Chapter 29 Business finance Flashcards
Why businesses need finance
- Setting up a business will require cash injections from the
owner(s) to purchase essential capital equipment and premises - All businesses will need finance for their working capital
(Current assets increase capital assets current liabilities) day-to-day finance to pay bills and expenses - When businesses expand, further capital will be needed to increase capital assets
- Expansion can be achieved by taking over other businesses = capital needed
- Special situations will often lead to a need for greater finance e.g. a decline in sales could lead to cash needs to keep the business stable
- Finance is often needed to pay for research and development
The difference between cash and profit
- Profit does not pay bills
- Profit is important to investors especially in the long run and the business needs more finance for investments
- cash is always important short term and long run
Why is cash is important especially to small businesses start
ups.
- New business start-ups are often offered much less time to pay suppliers than larger, well-established firms they are given shorter credit periods. = needs to pay quickly to avoid bad relationship
- Banks and other lenders may not believe the promises of new business owners as they have no trading record.
- Finance is often very tight at start-up, so not planning accurately is of even more significance for new businesses. Need to focus on building cash reserves for emergencies
- Survival- need to pay daily expenses
How much working capital is needed?
- enough to pay short term debts
- too much = opportunity cost of too much capital ties up in stock = could have been used elsewhere
Working capital cycle
- Materials ordered from suppliers
- Production converts material into finished products (outflow)
- Inventory held until sold
- Products sold to customers on credit
- Customer pay for purchases (inflow)
How is Inventory managed ?
- keeping smaller inventory levels
- using computer systems to record sales and inventory levels, and to order inventory as required
- efficient inventory control, inventory use and inventory handling so as to reduce losses through damage, wastage and shrinkage
- minimise the working capital tied up in inventories by producing only when orders have been
received (just-in-time inventory ordering) - getting goods to customers as quickly as possible to speed up payments from them.
How can Trade payables be managed
- delaying payments to suppliers to increase the credit period
- only buying goods from suppliers who will offer credit.
How can trade receivables be managed
- only selling products for cash and not on credit
- reducing the credit period offered to customers
Capital expenditure VS Revenue expenditure
*Revenue expenditure: any expenditure on costs other than non-current/fixed asset expenditure
*Capital expenditure: any item bought by a business and retained for no more than one year
Capital and revenue expenditure will be financed in different ways. The length of time that the money is tied up will be a major factor influencing the final finance choice
Internal sources of finance
Not for new business especially if its not profitable
Retained profit: any profit that remains after tax and dividends
Sale of assets:
Reduction in working capital: reduction of stock or debtors in order to gain finance = may risk reducing the firms liquidity
Advantages of internal sources of finance
- No direct cost to the business except when equipment has been sold, and leased again, there will be leasing charges.
- Will also not increase liabilities or debt
- Neither will you lose control of the company by issuing shares.
External sources of finance
Long-term
* Share issue: sale of shares
- Debentures: sale of bonds to investors. has no collateral
- Long-term loan: can be more than a year
- Grants: from government, no need to repay
Medium-term
* Leasing: business acquires the asset but does not own it, they have to pay regularly for it - contractual = has to be renewed
- Higher purchase: paying for the product by regular installments while using the product
- Medium-term loan: must be paid back between 2-10 years
Short-term
* Bank overdraft: The bank allows the business to overdraw on its account at the bank by making payments up to a greater value than the balance in the account. This overdrawn amount should always be agreed in advance and always has a limit beyond which the business should not go.
- Bank loan: shorter than or within a year it should be paid back- may not need any collateral
- Trade credit: delaying payment to suppliers for goods and services received
- Debt Factoring: selling trade receivables to a debt factor, immediate cash is obtained but not full amount
loan or share finance evaluation
loans have 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 sales
*Loans will be repaid eventually (apart from convertible debentures), so there is no permanent increase in the liabilities of the company
*Lenders have no voting rights at the annual general meetings.
*Interest charges are an expense of the business and are paid out before corporation tax is deducted. Dividends on shares, however, have to be paid from profits after tax.
*The indebtedness/gearing (ratio of long term loans to capital employed) of the company increases and this gives shareholders the chance of higher returns in the future.» when a company borrows more money for long term investments its debt increases this can be risky but it also means the company can grow faster, shareholders might make more money later because the company can use the borrowed money to make the bigger profits
share capital:
*It never has to be repaid
*Dividends do not have to be paid every year. Directors can decide to retain more earnings by reducing dividend payments. In contrast, loan interest must be paid even if the profit of the business is low or a loss is made.
*It lowers the indebtedness of the business, so debt finance becomes a lower proportion of total long-term finance.
Other sources of finance
Venture capital:
Venture capital comes from specialist organisations or sometimes wealthy individuals, who are prepared to lend risk capital to or purchase shares in business start-ups, or small to medium sized businesses that might find it difficult to raise capital from other sources. This could be because of the risk of the company (maybe new technology or complex research) in which other companies are not prepared to get involved. Venture capitalists take great risks and could lose all their money the reward can be great
but expect share of the profit or stake in business
Microfinancing:
Provide small capital sums to entrepreneurs in developing relatively low income countries.
Interest rates are quite high as the administration costs are
considerable. Could possible result in poor people making debt that they cannot repay
Crowd funding:
Basic idea is that entrepreneurs rarely have sufficient funds to setup
business. Crowdfunding websites allow individuals to promote their
business to thousands each possibly willing to invest small amount Social enterprises often give donations then. In business ventures that are successful, crowd funding investors
receive:
*Initial capital plus interest (peer to peer lending)
*An equity stake in the business and a share in the business profits
Finance for unincorporated businesses
Sole traders and partnerships
- they cannot raise finance from the sale of shares and are most likely unsuccessful in selling debentures(whena business gives money to a company/individual then they recieve more money later on) as they are relatively unknown.
*They might have access to bank overdrafts, loans and credit from suppliers
*They may even borrow from family and friends, use savings and profits made by the owners.
*A sole proprietor can take in a partner with capital
*Lenders are often reluctant to lend money to smaller businesses.
*Sometime grants are available to small firms
