Embedded Files
What Finance Departments Do
Record all financial transactions.
Prepare final accounts.
Produce financial information for managers.
Forecast cash flows.
Make financial decisions (e.g., choosing sources of finance).
Why Businesses Need Finance
Start‑up Capital
Needed to buy non‑current (fixed) assets and initial inventories before trading begins.
Lack of working capital is a major cause of start‑up failure.
Expansion
Finance required for larger buildings, machinery, takeovers, new products, and R&D.
Additional Working Capital
Needed for day‑to‑day expenses: wages, materials, bills.
Businesses can fail due to cash shortages, even if profitable.
Capital vs Revenue Expenditure
Capital expenditure → money spent on long‑term assets (buildings, machinery).
Revenue expenditure → day‑to‑day costs (wages, rent, utilities).
Internal Sources of Finance
Retained Profit
Advantages: no repayment, no interest.
Disadvantages: unavailable for new firms; may be insufficient; reduces dividends.
Sale of Existing Assets
Advantages: frees tied‑up capital; no debt.
Disadvantages: slow to sell; uncertain value; not available for new firms.
Reducing Inventory Levels
Advantages: lowers storage and opportunity cost.
Disadvantages: risk of stockouts.
Owners’ Savings
Advantages: quick; no interest.
Disadvantages: limited amount; increases owner risk (unlimited liability).
External Sources of Finance
Issue of Shares (only for limited companies)
Advantages: permanent capital; no interest.
Disadvantages: dividends expected; ownership dilution.
Bank Loans
Advantages: quick; flexible time periods; lower interest for large firms.
Disadvantages: must be repaid; interest; collateral required.
Debentures
Long‑term loan certificates.
Advantages: very long‑term finance.
Disadvantages: interest + repayment required.
Debt Factoring
Selling debts for immediate cash.
Advantages: improves cash flow; reduces collection risk.
Disadvantages: business receives less than full debt value.
Grants & Subsidies
Non-repayable financial aids, primarily provided by governments or organizations to support specific projects, industries, or, in the case of subsidies, to lower costs for consumers
Advantages: no repayment.
Disadvantages: conditions attached (e.g., location requirements).
Alternative Sources of Capital
Micro‑finance
Small loans to poor entrepreneurs lacking collateral.
Benefits: supports start‑ups in developing economies; encourages self‑employment.
Limitations: small loan sizes; higher interest rates sometimes.
Crowdfunding
Raising small amounts from many people online.
Advantages: tests public interest; fast; no upfront fees.
Disadvantages: may fail to reach target; idea can be copied; requires publicity.
Short‑Term Finance
Used for working capital needs.
Overdrafts
Flexible, interest only on amount used; but high interest and repayable on demand.
Trade Credit
Delaying payment to suppliers; but may lose discounts or damage relationships.
Factoring
(Already covered above.)
Long‑Term Finance
Used for fixed assets, expansion, takeovers.
Bank Loans
Hire Purchase
Buy asset over time; interest included; deposit required.
Leasing
Use asset without buying; maintenance handled by leasing company; but total cost higher.
Issue of Shares
Selling ownership in the business to raise permanent capital, which does not need repayment but reduces the original owners’ control.
Debentures
A long‑term loan to the company that must be repaid with fixed interest, giving lenders no ownership or voting rights.
Choosing the Right Source of Finance
Purpose & Time Period
Long‑term asset → long‑term finance
Temporary inventory → short‑term finance
Amount Needed
Large sums → share issue/long‑term loans
Small sums → overdraft/trade credit
Legal Form & Size
Only companies can issue shares or debentures.
Small firms rely more on owners’ savings and bank loans.
Control
Owners may avoid share issues to prevent loss of control.
Risk & Gearing
High gearing (>50%) = risky → banks reluctant to lend.
Interest must be paid even if profits fall.
When Banks Lend / When Shareholders Invest
Banks lend when:
Cash flow forecast is strong.
Business plan is clear.
Collateral is available.
Gearing is not too high.
Shareholders invest when:
Share price rising.
High dividends.
Good company reputation.
Strong growth prospects.
NOTES DONE BY FARIDA SABET
CLICK HERE TO GO TO THE PREVIOUS TOPIC
CLICK HERE TO GO TO THE NEXT TOPIC
CLICK HERE TO GO BACK TO THE NOTES MENU
Page updated
Google Sites
Report abuse