5.

1 – Business Finance: Needs and Sources

Finance is the money required in the share of profit and they may
business. Start-up capital is the initial resist the decision.
capital used in the business to buy fixed
 Sale of existing assets: assets
and current assets before it can start
that the business doesn’t need
trading.
anymore, for example, unused
Working Capital finance needed by a buildings or spare equipment can
business to pay its day-to-day running be sold to raise finance
expenses Advantages:
– Makes better use of capital tied
Capital expenditure is the money up in the business
spent on fixed assets (assets that will – Does not become debt for the
last for more than a year). Eg, business, unlike a loan.
machinery. Disadvantages:
Revenue Expenditure, similar to – Surplus assets will not be
working capital, is the money spent on available with new businesses
day-to-day expenses which does not – Takes time to sell the asset and
involve the purchase of long-term the expected amount may not be
assets. Eg: wages, rent. These are gained for the asset
short-term capital needs.  Sale of inventories: sell of
Sources of Finance finished goods or unwanted
components in inventory.
Internal finance is obtained from Advantage:
within the business itself. – Reduces costs of inventory
holding
Sources of Finance
Disadvantage:
Internal finance is obtained from – If not enough inventory is kept,
within the business itself. unexpected increase demand
form customers cannot be
 Retained Profit: profit kept in
fulfilled
the business after owners have
been given their share of the  Owner’s savings: For a sole
profit. Firms can invest this profit trader and partnership, since
back in the businesses. they’re unincorporated (owners
Advantages: and business is not separate),
– Does not have to be repaid, any finance the owner directly
unlike, a loan. invests from hos own saving will
– No interest has to be paid be internal finance.
Disadvantages: Advantages:
– A new business will not have – Will be available to the firm
retained profit quickly
– Profits may be too low to – No interest has to be paid.
finance Disadvantages:
– Keeping more profits to be used – Increases the risk taken by the
as capital will reduce owner’s owners.
Advertisements components in inventory.
Advantage:
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– Reduces costs of inventory
holding
Disadvantage:
Sources of Finance – If not enough inventory is kept,
Internal finance is obtained from unexpected increase demand
within the business itself. form customers cannot be
fulfilled
 Retained Profit: profit kept in
the business after owners have  Owner’s savings: For a sole
been given their share of the trader and partnership, since
profit. Firms can invest this profit they’re unincorporated (owners
back in the businesses. and business is not separate),
Advantages: any finance the owner directly
– Does not have to be repaid, invests from hos own saving will
unlike, a loan. be internal finance.
– No interest has to be paid Advantages:
Disadvantages: – Will be available to the firm
– A new business will not have quickly
retained profit – No interest has to be paid.
– Profits may be too low to Disadvantages:
finance – Increases the risk taken by the
– Keeping more profits to be used owners.
as capital will reduce owner’s Advertisements
share of profit and they may
resist the decision. Report this ad

 Sale of existing assets: assets

that the business doesn’t need
Sources of Finance
anymore, for example, unused
buildings or spare equipment can Internal finance is obtained from
be sold to raise finance within the business itself.
Advantages:
 Retained Profit: profit kept in
– Makes better use of capital tied
the business after owners have
up in the business
been given their share of the
– Does not become debt for the
profit.
business, unlike a loan.
Advantages:
Disadvantages:
– Does not have to be repaid,
– Surplus assets will not be
unlike, a loan.
available with new businesses
– No interest has to be paid
– Takes time to sell the asset and
Disadvantages:
the expected amount may not be
– A new business will not have
gained for the asset
retained profit
 Sale of inventories: sell of – Profits may be too low to
finished goods or unwanted finance.
  Sale of existing assets: assets 
that the business doesn’t need
o A permanent source of
anymore, for example, unused
buildings or spare equipment can capital, no need to repay
be sold to raise finance the money to shareholders
Advantages: no interest has to be paid
– Makes better use of capital tied Disadvantages:
up in the business
– Does not become debt for the 
business, unlike a loan. o Dividends have to be paid
Disadvantages: to the shareholders
– Surplus assets will not be
available with new businesses o If many shares are bought,
– Takes time to sell the asset and the ownership of the
the expected amount may not be business will change
gained for the asset hands. (The ownership is
decided by who has the
 Sale of inventories: sell of
highest percentage of
finished goods or unwanted
shares in the company)
components in inventory.
Advantage:  Bank loans: money borrowed
– Reduces costs of inventory from banks
holding
Advantages:
Disadvantage:
– If not enough inventory is kept, 
unexpected increase demand
form customers cannot be o Can be for varying lengths
fulfilled of time

