3.1 Introduction to Finance Role of Finance in Business: Finance helps businesses manage money, make investments, and ensure operations run smoothly.

3.1 Introduction to Finance

Role of Finance in Business:

Finance helps businesses manage money, make investments, and ensure operations run smoothly.
✅ Example: A company uses finance to buy raw materials, pay employees, and expand operations.

Capital Expenditure:

Spending on long-term assets like buildings or machinery.
✅ Example: A bakery buys a new oven.

Revenue Expenditure:

Spending on daily operations like wages and rent.
✅ Example: A bakery pays for flour and electricity bills.

Difference Between Capital & Revenue Expenditure:

• Capital expenditure is for long-term assets.

• Revenue expenditure is for short-term operational costs.
  ✅ Example: A company buys delivery trucks (capital) and pays for fuel (revenue).

3.2 Sources of Finance

Internal Sources of Finance

• Personal Funds: Money invested by the owner, important for sole traders to start businesses.
  ✅ Example: A freelancer uses personal savings to buy a laptop.

• Retained Profit: Profits reinvested into the business instead of being distributed to owners.
  ✅ Example: A café uses last year’s profits to renovate.

• Sale of Assets: Selling business-owned items (e.g., equipment) to generate cash.
  ✅ Example: A factory sells unused machines.

External Sources of Finance

• Share Capital: Selling shares to investors to raise money.
  ✅ Example: Tesla sells stock to fund new projects.

• Loan Capital: Borrowing money from banks that must be repaid with interest.
  ✅ Example: A startup takes a $50,000 bank loan.

• Overdrafts: Banks allow businesses to withdraw more money than they have in their account.
  ✅ Example: A store overdrafts $5,000 to pay rent before payday.

• Trade Credit: Businesses buy now and pay later, helping with cash flow.
  ✅ Example: A restaurant buys supplies and pays in 30 days.

• Crowdfunding: Raising small amounts of money from many people online.
  ✅ Example: A tech startup raises $1M on Kickstarter.

• Leasing: Renting assets instead of buying them.
  ✅ Example: A taxi company leases cars instead of buying them.

• Microfinance: Small loans given to low-income entrepreneurs.
  ✅ Example: A farmer in Africa borrows $500 to buy seeds.

• Business Angels: Wealthy individuals who invest in startups.
  ✅ Example: Jeff Bezos invests in an AI startup.

Choosing Finance Sources

• Short-Term Finance: Used for immediate needs, like overdrafts.
  ✅ Example: A store uses an overdraft to pay salaries before revenue comes in.

• Long-Term Finance: Used for large investments, like mortgages.
  ✅ Example: A hotel takes a mortgage to buy property.

• Balancing Risk & Cost: Businesses must consider interest rates, repayment terms, and risks before choosing finance.
  ✅ Example: A company compares loan options to find the lowest interest rate.

3.3 Costs and Revenues

Types of Costs

• Fixed Costs: Do not change with production.
  ✅ Example: Rent, insurance.

• Variable Costs: Change with production.
  ✅ Example: Raw materials, electricity.

• Direct Costs: Directly related to production.
  ✅ Example: Wood for making furniture.

• Indirect Costs (Overheads): Not linked to production.
  ✅ Example: Marketing expenses, office rent.

Revenue & Revenue Streams

• Total Revenue: Income from sales.
  ✅ Formula: Revenue = Price × Quantity.
  ✅ Example: A shop sells 100 shirts at $20 each → Revenue = $2,000.

• Revenue Streams: Different sources of income.
  ✅ Example: Apple earns from iPhones, iPads, and Apple Music.

• Tracking Costs & Revenues: Helps businesses control expenses and maximize profit.
  ✅ Example: A café tracks costs to see if it can afford a discount promotion.

3.4 Final Accounts

• Purpose of Accounts: Helps stakeholders understand financial performance.
  ✅ Example: Investors check accounts before buying shares.

• Profit & Loss Account: Shows a business’s revenues, costs, and profit over a period.
  ✅ Example: A restaurant’s profit and loss statement shows income and expenses.

• Balance Sheet: Shows assets, liabilities, and equity at a specific time.
  ✅ Example: A company’s balance sheet lists all its buildings, debts, and investments.

• Intangible Assets: Non-physical assets.
  ✅ Example: Trademarks, patents, brand reputation.

• Depreciation (HL Only): Reduction in asset value over time.
  ✅ Example: A truck loses value each year due to wear and tear.

3.5 Profitability and Liquidity Ratio Analysis

Profitability Ratios

• Gross Profit Margin: (Gross Profit / Revenue) × 100.
  ✅ Example: If revenue is $10,000 and gross profit is $4,000, GPM = 40%.

• Net Profit Margin: (Net Profit / Revenue) × 100.
  ✅ Example: A company with a 20% NPM keeps $0.20 per $1 revenue.

• Return on Capital Employed (ROCE): Measures efficiency in using capital to generate profit.
  ✅ Example: Investors use ROCE to compare business performance.

Liquidity Ratios

• Current Ratio: Current Assets / Current Liabilities.
  ✅ Example: A ratio of 2:1 means the business has twice the assets needed to cover debts.

• Acid-Test Ratio: (Current Assets - Inventory) / Current Liabilities.
  ✅ Example: Used when inventory is not easily converted to cash.

3.6 Efficiency Ratio Analysis (HL Only)

• Stock Turnover Ratio: Measures how fast inventory is sold.
  ✅ Example: A bakery with high turnover sells fresh bread quickly.

• Debtor Days Ratio: Measures time customers take to pay.
  ✅ Example: A store that allows 30-day payments has a debtor day ratio of 30.

• Creditor Days Ratio: Measures time taken to pay suppliers.
  ✅ Example: A supermarket negotiates 60-day payments to manage cash flow.

• Gearing Ratio: Measures debt levels compared to equity.
  ✅ Example: A highly geared company has more debt than equity.

3.7 Cash Flow

• Profit vs. Cash Flow: Profit is revenue minus costs; cash flow is actual cash movement.
  ✅ Example: A profitable company can still go bankrupt if cash inflow is too slow.

• Working Capital: Current Assets - Current Liabilities.
  ✅ Example: A store with high inventory but low cash may struggle to pay bills.

• Cash Flow Forecast: Predicts future cash inflows and outflows.
  ✅ Example: A company forecasts cash to plan investments.

3.8 Investment Appraisal

• Payback Period: Time taken to recover an investment.
  ✅ Example: A solar panel pays for itself in five years.

• Average Rate of Return (ARR): Measures investment profitability.
  ✅ Example: A project with a 10% ARR earns $10 for every $100 invested.

• Net Present Value (HL Only): Future earnings adjusted for inflation.
  ✅ Example: $100 today is worth more than $100 in 10 years.