IUNITR 3FUCKL Flashcards
Define Finance
refers to the various available moneythat an organisation has to fund its business activities
Define Capital expenditure
refers to business spending on non-current assets or capital equipment of a business.These are items of monetary value that have a long-term function for businesses, so can be used repeatedly.
Reasons for capital expenditure in businesses
-to add extra production capacity as the business grows
- to improve efficiency by utilising their latest technologies, including IT systems and production technologies
- to replace worn-out, damaged and/or obsolete (outdated) capital equipment and machinery
- to comply with changing legislation and regulations, such as green technologies
Challenges of capital expenditure (3)
- High costs involved
- limited sources of finance available for such investments
- some investments are simply not feasible
What is revenue expenditure
Revenue expenditure refers to finance spent on the daily operations of a business
Characteristics of Revenue expenditure
-Short-term tenure
-Does not add to the value of a firm’s -non-current assets
-Recurring (regular) expenditure
-Provides short-term benefits
-Includes low-cost expenditures
-Expenditure reflected in profit and loss account
-Does not improve operational efficiency
Characteristics of Capital expenditure
-Long-term tenure
-Adds to the value of a firm’s non-current assets
-Non-recurring (one-off) expenditure
-Provides long-term benefits
-Represents significant investments in the firm
-Expenditure reflected in the balance sheet
-Improves the firm’s operational efficiency
Internal sources of finance
Refer to money or funds that come within the business
What are the three internal sources of finance
- Personal funds
- Retained profit
- The sale of assests
Definition of personal funds
refers to the use of an entrepreneur’s own savings
Advantages of personal funds
-Personal funds do not need to be repaid.
-There are no interest charges incurred either, unlike with external finance.
-By investing their personal funds, sole traders and partners have a better chance of being able to borrow money if they need to, as it shows greater commitment to the business venture.
-Whilst internal sources of finance are the cheaper of the two options, external sources of finance usually generate much more funds for a business.
Disadvantages of personal funds
-As sole traders represent relatively high risk, they are less likely to be able to secure external sources of finance, so need to rely on their personal funds.
-Personal funds are rarely sufficient for most small businesses.
-Many entrepreneurs risk their entire life savings in a business venture. In particular, sole traders and partners risk losing all their personal funds if the business venture fails.
Definition of retained profit
Retained profit comes from having a financial surplus. These funds are reinvested in the business, rather than being distributed to the owners (shareholders).
Advantages of retained profit (3)
-As an internal source of finance, retained profit does not incur any interest charges.
-As the money belongs to the business, it is considered as a permanent source of finance, because it doesn’t have to be repaid. If a business project fails, the use of retained profit does not necessarily pull the organization into debt.
-The business also has great flexibility in the use of retained profit - the business can use this for any purpose within the business. By contrast, bank loans are approved for specific uses only.
Disadvantages of retained profit (3)
-Start-up business don’t have any retained profit, so this 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.
-Using the funds as retained profits for use to grow the business means there is less dividends paid out to shareholders and owners of the business.
Definition of profit
Profit is when a firm’s total revenue exceeds its total costs
Assest
asset is anything that a business owns and has a marketable value, such as buildings, vehicles, computers, equipment and intellectual property
Non-current assets
items a business owns and:
-uses for a period of more than 12 months
-can be used repeatedly
-generates income for the organization.
advantages of using the sale of assets as an internal source of finance include (3)
A large sum of money can be raised. For example, selling a fleet of old motor vehicles or a redundant (unused) office building can raise much needed finance for a business.
The sale of excess resources, redundant assets or obsolete (outdated) belongings is a sensible way for a business to raise finance. The alternative is that these resources would tie up much needed working capital for the organization.
Again, there are no costs of borrowing involved or interest repayments to make.
disadvantages of the sale of assets as an internal sources of finance too, (3)
The sale of certain non-current assets can hinder a firm’s productive capacity. For example, a struggling business that sells some of its computer equipment or machinery, which may actually be needed for production.
It can be very time consuming to find a suitable buyer for second-hand assets, especially if these are obsolete. Even if a buyer can be found, the purchase price is likely to be very low as the business is in a weaker bargaining position, especially if the business is desperate for cash.
