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Summary AS Section 5: Finance and Accounting
AS summary of Section 5: Finance and Accounting
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Unit 5: Finance and AccountingChapter 29: Business Finance
Why Businesses Need Finance:
1. Setting up the business.
2. Finance their working capital, day-to-day finance needed to for expenses (inventory, bills).
3. Business growth.
4. Taking over other businesses (buying out the owner of the firm).
5. Special situations: decline in sales possibly from economic recession.
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 & credit
offered to customers.
Working Capital= current assets – current liabilities
Short-Term Finance= money required for short periods of time up to one year.
- Helpful for businesses who experience seasonal demand.
Long-Term Finance= money required for more than one year.
Difference Between Cash & Profit:
- Cash is the money used to pay for day-to-day expenses & debts.
- Profit is the money earned after paying for the expenses & debts.
Profit= the value of goods sold (revenue) less costs.
Liquidity= the ability of a business to pay its short-term debts.
Administration= when administrators manage a business that is unable to pay its debts with the
intention of selling it as a going concern.
Bankruptcy= the legal procedure for liquidating a business (or property owned by a sole trader)
which cannot fully pay its debts out of its current assets.
Liquidation= when a business ceases trading & its assets are sold for cash to pay suppliers & other
creditors.
- Lack of finance is the most common cause of business failure. If it fails it is placed in
administration to keep the business operating. However, if this is unsuccessful, then
bankruptcy will follow. Which can lead to liquidation of the assets of the business.
Importance of Working Capital:
- Used for paying wages and inventory.
Current Assets= assets that either are cash or likely to be turned
into cash within 12 months (inventory & trade receivables or
debtors).
Current Liabilities= debts that usually have to be paid within one
year.
Managing Working Capital:
Inventory:
- Keeping smaller inventory levels.
- Using computer systems to record sales & inventory levels, to order inventory as required.
- Efficient inventory control, inventory use & inventory handling to reduce losses through
damage, wastage & shrinkage.
- Minimise working capital by producing only when orders have been received.
- Getting goods to customers as quickly as possible to speedup payments.
Trade Payables:
- Delaying payments to suppliers to increase credit period.
- Only buying goods from suppliers who will offer credit.
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, Trade Receivables:
- Only selling products for cash & not on credit.
- Reducing credit period offered to customers.
Capital Expenditure= the purchase of non-current assets that are expected to last for more than one
year, such as buildings & machinery.
Revenue Expenditure= spending on all costs & assets other than non-current assets, which includes
wages, salaries & inventory of materials.
Internal Sources= raising finance from the business’s own assets or from profit left in the business
(retained earnings).
- No type of direct cost to the business.
1. Retained Earnings= profit after tax retained in a company rather than paid out to shareholders
as dividends.
2. Sales of unwanted assets.
3. Sale & leaseback of non-current assets (pointless in long-term).
4. Working capital: reducing the level of inventory releases cash into the business.
External Sources= raising finance from sources outside the business, for example banks.
Short-Term:
Overdraft= a credit that a bank agrees can be borrowed by a business up to an agreed limit as &
when required.
- Most flexible. - High interest charge.
Debt Factoring= selling of claims over trade receivables (debtors) to a specialist organisation (debt
factor) in exchange for immediate liquidity. (specialist financial institution)
Trade credit: by delaying payment to suppliers for goods or services received.
- Some periods of credit are not free. - Discount for quick payments lost.
Long-Term:
Hire Purchase= a company purchases an asset & agrees to pay fixed payments over an agreed time
period. The asset belongs to the purchasing company on the final payment has been made.
Leasing= obtaining the use of an asset & paying a leasing charge over a fixed period, avoiding the
need to raise long-term capital to buy the asset. The asset is owned by the leasing company.
- High cost option but reduces inconvenience of repairs, maintenance & selling.
Debentures= long-term bonds issued by companies to raise debt finance, often with fixed rate of
interest.
Share (or Equity) Capital= permanent finance raised by companies through the sale of shares.
- Loss of control for owners.
- Never has to be repaid (permanent).
- Dividends don’t have to be paid every year.
- Lowers indebtedness, so debt finance becomes a lower proportion of total long-term finance.
Bank (Long-Term) Loans= loans that do not have to be rapid for at least one year.
- Can have variable or fixed rate of interest.
- No shares sold, so ownership remains unchanged.
- As repaid eventually, no permanent increase in the liabilities of the business.
- Interest chargers are expenses of business & are paid out before corporation tax is deducted.
- Increased level of indebtedness & gives shareholders chance of higher returns in the future.
Business Mortgage= long-term loans to companies purchasing a property for business premises, with
the property acting as collateral security on the loan.
Venture Capital= risk capital invested in business start-ups or expanding small businesses that have
good profit potential but do not find it easy to gain finance from other sources.
Government Grants= agencies that are prepared, under certain circumstances, to grant funds to the
businesses. Usually come with conditions (location and number of jobs to be created) if met, no repay
has to be done.
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