business finance Flashcards
Why business activity requires finance
■ Setting up a business will require cash injections from the owner(s) to purchase essential capital equipment and, possibly, premises. This is called start-up capital.
■ All businesses need to finance their working capital– the day-to-day finance needed to pay bills and expenses and to build up stocks.
■ Expansion can be achieved by taking over other businesses. Finance is then needed to buy out the owners of the other firm
Start-up capital:
the capital needed by an entrepreneur to set up a business
Working capital
the capital needed to pay for raw materials, day-to-day running costs and credit offered to customers. In accounting terms working capital = current assets– current liabilities.
Liquidity
the ability of a firm to be able to pay its shortterm debts.
Liquidation
when a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors
Capital expenditure
the purchase of assets that are expected to last for more than one year, such as building and machinery.
Revenue expenditure
spending on all costs and assets other than fixed assets and includes wages and salaries and materials bought for stock.
current assets
inventories, accounts receivable and cash in the bank and the tills
Where does the capital come from to purchase and hold these current assets
current liabilities– overdrafts and creditors
what is The simple working capital cycle?
the longer this cycle takes to complete, the more working capital will be needed
sell on credit >cash >materials and stock >production>sell on credit
Companies are able to raise finance from a wide range of sources. It is useful to classify these into
■ internal money raised from the business’s own assets or from profits left in the business (ploughed-back or retained earnings)
■ external money raised from sources outside the business
Internal sources of finance
- Profits retained in the business
- Sale of assets
- Reductions in working capital
External sources of finance
Short-term sources
■ bank overdrafts
■ trade credit
■ debt factoring
Overdraft
bank agrees to a business borrowing up to an agreed limit as and when required.
Factoring
selling of claims over trade receivables to a debt factor in exchange for immediate liquidity– only a proportion of the value of the debts will be received as cash.
Sources of medium-term finance
■ hire purchase and leasing
■ medium-term bank loan.
Hire purchase
an asset is sold to a company that agrees to pay fixed repayments over an agreed time period– the asset belongs to the company
Leasing
obtaining the use of equipment or vehicles and paying a rental or leasing charge over a fixed period, this avoids the need for the business to raise long-term capital to buy the asset; ownership remains with the leasing company.
External sources of finance
Long-term finance
■ long-term loans from banks
■ debentures (also known as loan stock or corporate bonds
Equity finance
permanent finance raised by companies through the sale of shares.
Long-term bonds or debentures
bonds issued by companies to raise debt finance, oft en with a fixed rate of interes
Debt finance has the following advantages
■ As no shares are sold, the ownership of the company does not change or is not ‘diluted’ by the issue of additional shares.
■ Loans will be repaid eventually (apart from convertible debentures), so there is no permanent increase in the liabilities of the business.
■ Lenders have no voting rights at the annual general meetings
Equity capital has the following advantages:
■ It never has to be repaid; it is permanent capital.
■ Dividends do not have to be paid every year; in contrast, interest on loans must be paid when demanded by the lender.
Other sources of long-term finance
Grants
Venture capital
Venture capital
risk capital invested in business start-ups or expanding small businesses that have good profit potential but do not find it easy to gain finance from other sources.
Finance for unincorporated businesses
bank overdrafts loans credit from suppliers Grants Crowd funding Microfinance:
Crowd funding
the use of small amounts of capital from a large number of individuals to finance a new business venture
Microfinance:
providing financial services for poor and low-income customers who do not have access to banking services, such as loans and overdraft s offered by traditional commercial banks.
the importance of a business plan
Without some evidence that the business managers have thought about and planned for the future it is most unlikely that bankers, venture capitalists or potential shareholders will invest money in the business
Business plan
a detailed document giving evidence about a new or existing business, and that aims to convince external lenders and investors to extend finance to the business.
Th e business-planning process not only provides essential evidence to investors and lenders and makes the finance application more likely to be successful, but it also
■ forces the owners to think long and hard about the proposal, its strengths and potential weaknesses– it might actually dissuade some people from progressing with their proposal, thus avoiding a near-certain businessflop
■ gives the owners and managers a clear plan of action to guide their actions and decisions, at least in the early months and years of the business