The option of asset sales is only available to established businesses; new businesses are unlikely to be in such a position.
External source of fiance
refers to money or founds that come from outside the business
What are the 8 sources of external finance
-Share capital
-Loan capital
-Overdrafts
-Trade credit
-Crowdfunding
-Leasing
-Microfinance providers
-Business angels
what is Share capital
is finance raised through the issuing of shares via a stock exchange/ stock market
long-term source of finance for limited liability companies, obtained by selling shares in the company.
what is an IPO ( initial public offering)
When a limited liability company sells its shares for the very first time on a public stock exchange
main functions of a stock exchange are to: (3)
-enable existing companies to raise share capital (through a share issue)
-oversees the initial public offering (IPO) of new publicly held companies
-to provide a market for trading of second-hand shares (and government bonds,).
Advantages of a share capital (4)
-It is permanent capital as it does not need to be repaid (shareholders sell their shareholdings to other buyers via the stock exchange).
-There are no interest payments made to shareholders, thus this reduces the expenses of the company.
-Unlike loan capital, share capital does not involve debt or incur interest repayments.
-Any publicly held company can raise further finance by selling additional shares (a process known as a share issue).
Disadvantages of share capital (3)
-Shareholders need to (at some point) be paid dividends if the company earns a profit.
-Although share capital can raise a lot of money for a company, the ownership and control of the organization may be diluted.
-Only publicly held companies can trade their shares using the stock market.
what is Loan capital
refers to borrowed funds from financial lenders, such as commercial banks.
Loan capital is typically used to purchase non-current assets, such as machinery and property.
what are the types of loan capital (4)
Bank loans
Mortgages
Debentures
Corporate boands
What is debenture
long-term loans issued by organizations that borrow money from investors and commit to repaying it with interest. Unlike secured loans, debentures are not backed by specific assets but depend on the borrower’s creditworthiness
what are corporate bonds
These are debt securities (guarantees) sold to investors
Advantages of loan capital (3)
-It enables the borrower to repay in regular instalments, making loan capital more accessible and affordable for many businesses as it is not burdened by having to pay a large lump sum of money.
-Large businesses are often able to negotiate a lower rate of interest on their loans (financial economies of scale).
-Loan capital is suitable if the owners need to raise finance but do not want to dilute their ownership or potentially lose control through issuing shares.
Disadvantages of loan capital (3)
-Interest is charged on the amount of borrowed funds. The interest rate can be a fixed or variable rate.
-In many cases, businesses have to offer collateral (security) before loans can be approved. Failure to repay the loan can lead to the lender being able to legally seize the firm’s assets to pay for the outstanding amount borrowed.
-Firms that borrow loan capital on variable interest rates may suffer from liquidity problems if the rate of interest increases, because their debt repayment burden will increase.
What is an overdraft
a financial service that allows a business to temporarily overdraw on its bank acccount,
i.e. to take out more money than it has in the account
Advantages of overdrafts (4)
- when there is a need for a large cash outflow
-Overdrafts are quite easy to obtain, (so are an important source of external finance for small businesses in particular).
-Overdrafts provide businesses with emergency funds to finance their operations, such as making payment to suppliers / wages to staff, during times when liquidity is a problem.
-It provides great flexibility for businesses as overdrafts are only used as and when needed.
Disadvantages of overdraft (4)
Interest is charged on the amount overdrawn, usually at rates higher than those charged for ordinary bank loans.
-Banks usually only lend a small amount of money, in order to keep a business operation; it is not a suitable source of finance for purchasing non-current assets, for example.
-Banks can ask for overdrafts to be repaid at very short notice.
-It is essentially a high cost, short-term loan for businesses.
what is trade credit
Trade credit enables a customer to purchase and obtain goods and services but to pay for these at a later date. (typically 30-60 days)
Advantage of trade credit (2)
-Buying goods and services on trade credit does not incur any interest charges if the amount owed is paid in full within the trade credit period.
-can help when firms are struggling with cashflow
what is crowdfunding
raising small amounts of money from a large number of people to fund a particular business project or venture
equity crowdfunding
involves the sale of a stake in a business to a number of investors in the crowd
donation-based crowdfunding
individuals donate small amounts of money to help fund a specific charitable project while receiving no financial stake or return for doing so.
