finance (chapter 3) Flashcards
Capital expenditure
the finance spent on fixed assets, items of monetary value that have a long-term function so can be used repeatedly. They are not intended for resale (in the short term) but for the purpose of generating money for the business.
Revenue expenditure
payments for the daily running of the business (short term), and indirect costs such as advertisement or insurance.
Typically the main source of finance for sole traders is their personal savings, By contrast, larger and more established businesses can seek other sources of finance for expansion purposes (by issuing shares or selling debentures).
Internal sources of finance
Internal sources of finance come within the business:
Personal funds
Retained funds - profits that business keeps after taxes and dividends, used for purchasing / upgrading fixed assets
Sale of assets - selling dormant (unused) assets such as old machinery etc.
personal funds
personal funds usually relied on by sole traders and partners (so from their savings to finance a start up business)
advantages:
- do not need to be repaid
- no interest charges included
- the sole traders//partners have higher chances of being able to borrow money if they need to because investing your own personal funds shows greater determination and commitment
disadvantages:
- rarely sufficient are rarely sufficient for a small business
- many entrepreneurs risk their life savings and its a bad idea cause may not pay off if the business venture fails
- they are less likely to be able to secure external sourced of finance so they need to rely on their personal funds
retained funds//profit
profits that business keeps after taxes and dividends, used for purchasing / upgrading fixed assets
retained funds//profit adv & dis
advantages:
- as an interal source of finance retained profit does not incur any interest charges
- as the money belongs to the business it is considered a permanent source of finance
- flexibility in use of the retained profit (you can use it for whatever you wish, unlike bank loans which serve a specific purpose and you cant use them for anything else)
disadvantages:
- start up businesses do not have any retained profit and therefore it is not a possible source of finance for creating a new business
- retained profit is rarely enough as a sole source of finance for most businesses in their pursuit of growth and evolution
- usage of the funds as retained profit to grow the business means there is less dividends for shareholders and owners
sale of assets
selling dormant (unused) assets such as old machinery etc.
sale of assets adv & dis
advantages:
- a large sum of money can be raised
- selling excess resources, or ouytdated items which just aren’t in their best form atm is a sensible way of raising finance
- no costs of borrowing, you don’t have to make interest repayments
disadvantages:
- the sale of certain non current assets might negatively impact productivity
- time consuming to find a responsible, suitable buyer
- the purchase is likely to be a small price esp if the item is obsolete also bc the business is in the weaker bargaining position
- only available to established businesses
external sources of finance
share capital
loan capital
overdrafts
trade credit
debts
grants
trade factorising
leasing
venture capitals
business angels
share capital // equity capital
money raised from selling shares in the company on the stock exchange, can provide a large amount of finance hence many companies decide to do the initial public offering and float their shares on the market, the stock exchange for the first time
share capital dis & adv
adv
- permanent capital (no repaying)
- provides significant funding
- improves company gearing (debt to equality ratio)
- does not require interest repayments
dis
- shareholders must be paid dividents if the company earns profit
- the ownership and control of existing shareholders may be diluted
- only for publicly held companies
loan capital
medium long source of finance from commercial lenders such as banks
- a mortgage (secured loan for the purchase of property such as land or building) id loaner fails to repay they might reposes the property
- a business development loan to meet specific development needs
- debentures (long term flexible loans issued by a business interest and initial amount is paid)
adv & dis loan capital
adv
- allows the lender to repay the money in regular instalments making it more accessible and affordable
- possibility of negotiating a lower rate of interest on a loan
- suitable if the owners need to raise finance without weakening their ownership and losing control through issuing shares
dis
- interest must be paid (according to the amount of borrowed funds)
- businesses forced to offer collateral, which is a risk that the lender might seize the firms assets if they fail to repay the loan
- firms that borrow loan capital on variable interets rates might suffer from liquidity ptoblems if rate of interest increasese
overdrafts
Overdrafts allow a business to spend in excess of the amount in its bank account, up to a predetermined limit. They are the most flexible form of borrowing in the short term.