 Owner’s savings: o Large companies can get

very low rates of interest
 Advantages: on their loans
– Will be available to the firm
quickly Disadvantages:
– No interest has to be paid. 
Disadvantages:
– Increases the risk taken by the o Need to pay interest on
owners. the loan periodically
o It has to be repaid after a
specified length of time
.
External finance is obtained from
sources outside of the business.  Debenture issues: debentures
are long-term loan certificates
 Issue of share: only for limited
issued by companies. Like
companies.
shares, debentures will be issued,
Advantage:
 people will buy them and the 
business can raise money
o There are usually certain
 Advantages conditions to fulfil to get a
grant. Example, to locate
o Can be used to raise very
in a particular under-
long-term finance,
developed area.
Disadvantage:
 Micro-finance: special institutes
 are set up in poorly-developed
countries where financially-
o Interest has to be paid and lacking people looking to start or
it has to be repaid expand small businesses can get
 Debt factoring: a debtor is a small sums of money. They
person who owes the business provide all sorts of financial
money for the goods they have services
bought from the business.  Crowdfunding: raises capital by
 Advantages: asking small funds from a large
pool of people, e.g. via
Kickstarter. These funds are
voluntary ‘donations’ and don’t
o Immediate cash is
have to be return or paid a
available to the business
dividend.
o Business doesn’t have to
handle the debt collecting
Short-term finance provides the
Disadvantage:
working capital a business needs for its
 day-to-day operations.

o The debt factor will get a  Overdrafts: similar to loans, the

percent of the debts bank can arrange overdrafts by
collected as reward. Thus, allowing businesses to spend
the business doesn’t get more than what is in their bank
all of their debts account.

 Grants and subsidies:  Advantages:

government agencies and other
external sources can give the
business a grant or subsidy  Interest has to be
paid only on the
Advantage:
amount overdrawn
  Overdrafts are
generally cheaper
o Do not have to be repaid, than loans in the
is free long-term
Disadvantage: Disadvantages:
 o The firms doesn’t need a
large sum of cash to
o Interest rates can vary
acquire the asset
periodically, unlike loans
which have a fixed interest Disadvantage:
rate.

o The bank can ask for the
o A cash deposit has to be
overdraft to be repaid at a
paid in the beginning
short-notice.
o Can carry large interest
 Trade Credits: this is when a
business delays paying suppliers charges.
for some time, improving their  Leasing: this allows a business
cash position to use an asset without
Advantage: purchasing it. Monthly leasing
payments are instead made to
o No interests, repayments the owner of the asset.
involved
 Advantages:
Disadvantage:

o The firm doesn’t need a
o If the payments are not large sum of money to use
made quickly, suppliers the asset
may refuse to give
o The care and maintenance
discounts in the future or
refuse to supply at all of the asset is done by the
leasing company
 Debt Factoring: (see above)
Disadvantage:

Long-term finance is the finance that o The total costs of leasing

is available for more than a year. the asset could finally end
up being more than the
 Loans: from banks or private cost of purchasing the
individuals. asset!
 Debentures
 Issue of Shares Factors that affect choice of source
of finance
 Hire Purchase: allows the
business to buy a fixed asset and  Time-period: for long-term uses
pay for it in monthly instalments of finance, loans, debenture and
that include interest charges. share issues are used, but for a
short period, overdrafts are more
 Advantage:
suitable.
  Amount needed: for large Cash outflows are the sums of money
amounts, loans and share issues paid out by the business over a period
can be used. For smaller of time. Eg:
amounts, overdrafts, sale of
 purchasing goods and materials
assets, debt factoring will be
for cash
used.
 paying wages, salaries and other
expenses in cash
Finance from banks and
.
shareholders
The cash flow cycle:
Chances of a bank willing to lend a
business finance is higher when:
 A cash flow forecast is presented
detailing why finance is needed
and how it will be used
 Details of existing loans and
sources of finance being used

