Topic 3 Accounts & Finance Sources Of Finance

Learning Objectives To understand internal and external finance To be able to analyse the different sources of long-, medium-, and short-term finance To understand the role played by the main financial institutions To evaluate the advantages and disadvantages for each form of finance for a given situation

Finance is required for many business activities Start up capital Working capital Expansion Current assets – current liabilities Finance is required for many business activities Special situations EG. Recession R&D, Marketing

The Accounting Equation ASSETS = LIABILITIES + OWNER EQUITY BANK LOANS A PROMISE TO PAY ALSO HAVE TO PAY INTEREST SHARES IN EXCHANGE FOR INVESTING IN A COMPANY THEY RECEIVE OWNERSHIP AND PROFIT

What are assets and liabilities? The resources of the business The stuff you have to make a difference! Something that has a potential for future value E.g. cash, supplies, inventory / stock Liabilities Promises to pay in future, or, responsibilities to others Debts E.g. a bank loan

What is sales revenue vs. profit? You own a business selling cookies. You are in competition with other cake companies. Your objective is to make a big profit. Every week you have to make 2 decisions: How many packets of cookies to make What price to sell each packet of cookies Every week you must pay fixed costs of $100 to pay for the kitchen where you make the cookies. Also, every packet of cookies has variable costs of $20.

What is sales revenue vs. profit? So if you make 3 packets of cookies your costs are: Fixed costs $100 Variable costs $60 Total costs $160 Your customer will order the packets of cookies as follows: Cheapest price – 8 packets of cookies Next cheapest price – 6 packets of cookies Next cheapest price - 4 packets of cookies Highest price - 2 packets of cookies

Break-even quantity To find out whether it is worthwhile to make a product To estimate the level of profit for a product Break-even quantity = total fixed costs contribution per unit …where contribution = price per unit – variable cost per unit

Capital & Revenue Expenditure Capital expenditure is the purchase of assets that are expected to last for more than one year. Machinery etc. Revenue expenditure is spending on all costs and assets other than fixed assets. Wages, electricity etc. Fixed Assets are items of a monetary value which have a long term function such as land

Olympic Games 2012 The UK construction industry has been very optimistic since London was announced as the host of the 2012 Olympic Games. News media reported an estimated half a million new recruits to the industry in preparation for the global sporting event Use examples to distinguish revenue expenditure from capital expenditure [4 marks]

Sources of finance Internal – From within the business External – Outside the business

Internal Finance Personal Funds Main source of finance for sole traders and partnerships Family & Friends Borrowing money from family and friends is another popular source of finance for sole traders and partnerships Very limited and could lead to fall outs

Internal Finance Working Capital Retained Profits Money that is available for the day to day running of a business Comes from the sale of goods and services Vital source of finance as it is used to pay wages, bills etc Retained Profits Value of profit that business holds of to use within the business Also known as internal profits / ploughed-back profits Often used for purchasing or upgrading fixed assets Also may be saved in a contingency fund If retained profits are used the business does not need to rely on much borrowing Retained profits alone may not be enough and also decreases the dividends

Internal Finance Selling Assets Businesses can sell their dormant assets (unused assets) They could sell fixed assets to survive Investing Extra Cash Putting money into bonds which earns interest

External Finance Share Capital Share capital - a limited company can raise money by selling shares.  Anyone who buys shares becomes a part owner of that company. In return for buying shares, shareholders receive a dividend (i.e. share of the profits) for each share they possess Ordinary Shares (Equities): Ordinary shareholders have voting rights Dividend can vary Last to be paid back in event of collapse Share price varies with trade on stock exchange Preference Shares: Paid before ordinary shareholders Fixed rate of return Cumulative preference shareholders – have right to dividend carried over to next year in event of non-payment

External Finance Loan capital - providers of loan capital are known as creditors. These creditors charge interest on any money borrowed and money owing must be paid out of profits before any dividends are paid to shareholders

External Finance Overdrafts- these occur when a bank allows an account holder to overspend on their current account. They are flexible and are widely used to aid short term cash flow problems

External Finance Trade credit - another common source of finance where suppliers supply goods and then allow a period of time before collecting payment Government assistance - this is selective as it normally only applies in areas where the government is trying to encourage businesses to locate (e.g. areas of high unemployment) Assistance normally takes the form of a government grant (or gift) although other inducements can also be offered Subsidies

External Finance Leasing - this eliminates the need for large amounts of capital by allowing the business to lease (rent) an asset rather than purchase it Hire purchase - this involves regular payments for an asset which becomes the purchasers' property once the final payment has been made. Interest payments are high but little security is required

External Finance Debt factoring – When a company sells goods on credit it creates a debtor. The longer the time allowed to pay this debt, the more finance the business has to find to carry on trading. Debt factoring companies buy these claims at a discount and make profit when they collect the money from the original customer Sometimes called - Non recourse factoring

External Finance Venture Capital Business Angels Pooling of capital in the form of limited companies – Venture Capital Companies Looking for investment opportunities in fast growing businesses or businesses with highly rated prospects May also buy out firms in administration who are going concerns May also provide advice, contacts and experience Business Angels Individuals looking for investment opportunities Generally small sums up to £100,000 Could be an individual or a small group Generally have some say in the running of the company

External Finance Debentures or Long Term Bonds Putting money away for a long period of time (25 years) and in return interest is paid, businesses can sell these debentures to other companies / individuals