Finance for Business Overview

Role of Finance for Business

• Businesses need capital for various reasons, including starting up, expanding, daily operations (fuel, labor), owner compensation, and taxes.
• Finance measures business performance through profits. Profit indicates if a business risks collapse due to insufficient funds for daily expenses.

Capital Expenditure and Revenue Expenditure

• Business expenditures are categorized into capital and revenue expenditure.
• Capital expenditure involves items used repeatedly over a year, mainly non-current assets (e.g., equipment). This is shown on the balance sheet.
• Revenue expenditure covers daily operational costs consumed within a short timeframe, shown on the profit and loss statement.

Internal Sources of Finance

• Personal Funds: Owners' savings used to finance the business.
• Sale of Assets: Selling unused assets to raise capital. This includes land, buildings, and equipment.
• Retained Profit: Reinvested profits not paid as dividends. A major source, particularly for smaller businesses.

External Sources of Finance

• Funds Needed for Activities: Daily operations, startups, expansions, etc.
• Personal Funds: The main source for sole traders seeking maximized control. Reflects personal commitment to the business.
• Retained Profit: Within the company, easier access than external loans.
• Sale of Assets: Selling assets not needed for business operations.
• Share Capital: Funds raised by selling shares in a limited company. Shareholders receive dividends if profitable, and have a right to the profits.
• Loan Capital: Money borrowed from financial institutions (e.g., banks). Interest is charged on the loan and installments are spread evenly until paid off.
• Overdraft: A business can withdraw more money than what is currently in their account, interest is typically charged on the amount overdrawn.
• Trade Credit: An agreement allowing businesses to pay at a later date.
• Crowdfunding: A large number of individuals contribute small amounts to fund a business venture.
• Leasing: Using an asset without purchasing it, typically with periodic payments. The lessee has the option to buy the asset at the end of the lease agreement.
• Microfinance Providers: Institutions offering banking services to low-income or unemployed individuals, including loans and other banking services. This includes microcredit, microinsurance, savings, and current accounts.
• Business Angles: Individuals who provide financial capital in return for equity in start-ups or small businesses with demonstrated growth potential.
• Venture Capital: Risk capital funding early-stage or expanding small businesses with high profit potential, but typically challenging to access traditional funding.

Short and Long Term Finance

• Match the type of finance to the asset being financed (short-term assets with short-term sources, etc.)
• Be mindful of investor preferences.
• Consider day-to-day operations and longer-term improvement needs.

Factors influencing Choice of Financing

• Purpose of the funds
• Cost
• Status and size
• Interest payments
• Flexibility
• Risk

Profit and Loss Account

• Shows a business's profit or loss, before interest and tax, from a specified time period.
• Involves subtracting expenses from sales revenue.

Balance Sheet

• Presents a company's assets, liabilities, and equity at a specific point in time.
• Assets = Liabilities + Equity

Cash Flow

• Tracks the movement of cash inflows and outflows over a period.
• Cash inflows: money coming into the company.
• Cash outflows: money leaving the company.
• Essential for measuring a company's ability to meet its obligations.

Liquidity Ratios

• Current Ratio: Compares current assets to current liabilities, assesses short-term financial health.
• Acid Test Ratio: A more stringent liquidity measure, excludes inventory from current assets to assess a company's ability to pay off immediate debts.

Efficiency Ratios

• Stock Turnover Ratio: Measures how quickly stock is sold and replaced.
• Debtor Days: Time taken to collect money owed to the business (accounts receivable).
• Creditor Days: Measures the time within which the business pays its suppliers (accounts payable).

Limitations of Ratio Analysis

• Single-ratio result is not sufficient, requires comparison with other businesses or previous periods.
• Financial statements are created as of a particular date (not a measure of ongoing performance),
• Results can be influenced by window-dressing manipulations (making the company look more profitable).

Insolvency and Bankruptcy

• Insolvency: when a business cannot meet its debt obligations on time.
• Bankruptcy: the legal process when a person or firm declares it cannot service its debts, and the firm's assets are liquidated to pay off creditors.

Cash Flow Forecasting

• Predictive financial document estimating future cash inflows and outflows, often on a monthly basis.
• Shows cash to meet obligations, enabling business planning.

The Value of Money

• Investors prefer receiving money sooner.
• Time value of money is impacted by: interest rates, time horizon.
• Considering time value of money in making financial decisions is vital.

Compound Interest

• Interest that is calculated not only on the initial principal, but also on the accumulated interest from previous periods. This causes the total growth to accelerate over time.

Discounting

• Process of reducing (discounting) future values to present values with consideration of time value of money.
• Essential for comparing investments of different time horizons.

Net Present Value (NPV)

• NPV = Sum of Present Values of Future Cash Flows − Initial Investment
• A financial method for evaluating projects, considering time-value of money, to determine whether the investment will be profitable.