Comprehensive Study Notes on Business Planning and Finance
Understanding Why Businesses Plan
Businesses fail for numerous reasons, often because they do not have a robust strategy in place. Specifically, the following factors contribute to business failure: poor financial control, a lack of knowledge of the market, and a lack of knowledge regarding competitor behaviour. Furthermore, failure can occur when a business lacks a clear and unique selling point (USP). Businesses also face concentration risk, which is exemplified by relying on a single major supplier. Finally, flawed business plans themselves are a primary cause of failure. As noted in Figure 1.19, titled "A business performs better when it plans," the act of planning is vital for optimizing performance. Effective planning reduces the likelihood of business failure by improving the overall chances of business survival, steering a business towards its objectives, avoiding unnecessary risk, and producing new ideas to keep the business competitive.
Determining Appropriate Sources of Finance
Identifying appropriate sources of finance is a complex challenge that every business must address, as noted in Figure 1.20. Finance is a core component of the business environment. Businesses can raise necessary funds from either an internal source or an external source. The suitability of a financial source is often determined by the duration of the need. Some sources are categorized as meeting short-term financial needs, while others are more suited to meeting long-term financial needs.
Factors Influencing the Selection of Finance
The choice of which finance source to use depends on three critical criteria: the availability of the finance, the cost of the finance, and the specific reason why the finance is required.
The Availability and Constraints of Financial Sources
Not all sources of finance are accessible to every business, as availability depends on the legal structure and history of the entity. For example, a new business in its first year of trading does not have any reserves or retained profit to use as internal funding. Additionally, business types such as sole traders and partnerships cannot raise money by issuing shares. Some forms of borrowing are specific to assets; for instance, mortgages are only available to businesses that are borrowing against property. Furthermore, businesses that have a poor financial record are unlikely to be able to borrow money from a bank due to the perceived risk.
Cost and Purpose of Business Finance
Cost is a significant factor in financial decision-making. Generally, internal sources of finance, provided they are available, are cheaper than external sources of finances. The underlying reason for the finance significantly dictates the choice. Finance might be required for various purposes, including to start-up a new business, to replace outdated machinery, to buy out a competitor's business, to purchase a new building, to deal with an urgent cash flow crisis, or to buy raw materials.
Key Financial Terminology and Definitions
Several key terms are essential for understanding business finance. An internal source of finance refers to funding obtained from the business itself, with retained profit being a standard example. An external source of finance refers to funding obtained from outside of the business, such as a bank loan. In terms of duration, short-term financial needs are defined as finance required for up to . In contrast, long-term financial needs refers to finance required for longer than .