adv and dis overdrafts
adv
- quick and easy
- emergency funds
-flexivility
dis
- interest higher than standard bank loans
- smaller amount of money
- banks can ask for overdrafts to be repaid at a very short notice
trade credit
Trade credit allows a business to ‘buy now and pay later’. The credit provider does not receive any cash from the buyer until a later date (usually allow between 30-60 days).
grants
Grants are government financial gifts to support business activities. They are not expected to be repaid by the recipient.
crowdfunding
s raising small amounts of money from a huge number of people to fund a specific business project or venture
typically done through online platforms (fundraisers)
debt factoring
Debt factoring is a financial service whereby a factor (such as a bank) collects debts on behalf of other businesses, in return for a fee.
leasing
Leasing is a form of hiring whereby a contract is agreed between a leasing company (the lessor) and the customer (the lessee). The lessee pays rental income to access assets from the lessor ,who is the legal owner of the assets.
Sale-and-leaseback involves a business selling a particular fixed asset and immediately leasing the property back.
Hire purchase (HP) allows a business to pay its creditors in instalments, perhaps over 12 or 24 months. The asset is legally the property of the creditor until all payments have been made.
adv and dis of leasing
adv
- the lessor takes responsibility for maintaining capital equipment or any leased property
- esp if you only need the item fir a short period of time
- enables a company to access non current assets without the high costs of capital expenditure
dis
- you never own the asset
- might be expensive over a long period of time
micro-finance providers
or profit social enterprises that offer a financial service to jobless or very low income people who wouldn’t be able to secure bank loans the aim is to help entrepreneurs struggling to finance their start up business gain access to loans of a small account
micro finance adv and dis
- helps individuals get ut of poverty
- socially repsonsible
- helps empower enterprenuers of small businesses
dis
- gaining profit off of low inome ppl
- only provides finance on a small scale so no major difference
venture capital
Venture capital is high-risk capital invested by venture capital firms, usually at the start of a business idea. The finance is usually in the form of loans and/or shares in the business venture. They look at a number of criteria before committing their capital in an investment project including:
Return on investment - Investors demand a return on their capital
The business plan - This should outline the long-term aim and purpose of the business venture
People - Ineffective people management is a major cause of business failure
Track record - Investors will asses the past track record of a business and its management before investing any capital
business angels
Business angels are wealthy entrepreneurs who risk their own money by investing in small to medium-sized businesses that have high growth potential.
short term need for finance
current fiscal (tax) year, everything must be repaid to the creditor in the following months
medium term
everything has to be repaid to the creditors in more than 12 months but less than 5 years
costs
the money incurred by a business during the production process
direct costs
production or sale of a particular good or service they can be traced back to the product and or cost centre
indirect costs (overhead)
not directly linked with production
fixed costs
do not vary with the level of output (they must be paid anyway) (rent payment, insurance payments, salaries to management)
variable costs
variable costs change with the level of output. they increase with the firms output or sales value (the cost of purchasing raw materials and components for production, commissions paid to sales staff, wages paid to employees)
price
Price refers to the amount of money a product is sold for, i.r. The sum paid by the customer.
revenue
Revenue is the money that a business collects from the sale of its goods and services. It is calculated by multiplying the unit price of each product by the quantity sold.
revenue streams
the way money comes into a business from its various activities
contribution
the sum of money that remains after all direct and variable costs have been taken away from the sales revenue
how to increase profir (3)
- increase the number of sales of a product
- reduce variable costs (get better deals with suppliers ot seek more competitive ones)
- reduce fixed costs or overheads
uses of contribution analysis (3)
- pricing strategy
- product portfolio management (which products should be given investment priority)
- make or buy decisions
break even analysis
management tools used for calculating the level of sales needed to cover all costs of production so that further sales generate a positive safety margin and profit for the business
break even point
the production level at which total production revenue equals total production costs
to calculate it fixed costs/contribution
margin of safety
if a firm is producing and selling more than the break even level they are said to have a margin of safety
is it is a range of output over which profit can be sustained
adv & dis of break even
adv
- useful in industries with standardised products and work in a single market or make products and work in a single market or make products from order
dis
- limited use in service industries
- manufacturing industries experiance changes in fixed costs
- assumed all output can be sold
- relies on accuracy of data
- asumes that total costs and revenue functions are linear