Advantages of crowdfunding (5)
-As each individual lends a relatively small amount of money to the fundraiser, this limits the risks and impacts should the business project fail to succeed.
-It avoids the need for business owners or entrepreneurs to deal with commercial banks, which is often a time-consuming and bureaucratic process.
-Many people can invest in the business, so this can help to raise lots of much-needed finance for small to medium-sized enterprises.
-Unlike business angels, individuals of the crowd do not take any controlling interest in the organization.
-Crowdfunding is usually less costly than being listed on a public stock exchange.
Disadvantages of crowdfunding (3)
-There are legal challenges and considerations, such as transparent disclosure of legal documents, holding annual general meetings with investors, and publication of annual reports. This adds to the costs of the business.
-There needs to be due diligence Investors have the option to ask for additional information from the fundraiser, so this can delay decision making and incur additional costs for the business.
There are a lot of cases of crowdfunding scams. The loose regulatory requirements for crowdfunding in many parts of the world exposes investors to fraud.
Leasing
involves the business or customer drawing up a contract with the leasing company to use particular non-current assets for an agreed fee. Examples: machinery, tools, equipment,
Advantages of leasing (3)
-The lessor does not have to purchase the expensive equipment, machinery, vehicles or other type of capital. Instead, its money can be used for revenue expenditure purposes.
-The lessor takes responsibility for the maintenance of the capital equipment and other leased property. This helps to cut the operating costs of the lessee.
-Leasing is particularly advantageous if the business only needs to use the fixed capital for a short period of time, or if it does not want to deal with the hassles and costs of repairs and maintenance.
Disadvantages of leasing (2)
With leasing, the lessee never owns the asset. Ownership remains with the lessor (the leasing company) before, during and after the leasing contract.
Over a long period of time, leasing can be more expensive than buying the asset outright due to the accumulated costs of leasing the asset over time.
Sale-and-leaseback
Involves a business selling a particular fixed assets and immediately leasing th property back.
i.e. the business transfers ownership although the asset does not physically leave the business
Microfinance providers
for-profit social enterprises that offer a financial service to those without a job or on very low incomes.
aim of microfinance
help entrepreneurs struggling to finance their business start-ups to gain access to loans of a small amount. Microfinance can give these people the opportunity to become self-sufficient and empower them to run their businesses. As with the majority of loans, interest is charged on the amount borrowed, although these are typically lower than what commercial banks would charge.
Advantages of microfinance providers (4)
-Microfinance can help many people to get out of poverty by making them become financially independent.
-can help to create new job opportunities
-Microfinance can create benefits for the wider community, such as improved healthcare, education and employment opportunities.
-Microfinance can help to build and foster a culture of entrepreneurialship and economic independence.
Disadvantages of microfinance providers (5)
Due to relatively low profitability, microfinance providers may struggle to attract and/or retain employees and managers, given that their remuneration packages are unlikely to be matched by larger for-profit financial companies such as commercial banks and insurance companies.
Microfinance only provides finance on a small scale, so is unlikely to be sufficient to make a real difference to society as a whole.
Microfinance loans incur interest charges, so can be rather expensive for small business owners who find it difficult to earn enough revenue to keep up with their loan repayments.
Microfinance increases the debts of entrepreneurs who may subsequently struggle in their business venture.
Some people regard the practice of microfinance providers as being unethical as they earn profits from low-income individuals and households.
Who are business angels
are wealthy and successful private individuals who risk their own money in a business venture that has high growth potential.
i.e. high-risk, high-return business ventures
what business angles consider before investing (4)
-Return on investment (positive)
-The business plan
-People (good team of people)
-Track record
Advantages of business angels (3)
-Business angels provide an essential source of finance for start-ups and small businesses that are unable to secure finance from conventional providers of finance, such as commercial banks and other financial institutions.
-The business can benefit from the expertise and experiences of the business angels, who are likely to provide their input in order to secure a significant return on their investment (ROI).
-It is particularly useful for small businesses and inexperienced entrepreneurs who are unable to raise sufficient finance on their own, such as those which are unable to secure loan capital or those that are not permitted to sell shares on a public stock exchange.
