section 5 Flashcards
Finance
the money required in the business. Finance is needed to set up the business, expand it and increase working capital (the day-to-day running expenses).
Start-up capital
the initial capital used in the business to buy fixed and current assets before it can start trading.
Working Capital
finance needed by a business to pay its day-to-day running expenses
Capital expenditure
the money spent on fixed/non current assets (assets that will last for more than a year)
Revenue Expenditure
similar to working capital, is the money spent on day-to-day expenses which does not involve the purchase of long-term assets. Eg: wages, rent. These are short-term capital needs.
Internal finance
finance that’s obtained from within the business itself
Retained Profit
ADV
DISADV
profit kept in the business after owners have been given their share of the profit. Firms can invest this profit back in the businesses.
Advantages:
– Does not have to be repaid, unlike, a loan.
– No interest has to be paid
Disadvantages:
– A new business will not have retained profit
– Profits may be too low to finance
– Keeping more profits to be used as capital will reduce owner’s share of profit and they may resist the decision.
Sale of existing assets
ADV
DISADV
assets that the business doesn’t need anymore, for example, unused buildings or spare equipment can be sold to raise finance
Advantages:
– Makes better use of capital tied up in the business
– Does not become debt for the business, unlike a loan.
Disadvantages:
– Surplus assets will not be available with new businesses
– Takes time to sell the asset and the expected amount may not be gained for the asset
- asset will be sold at a lower value than it was bought at
Sale of inventories
ADV
DISADV
sell of finished goods or unwanted components in inventory.
Advantage:
– Reduces costs of inventory holding
Disadvantage:
– If not enough inventory is kept, unexpected increase demand form customers cannot be fulfilled
Owner’s savings
ADV
DISADV
For a sole trader and partnership, since they’re unincorporated (owners and business is not separate), any finance the owner directly invests from hos own saving will be internal finance.
Advantages:
– Will be available to the firm quickly
– No interest has to be paid
Disadvantages:
– Increases the risk taken by the owners.
- savings may be too low
External finance
obtained from sources outside of the business
Issue of share
ADV
DISADV
only for limited companies.
Advantage:
A permanent source of capital, no need to repay the money to shareholders
no interest has to be paid
Disadvantages:
Dividends have to be paid to the shareholders
If many shares are bought, the ownership of the business will change hands. (The ownership is decided by who has the highest percentage of shares in the company)
Bank loans
ADV
DISADV
money borrowed from banks
Advantages:
Quick to arrange a loan
Can be for varying lengths of time
Large companies can get very low rates of interest on their loans
Disadvantages:
Need to pay interest on the loan periodically
It has to be repaid after a specified length of time
Need to give the bank a collateral security (the bank will ask for some valued asset, usually some part of the business, as a security they can use if at all the business cannot repay the loan in the future.
Debenture issues
ADV
DISADV
debentures are long-term loan certificates issued by companies. Like shares, debentures will be issued, people will buy them and the business can raise money. But this finance acts as a loan- it will have to be repaid after a specified period of time and interest will have to be paid for it as well.
Advantage:
Can be used to raise very long-term finance, for example, 25 years
Disadvantage:
Interest has to be paid and it has to be repaid
Debt factoring
ADV
DISADV
a debtor is a person who owes the business money for the goods they have bought from the business. Debt factors are specialist agents that can collect all the business’ debts from debtors.
Advantages:
Immediate cash is available to the business
Business doesn’t have to handle the debt collecting
Disadvantage:
The debt factor will get a percent of the debts collected as reward. Thus, the business doesn’t get all of their debts
Grants and subsidies
ADV
DISADV
government agencies and other external sources can give the business a grant or subsidy
Advantage:
Do not have to be repaid, is free
Disadvantage:
There are usually certain conditions to fulfil to get a grant. Example, to locate in a particular under-developed area.
Short-term finance
provides the working capital a business needs for its day-to-day operations.
Short-term finance
provides the working capital a business needs for its day-to-day operations.
Micro-finance
special institutes are set up in poorly-developed countries where financially-lacking people looking to start or expand small businesses can get small sums of money. They provide all sorts of financial services
Crowdfunding
raises capital by asking small funds from a large pool of people, e.g. via Kickstarter. These funds are voluntary ‘donations’ and don’t have to be return or paid a dividend.
Overdrafts
ADV
DISADV
similar to loans, the bank can arrange overdrafts by allowing businesses to spend more than what is in their bank account. The overdraft will vary with each month, based on how much extra money the business needs.
Advantages:
Flexible form of borrowing since overdrawn amounts can be varied each month
Interest has to be paid only on the amount overdrawn
Overdrafts are generally cheaper than loans in the long-term
Disadvantages:
Interest rates can vary periodically, unlike loans which have a fixed interest rate.
The bank can ask for the overdraft to be repaid at a short-notice.
Trade Credits
ADV
DISADV
this is when a business delays paying suppliers for some time, improving their cash position
Advantage:
No interests, repayments involved
Disadvantage:
If the payments are not made quickly, suppliers may refuse to give discounts in the future or refuse to supply at all
Long-term finance
Examples
is the finance that is available for more than a year.
Loans: from banks or private individuals.
Debentures
Issue of Shares
hire purchase
leasing
Hire Purchase
ADV
DISADV
allows the business to buy a fixed asset and pay for it in monthly instalments that include interest charges. This is not a method to raise capital but gives the business time to raise the capital.
