GCE PROFESSIONAL BUSINESS SERVICES AS 3 FINANCE MANAGEMENT

FINANCE MANAGEMENT – Internal Sources of Finance Internal Sources of Finance (Companies): Profit After Tax (Retained earnings c/fwd): profit earned for the accounting period; or The Profit/Loss Reserve is the accumulation of profits/losses from previous accounting periods Advantages: Represents a cheaper source of finance Enables control to be retained within the company Disadvantages: Unpredictable – changes from one period to another, therefore not possible to predict accurately

FINANCE MANAGEMENT – Internal Sources of Finance Net Profit (Sole Traders): profit earned after the deduction of expenses Advantage: represents a cheaper source of funds for use in the future Disadvantages: reducible by the amount of drawings Unpredictable – it can change in amount in each trading period and is therefore not possible to accurately predict

FINANCE MANAGEMENT Owner’s Capital: Advantage: Disadvantage: money invested in the business by a sole trader. It can be increased by the introduction of additional funds or net profits or decreased with the impact of a net loss or drawings Advantage: Enables control to be retained within the business Disadvantage: Any funds introduced are subject to unlimited liability in the event of bankruptcy

Finance Management Disposal of Non-current Assets: Advantage: an asset is an item of value held by a business which is likely to generate future income. Advantage: this can generate additional income/revenues for a business Disadvantages: Business may suffer from the loss of an asset The non-current asset may have depreciated substantially, thus less income may be received than anticipated

FINANCE MANAGEMENT – External Sources of Finance Issue of Ordinary shares: A share is a ‘unit’ or ‘part’ of the total capital of a company. represents the amount of money invested in the company by its shareholders. Advantage: Investor holds voting rights at an AGM Investor is entitled to a variable rate of dividend Disadvantages: High risk investment with no dividend guaranteed Company can still be the subject of a ‘hostile’ takeover

FINANCE MANAGEMENT – External Sources of Finance Issue of Preference shares: represents the amount of money invested in the company by preference shareholders. Advantage: Can represent a cheaper source of finance for management since dividends are fixed Disadvantage: Investor does not have voting rights Investor only receives a fixed rate of dividend Dividends do not qualify for tax relief compared to interest payments on a loan

FINANCE MANAGEMENT – External Sources of Finance Debt: Loan Capital: a loan is an amount of money borrowed from a lender, which is usually repaid over a fixed time period and at a fixed rate of interest. A lender may be a financial institution or financial services provider such as a bank, debenture-holder, leasing company, another business or another individual/friends/family

FINANCE MANAGEMENT – External Sources of Finance Loan Capital: Advantages: Enables a business to buy an asset up-front with cash Enables a business to successfully manage cash flows Usually carries a fixed rate of interest, so cost is known in advance Disadvantages: Reduces profit – interest rates can be high, an additional expense, thus reduces profit Reduces cash flow – reduces cash flow in long term as payments are made over the loan period

FINANCE MANAGEMENT – External Sources of Finance Leasing: an agreement between to two parties to provide a business with an asset which is required for use in a business for a fixed period of time, in return for a fixed amount of money repaid over a fixed time period Advantages: the lessee (customer) does not own the asset and returns the asset to the owner (lessor) at the end of the contract period. Business not responsible for repairs or updates/upgrades to asset Disadvantages: The business (lessee) will never own the asset, which might be critical in some businesses Lease agreement must be paid regularly and may be a burden on cash flows in the long term

FINANCE MANAGEMENT Hire Purchase: an agreement between to two parties to provide a business with an asset which is required for use in a business for a fixed period of time, in return for a fixed amount of money repaid over a fixed time period, e.g. 5 years. Advantages: The business has the use of the asset immediately at the end of the contract period, ownership of the asset transfers to the customer only when the final payment is made Disadvantages: the hire purchase company owns the asset at all times until the final payment has been made by the customer Regular payments must be maintained, which may represent a financial burden on cash flow position over the long term

FINANCE MANAGEMENT – External Sources of Finance Trade payables: Money that is owed by a business to a supplier who provided goods/services on credit. Advantage: Represents a short term, cheaper source of finance, since the supplier usually provides a period of credit at 0% interest until invoice is paid in the following month Disadvantage: Suppliers may refuse to supply further goods if invoices are not paid on time Suppliers may levy additional charges if balances are not settled within the credit period allowed

FINANCE MANAGEMENT Trade receivables: Advantage: Disadvantages: Money that is owed by customers to the business (i.e. goods sold on credit or provided in advance of the business receiving money for such goods/services) Advantage: Could encourage growth in the business, since revenue receipts are merely ‘postponed’ to a later date Disadvantages: Represents an expensive cost to the business, as customers have received the goods which are not paid for Credit control costs incurred in recovering outstanding debts

FINANCE MANAGEMENT Decisions need to be taken regarding: Cost of finance: Internal sources of finance tend to be cheaper A dividend does not have to be paid, therefore costs are saved A profit can be retained and re-invested External sources of finance tend to be more expensive Set up/administration costs (legal fees, loan agreements) Interest rates may be higher than a dividend payable

FINANCE MANAGEMENT Decisions need to be taken regarding : Timing of the finance requirement: Adviser must decide on the project lifespan in order to determine how long the finance is required for Adviser must decide at which time point(s) the finance is required to fund the project/investment – e.g. at start of a project or part-way through the project Adviser must identify number of time points and their frequency, which the providers of capital can expect to receive returns and/or a repayment of capital/funds provided for the project

FINANCE MANAGEMENT Decisions need to be taken regarding: Flexibility of availability of finance: Adviser must identify what type of finance is required Short term projects are likely to be financed internally with quick repayment This must be matched with short term finance – e.g. profits/retained earnings/bank overdraft Long term projects are likely to be financed externally with longer repayment periods This must be matched with long term finance – e.g. loans/leasing agreements

FINANCE MANAGEMENT Decisions need to be taken regarding: Status of the business Adviser must decide on status of the business The credit status of the business must be satisfactory before a lender may agree to advance funds – this can be checked using a credit referencing agency Lending criteria may require that certain conditions are in place prior to granting an advance – e.g. a business cannot borrow more money once an original advance has been granted Adviser must check on the cash flow position – a business must be able to afford the expected future repayments

FINANCE MANAGEMENT Decisions need to be taken regarding: Size of the business Smaller, sole trader type businesses may find it difficult to raise finance Lenders need to be convinced of business growth in order to advance funds and may require business plans/accounts Larger, blue-chip businesses may find it easier to raise finance Lenders may request a business adviser or a representative be appointed to the board of directors in order to supervise use of funds advanced

FINANCE MANAGEMENT Decisions need to be taken regarding: Financial situation of the business Adviser must be familiar with: Current financial position of the business in terms of profitability, solvency and gearing Cash flow position and cash flow forecast Likely prospects facing the business, e.g. increased orders, loss of market share Capacity of the business to meet future repayments on funds advanced