UNIT 3: FINANCE & ACCOUNTS
IB Business Management
Revision Guide
3.1 Sources of Finance
Finance: the process of providing funds for business activities, making purchases
or investing
What business activities is finance required for?
- Setting up a business will require start-up capital of cash injections from the
owner(s) to purchase essential capital equipment and, possibly, premises.
- Businesses need to finance their working capital
- Business expansion needs finance to increase the capital assets held by the
firm – and, often, expansion will involve higher working capital needs.
- Special situations will often lead to a need for greater finance. A decline in
sales, possibly as a result of economic recession, could lead to cash needs to
keep the business stable; or a large customer could fail to pay for goods, and
finance is quickly needed to pay for essential expenses.
- Apart from purchasing fixed assets, finance is often used to pay for research
and development into new products
Start-up capital: capital needed by an entrepreneur to set up/start a business
Working capital: capital needed to pay for raw materials, day-to- day running costs
and credit offered to customers (working capital: current assets - current liabilities)
1
,Capital: wealth in the form of money or other assets
Role of finance for businesses (AO2)
Finance has two roles:
Capital Expenditure: firms’ investments to acquire fixed assets such as new
equipment, machinery, vehicles or office buildings needed to carry out their
business activities (it is a long term investment).
Revenue Expenditure: money used on day-to-day operations for a business,
spending on all costs and assets other than fixed assets and includes wages,
salaries and materials bought for stock
*these two types of spending will be financed in different ways, in general short
term finance is used to pay for revenue expenditure while long term finance is used
to pay for capital expenditures.
The following internal sources of finance: personal funds, retained profit, sale of assets
(AO2)
Personal funds (for sole traders)
funds that a sole trader has acquired and gathered as personal savings
PROS:
-sole traders maximize control over the business
-shows commitment to the business to other investors and providers of
finance
-easily available and no interest will need to be paid
2
, CONS:
- poses a big risk to the owners/sole traders because they could be
investing a lot of money
- if the savings are not large enough, it may be difficult to start or
maintain a business
Retained profit (most important long-term finance)
the profit that the business keeps to use within the business (after paying taxes to
the government and dividends to it shareholders), often used for
purchasing/upgrading fixed assets
PROS:
- it is cheap since it no interest charges need to be paid
- high control and flexible (business controls their retained profit in whichever
way they want)
- represents a permanent source of finance that doesn’t have to be repaid
CONS:
- start-up business will not have any as they are new ventures
- if it is too low, it may not be sufficient for expansion
- owners may overuse it and leave no money for emergencies of future growth
opportunities
- business can hoard the money ( if it doesn’t lead to increased profits,
shareholders may argue)
Sale of assets
3
, when a business sells of its unwanted or unused assets to raise funds (if a business
has chosen to relocate, it can raise finance through the sale of land and buildings.
In more extreme cases, business can sell their fixed assets to survive a liquidity
problem)
PROS:
- good way of raising cash from capital that maybe tied up in assets that are
not being used
- no interest or borrowing costs are incurred
- makes profit, reduces debt
CONS:
- may only be an option for established business (new ones may lack excess
assets to sell)
- can be time consuming to find a buyer to sell the assets to
* In some cases businesses may adopt a sale and lease back option, which involves
selling an asset that the business still needs to use. In this case the business will sell
the asset to a specialist firm that then leases the asset back to the business. This
will raise capital but there will be an additional fixed cost in the leasing payment.
liquidity: the ability of a firm to pay its short-term debts
The following external sources of finance: share capital, loan capital,overdrafts,trade credit,
grants,subsidies, debt factoring, leasing, venture capital, business angels (AO2)
Share capital (equity capital)
4
IB Business Management
Revision Guide
3.1 Sources of Finance
Finance: the process of providing funds for business activities, making purchases
or investing
What business activities is finance required for?
- Setting up a business will require start-up capital of cash injections from the
owner(s) to purchase essential capital equipment and, possibly, premises.
- Businesses need to finance their working capital
- Business expansion needs finance to increase the capital assets held by the
firm – and, often, expansion will involve higher working capital needs.
- Special situations will often lead to a need for greater finance. A decline in
sales, possibly as a result of economic recession, could lead to cash needs to
keep the business stable; or a large customer could fail to pay for goods, and
finance is quickly needed to pay for essential expenses.
- Apart from purchasing fixed assets, finance is often used to pay for research
and development into new products
Start-up capital: capital needed by an entrepreneur to set up/start a business
Working capital: capital needed to pay for raw materials, day-to- day running costs
and credit offered to customers (working capital: current assets - current liabilities)
1
,Capital: wealth in the form of money or other assets
Role of finance for businesses (AO2)
Finance has two roles:
Capital Expenditure: firms’ investments to acquire fixed assets such as new
equipment, machinery, vehicles or office buildings needed to carry out their
business activities (it is a long term investment).
Revenue Expenditure: money used on day-to-day operations for a business,
spending on all costs and assets other than fixed assets and includes wages,
salaries and materials bought for stock
*these two types of spending will be financed in different ways, in general short
term finance is used to pay for revenue expenditure while long term finance is used
to pay for capital expenditures.
The following internal sources of finance: personal funds, retained profit, sale of assets
(AO2)
Personal funds (for sole traders)
funds that a sole trader has acquired and gathered as personal savings
PROS:
-sole traders maximize control over the business
-shows commitment to the business to other investors and providers of
finance
-easily available and no interest will need to be paid
2
, CONS:
- poses a big risk to the owners/sole traders because they could be
investing a lot of money
- if the savings are not large enough, it may be difficult to start or
maintain a business
Retained profit (most important long-term finance)
the profit that the business keeps to use within the business (after paying taxes to
the government and dividends to it shareholders), often used for
purchasing/upgrading fixed assets
PROS:
- it is cheap since it no interest charges need to be paid
- high control and flexible (business controls their retained profit in whichever
way they want)
- represents a permanent source of finance that doesn’t have to be repaid
CONS:
- start-up business will not have any as they are new ventures
- if it is too low, it may not be sufficient for expansion
- owners may overuse it and leave no money for emergencies of future growth
opportunities
- business can hoard the money ( if it doesn’t lead to increased profits,
shareholders may argue)
Sale of assets
3
, when a business sells of its unwanted or unused assets to raise funds (if a business
has chosen to relocate, it can raise finance through the sale of land and buildings.
In more extreme cases, business can sell their fixed assets to survive a liquidity
problem)
PROS:
- good way of raising cash from capital that maybe tied up in assets that are
not being used
- no interest or borrowing costs are incurred
- makes profit, reduces debt
CONS:
- may only be an option for established business (new ones may lack excess
assets to sell)
- can be time consuming to find a buyer to sell the assets to
* In some cases businesses may adopt a sale and lease back option, which involves
selling an asset that the business still needs to use. In this case the business will sell
the asset to a specialist firm that then leases the asset back to the business. This
will raise capital but there will be an additional fixed cost in the leasing payment.
liquidity: the ability of a firm to pay its short-term debts
The following external sources of finance: share capital, loan capital,overdrafts,trade credit,
grants,subsidies, debt factoring, leasing, venture capital, business angels (AO2)
Share capital (equity capital)
4
