Business Studies Unit 5

Reasons for needing finance

Pay start-up costs for a new business
Finance operations before sales
Cash to cover day to day costs
Some customers do not pay for good immediately
To finance expansion/ repair machinery

Capital expenditure

money spent on non-current assets expected to last longer than a year

Internal finance

money obtained from sources within business itself

Short term sources of internal finance include

managing working capital
sale of inventories

Manage working capital

making best use of current assets. Asking customers to pay quicker, reducing inventory and asking customers to pay quicker or paying suppliers slowly
Pros
No interest has to be paid
No need to repay
Can help business improve efficiency
Cons
Could upset customers since business asking for quicker payments
Not enough inventory to make products
Suppliers might not provide inventory or not provide discounts

Sale of inventories

sell finished goods or unwanted components in inventory.
Pros
Reduces costs of inventory holding
Cons
If not enough inventory is kept, unexpected increase demand from customers cannot be fulfilled

long term sources of internal finance

retained profits
owners savings
sale of non-current assets

Retained Profit

profit kept in the business after owners have been given their share of the profit is invested back into the business.
Pros
Does not have to be repaid, unlike, a loan.
No interest has to be paid
flexible
Cons
A new business will not have retained profit
Profits may be too low to finance
Will reduce the owner's share of profit and they may resist the decision.

Owner's savings

using money put into business by owners at start-up.
Pros
Will be available to the firm quickly
No interest has to be paid.
No need to repay
Cons
Increases the risk taken by the owners.
Might only raise limited amounts of money

Sale of non-current assets

assets that the business doesn't need anymore can be sold to raise finance
Pros
Makes better use of capital tied up in the business
No need to repay
No interest to be paid
Cons
Might not raise much money
Takes time to sell the asset
Limited number of assets sold

Short term sources of external finance

overdrafts
trade credits
debt factoring

Overdrafts

short term loan used to solve cash flow problems repayable within 12 months
Pros
Flexible form of borrowing since overdrawn amounts can be varied each month
Interest has to be paid only on the amount overdrawn
Quicker to arrange
Overdrafts are generally cheaper than loans in the long-term
Cons
Interest rates can vary periodically
The bank can ask for the overdraft to be repaid at a short-notice.
Bank may ask for security

Trade Credit

this is when a business delays paying suppliers for some time, improving their cash position
Pros
No interest needs to be paid
Easy to arrange
Cons
If payment late, supplier may stop delivery
Loss of discounts will increase cost of sales

Debt factoring

business sells outstanding trade receivables to another business in exchange for immediate but not full cash payment
Pros
Quick access to cash
Business doesn't have to handle the debt collecting
Cons
Do not receive full amount of debt owed

Long term sources of external finance

bank loans
debenture
mortgage
hire purchase
leasing
issue of loans

Bank loans

money borrowed from banks repayable after 12 months
Pros
Set period of time to repay
Large amounts can be borrowed
No risk of takeover
Cons
Finance costs
Security needed if business cannot be repaid
Increased risk -lenders can force money to be handed over or shut down business

Debenture

limited companies can issue a bond to raise large sums of money. Lenders receive a fixed rate of interest each year.
Pros
Can be used for very long term finance
Cons
Interest has to be paid and it has to be repaid

Mortgage

used to purchase land or buildings. The asset acts as security in case the loan cannot be repaid.

Hire Purchase

a business buys an asset in fixed amounts while having the benefit of using it before full payment is made
Pros
No initial large payment is needed
Business owns item at end of agreement
Cons
Responsible for maintenance
Monthly payments must be made

Leasing:

business pays a set monthly amount to use or rent property
Pros
The firm doesn't need a large sum of money to use the asset
The care and maintenance of the asset is done by the leasing company
Can update when technology improves
Cons
Business never owns asset so cannot sell it if needed
The total costs of leasing the asset could finally end up being more than the cost of purchasing the asset!

Issue of shares

only for limited companies.
Pros
A permanent source of capital, no need to repay the money to shareholders
no interest has to be paid
Cons
Risk of takeover
Dividends still need to be paid

Alternative sources of finance

Micro-finance: Financial services including small loans provided to poor people who are not served by traditional banks
Crowdfunding: this is financing a business ida by obtaining small amounts of capital from a larger number of people using internet and social media

Factors to consider when making financial choices

How long?
How much?
Risk involved
Type of business
Size of business
Cost of finance
Current level of debt

Cash flow forecast

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

Features of cash flow forecast

Predict gaps and shortfalls between cash in and out
Gives business time to arrange extra funds
Helps loan applications , show why the money is needed
Helps business planning

Ways to solve cash flow problems

Increase cash loan
Short term loan
Arrange a bank overdraft
Reduce amount of inventory held
Ask trade receivables to pay more quickly
Ask trade payables for more time
Use trade credit

Liquidity

the ability of a firm to pay off its short term debt

Working capital

money needed to cover dat to day expenses

working capital is needed to

Pay wages and trade payables
Buy inventory to produce goods
Ba able to offer and receive discounts

Working capital formula

current assets- current liabilities

Profit

the difference between revenue and total costs. Profit is long term cash is short term

Features of an income statement
Used for business to see its performance within a period of time
Compare performance with other businesses
Plan because you can see how business affects revenue and costs

Income statement

the statement that records income and expenditure over a period of time,

Cost of sales variable costs of making a product or service

Gross profit

revenue - cost of sales

Expenses

costs not directly linked to producing the product eg rent, insurance, marketing

Retained profit

amount of profit keep that can be reinvested into business

Statement of financial position

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

Non current assets

items owned that are expected to last more than a year

Current assets

items owned that will last less than a year

Trade receivables

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

Trade payables

the amount a business owes to its suppliers for goods bought on credit

Current liabilities

money owed that has to be paid is less than a year

Non- current liabilities

money owed that can be paid in over a year

Net assets

(non-current liabilities + current assets) - less current liabilities

Capital employed - owners equity + retained profit +non-current liabilities


Ratios calculated allows businesses to

Judge business results
Identify trends in performance
Make decisions
Make comparisons with similar businesses

Gross profit margin can be improved by

increasing revenue and cutting costs of sales by lowering wages and material costs

Profit margin can be improved

with increased revenue and reduced expenses

ROCE can be improved by

better use of capital employed without reducing profit and increase profit without changing capital employed

Limitations of ratio analysis

Cannot predict future
Must be compared to past years to be useful
Businesses have different liquidity requirements
Only consider financial data