Business Management HL - Sources of Finance, Investment Appraisal, Costs & Revenues, Final Accounts, Cash Flow, Role of Finance, Budgets, Ratio Analysis

Internal Sources of Finance

Internal finance originates within the business, encompassing owner's capital (personal savings), retained profits, and the sale of assets.

• Owner's Capital: Funds from personal savings, particularly vital during the startup phase. Owners may inject further capital as needed.
• Retained Profit: Reinvesting previous years' undistributed profits. It's a cost-effective option without interest or fees, but it carries an opportunity cost for shareholders.
• Sale of Assets: Selling surplus assets like machinery or property. Sale and leaseback arrangements allow continued asset use while freeing up capital.

Evaluation of Internal Finance

Advantages:

• Often free and quick to access.
• Avoids external influence.

Disadvantages:

• Significant opportunity cost.
• May be insufficient for business needs.

External Sources of Finance

External finance is sourced from outside the business, including family, friends, and a wider range of options as the business expands, such as:

• Share Capital: Funds from selling company shares.
• Loans: Secured loans repaid over several years with varying interest rates. Mortgages are long-term secured loans for property purchase.
• Overdrafts: Short-term bank arrangements to spend beyond account balance, useful for managing cash flow.
• Trade Credit: Delayed payment agreements with suppliers, typically interest-free.
• Leasing: Renting assets like machinery for regular payments, without ownership or responsibility for maintenance.
• Crowdfunding: Raising funds from numerous small investors via online platforms.
• Microfinance Providers: Small lenders offering finance to higher-risk individuals or businesses.
• Business Angels: Individual investors who provide capital for start-ups, often taking a stake in the business.

The Best Choice of Finance

Selecting the right finance involves considering factors like timescale, legal structure, cost, control, purpose, and existing debt.

• Timescale: Short-term finance for immediate costs, long-term for assets.
• Legal Structure: Limited options for sole traders/partnerships.
• Cost: Interest rates and flotation expenses impact cost.
• Control: Selling shares dilutes ownership.
• Purpose: Match finance to specific needs (e.g., mortgage for property).
• Existing Debt: High debt may deter lenders.

Investment Appraisal

Simple Payback Period

It calculates the time required to recover the initial investment.

• Advantages: Simple, useful for cash flow-focused businesses.
• Disadvantages: Ignores profitability and timing of cash inflows.

Average Rate of Return (ARR)

ARR considers all cash flows generated by an investment over its lifespan.

• Advantages: Easy to understand and compare returns.
• Limitations: Depends on averages and ignores timing/opportunity costs.

Net Present Value (NPV)

NPV accounts for interest rates and the time value of money using discount tables.

• Advantages: Considers opportunity cost and risk through discount rates.
• Disadvantages: Complex, relies on accurate forecasting, and ignores non-financial factors.

Limitations of Investment Appraisal

• Reliance on forecasted cash flows.
• Potential for bias.
• Ignores non-financial factors.

Types of Costs

• Fixed Costs (FC): Costs that remain constant regardless of output level.
• Variable Costs (VC): Costs that change directly with the output.
• Total Costs (TC): The sum of fixed and variable costs.
• Direct Costs: Costs directly related to production.
• Indirect Costs: Overheads not easily allocated to a product.

Sales Revenue

Sales revenue is calculated by $quantity <br />\newline sold <br />\newline x <br />\newline selling <br />\newline price$.

Revenue streams include dividends, donations, interest, subscription fees, merchandise sales, sponsorships, and advertising.

Statement of Profit or Loss

Financial accounts detail a business’s financial performance.

• The Statement of Profit or Loss (Income Statement) shows income, expenditure, and profit over time.
• The Statement of Financial Position (Balance Sheet) shows a business's assets, liabilities, and equity at a specific point in time.

The Statement of Profit or Loss includes the trading, profit and loss, and appropriation accounts.

Stakeholders (government, local community) use it to assess tax, stability, and potential for sponsorship.

Statement of Financial Position (Balance Sheet)

Assets = Liabilities + Equity.

Stakeholders use the Statement of Financial Position to assess asset structure, solvency, and business value.
Different types of intangible assets include: intellectual property, brand value, customer relationships, software and technology, contracts and agreements, goodwill, domain names and other online assets and licenses, and permits.

Depreciation Methods

Depreciation reflects the declining value of fixed assets over time.

• Straight Line Method: Reduces asset value by the same amount each year of its useful life.
  $Annual <br />\newline depreciation = <br />\newline (Historic <br />\newline cost - Residual <br />\newline Value) / Life <br />\newline Expectancy$
• Units of Production Depreciation

Cash Flow & Working Capital

Profit differs from cash flow. Profit is calculated at a specific time. While cash flow measures the money flowing in and out of a business.

• Working capital = Current assets - Current liabilities

Cash Flow Forecasts

Cash flow forecasts predict cash inflows and outflows.

• The net cash flow: total inflows - total outflows

Cash flow forecasts can support loan applications and identify potential cash shortfalls.

Strategies to Improve Cash Flow

Improve cash flow and manage the business better.

• To identify potential cash flow issues before they arise - take appropriate action
• To budget effectively to carefully control spending

Methods to improve cash flow: reduce the credit period offered to customers, ask suppliers for and extended repayment period, make use of overdraft facilities or short-term loans, sell off access stock, sell assets and lease fixed assets, introduce new capital and reduce drawings from the business.

Role of Finance for Businesses

Businesses need finance for: setup costs, expansion and growth plans, capital expenditure, working capital, research & development, marketing & advertising, risk management, debt servicing, and business performance.

• Capital Expenditure: spending on non-current assets.
• Revenue Expenditure: spending on short-term operational needs.

Cost & Profit Centers

• Cost Centers: Responsible for incurring costs, not generating revenue.
• Profit Centers: Generate revenue and incur costs and manager are fully accountable for their profitability and loss.

Cost and profit centers improve: organization, control, support, accountability and can improve motivation

Budgets & Variances

Budgets are financial plans that show businesses costs and revenue for a given time period.

Types of budgets: Historical figure, zero-based.

Understanding budget variances; A budget variance is a difference between a figure budgeted and the actual figure achieved by the end of the budgetary period.

Profitability Ratios

Ratio analysis supports evidence-based decision making, as it provides measurable data that can be used to support judgements and compare performance against objectives

• Gross Profit Margin = $\frac{Gross \newline Profit}{Sales \newline Revenue} * 100$
• Operating Profit Margin = $\frac{Profit \newline before \newline Interest \&amp; \newline Tax}{Sales \newline Revenue} * 100$
• Return on Capital Employed = $\frac{Profit \newline before \newline interest \&amp; \newline tax}{Capital \newline Employed} * 100$

Liquidity Ratios

• Current Ratio = $\frac{Current \newline assets}{Current \newline liabilities}$
• Acid Test Ratio = $\frac{Current \newline assets - stock}{Current \newline liabilities}$

Efficiency Ratio Analysis

• Average Stock = $\frac{Opening \newline stock + Closing \newline stock}{2}$
• Stock Turnover = $\frac{Cost \newline of \newline sales}{Average \newline value \newline of \newline stock}$
• Stock Turnover in Days = $\frac{Average \newline stock}{Cost \newline of \newline sales} * 365$
• Gearing Ratio = $\frac{Non Current \newline Liabilities}{Capital \newline Employed} * 100$
• Debtor Days = $\frac{Debtors}{Total \newline credit \newline sales \newline revenue} * 365$
• Creditor Days = $\frac{Creditors}{Cost \newline of \newline Sales} * 365$