TOPIC 3ACCOUNTS &

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 capitalWORKING CAPITAL

Current assets – current liabilities

Expansion

Special situationsEG. 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?

• AssetsThe resources of the businessThe stuff you have to make a difference!Something that has a potential for future valueE.g. cash, supplies, inventory / stock

• LiabilitiesPromises to pay in future, or, responsibilities to othersDebtsE.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 $100Variable 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 cookiesNext 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 2012The 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

1. 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 • 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

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