Disadvantages of business angels (4)
-For the business angels, such business ventures are extremely high risk, especially as they risk losing their personal money. Hence, the amount of finance available is often not easily available for start-ups and small businesses.
-This also means that there are no guarantees than angel investors will earn a satisfactory ROI, despite the high potential returns.
-Such finance is difficult to come by, not only due to the risks involved but also due to the large number of entrepreneurs competing for such funds.
-The use of business angels will dilute the firm’s control and ownership as the angel investors will want a share and say in the organization.
revenue expenditure
is the day-to-day or routine spending of a business, required for its ordinary operations.
Examples include the payment of rent, raw materials, wages, salaries, and utility bill
Short-term finance
refers to sources of finance needed for the day-to-day running of a business, i.e., its revenue expenditure.
examples of short-term finance (4)
Personal savings
Sale of assets
Overdrafts
Trade credit
Long-term finance
refers to sources of finance of more than one year from the balance sheet date.
The finance is used mainly to pay for fixed assets, i.e., capital expenditure such as the purchase of capital equipment, machinery, and motor vehicles.
Examples of long-term finance (6)
-Share capital
-Loan capital, such as mortgages
-Leasing
-Business angels
-Microfinance providers
-Crowdfunding
Appropriateness of sources of finance for a given situation (SPACED)
- Size and status of the firm
-purpose of finance - amount required
- cost of finance
-external factors
-duration
what are costs
Costs are the charges that an organization incurs from its operations
Set-up costs
items of expenditure needed to start a business
Running costs
ongoing costs of operating the business
what are Fixed costs
Fixed costs are costs of production that a business has to pay regardless of how much it produces or sells.
e.x: rent, loans, salaries, etc
Total cost equation
TC= TVC + TFC
Total cost = total variable cost + total fixed costs
what are variable costs
Variable costs are the costs of production that change in proportion with the level of output or sales.
i.e As output increases total variable cost increases
Direct cost
items of expenditure that can be evidently and explicitly associated with the output or sale of a certain good, service, or business operation.
example: direct costs for a hair salon include the money spent on hair products such as shampoos, conditioners, hair sprays, and hair dyes.
Direct costs may comprise of
Variable costs, such as direct raw materials and direct labour costs, or
Fixed costs, such as third party motor insurance and depreciation costs for taxi operators. Rent is another example of a direct cost if this fixed cost is for a production facility.
definition of revenue
Revenue refers to the money coming into a business from the sale of goods and services.
Indirect costs
those that cannot be clearly traced to the production or sale of any single product
examples:
-Rent on premises.
-Salaries for administrative staff.
-Fees paid for legal and accounting services.
-Utility bills (gas, electricity, and water).
-General insurance for third parties, fire, and theft.
-Costs involved with maintaining and running the organization.
what are revenue streams
refers to the various sources of revenue for a business.
Total reveunue
sum of income received by a business from its trading activities
Formula of Total revenue
TR = P × Q
Total revenue = P) of a good or service X the quantity sold (Q)
Formula of Average revenue
AR = TR ÷ Q
Average revenue = Total revenue divided ÷ Quanitity
Examples of revenue streams
-Advertising revenue
-Transaction fees
-Franchise costs and royalties
-Sponsor ship revenue
-Subscription fees
-Merchandise
-Interest earnings
-Dividends
-Donations
-Subventions
what is a final account
published accounts of an organisation, made available to and used by different stakeholders
what are the two final accounts
- Profit and loss account (income statement)
2.. Balance sheet
Why would managers be interested in a final account (6)
-measure the performance of the business against organizational targets.
-benchmark key indicators (such as net profit figures) against those of rival businesses.
-help with decision-making, e.g., to assess whether the business has sufficient funds for new investment projects.
-set budgets and targets for the future, e.g., target profit.
-monitor and control business expenditure across the various departments in the organization.
Why would suppliers be interested in a final account (3)
-Assess whether the business has sufficient liquidity to pay its debts (trade credit).
-Determine the creditworthiness of the business in order to gauge the level of risk involved.
-Negotiate improved credit terms, such as deciding whether to extend the trade credit period or to demand immediate cash payment.
