Notes

Section 5

5.1 Finance is the money required in the business. Finance is
needed to set up the business, expand it and increase working
capital (the day-to-day running expenses).

Start-up capital is the initial capital used in the business to buy
xed and current assets before it can start trading.

Working Capital nance needed by a business to pay its day-to-
day running expenses

Capital expenditure is the money spent on xed assets (assets
that will last for more than a year). Eg: vehicles, machinery,
buildings etc. These are long-term capital needs.

Revenue Expenditure, similar to working capital, is the money
spent on day-to-day expenses which does not involve the purchase
of long-term assets. Eg: wages, rent. These are short-term capital
needs.




Sources of Finance

Internal nance is obtained from within the business itself.

• Retained Pro t: pro t kept in the business after owners have
been given their share of the pro t. Firms can invest this pro t
back in the businesses.
Advantages:
– Does not have to be repaid, unlike, a loan.
– No interest has to be paid
Disadvantages:


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, – A new business will not have retained pro t
– Pro ts may be too low to nance
– Keeping more pro ts to be used as capital will reduce
owner’s share of pro t and they may resist the decision.
• Sale of existing assets: assets that the business doesn’t
need anymore, for example, unused buildings or spare
equipment can be sold to raise nance
Advantages:
– Makes better use of capital tied up in the business
– Does not become debt for the business, unlike a loan.
Disadvantages:
– Surplus assets will not be available with new businesses
– Takes time to sell the asset and the expected amount may
not be gained for the asset
• Sale of inventories: sell of nished goods or unwanted
components in inventory.
Advantage:
– Reduces costs of inventory holding
Disadvantage:
– If not enough inventory is kept, unexpected increase demand
form customers cannot be ful lled
• Owner’s savings: For a sole trader and partnership, since
they’re unincorporated (owners and business is not separate),
any nance the owner directly invests from hos own saving will
be internal nance.
Advantages:
– Will be available to the rm quickly
– No interest has to be paid.
Disadvantages:
– Increases the risk taken by the owners.




External nance is obtained from sources outside of the business.

• Issue of share: only for limited companies.



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, Advantage:

• A permanent source of capital, no need to repay the
money to shareholders
no interest has to be paid
Disadvantages:

• Dividends have to be paid to the shareholders
• If many shares are bought, the ownership of the business
will change hands. (The ownership is decided by who has
the highest percentage of shares in the company)
• Bank loans: money borrowed from banks
Advantages:

• Quick to arrange a loan
• Can be for varying lengths of time
• Large companies can get very low rates of interest on
their loans
Disadvantages:

• Need to pay interest on the loan periodically
• It has to be repaid after a speci ed length of time
• Need to give the bank a collateral security (the bank will
ask for some valued asset, usually some part of the
business, as a security they can use if at all the business
cannot repay the loan in the future. For a sole trader, his
house might be collateral. So there is a risk of losing
highly valuable assets)
• Debenture issues: debentures are long-term loan certi cates
issued by companies. Like shares, debentures will be issued,
people will buy them and the business can raise money. But
this nance acts as a loan- it will have to be repaid after a
speci ed period of time and interest will have to be paid for it
as well.


Advantage:




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