Business finance refers to the money required by businesses for various purposes, including starting a business, expanding operations, purchasing assets, and funding day-to-day operations.
Key Financial Needs:
Start-up Capital: Funds needed to launch a business, including buying equipment, renting premises, and purchasing initial inventory.
Working Capital: Money required for day-to-day operations, such as paying wages, purchasing inventory, and covering overheads.
Expansion Capital: Finance needed for growing the business, such as opening new branches, increasing production capacity, or entering new markets.
29.2 Internal vs. External Sources of Finance
Internal Sources:
Retained Profits: Profits that are kept within the business rather than distributed to shareholders. This is a key source of finance for expansion and reinvestment.
Advantages: No interest or repayment required.
Disadvantages: Limited to the amount of profit the business generates.
Sale of Assets: Selling off non-essential assets to raise finance.
Advantages: Provides immediate cash.
Disadvantages: Selling valuable assets may hinder long-term operations.
Working Capital Management: Efficiently managing working capital, such as reducing stock levels or extending payment terms with suppliers.
External Sources:
Bank Loans: A lump sum of money provided by a bank that is repaid over time with interest.
Advantages: Allows businesses to access large amounts of capital.
Disadvantages: Interest rates can be high, and repayment terms can be strict.
Overdrafts: A facility that allows businesses to withdraw more money from their account than they have.
Advantages: Flexible and quick to arrange.
Disadvantages: High interest rates can make overdrafts expensive.
Trade Credit: Suppliers allow the business to pay for goods at a later date (e.g., 30, 60, or 90 days after purchase).
Advantages: Improves cash flow by delaying payment.
Disadvantages: Missed payments can damage relationships with suppliers.
Debt Factoring: A business sells its outstanding invoices to a factoring company at a discount for immediate cash.
Advantages: Immediate cash inflow.
Disadvantages: The business does not receive the full value of the invoices.
Issuing Shares (for public companies): Selling shares in the business to raise capital.
Advantages: No interest payments.
Disadvantages: Dilutes ownership and control of the company.
29.3 Long-Term vs. Short-Term Finance
Short-term finance is used to cover immediate expenses and lasts for a period of less than one year (e.g., overdrafts, trade credit). Long-term finance is used for larger investments such as property or machinery and is repaid over several years (e.g., mortgages, long-term loans).
Choosing the Right Source:
Businesses need to consider the following factors when choosing a source of finance:
Cost: The interest rate or fees associated with the finance.
Flexibility: The ease of adjusting repayment terms.
Risk: Some forms of finance, such as loans, require repayment regardless of business performance.
Ownership Control: Issuing shares may reduce control over the business.
29.4 Equity vs. Debt Financing
Equity financing involves raising money by selling shares in the company. In contrast, debt financing involves borrowing money through loans or bonds.
Equity Financing:
Advantages: No interest or repayment required, less risk for cash flow.
Disadvantages: Shareholders have a claim on profits (dividends) and can influence business decisions.
Debt Financing:
Advantages: Retain full ownership, and interest payments are tax-deductible.
Disadvantages: Interest payments can strain cash flow, and debt increases financial risk.
Chapter 30 : Forcasting and Managing cash flows
30.1 The Importance of Cash Flow Forecasting
A cash flow forecast is a financial tool that predicts the future inflows and outflows of cash over a specific period. It helps businesses ensure they have enough cash to meet obligations and avoid liquidity problems.
Purposes of Cash Flow Forecasting:
Managing Liquidity: Ensures the business has enough cash to pay suppliers, employees, and other expenses.
Planning for Shortfalls: Identifies periods of negative cash flow, allowing the business to take corrective action, such as arranging an overdraft.
Supporting Financial Decisions: Cash flow forecasts help managers make informed decisions about financing, investments, and growth.
30.2 Components of a Cash Flow Forecast
Opening Balance: The amount of cash available at the start of the period.
Cash Inflows: Money coming into the business, including sales revenue, loans, and investments.
Cash Outflows: Payments made by the business, including wages, rent, utilities, and supplier payments.
Net Cash Flow: The difference between total cash inflows and outflows.
