business finance : needs and soruces chapter 22 part 1

What do the finance department do

1. Record all financial transactions - sales and payments

2. Prepare final accounts

3. Produce financial reports for managers

4. Forecasting cash flow

5. Making decisions about where to get capital for different purposes

Why business needs finance

1. To start a business (start-up capital)—> purchase fixed assets, goods for resale

2. For expansion / invest in another market

3. Increase working capital. As the business increases in size , the need for more cash in day to day operations

Finance

Money required for the business

Start up capital

The initial capital used in the business to buy fixed and current assets before it can start trading

Working capital

Finance needed by a business to pay its day to day running expenses

Capital expenditure

The money spent on fixed assets (last for more than a year)

Expenditure

Money spent on day to day expenses which does not involve the purchase of long term assists

Internal finance

Obtained from within the business itself (useful for smaller sums of money)

Internal finance examples

1. Sales of existing assets

2. Sales of inventory

3. Owners savings

4. Retained profit

Retained profit (internal finance)

Profit kept in the business after owners have been given their share of the profit . Firms can invest this profit back in the business

Advantages of retained profit

1. Does not have to be repaid unlike a loan

2. No interest has to be paid

Disadvantages of retained profits

1. Profits may be too low to finance

2. A new business will not have retained profit

3. Keeping more profits to be used as capital will reduce owners share of profit and they may resist the decision

Sales of existing assets (internal finance)

Assists that the business doesn’t need anymore, for example , unused buildings or spar equipment can be sold to raise finance

Advantages of sales of existing assest

1. Makes better use of capital tied up in the business

2. Does not become debt for the business unlike a loan

Disadvantages of sales of existing assets

1. Surplus will not be available to the new business unlike

2. Takes time to sell the asset and expected amount may not be gained

Sales of inventory (internal finance )

Sale of finished goods or unwanted components in inventory

Advantages of sale of inventories

Reduce costs of inventory holding, clearing stock

Disadvantages of sales of inventory

If not enough inventory is kept , an unexpected increase in demand from customers may not be fulfilled

Owners saving (Internal finance)

For a sole trader and partnership, since they’re unincorporated , any finance the owner directly invests from his own saving will be internal finance

Advantages of owners savings

1. Will be available to the firm quickly

2. No interest has to be paid

Disadvantages of owners savings

Increase risk taken by owners

External finance

Obtained from sources outside of the business

External finance examples

1. Issue of share

2. Bank loans

3. Debenture issues

4. Debt factoring

5. Grants and subsidies

6. Micro finance

7. Crowdfunding

Issue of share

Only for limited company’s with limited liability

Advantages of external finance

1. A permanent source of capital , no need to repay the money to the shareholders

2. No interest to be paid

Disadvantages of issue of share

1. Dividends have to be paid to shareholders

2. If many shares are bought , the ownership of the business will change hands/ power. More shares= more power of voting

Bank loans

Money borrowed from banks

Advantages of bank loans

1. Quick to arrange a loan

2. Can be varying lengths of time

3. Large companies can get very low rates of interest on their loans

Disadvantages of bank loans

1. Need to pay interest on their loan periodically

2. Has to be repaid after a specified length of time

3. Need to give the bank a collateral security (eg. Personal asset some part of the business/ for sole traders their house for instance)

Debenture issues

Long term loan certificates issued by the company. People can buy them so the business can raise money

Advantages of debenture issue

Can be used to raise very long term finance

Disadvantages of debenture issues

Interest has to be paid and it has to be repaid

Debt factoring

A debtor is a person who owes the business money for the goods they have bought from the business . Debt factors are specialist and nets that can collect all the business debts from the debtor

Advantages of debt factoring

1. Immediate cash is available to the business

2. Business doesn’t have to handle the debt collecting (less stress)

Disadvantages of debt factoring

The debt factor will get a percent of the debts collected as a reward, the business doesn’t get all their debt back

Grants and subsidies

Government agencies and other external sources can give the business a grant or subsidy

Advantages of grant or subsidy

Do not have to be repaid its free

Disadvantages of grants and subsidies

There are usually certain conditions to fulfil a grant . Eg, relocate to places with high unemployment rates

Micro finance

Special institutes are set up in poorly developed countries where financially lacking people looking to start or expand small businesses can get small sums of money. (Charges interest)

Crowdfunding

Raises capital by asking small funds from a large pool of people . These funds are voluntary ‘donations ‘ and dont have to be returned or paid a dividend