Business Finance: Why businesses need finance

Study Notes

Why Businesses Need Finance

Businesses need finance for various reasons, including:
Start-up capital to purchase essential equipment or premises
Working capital for day-to-day operations, such as paying bills and building inventory
Growth and expansion, including buying new assets and paying for higher working capital needs
Research and development to create new products
External growth through acquiring other businesses
Paying off debts, including loans and other forms of debt
Marketing and promotion to attract customers and increase sales

Short-Term and Long-Term Finance

Short-term finance is needed for a short period (up to one year) to meet immediate financial needs
Long-term finance is needed for a longer period (more than one year) for investments like buying buildings or equipment

Profit and Cash

Profit is the value of goods sold (revenue) minus costs
Cash is the money that flows in or out of a business over a given time period
Cash flow is critical, as lack of finance is a common cause of business failure

Managing Working Capital

Managing working capital involves managing inventory, accounts payable, and accounts receivable
Key factors to consider include the cash conversion cycle and days inventory outstanding

Capital Expenditure and Revenue Expenditure

Capital expenditure is long-term spending on non-current assets (e.g., buildings, land, and equipment)
Revenue expenditure is short-term, day-to-day spending on assets other than non-current assets (e.g., wages, insurance)

Sources of Finance for Limited Companies

Internal sources: retained profits, reduction of working capital, sale of unwanted assets, and sale and leaseback of non-current assets
External sources: debt financing (e.g., share capital, debentures, bank loans, business mortgage, venture capital, and government grants) and equity financing (e.g., share capital, hire purchase, leasing, and medium-term loans)

Internal Sources of Finance

Retained earnings: profit left after all additions and deductions from sales revenue, kept for future use rather than being spent on dividends
Sale of unwanted assets: selling unnecessary assets to raise finance for more profitable ventures
Share capital/equity capital: a method of permanent finance for limited companies, issuing shares to purchase necessary assets

Description

This quiz covers the importance of finance for businesses, including start-up capital, working capital, growth or expansion, and research & development. Understand the different types of financial needs that businesses have to ensure growth and sustainability.