Advantage:
The firms doesn’t need a large sum of cash to acquire the asset
Disadvantage:
A cash deposit has to be paid in the beginning
Can carry large interest charges.
Leasing
adv
disadvantage
this allows a business to use an asset without purchasing it. Monthly leasing payments are instead made to the owner of the asset. The business can decide to buy the asset at the end of the leasing period. Some firms sell their assets for cash and then lease them back from a leasing company. This is called sale and leaseback.
Advantages:
The firm doesn’t need a large sum of money to use the asset
The care and maintenance of the asset is done by the leasing company
Disadvantage:
The total costs of leasing the asset could finally end up being more than the cost of purchasing the asset
what is cashflow of a business
the cash inflows and outflows over a period of time
not the same as profit
cash inflows
the sums of money received by a business during a period of time
cash outflows
the sums of money paid out by a business during a period of time
what is a cashflow forecast
an estimate of future cash inflows and outflows of a business usually on a month by month basis. this then shows the expected cash balance at the end of each month
difference between cashflow and profit
cashflow is the total cash inflow and outflow and profit is the money left after total costs have been subtracted from total revenue.
net cash flow
difference each month between inflows and outflows
what can the cashflow forecast tell the manager
It can help tell the manager:
how much cash is available for paying bills, purchasing fixed assets or repaying loans
how much cash the bank will need to lend to the business to avoid insolvency (running out of liquid cash)
whether the business has too much cash that can be put to a profitable use in the business
Uses of cash flow forecasts
when setting up the business the manager needs to know how much cash is required to set up the business.
required by bank managers when the business applies for a loan. The bank manager will need to know how much to lend to the business for its operations, when the loan is needed, for how long it is needed and when it can be repaid
Managing cash flow– if the cash flow forecast gives a negative cash flow for a month(s), then the business will need to plan ahead and apply for an overdraft so that the negative balance is avoided
How can cash flow problems be overcome?
Increase bank loans- but will have to be paid on a regular basis with interest
Delay payment to suppliers- could cause suppliers to refuse to provide to the business
Delay or cancel purchases of capital equipment
how can cashflow be improved in the long term
attracting new investors - eg by selling company shares
cutting costs and increasing efficiency
developing new products to attract more customers
working capital
the capital available to a business in the short term to pay for day-to-day expenses
definition of accounts
financial records of a firms transactions
financial accounts
produced at the end of the year and give details of the profit or loss made over the year and the worth of the business
How to increase profit?
Increase sales revenue
Cut costs
Why is profit important to a business?
It is a reward for enterprise: entrepreneurs start businesses to make a profit
It is a reward for risk-taking
It is a source of finance: after payments to owners, profits are reinvested back into the business for further expansion
It is an indicator of success- more profit means the business is doing very well
income statement / profit and loss account
a financial statement that records the income of a business and all costs incurred to earn that income over a certain period of time
revenue
income to a business during a period of time from the sale of good or service
gross profit
made when revenue is greater than the cost of sales
depreciation
fall in the value of a fixed asset over time
Uses of Income Statement
know the profit/loss made by the business
compare their performance with the previous year/ month
know the profitability of individual products
help decide what products to launch
statement of financial position
shows the value of a business’ assets and liabilities at a particular time
assets
items of value owned by the business
liability
debts owed by the business
non current assets
items owned by the business for more than a year
current assets
items owned by the business for less than a year
non current liabilities
long term debts owed by a business that can be repaid over a year. eg long term bank loans
current liabilities
short term debts owed by a business that need to be repaid within a year. eg loans, bank overdraft, money owed to supplies
what is Shareholder’s Equity/ total equity/ shareholders funds
is the total amount of capital invested in the company by shareholders
Uses of a statement of financial position
to see if the firm will be able to pay back its debt
capital employed
shareholders equity + non-current liabilities
and in the total long term and permanent capital invested in a business
liquidity
ability of a business to pay back its short term debts
profitability
measurement of the profit made relative to either the value of sale achieved or the capital invested in a business
Return on Capital Employed (ROCE)
calculates the % of net profit earned on each unit of capital employed. The higher the ROCE the better the profitability is
Gross Profit Margin
the % of gross profit made on each unit of sales revenue. The higher the GPM, the better
Net profit Margin
the % of net profit generated on each unit of sales revenue. The higher the NPM, the better
illiquid
means that the assets are not easily convertible into cash
Current Ratio
basic liquidity ratio that calculates how many current assets are there in proportion to every current liability, so the higher the current ratio the better
Liquid Ratio/ Acid Test Ratio
this ratio doesn’t consider inventory to be a liquid asset, since it will take time for it to be sold and made into cash. A high level of inventory in a business can thus cause a big difference between its current and liquidity ratios
Liquid Ratio/ Acid Test Ratio
this ratio doesn’t consider inventory to be a liquid asset, since it will take time for it to be sold and made into cash. A high level of inventory in a business can thus cause a big difference between its current and liquidity ratios
Uses and users of accounts
Managers- keep control of business
take better decisions
comparison of ratios
shareholders- investing in business
compare ratios with other companies and with previous years
creditors- if there are liquidity problems they won’t supply
how to improve GPM
- increase sales revenue - price goes up if customers are price insensitive
price goes down if competition is high or customers are price sensitive - reduce costs
- promotion - advertisements, new products, deals - sales increase, NPM might decrease
what is opening balance
The opening balance is the amount of money a business starts with at the beginning of the reporting period , usually the first day of the month: opening balance = closing balance of the previous period.