Net Cash Flow formula:
Net Cash Flow= Total Inflows−Total Outflows
Closing Balance: The cash available at the end of the period, calculated as:
Closing Balance=Opening Balance+Net Cash Flow
Cash Flow Forecast Example:
Month Opening BalanceCash InflowsCash Outflows Net Cash FlowClosing Balance
January $10,000 $15,000 $12,000 $3,000 $13,000
February $13,000 $18,000 $14,000 $4,000 $17,000
30.3 Cash Flow Problems and Solutions
Common Causes of Cash Flow Problems:
Overtrading: Rapid expansion without sufficient working capital.
Late Payments: Customers delay payments, reducing cash inflows.
High Inventory Levels: Too much cash is tied up in unsold stock.
Unexpected Expenses: Unplanned costs such as repairs or legal fees.
Solutions:
Improving Cash Inflows: Offering discounts for early payments or factoring receivables.
Reducing Cash Outflows: Negotiating longer payment terms with suppliers or cutting unnecessary expenses.
Arranging Short-term Finance: Securing an overdraft or short-term loan to cover temporary shortfalls.
Chapter 31 : Costs
31.1 Types of Costs
Understanding different types of costs is essential for pricing, budgeting, and financial decision-making. Businesses need to know their fixed costs, variable costs, and total costs to manage profitability.
Fixed Costs:
Costs that remain constant regardless of the level of production or sales (e.g., rent, salaries of permanent staff). These costs do not change with output.
Variable Costs:
Costs that vary directly with the level of production (e.g., raw materials, wages of temporary workers). These costs increase as output increases.
Semi-Variable Costs:
These have both fixed and variable components (e.g., telephone bills, where there is a fixed rental charge and additional charges based on usage).
Direct and Indirect Costs:
Direct Costs: Costs that can be directly attributed to a specific product or service (e.g., raw materials for manufacturing).
Indirect Costs (Overheads): Costs that cannot be directly linked to a specific product (e.g., utilities, administrative expenses).
Total Costs:
The sum of all fixed and variable costs.
Total Cost (TC) formula:
Total Cost (TC)=Fixed Costs (FC)+Variable Costs (VC)
Break-even analysis helps a business determine the level of sales needed to cover all costs. The break-even point is where total revenue equals total costs, resulting in no profit or loss.
Break-even Point (BEP) formula:
BEP (units)=Fixed Costs / (Selling Price per unit−Variable Cost per unit)
Break-Even Example:
Fixed costs = $5,000
Selling price per unit = $50
Variable cost per unit = $30
BEP= 5,000/(50−30) = 250 units
Thus, the business must sell 250 units to break even.
31.3 Contribution per Unit
Contribution per unit is the amount that each unit sold contributes toward covering fixed costs and generating profit.
Contribution per unit formula:
Contribution per unit = Selling Price−Variable Cost per unit
Chapter 32 : Budgets
32.1 Importance of Budgets
A budget is a financial plan that estimates revenue and expenses over a specific period. Budgets help businesses plan for the future, control costs, and make informed decisions.
Key Purposes of Budgets:
Planning: Budgets help businesses allocate resources and set targets for the future.
Control: Monitoring actual performance against the budget allows businesses to identify areas where they are overspending or underspending.
Decision Making: Budgets provide information to support decisions, such as whether to invest in new projects or reduce costs.
32.2 Types of Budgets
Sales Budget: Forecasts the expected sales revenue based on market conditions, pricing strategies, and promotions.
Expenditure Budget: Estimates the expected costs for various business operations, including production, marketing, and administration.
Cash Budget: A forecast of cash inflows and outflows, ensuring the business has enough cash to meet its obligations.
Capital Budget: A plan for significant investments in assets such as equipment or property.
32.3 Variance Analysis
Variance analysis involves comparing the budgeted figures to the actual performance to assess how well the business is sticking to its financial plans.
Favorable Variance: When actual revenue is higher than budgeted, or actual costs are lower than budgeted.
Adverse Variance: When actual revenue is lower than budgeted, or actual costs are higher than budgeted.
Variance Analysis Example:
Budgeted RevenueActual Revenue VarianceType of Variance
$100,000 $110,000 +$10,000 Favorable
32.4 Zero-Based Budgeting
Zero-based budgeting requires managers to justify all expenses from scratch, rather than using the previous year’s budget as a starting point. This method ensures that all spending is necessary but can be time-consuming.