Introduction to Finance

Introduction to Finance

• Capital is the money invested in a business to purchase assets like machinery and stocks
• Revenue expenditure is for items used up quickly, such as fuel and materials
• Capital expenditure funds non-current assets (used >1 year) like premises and equipment
• A statement of financial position (balance sheet) records a business's possessions (assets) and debts (liabilities) at the end of accounting period
• A statement of profit or loss (profit and loss account) shows sales revenue and related costs over a period

Internal Sources of Finance

• Internal sources of finance exist within a business such as owner's savings.
• Personal funds involve an owner using savings, loans, or persuading family for investment
• Sale of assets raises cash by selling unneeded assets like land or buildings
• Sale and leaseback generates capital while maintaining asset use but commits to payments
• Retained profits from prior years are reinvested and avoid interest on loans or selling more shares

External Sources of Finance

• External sources are injections of funds from individuals, governments, or financial institutions
• A bank loan is an example
• External sources are more likely when large funds are needed or risk is low
• Share capital is raising from selling shares to shareholders, giving them company ownership
• Issuing shares can be expensive and is best for large capital sums
• Share capital is available to private and public companies

Loan Capital

• Loan Capital is money borrowed over the medium or long term
• Options include bank loans, mortgages, and debentures

Bank Loans

• A bank loan provides money for a specific purpose, repaid with interest
• Repayment periods can range from 2 to 20 years
• Banks prefer borrowers with a good financial history, and charge higher rates for risky loans
• Small businesses often pay 2% above the prime rate
• Fixed interest rates remain constant, variable rates change during the loan period
• Bank loans are inflexible due to repayment commitments
• Collateral such as property may be required as security that can be sold if payments default

Mortgages

• Mortgages are long-term (up to 50 years) loans to buy land or property, which secures the loan
• Fixed or variable interest rates are possible
• Remortgaging raises capital via increased or new mortgages, popular with small businesses

Debentures

• Debentures are long-term loans with fixed interest rates, secured using land/property
• Interest is paid during the loan's term, with the borrowed sum repaid at the end
• Some debentures are irredeemable, representing a permanent loan secured by non-current assets

Overdrafts

• An overdraft is short-term finance where banks let firms borrow up to a limit, offering flexibility
• Amounts can vary as long as they remain within the agreed limit
• Overdrafts come with interest which is between 4 and 6% above the bank's normal lending rate
• Overdrafts can be expensive long term and repayment can be demanded immediately

Trade Credit

• Trade credit is short-term finance, with 1-3 month periods
• Suppliers provide goods/services before customers pay, creating an interest-free loan for 30–90 days

Crowdfunding

• Crowdfunding entails collecting small amounts of money from many supporters
• Internet communication used to connect with potential supporters

Leasing

• Leasing involves payments for assets like vehicles, where the business rents rather than owns
• Leasing avoids large capital sums and enables using updated technology
• Regularly updating computer networks and equipment to improve business efficiency

Microfinance Providers

• Microfinance providers supply financial services to low-income clients
• Services include savings, money transfer and insurance.
• It supports money transfer from higher-income people to relatives abroad

Business Angels

• Business angels are wealthy individuals who support risky ventures, also called angel investors
• They often managed successful businesses and may specialize in sectors
• Business angels invest from $15,000 to $750,000 and often offer business advice

Venture Capital

• Venture capital includes business angels, important for risky small/medium businesses
• It mixes loan and share capital from financial institutions and wealthy individuals
• Venture capital firms seek control via share sales/non-executive roles
• They offer capital, experience, and advice, but rarely exceed $850,000 per deal

Profit and Loss Account

• A statement of profit or loss (aka profit and loss account) tracks revenue and expenditure over a period
• Possible to earn gross profit, profit before intrest and tax, profit before tax and profit for period
• Profit is revenue less costs; losses happen if costs exceed revenues

Gross Profit

• Gross profit is sales revenue minus expenses like materials.

Profit Before Interest and Tax

• Profit before interest and tax is revenue less expenses like rent.
• Providing a better view of performance

Profit Before Tax

• Profit before tax factors in interest and savings
• Calculated as Profit after intrest and tax, minus intrest

Profit for Period

• Profit for period factors in all income/costs, and taxes
• An excess of revenue over costs in non-profits is a surplus