Business Studies Unit 2.3

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finance for a large business

Why do large businesses need finance?

·         New property, such as offices, shops or factories

·        
Machinery, equipment and vehicles

·         Recruiting and training new employees

·         Raw materials

·         Developing new goods and services

·         Introducing new methods of production

·         To pay for major marketing campaigns

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Sources of finance

Sources of finance for large businesses:

Retained profits:  This is profit made by the business in earlier years that is not used to pay shareholders dividends.  This source of finance may be available immediately to a successful business. 

 

Selling Assets:  Assets can be sold in two ways:

·         Selling assets such as buildings for cash

·         Selling an asset and leasing it back.  The business sells the asset then leases it back so that it is still available for use.

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Ways of getting finance

Bank loans and Mortgages:  A bank loan is a sum of money given by a bank to a business in return for the business agreeing to repay it in instalments over the next few years.  A bank might ask for collateral – an asset belonging to the business that is borrowing the money. 

A mortgage is a special type of loan.  It is used by businesses to buy property such as offices, shops and factories.  A mortgage may be for a large sum of money and is normally paid back monthly, over a long period of up to 50 years. 

 

Issuing New Shares:  Only companies can sell shares.  It is easier for public limited companies to sell shares as they use the Stock Exchange.  

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Sources of finance Advantages and disadvantages

Source of Finance

Advantages

Disadvantages

Retained Profits

·      No interest payments

·      Can be arranged immediately

·      Only available to profitable businesses

·      Shareholders may oppose the decision

Selling Assets

·      No interest payments

·      May keep assets (if leased back)

·      Many businesses do not have suitable assets

·      Leasing assets back means regular payments

Bank Loans & Mortgages

·      Can be arranged quickly

·      Allows repayment over a long period of time

·      Interest has to be paid

·      Banks may require an asset as collateral

Selling Shares

·      No interest payments

·      The owners may lose control of the company

·      Only available to companies

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Choosing a suitable source of finance

The best source of finance will depend on the following:

Profitability of the business: a profitable business will be more able to use retained profits as a source of finance.  However, a more profitable business may be able to persuade banks to lend them money

 Assets owned: a business with assets such as buildings can sell them.  They may also be able to use these assets as collateral against a loan

 Past history and future prospects: if a business is expected to make a profit in the future banks are more likely to give them a loan.  Equally, if a business has a good history for paying loans on time they may be in a better position to agree a bank loan or mortgage.

 Legal structure: only companies can sell shares.  Private limited companies must have all shareholders in agreement that this source is used.

 Amount of finance that has to be raised: if the amount is large a business may use more than one source of finance.  Bank loans are not prepared to loan large sums, and selling enough shares may mean the current owners may lose control of the business.

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PROFIT & LOSS AND BALANCE SHEETS

Why do businesses prepare financial statements?

·         The law -legal requirement under the Companies Act.  Large companies must prepare these or they could be fined.  Smaller businesses (sole traders, partnerships), do not have to follow the same legal rules

·         To help the business’s managers - they assist the managers in making decisions to improve the business’s performance

·         To guide investors - people planning to invest in businesses will gain a lot of information from its accounts.  They will be able to judge how safe the investment is.

Profit and Loss Account

Shows three key pieces of information:

1.    The revenue earned by the business – often called turnover or sales income

2.    The costs of production that have been paid by the business

3.    The amount of profit earned by the business or the loss it has made

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PROFIT & LOSS AND BALANCE SHEETS

  Profit and Loss Key Terms:

·         Revenue – income received by a business from selling its goods and services

·         Cost of Sales – these are the costs involved in directly supplying the good or service, this includes: wages, raw materials and energy costs

·         Gross Profit – this is the revenue minus the cost of sales

·         Overheads – these are the costs that do not alter when the level of production changes.  This includes: salaries of managers, insurance costs, interest on loans

·         Net profit – this is calculate by taking overheads away from the gross profit

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Balance Sheet

Balance Sheet

This sets out the assts and liabilities that a business has on a particular day.  It shows where the business’s money is coming from and how the business has spent the money that it has raised.

 The balance sheet will contain the following information:

Assets: An asset is anything that is owned by a business, there are two types: 

·         Fixed Assets – a business will normally keep this type of asset for many years.  Examples include shops and vehicles.  Also called non-current assets

·         Current Assets – these are assets that the business only expects to have for a short time (usually less than a year).  Examples include cash, stocks of raw materials.  Current assets are used by the business to settle debts such as paying for raw materials.

 Liabilities: Liabilities are the amounts owed by a business to other businesses and individuals.  There are two types:

·         Current liabilities – debts that a business will pay within a year.  Examples include money owed to suppliers and that the business has to pay.

·         Long-term liabilities – debts that will be paid back over many years.  Examples include loans from the bank or a loan to buy property (mortgage).  They are also called non-current liabilities.

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Total Equity

Total Equity: Total equity is part of a company’s money that belongs to shareholders.  If a company stops trading and sells all its fixed and current assets it would normally have a large sum of money remaining.  This would be used to pay all the company’s liabilities (debts).  The money that is left once this is done is called total equity.  Net assets always equals total equity.


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Total Equity

Total Equity: Total equity is part of a company’s money that belongs to shareholders.  If a company stops trading and sells all its fixed and current assets it would normally have a large sum of money remaining.  This would be used to pay all the company’s liabilities (debts).  The money that is left once this is done is called total equity.  Net assets always equals total equity.


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Ratios

Ratios Ways to judge whether the business is successful.

 Profit Ratios:

Gross Profit Margin

This compares the business’s gross profit for a trading period with the revenue figure from the same year. The answer will always give you a percentage. 

 Net Profit Margin

This compares a business’s net profit for a trading period with the revenue figure for the same period. Again this figure will give you a percentage.

 These figures need to be compared with the following in order to make a judgement:

·         The business’s target for its gross/net profit margin

·         The business’s gross/net profit margin for earlier years

·         The gross/net profit of other similar businesses

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Liquidity Ratios

Current Ratio:

This ratio compares the value of the current assets that a business has with the figure for its current liabilities.  This will help you to see whether a business has enough assets that it may sell for cash to enable it to pay its short-term debts.

As an example, if a business’s current assets are £125,000 and its current liabilities are £50,000, then its current ratio will be as follows:

This means that the business has £2.50 for each £1 of short-term debts that it will have to pay.  A good current ratio figure is normally said to be one that is higher than 2:1.  Having twice as much cash as the business is likely to need allows it to cope with situations such as an unexpected bill from suppliers.

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Liquidity Ratios

 Acid Test Ratio:

The current ratio is not always a good guide to whether a business can pay its short-term debts as it includes a figure for stock.  Stock is not always easy to sell quickly.

 As an example, if a business’s current assets minus stock is £75,000 and its current liabilities are £50,000, then its current ratio will be as follows:

 This means that the business has £1.50 for each £1 of short-term debts that it will have to pay.  The ‘standard’ figure for the acid test ratio is 1.1:1

 Liquidity ratios need to be compared with one of the following:

·         Results for the same ratios for the previous year or years

·         Results for similar businesses

·         Some ‘standard’ figure for that ratio

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