Business Finance: Needs and Expenditure

The Need for Business Finance

• Finance is used to acquire assets and cover expenses.
• Crucial for revenue generation and business sustainability.
• Start-up capital is the finance needed for essential fixed assets and current assets to initiate business operations.
• Additional working capital covers capital expenditure or revenue expenditure.
• Research and development finances new products or marketing strategies.

Working Capital

• Covers day-to-day expenses like fuel, bills, and raw materials.
• It is the "bloodline" of a business.
• Failure to manage working capital can lead to business shutdown.
• Improve working capital by accelerating debtor payments and delaying creditor payments.
• Current assets are short-term assets held for less than a year.
• Current liabilities need to be settled within a year.

Revenue Expenditure and Capital Expenditure

• Revenue expenditure covers day-to-day expenses, providing short-term benefits like wages, fuel and rent.
• Capital expenditure concerns non-current assets with long-term benefits, such as buildings and vehicles.
• Revenue expenditure maintains the life of assets.

Significance of Distinguishing Between Expenditures

• They have different impacts on business, and are financed differently, and recorded differently in financial accounts.
• Revenue expenditure is short-term, regular: maintains assets
• Capital expenditure is long-term, irregular: produces assets.
• Capital expenditure utilizes debt/loan financing
• Revenue expenditure relies on working capital, trade credit, and credit cards.
• Revenue expenditure is recorded on the Income Statement
• Capital expenditure is recorded as depreciation on the Income Statement and as asset valuation on the Statement of Financial Position.
• Two financial accounts include both the income statement and balance sheet.

Sources of Finance

• Sources of finance are divided into short-term and long-term.
• Short-term sources like overdrafts and trade credit provide working capital for daily operations, repaid within a year.
• Long-term sources, used for fixed assets and acquisitions, are repaid over a year.

Internal Sources of Finance

• Internal sources originate within the business.
• Retained profits are reinvested after-tax earnings, recommended due to no borrowing costs.
• Selling idle assets generates funds without incurring debt.
• Sale and leaseback involves selling assets and leasing them back.
• Working capital can be managed through payment strategies.

External Sources of Finance

• External sources come individuals/institutions like banks or government.
• Overdrafts provide the right to overdraw, but with high interest rates.
• Trade credit involves purchasing goods from suppliers with deferred payment.
• Debt factoring is buying a firm's debts for immediate cash, where agencies offer a percentage of the debt.
• Hire purchase involves a down payment with installments for asset acquisition.
• Leasing is renting assets via monthly.
• Money for bank loans is borrowed with interest.
• Debentures raise funds, so debenture holders serve as creditors.
• Share capital involves raising capital by selling shares. Venture capital is long-term investment from venture capitalists.
• Mortgages are loans secured for land/buildings. New partners bring additional funding.
• Micro-finance provides financial services to those traditional banks ignore.
• Crowd funding raises money from a large number of individuals.
• Government grants are sums of money given to businesses for a specific purpose.

Factors Influencing Choice of Finance

• Consider cost, flexibility, control retention, intended use, and existing debt levels when choosing sources of finance.
• High existing debt advises against bank loans, favoring options like issuing shares.
• Gearing Ratio indicates financial risk, calculated as non-current liabilities divided by capital employed.

Cost Accounting

• Needed by every firm for informed decisions.

Reasons to Have Accurate Cost Data

• To calculate profits/losses to maximize performance.
• To make comparisons to gauge company performance and strategies.
• To decide which resources to use (labor vs. automation).
• To prepare budgets for the future with targets and performance analysis.
• To determine pricing strategies, e.g., cost-plus or contribution pricing.

Revenues, Costs, and Profits

• Revenue is income from selling goods/services.
• Formula: Revenue = Quantity sold x Average selling price.

Costs

• Expenses a business pays to trade.
• Fixed costs: constant regardless of production level (rent, insurance).
• Variable costs: vary directly with production (wages, raw materials).
• Semi-variable costs: have fixed and variable components (telephone bill).
• Total Cost = Fixed cost + Variable Cost
• Average Cost is the per-unit cost of production, calculated by Total Costs / Total Output.
• Marginal costs is the cost to produce one extra units.

Direct and Indirect Costs

• Direct costs relate directly to the production of a product
• Indirect costs cannot be allocated
• Formula: Average Cost of Production
• Cost is an estimate figures

Profit

• Profit is the excess of revenue over costs, also calculated as Total Revenue - Total Cost.

Break-Even Analysis

• Break-even output: level where total costs equal total revenue.
• Break-even point: the business has made neither profit nor loss.
• Break-even charts graphically represent costs and revenues vs. sales.

Methods to Improve Break-Even

• Reduce fixed costs by cutting rent or insurance.
• Increase selling price by improving brand image or quality.
• Reduce variable costs by finding cheaper suppliers.
• Break Even can only provide provide the quantative data and Qualitative data in order to build strategy by the marketing department.
• Depends on how reliable is the data.