:

• loss of control

• Dividends

• Takeover

• Low availability

Loan capital

When a business organisation acquires raw acquires funds from financial institutions(such as banks)

The borrowing business should repay these funds plus interest charges at specific dates

Advantages and disadvantages of loan capital

Advantages:

• satisfaction of needs

• Small payments - business organisations repay loans in small instalments that can be managed on time

• No effect on ownership - loan capital does not affect the business owner

• Availability

Disadvantages:

• expensive

• Collateral - businesses may risk losing their pledged assets if they fail to repay the loan

• Variable interest - some loans might have variable interest rates

Overdraft

A short-term financing tool that should be repaid in a short period of time (only used whenever really needed, allowing business organisations to withdraw more than what they have in their financial account

Advantages and disadvantages of Overdraft

Advantages:

• accessibility

• Covering of emergencies

• Flexibility

Disadvantages:

• limited - can only be used to cover short-term financial needs

• Quick repayments

• Interest - banks charge high interest rales for overdraft

Trade credit

When a business organisation acquires raw materials from suppliers on credit (the business is borrowing raw materials from its suppliers)

Advantages and disadvantages of Trade credit

Advantages:

• improved cash flow - delays immediate payment, aiding cash management

• Financial flexibility

• Better supplier relations

Disadvantages:

• risk of over-reliance - can lead to unsustainable debt

• Creditworthiness impact - late payments may harm a business credit rating

• Potential higher costs

Crowdfunding

Where the business organisation acquires funds or money from the public to finance their operations, commonly used by NPOs to afford their social causes

Advantages and disadvantages of Crowdfunding

Advantages:

• large amounts of money

• Time-saving

• Permanent

• No effect on ownership

Disadvantages:

• might be illegal - it’s illegal in some countries as they are not controlled

• Limited

• Scams

• Requires time to get public support

Leasing

Where a business can use fixed assets owned by other businesses in return for a specific monthly fee

Advantages and disadvantages of Leasing

Advantages:

• asset access

• Lower costs

• Resources update

Disadvantages:

• no ownership - the lease will not own the fixed assets unless al the payments have been made

• Higher total cost

Business angels

When provides financial resources for start-up business and new ventures to satisfy their financial needs in exchange for a share of the business or a percentage of sales

Business angels advantages and disadvantages

Advantages:

• technical support

• No interest

Disadvantages:

• Loss of control

• Angel’s interest

Types of finance

1. Short-term financing

2. Medium-term financing

3. Long-term financing

Short-term financing

Duration: less then one year

• overdraft

• Trade credit

Medium-term financing

Duration: 1-10 years

• leasing

Long-term financing

Duration: more then 10 years

• share capital

• Loan capital

Revenue

The amount of money generated from selling goods and services

Cost

The expenditures that business organisations pay and incur to produce goods and services

Profit & Loss

The difference between revenue and cost, which can be positive or negative

Fixed cost

The expenditure that should be made regardless of the business activities and production amount (rent, and salaries (fixed payment))

Variable costs

The expenditure that are directly (positive) related to the business activities (raw materials and wages (dependent on hours worked))

Semi-variable costs

Expenditures are fixed up to a certain level, and then they start to increase with more production (internal express and electricity)

Direct costs

The costs that consumers can trace in final products attributed to the production of specific goods or services

Indirect costs

There costs cannot be traced by the consumers in the final products, but they are essential for the business to produce them

Total revenue

Total cost

Total profit

Total profit

6 main types of revenue streams other than sale of goods

1. Rental income

2. Sale of fixed assets owned by

3. Dividend revenues

4. Interest revenue

5. Donations

6. Grants and subsidies

Rental

When the business organisation generates revenue from leasing one of its fixed assets

Sale of fixed assets

whenever the business organisation sells its unused, obsolete assets to generate funds

Dividends revenues

Received by the business organisation when they buy or acquire shares from other PLCs

Interest revenue

The money generated from deposits in financial institutions in the form of interest revenues

Donations

Financial support that business organisations receive from the general community to support their social causes

Grants and subsidies

Financial support provided by the government or international agencies