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
Where may sources of finance for working capital come from?
- Cash balances
- Reducing inventory levels
- Reducing trade/account receivables (debtors)
What are cash balances?
- Any cash that a business has can be used to finance capital expenditure
- However, there must be enough to finance day-to-day expenses, unexpected expenditure and short-term debts
- The survival of the business could be threatened if too much cash is used to finance capital spending, therefore day-to-day expenses are at the risk of not being able to be paid
What’s reducing inventory levels?
Business may decide to reduce the quantity of raw materials and component or finished goods it holds.
What is a trade receivable?
Amount owed to a business by its customers who bought goods on credit.
What’s reducing trade/account receivables?(Card 1)
- Most businesses sell goods to customers on credit
- This means customers receive goods but pay for them at an agreed date in future e.g. 30 days after delivery
What’s reducing trade/account receivables?
(Card 2)
- A business can reduce the time it has to wait for payment by offering discounts on early payment (e.g. with car fines) or pushing customers to pay on time
- By reducing the time trade receivables are paid, in this way the business’s cash balances increase, providing a possible source of internal funds for capital expenditure
https://www.netsuite.com/portal/resource/articles/accounting/reducing-accounts-receivable.shtml
KEY WORD: Working capital
The capital needed to finance the day-to-day running expenses and pay the short-term debts of a business.
What does the amount of finance raised by reduced working capital depend on?
The size of the business, as larger businesses are likely to have higher levels of inventory and credit sales than small businesses.
Why is reducing the value of working capital risky?
Since it may reduce the business’s liquidity and its ability to pay short-term debts.
Name the external sources of finance which are short-term
- Overdraft
- Trade credit
- Debt factoring
Name the external sources of finance which are long-term
- Bank loan
- Hire purchase
- Leasing
- Mortgage
- Debenture
- Share issue
What are alternative sources of capital?
- Micro-finance
- Crowd-funding
