Paper 2 Flashcards
What is external finance and why does everyone not have it
Finances from sources outside the business. Business start ups have no trading records and therefore present too much risk for the lenders. Once they survive the initial ‘uncertain’ stages of business development, external sources of finance become a realistic option
Sources of finance (6)
- Family and friends; particularly in small business, interest will be little to none
- Banks; loans, drafts and mortgages. They need a bank account to facilitate financial transactions with customers and suppliers. May also offer advisory services
- Peer-to-peer lending (P2PL); people lending money to unrelated individuals or ‘peers’ and therefore avoiding the use of a bank. Unsecure so no protection for lenders, no previous relationship between lenders needed, interest rates are better than the bank
- Business angels; invest between £10,000 and £100,000+ in exchange for a stake in the business. Usually for business start ups or early stages of expansion
- Crowd funding; people in business or groups who are involved in a particular venture. Online so business can publish details of their project/idea, how much cash they need, how they will use it and how investors stand to profit from it
- Other businesses; Some set up joint ventures, where the businesses share the finance, costs and profits of a specific venture. Some PLCs buy shares into other companies to earn an income if they have a surplus of cash or build a controlling stake with intentions of taking over in the future
loans (methods of finance)
- Loans; arrangement where the amount borrowed must be repaid over a clearly stated period of time
- Bank loans;unsecured loans, lender has no protection if borrower fails to repay money owed
- Mortgages; secured loans where the borrower has to provide some assets as collateral to support the loan. Lender is entitled to sell the assets and use the proceeds to repay the outstanding amount.
- Debentures; specialised method of loan finance. Holder of debenture is creditor of a company not an owner. Entitled to fixed rate of return but have no voting rights and have to be repaid by certain date
Share capital (methods of finance)
-Share capital; also referred to as permanent capital as isn’t usually redeemed issued SC is the money raised from the sale of shares. Authorised SC is the maximum amount shareholders want to raise. Shareholders can make a capital gain by selling the share at a higher price than what it was originally bought for. Doesn’t usually get bought back by the business
3 types of shares (methods of finance)
Ordinary shares; (equities) riskiest type of share since there is no guaranteed dividend. Size of dividend depends on how much profit is made and how much directors want to retain
- Preference shares; Owners of these shares receive a fixed rate of return when a dividend is declared. Less risky since shareholders are entitled to their dividend before the holders of original shares.
- Deferred shares; Not used often. Usually held by the founders of thee company. Receive a dividend after original shareholders have been paid a minimum amount
Venture capital (methods of finance)
Invest in businesses after the initial start-up and often prefer technology companies with high growth potential. Prefer stake so have some control and are entitled to a share in the profit. Likely to exit after about 5 years
Bank overdraft (methods of finance)
Business can spend more money than it has in its account. Bank and business agree on an overdraft limit and interest is only charged when account is overdrawn.
Leasing A+D (methods of finance)
A contract which a business acquires the use of resources such as property, machinery or equipment in return for regular payments. After end of period they are given option of then buying the resource
+no large sums of money are needed to buy the use of equipment
+not responsible for maintenance and repair costs
+Hire companies can offer the most up to date equipment
+easier to obtain than any other forms of loan finance
-long period of time leasing is expensive than the outright purchase of plant and machinery
Trade credit (methods of finance)
arrangement to buy goods and/or services on account without making immediate cash or cheque payments.
Grants (methods of finance)
A sum of money provided by the government to a business that does not have to be repaid
Unlimited liability
No legal difference between the owners and the business.
If owner doesn’t have the money to pay off debts they can be forced to sell private assets to raise necessary cash
Easier to raise finance as lenders will be reimbursed if a business defaults.
Seen as more credible as owners personal assets are at risk
Limited liability
Legal identity separate from its owners. Business can be liquidated but owner’s possessions are safe
+Limited to the amount of money they put into the business
financial position (choosing appropriate finance)
lenders are more reluctant to offer finance to a business in a poor financial position.
types of expenditure for which the money is needed (choosing appropriate finance)
heavy capital-long term eg building new factory may be financed by mortgage
Revenue expenditure- short term eg purchase of raw materials funded by trade credit or bank overdraft
cost (choosing appropriate finance)
Prefer sources and methods that are less expensive in terms of interest payments and administration costs
finance appropriate for unlimited liability business
- personal savings
- retained profits
- mortgage
- unsecured bank loans
- peer-to-peer lending
- crowd funding
- bank overdraft
- grants
accessible to small businesses. have fewer sources as they have fewer assets to be used as collateral. have no trading record which may discourage lenders
finance appropriate for limited liability businesses
- share capital;the money raised from the sale of shares
- debentures; long term loan- no control over the business
- retained profit
- venture capitalists; buy shares into business to have some control over key decisions. invest in small & medium sized businesses-invest more than business angels
- business angels; buy shares into the business early stages. difficult to find.