Chances of a shareholder willing to

invest in a business is higher when:
 dividends and profits are high
 the company has a good Advertisements
reputations and future growth
plans Cash Flow Forecasts
A cash flow forecast is an estimate of
future cash inflows and outflows of a
5.2 – Cash Flow Forecasting and business, usually on a month-by-month
Working Capital basis.
. Uses of cash flow forecasts:
Cash Flow  when setting up the business
the manager needs to know how
The cash flow of a businesses is its
much cash is required to set up
cash inflows and cash outflows over a
the business.
period of time.
 A statement of cash flow forecast
Cash inflows are the sums of money
is required by bank managers
received by the business over a period
when the business applies for
of time. E.g.:
a loan. The bank manager will
 sales revenue from sale of need to know how much to lend
products to the business for its operations.
How can cash flow problems be An income statement is a financial
overcome? document of the business that records
all income and cost of the business .
When a negative cash flow is forecast
(lack of cash) the following methods
can be used to correct it: Uses of Income Statement
 Increase bank loans: Income statements are used by
managers to:
 Delay payment to suppliers:
 know the profit/loss made by
 Ask debtors to pay more
the business
quickly: Working Capital
 compare their performance
Working capital the capital required by
with that of previous years’ and
the business to pay its short-term day-
with that of competitors’
to-day expenses.
5.4 – Statement of
Financial Position
.4 – Statement of Financial Position
The balance sheet, along with the
5.3 – Income Statements income statement is prepared at the
Accounts are the financial records of a end of the financial year. It shows the
firm’s transactions.. value of a business’ assets and
liabilities at a particular time.
Profit
Assets are those items of value owned
Profit = Sales Revenue – Total cost by the business..
When the total costs exceed the sales  Short-term/current assets
revenue, then a loss is made. (inventory, trade receivables
How to increase profit? (debts from customers), cash etc)
are owned only for a very short
 Increase sales revenue time.
 Cut costs  There can also intangible
(cannot be touched or felt) non-
Why is profit important to a
current assets like copyrights
business?
and patents that add value to the
 It is a reward for enterprise: business.
entrepreneurs start businesses to
Liabilities are the debts owed by the
make a profit
business to its creditors.
 It is a source of finance: after
 Long-term/non-current
payments to owners, profits are
liabilities (loans, debentures
reinvested back into the business
etc.)- they do not have to be
for further expansion (this is called
repaid within a year.
retained earnings)
  Short-term/current liabilities
(trade payables (to suppliers),
overdraft etc.)- these need to be
repaid within a year.
o Gross Profit Margin:
CURRENT ASSETS – CURRENT
o
LIABILITIES = WORKING CAPITAL
This is because the liquid cash a
company has with them will be the
liquid (short-term) assets they own less
the short-term debts they have to pay. o Net profit Margin:

Shareholder’s Equity is the total

amount of money invested in the
company by shareholders.  Liquidity Ratios: liquidity is the
ability of the company to pay
back its short-term debts.
o Current Ratio:

o Liquid Ratio/ Acid Test

Ratio

Uses and users of accounts

 Managers: they will use the
accounts to help them keep
5.5 – Analysis of Accounts control over the performance of
5.5 – Analysis of Accounts. each product or each division.

Ratio Analysis o .

 Profitability Ratios: profitability o Ratios can be compared

is the ability of a company to with other firms in the
use its resources to generate industry/competitors and
revenues in excess of its also with previous years to
expenses. see how they’re doing.

o Return on Capital  Shareholders: since they are

Employed (ROCE): the owners of a limited company,
it is a legal requirement that they
be presented with the financial
accounts of the company.
 A higher profitability, the higher business. They will only lend to
the chance of getting dividends. profitable and liquid firms.
They will also compare the
Limitations of using accounts and
ratios with other companies
ratio analysis
and with previous years to
take the most profitable decision.  Ratios are based on past
accounting data and will not
 Creditors: The balance sheet
indicate how the business will
and liquidity ratios will tell
perform in the future
creditors (suppliers) the cash
position and debts of the  Different companies may use
business.. different accounting methods
and so will have different ratio
 Banks: Similar to how suppliers
results, making comparisons
use accounts, they will look at
between companies unreliable
how risky it is to lend to the