Ch 28 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
- All businesses will have a need to finance their working capital - the day to day finance needed to pay bills and expenses and to build up stocks
- Expansion requires further finance to increase the capital assets and often they require higher working capital needs
- A change in the environment such as economic recession, new competition leading to decline in sales result in the need for cash
- Finance is also being used to pay for research and development into new products or marketing strategies and campaigns to enter overseas marker
Why different needs for finance might mean different sources are appropriate?
Some of the situations will need investment for many years while other will need short term funding. Some might be medium term finance - between one and five years. Thus, not one source of finance is likely to be suitable in all cases
Define start-up capital
Investment required by an entrepreneur or business person to build up their business e.g. expenditure on capital equipment
Define working capital
The capital needed to pay for raw materials, day-to-day running costs and credit offered to customers Working capital = current assets - current liabilities
Define capital expenditure
Involves the purchase of assets that are expected to last for more than one year, such as building and machinery
Define revenue expenditure
Is spending on all costs and assets other than fixed assets and includes wages and salaries and materials bought for stock
Define liquidity
The ability of a firm to be able to pay its short-term debts
Define liquidation
When a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors
Significance of working capital
- The lifeblood of a business
- Finance is needed to pay for everyday expenses such as the payment of wages and buying of stock
- Without sufficient working capital a business will be illiquid - unable to pay its short term debts => bank loan or liquidation
How much working capital is needed?
Too low => illiquid Too high is a disadvantage, the opportunity cost of too much capital tied up in inventories, accounts receivable and idle cash is the return that money could earn elsewhere in the business. e.g. invested in fixed assets
Working capital cycle
- Production -> sell on credit -> cash -> materials and stock (cycle repeats and goes in circle) - How much working capital is needed depends on the length of the working capital cycle - The longer the time period, the greater the working capital needs - To give more credit than is received is to increase the need for working capital - To receive more credit than is given is to reduce the need for working capital
What are the internal sources of finance?
- Profits retained in the business
- Sale of assets
- Reductions in working capital
What are the external sources of finance?
- Long term: share issue, debentures, long term loan, grants
- Medium term: leasing, hire purchase, medium-term loan
- Short term: bank overdraft, bank loan, creditors, factoring
Differences between short term and long term finance
- Short term finance: up to a period of a year, increase inventory orders, payrolls and daily supplies
- Long term finance: acquire new equipment, for R&D, ash flow enhancement and company expansion
Retained profits
After the profits has been taken in tax by the government and has been paid out to the shareholders as dividens, retained profits are remained as a source of finance for future activities
