Finance

Why do businesses need finance?

  • Start up a business, eg pay for premises, new equipment and advertising.
  • Run the business, eg having enough cash to pay staff wages and suppliers on time.
  • Expand the business, eg having funds to pay for a new branch in a different city or country.
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Short-term sources of external finance

  • An overdraft facility - where a bank allows a firm to take out more money than it has in its bank account.
  • Trade credits - where suppliers deliver goods now and are willing to wait for a number of days before payment.
  • Factoring - where firms sell their invoices to a factor such as a bank. They do this for some cash right away, rather than waiting 28 days to be paid the full amount.
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Long-term sources of external finance

  • Owners who invest money in the business. For sole traders and partners this can be their savings. For companies, the funding invested by shareholders is called share capital.
  • Loans from a bank or from family and friends.
  • Debentures are loans made to a company.
  • A mortgage, which is a special type of loan for buying property where monthly payments are spread over a number of years.
  • Hire purchase or leasing, where monthly payments are made for use of equipment such as a car. Leased equipment is rented and not owned by the firm. Hired equipment is owned by the firm after the final payment.
  • Grants from charities or the government to help businesses get started, especially in areas of high unemployment.
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Revenue

  • Revenue is the income earned by a business over a period of time, eg one month.
  • The amount of revenue earned depends on two things - the number of items sold and their selling price.
  •  Revenue = Price x Quantity.
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Variable costs

  • Some costs, called variable costs, change with the amount produced.
  • For example, the cost of raw materials rises as more output is made.
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Fixed costs

  • Other costs, called fixed costs, stay the same even if more is produced. 
  • Office rent is an example of a fixed cost which remains the same each month even if output rises.
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Total costs

  • The total cost is the amount of money spent by a firm on producing a given level of output.
  • Total costs are made up of fixed costs (FC) and variable costs (VC)
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Profit

Profit is the reward for risk-taking. A business can use profit to either:

  • reward owners
  • invest in growth
  • save for the future, in case there is a downturn in revenue
  • Profit = Total revenue - Total costs.
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Cash flow

  •  Cash flow is about money coming and going from the business.
  • The challenge for managers is to make sure there is always enough cash to pay expenses when they are due, as running out of cash threatens the survival of the business.
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Improving cash flow

  • Reducing cash outflows - eg by delaying the payment of bills, securing better trade credit terms or factoring.
  • Increasing cash inflows - eg by chasing debtors, selling assets or securing an overdraft.
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