Business Finance Ch 25

Finance
Finance is some means of purchasing the material and assets or services which are needed before the
production of goods or providing of services. Financial decisions are the most important decisions in
any business.
 Why business activity requires finance
To set up a business
To run a business
For business expansion
To avail the opportunities and face threats
Capital Expenditures
Capital expenditures are spending on business resources (fixed assets) which can be used repeatedly
over a period of time such as machinery, building etc
Revenue Expenditures
Revenue expenditures are spending on business resources (other than fixed assets) which have already
been consumed or will be consumed very shortly such as materials, salaries etc.
Working Capital
 Working capital is the funds available to meet day to day requirements for running a business.
 If a firm has too little working capital available, it may be come illiquid and unable to pay its
debts. If a firm has too much working capital, it may not be able to afford the new machinery
that could boost efficiency.
Formula: working capital = current assets – current liabilities
o Current Assets
Any thing owned by the organization which is likely to be turned into cash before the
next balance sheet date, usually within one year. Typical current assets are cash, short
term investments, stock debtors etc.
o Current Liabilities
Any thing owned by the organization which is likely to be paid in cash before the next
balance sheet date usually within one year. Typical current liabilities are creditors,
overdrafts, dividends and unpaid taxes.
 The working capital requirement for any business will depend upon the length
of its “working capital cycle”.
Working Capital Cycle
The working capital cycle shows the movements of cash and other liquid resources into and
out of business.
Work in Process

Material Finished Goods

Cash Drains Cash Injections

Dividends Loans
Drawings Creditors Debtors Fresh Capital
Repay Loans Sale of Assets
New Assets Non Operating
Taxes Income
Cash

Creditors
Creditors are those to whom organization owes money, perhaps through having purchased
goods and services on credit. Creditors appear under current liabilities in the balance sheet.
 Debtors
Debtors are the people who owe you money perhaps through credit purchase.

Sources of Finance
 For Limited Companies
 Internal
 Retained profit
 Sales of assets
 Reduction in working capital
 External
 Long term
 Medium term
 Short term
(Note: See detail on page 395 Figure 25.2)
Debt Factoring
Factoring is a banking service which provides %age (80%, 90% etc, depends on situation) of the value
of invoiced sales as a cash advance, and then organizes the collection of the debt.
Hire Purchase
Hire purchase is a system of obtaining credit for the purchase of an asset whereby the purchaser puts
down a proportion of the price as a deposit and pays the balance in equal installments over an agreed
repayment period. Ownership is transferred when last installment is paid by the purchaser.
Lease
Lease is a contractual arrangement between the owner of asset (lessor) and user of asset (lessee),
which calls for the lessee to pay the lessor an established lease payment. There are two kinds of leases.
 Operating Leases
Operating lease means that the leasing company simply hires out the assets for an agreed
period of time. The user never owns the asset for example rented house.
 Financial Leases
Financial lease is same as hire purchase. Difference between lease and hire purchase is that
ownership of asset is transferred at the end (after last installment) in hire purchase and in
financial lease it is transferred at the time of lease agreement .
Debentures
It is certificate which shows acknowledgement of debt.
Venture Capital
Some specialist organizations or wealthy persons give loans or purchase shares of small or medium
size business that need funds to meet requirements. These business may have bad image in market or
they are unlisted in stock exchange, can approach for such form of fund raising. Venture capitalists
take great risks and could lose all of their money or enjoy a great reward.
 For Sole Traders and Partnerships
Bank overdrafts, loans, credit from suppliers, borrowing etc
Business Plan
Business plan is a detailed document giving evidence about a new or existing business that aims to
convince external lenders and investors to extend finance to the business. A typical business plan
contents are;
 Introduction of business-aim, objectives
 Business description – past performance, capital structure, legal structure
 Market research and plan
 Operations plan
 Financial information