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1 Sources of
finance
IB BUSINESS MANAGEMENT
3.1 Sources of finance
By the end of this chapter, you should be able to:
Explain the role of finance for businesses in terms of capital
expenditure and revenue expenditure
Comment on the internal sources of finance
Comment on the external sources of finance
Define short, medium and long term finance
Discuss the appropriateness, advantages, and disadvantages
of sources of finance for a given situation
Why is financial information so important?
Finance is the language of business.
Money is the unit that provides a means to compare and
understand businesses, to judge their successes and their
failures.
Profit is the goal that inspires entrepreneurs and drives them
to take risks.
Financial information can show:
where the money to set up a business has come from
how this money has been used
how much money is owed to others
what a business is worth
how much cash is available to pay off debts
how much it costs to make a product
how much profit or loss is being made
Using financial information is vital because it:
allows business success or failure to be measured
makes it easy to compare performance over time, and with
the performance of other businesses
helps business managers to make decisions about their
prices, their production and their investment
enables a business to keep control of its spending and use of
other resources
makes it possible to plan ahead so as to ensure cash is
available when it is needed
Who needs to use financial information?
Internal users
Management
Owners
Employees
External users
Potential investors
Lenders
Suppliers
Government
Customers
Competitors
Main types of financial information and
documents
Financial accounting
It is the recording and publishing of financial information to
meet the necessary legal requirements.
The accounts published will allow the external and internal
users to assess the businesss financial position.
Management accounting
It is for the use of managers to help them plan, make
decisions and control the business effectively.
It shows managers what is going on within the business and
allow them to monitor and review the impact of their
decisions.
Financial accounting
Balance sheet
A summary of a firms financial position at a specific point in
time
Profit and loss account
A record of the costs and revenues of a business over a period
of time
Cash-flow statement
A summary of the cash that has come into and out of the
business over a period of time
Cash-flow forecasts
A plan of the expected movements of cash into and out of the
business in the year ahead
Management accounting
Budget
A financial plan for each unit or department within the
business
Breakeven forecast
By calculating the different types of costs and the revenue to
be gained from different levels of sales
Investment appraisal
A calculation of the expected costs and revenues arising from
a new investment
Sources of finance
All businesses require funding for their activities.
For example a loan to purchase a new computer system, or a
bank overdraft to pay suppliers before the receipt of
customers cash.
Just like people, organizations require a variety of funding for
a range of purposes.
These purposes can be classified
as either capital expenditure or
revenue expenditure.
Sources of finance can come
from within a business (internal
sources) or from outside of it
(external sources).
Capital expenditure
Money spent to acquire items in a business that will last for
more than a year and may be used over and over again.
Such items are known as fixed assets.
Fixed assets include machinery, land, buildings, vehicles, and
equipment.
Fixed assets are needed for the purpose of generating
income for the business over the long term. Capital
expenditures are therefore long-term investments intended
to assist businesses to succeed and grow.
Fixed assets can be used as collateral (financial security
pledged for repayment of a particular source of finance such
as bank loans).
Revenue expenditure
Money spent on the day-to-day running of a business.
These payments or expenses include rent, wages, raw
materials, insurance, and fuel.
Does not involve the purchase of longer-terms, fixed assets.
Needs to be covered immediately to keep the business
operational and should therefore provide immediate
benefits, unlike capital expenditure which has a long-term
focus.
Businesses need to be cautious not to have consistently high
revenue expenditure as this will make it difficult for them to
build sufficient capital in order to make long-term
investments.
Factors to be considered
A business should match the source of finance to:
Its specific use
The cost of the source
The organizations objectives
The flexibility and availability to the finance
The impact the new funding would have on the
organizations current financial structure
The state of the external environment
The type of business structure it is
Activity
Be a researcher
Match the sources of finance for an individual to the best
possible uses listed.