Cambridge International AS and A Level Business Coursebook with CD-ROM
Business studies notes on sources of finance. Summary like notes which facilitates understanding. contain notes on the different sources of finance and their advantages and disadvantages. Contains also the reasons why each source of finance is use and on which situation they are used. They are divi...
CHAPTER 28: BUSINESS FINANCE
Start-up Capital: The capital needed by an entrepreneur to set up a business
Working Capital: The capital needed to pay for raw materials, day-to-day running costs and credit
offered to customers.
Calculation: WORKING CAPITAL= CURRENT ASSETS – CURRENT LIABILITIES
WHY BUSINESS NEED FINANCE?
1. To start up a business; to buy equipment, premises
2. To finance the day-to-day activity of the business; paying bills, buying stock
3. For expansion; buy new assets, buy new firms (takeovers)
4. For special situation; a decline in sales recession or large number of consumers failing to pay on
time.
5. For research and development; invest in R&D of new product or invest in new market
strategies: for example; opening up overseas market.
CAPITAL AND REVENUE EXPENDITURE
Capital expenditure refers to the purchase of assets that are expected to last for more than one
year, such as building and machinery.
Revenue expenditure refers to spending on all costs and assets other than fixed assets and
including wages and salaries and materials bought for stock.
Liquidity: The ability of a firm to be able to pay its short term debts.
Liquidation: When a firm creases trading and its assets are sold for cash to pay suppliers and
other creditors.
SOURCES OF FINANCE
A. Internal source of finance: This represents finances that are made available within the business
itself.
1. Retained profits: It is profit that has been kept within the business in the past. This is profit made
after deduction of corporate tax, interest and dividends.
ADVANTAGES:
No interest has to be paid
Immediately available
Does not have to be repaid
, DISADVANTAGES:
Amount available maybe limited
Shareholders may be unhappy as they may see their dividend fall
2. Sales of assets:
Selling of assets which are not being used could help a firm to raise finance.
Sometimes the assets are still needed for use in business but due to lack of finance the firm can sell it to a
leasing company and lease back the assets from the leasing company. This is known as sale and lease
back.
ADVANTAGES:
Quick source of finance
Does not have to be repaid
No interest have to be paid
DIASADVANTAGES:
If asset is outdated, it may take time to find a buyer
Once asset is sold, it will be no longer owned by the company, NCA will decrease
Sometimes assets are sold at a much lower price than their NET BOOK VALUE (NBV).
3. Reduction in working capital:
Buying and selling of inventories or ask customers to repay back their debt quicker, a firm can make
its working capital fall. By reducing working capital, capital is released since non liquid assets are
being converted into liquid assets which could be used to finance other activities.
ADVANTAGES:
Business can get rid of all its inventory.
Force the business to use better debtor collection method to obtain cash from debtors quickly.
DISADVANTAGES:
Debtors maybe unhappy if asked to pay quickly
Discourage customers from purchasing the firm’s product due to short credit periods.
Amount obtained can be limited.
Internal sources of capital (Evaluation)
Has no direct cost to the business.
Does not increase liabilities or debt of the firm
No risk of loss of control by original owners
Not available to everyone, newly formed companies won’t have any retained profit.
May slow down business growth
The firm will have to pay leasing charged on the “sale or lease back”.
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