Chapter 19: Business finance - needs and sources Flashcards
KEY WORD: Capital expenditure
Spending by a business on non-current assets such as machinery and buildings.
KEY WORD: Non-current assets
Resources owned by a business which will be used for a period longer than one year, e.g. buildings and machinery.
Why do businesses need finance?
- To set up the business (start-up capital)
- To pay day-to-day expenses of the business e.g. wages, suppliers of raw materials and fuel expenses (working capital)
- To purchase buildings and other non-current (fixed) assets e.g. machines ro replace ones that are no longer working efficiently / obsolete
- To invest in latest technology (capital expenditure)
In what circumstance could long-term finance be used?
Building a new factory (large amount of money which will be invested over several years)
In what circumstance could short-term finance be used?
The purchase of new computers (they need smaller amounts of money over a short period of time)
Are all the sources of finance you’re learning about suitable for limited companies/sole traders + partnerships?
All suitable for limited companies but may not be for sole traders + partnerships.
Why? (Card 4)
- Unincorporated businesses can’t raise capital through the sale of shares
- Only need to finance small expenditure projects
- Often considered to be too high-risk for large-scale borrowing by lenders
Name 4 internal sources of finance
- Retained profits
- Sale of non-current (fixed) assets e.g. equipment
- Use of working capital
- Owner’s savings
Notes on retained profits
- Owners of a profitable business may decide to reinvest some of their profits in the business instead of taking the profits themselves
- Interest on borrowing and taxation and other business expenses has to be paid first, then the profit remaining belongs to owners
- Normally, owners receive part of the profit and the rest is reinvested back into the business
- Can be used to fund capital expenditure projects
What is shown in an income statement?
The distributions of after-tax profit between dividends and retained profits.
Is the amount available from retained profits more likely to be higher for a multinational company or a sole trader?
A multinational company, but it’s still a very important source of finance for all businesses.
Benefit and limitation of using retained profits
Benefit: There’s no cost to the business and the profit has been earned through its trading activities
Limitation: Only available when the business is profitable and if profit’s low, there won’t be enough retained profits to fund large investment projects. Also, if the business makes a loss, there’ll be no RP for reinvestment.
Notes on sale of non-current assets
- Sales of unwanted non-current assets
- Sale and leaseback of non-current assets e.g. selling land and buildings owned by the business + then rent them back from the new owner
- Unwanted assets such as buildings are more commercial (profitable) than machinery that has a very specialised purpose; inflexible (just seen as a scrap of metal)
Benefits of selling non-current assets
- No direct cost to the business
- Can often raise large amounts of money
Limitations of selling non-current assets
- Future fixed cost of the business will increase as they now have to pay annual leasing charges to the new owner
- Leasing charges increase each time the lease is renewed
- Once leasing agreement ends business may have to find new premises if the new owner decides they want to use the land/buildings for other purposes
