Please enable JavaScript.
Coggle requires JavaScript to display documents.
Chapter 15 - Business finance - Coggle Diagram
Chapter 15 - Business finance
Need for business finance
Reasons why businesses need finance to start up, to grow and to survive
Business start up
When a business is set up, the owners need finance to buy premises, equipment and raw materials
Service businesses will also need initial finance
BUsinesses usually experience other expenses like wages before income is received
Business growth or expansion
Established business frequently make the decision to expand, involving acquiring additional premises or equipment
In some cases, finance might be required in order to buy another existing business
This differs from start-up capital because this finance is only needed after business is operational
Distinction between short and long term need for finance
Finance might be needed for a long-term project, and for this long term sources of finance are likely to be used
Businesses might need finance for new product development, exploration and development of new markets, increased levels of promotion
Need for finance might also be short term, such as waiting for payment from clients
Could be purchasing materials, paying wages or utility bills, pay for promotional activities
Amount of money required, regardless of length of time for, also influences the source of finance that would be used
Difference between short term and long term sources of finance
Short term finance is defined as being repayable within 12 months
Long term finance is repayable over a long time like 10-20 years
Difference between cash and profit
Cash is the money that flows in and out of the business on a daily basis
Cash in is coming in from sales
Cash out pays for inventory and other costs
Net cash flow = cash in - cash out
Profit is the surplus that remains after all costs have been paid for
Profit = total sales revenue - total costs
A business pay be profitable, but fail due to running out of cash to pay day to day expenses
Business failure: Bankruptcy, liquidation, administration
In the case of business failure due to lack of finance, the process varies depending on the form of business ownership
Bankruptcy - Individual, sole trader or partnership, judged by a court of law to be unable to pay their debts
Liquidations - Dissolution of a limited company, assets are sold to pay the outstanding liabilities, any money left goes to shareholders
Administration - Protects a limited company for a period of time, giving time for renegotiation of debts, or finding new sources of finance
Working capital
Meaning and importance of working capital
Working capital is used to finance the day to day activities of a business
Important because it fiances the purchase of materials and the payment of wages to employees
Working capital = current assets - current liabilities
Current assets consist of liquid assets (quickly made into cash) like inventor, trade receivables (debts)
Short term liabilities consist of trade and other payables and overdrafts
Positive working capital
Where a business has positive working capital (more assets than liabilities)
Means a business has plenty of finance to cover day to day expenses, will not need to use short term loans
Too much capital means the businesses assets are not working hard enough, money tied up in stock and is an opportunity cost
Negative working capital
Current liabilities exceed current assets
Too little working capital means a business is unable to pay its short term liabilities such as suppliers or wages
A shortfall in working capital is resolved by agreeing an overdraft to enable the business to continue to function
Many businesses fail due to a lack of working capital, even thought they are profitable
Managing trade receivables and trade payables
A business may try to improve its cash flow by delaying the trade payables and asking the trade receivables to pay more quickly, risks upsetting supplyers and losing customers
Managing trade receivables and trade payables is part of monitoring the working capital cycle
Ways of improving the working capital cycle
Improvements can be made to the cycle by shortening the time customers take to settle their debt, speeding up the production process
Positive working capital doesn't means that a business has lots of cash to spend
Although it means that the current assets are greaten than what the business owes in the short term, high inventory levels are included in the working capital figure and a business cannot use that stock to pay pages of its workers or to settle debt
Distinction between revenue expenditure and capital expenditure
Revenue expenditure
Expenditure on everyday running costs within a business
Costs might include the purchase of raw materials, payment of wages, electric payments
Shown as an expense in the income statement
Capital expenditure
Expenditure on non-current assets (fixed assets) such as buildings or machinery
Used within a business for a long time
Recorded in the statement of financial position