legal status allows them raise finance from a more range of sources
relevance of a business plan
more likely to succeed if you have a plan.
lenders and other investors are not likely to put money into a business unless they can show a clear plan(how much money needed and what they can get out of it)
- owners will take an objective view
- provides a road map shows direction
- identifies key tasks needed to be undertaken
- flags up potential problems so solutions can be found
- shows investors owner is responsible
contents of a business plan
- executive summary; overview of the business start up, sales strategy
- business opportunity; description of the product or range of products, quantity sold and price
- buying and production; where to buy supplies, production method and cost
- financial forecasts; variety of forecasts needed: sales, cash flow, profit&loss, break-even analysis
- business and its objectives; name, address, legal structure, aims&objectives
- the market; size of potential market, description of potential customers, nature of competition, marketing priorities
- personnel;who will run the business, how many employees, skills qualifications and experience needed
- premises and equipment; what stuffs needed
- finance; where will the finance come from
cash flow forecasts
lists inflows and outflows over a period of time
the use of cash flow forecasts
identifying the timing of cash shortages and surpluses; particularly helpful if you have seasonal demand
- supporting applications for finance; lenders would want to see this to show if they are able to pay back loan and when
- enhancing the planning process; key part of business plan. helps to clarify aims and improve performance
- monitoring cash flow; compare predicted cash flow forecast and what happened to see how you can address any problems that may’ve occurred
limitations of cash flow forecasts
- based off estimates; may not be accurate
- external forces beyond owners control may affect cash flow
- uses resources and time to make forecast and needs to be updated regularly; may spend too much time on it rather than meeting customer needs eg
- only focuses on cash; not productivity profit margins etc
Business aims
intentions to do in the long term- its purpose or reason for being. less specific than objectives
mission statements and why it is made
declares business’s overriding purpose but may also reflect its goals and values.
- describes in general terms company’s core activities
- what market it will operate in
- key commercial objectives
- clarifies direction to remind owners why the business exists
- forms a promise to customers what they can expect the business to strive for
- bring a company’s workforce together with a shared purpose
corporate objectives
objectives set by senior managers and directors for a company(SMART)
Specific Measurable Agreed Realistic Time specific
departmental and functional objectives
day-to-day goals. should align with corporate objectives
difference between small and large firms (objectives)
small have a wide variety of objectives eg breaking even by the end of the tax year, reduce energu consumption, hire new staff
large tend to focus on the financial aspect as they have many stakeholders to satisfy. financial objectives are more quantifiable and objective making it easier to communicate
critical appraisal of mission statements and corporate aims
need to constantly assessed to ensure they have continued relevance for the business.
what is the purpose?
who is its intended audience?
how does the strategy followed by the business fit with its stated mission?
are the aims and objectives realistic and achievable?
business strategy
in order to fulfil their plan, they may use SWOT analysis. successful strategy will give them an advantage in the competitive market place and fulfil stakeholder expectations
Ansoffs matrix (development of corporate strategy)
- market penetration (existing market, existing product); increase brand loyalty, encourage consumers to use product more
- product development (existing market, new product); risky, 1 in 5 succeed. product innovation
- market development (new market, existing product); moving country- customers may have different tastes and preferences
- diversification (new market, new product); high risk, performance may be poor
Porters strategic matrix (development of corporate strategy)
triangle
cost leadership; lowest cost provider in the market. needs large market share to achieve the lowest costs
differentiation; adding value in a unique way (USP). difficult to know if people would be willing to spend premium prices
focus; focusing on a narrow range of customers
- cost focus; cost minimisation in focused market eg aldi
- differentiation focus; different strategies in focused market
achieving competitive advantage through distinctive capabilities
- achieved through superior quality or design, reputation or ethical stance
- distinctive capability; form of competitive advantage, cant be easily reproduced.
> architecture; refers to contracts and relationships within and around an organisation. eg suppliers,partners,customers
innovation; developing a new product or process
reputation; brand image- takes time to build
portfolio analysis
- categorising products to see where each fits within the strategic plan
>stars(high market share, high market growth)
>cash cows(high market share, low market growth)
>question marks(low market share, high market growth)
>dogs(low market share, low market growth)
internal audit
analysis of the busienss itself and how it operates, identifies S+W
external audit
analysis of the environment in which the business operates (little to no control). analyse their competitors. Political Economic Social Technological Legal Environmental
SWOT analysis
Looks at internal strengths and weaknesses and external opportunities and threats
