SECTION 2.1 Overdraft - excess of cash allowed by a bank to a business, permitting the withdrawal of more from a bank account than it holds
Why do business need finance:
+ Easy to arrange and flexible (tailored to the businesses needs) e.g. seasonal business
● To fund expansion e.g. buy fixed assets + Interest is only paid to the amount used
● To pay day to day costs e.g.wages + No control is given up
● To assist future forecasted cash-flow problems + Short term debt so not included in gearing ratio
● To survive in periods of seasonality - High interest rates = increased costs
● To fulfil demand - Increased risk as it’s payable to the bank at any time, the bank may cancel overdraft at any time
● To pay off debts - Persistent use of overdraft will lower credit rating
Sources of finance depend on: Peer to peer funding (P2P) - an online platform that enables individuals or businesses to obtain loans directly from other individuals
❏ Amount of finance required + Business pays less interest than at the bank
❏ Level of risk involved + Quick and easy to apply
❏ Business’s organisational structure - Application fee
❏ Cost of finance e.g. interest rates, share of the business or profits - Needs to pass a credit score and internal checks to secure the loan
Short term finance: usually repaid within a year Crowdfunding - raising capital via the internet from a large number of people who each contributes a small amount
Long term finance: repaid over a longer period usually 3 years or more
+ Can raise finance from a large group of investors
Internal sources of finance: raising capital from within the company’s resources + No interest rate/doesn’t need to be repaid = lower costs
+ Investors may require a lower level of reward than a bank allowing the business to maximise their returns
Owner's capital - the personal funds of the owner, which may be used to invest in the business e.g. by buying shares + Improves brand image as investors promote the business via word of mouth
+ Business raises awareness of its products or brand to people using the crowd funding website = increased sales
+ No financial cost - no interest, doesn’t need to be paid back, no loss of control + Gain good feedback enabling the business to make improvements
+ Easy and quick to access - Profits will be shared with investors therefore lower profits for founder
- Amount of finance is likely to be limited - it depends on the personal wealth of the owner - Investors may not be experts in the market so guidance may be limited if they contribute a small sum of money
- If business doesn’t initially make profit using savings it may lead to financial pressures - Failed projects risk damage to the reputation of the business and investors
- Unless the full amount is raised, the business will not receive any finance from the crowd funding
Retained profits - when a business uses historical profits from previous years to invest
Business angels - individuals who invest money into new or innovative businesses that they think have the potential to be successful
+ No financial cost - no interest, doesn’t need to be paid back in return for a share of the business
+ Flexible - management has complete control over how they’re reinvested
+ Doesn’t dilute the ownership of the company + Offer the business owners advice and guidance
- Retaining profit may cause the business to miss out on investment opportunities + A business angel might have lots of business knowledge and useful contacts
- May create conflict between shareholders due to low dividends - Difficult and time consuming to find a business angel willing to invest
- Usually limited therefore slow growth - A share of the business has to be given up, loss of control and decision making power
- No expertise added e.g. bank advisors, shareholders
Venture capitalist - finance offered by a venture capitalist fund to high risk; high reward firms in exchange for a share of the business -
Sale of assets - raising capital via the sale of surplus fixed assets e.g. machinery it can be provided by business angels or by venture capitalists
+ No financial cost - no interest + Does not need to be repaid and involves no payment of interest = lower fixed costs = ability to survive
+ Providing you can find a buyer it’s a quick form of cash + Can raise substantial amounts making expansion possible, due to the high risk involved banks may not be interested
+ No control given up + Reduces personal risk as venture capitalist fund has taken a % of risk
- Likely to be limited - businesses are likely to have few surplus assets + Venture capitalist could be a valuable source of advice due to their expertise and contacts in the industry
- Risk: - Share of the business is given up therefore profits have to be shared
➔ Can’t find buyer - Loss of control and decision making power if more than 50% of share is given up
➔ Don’t receive true value for the fixed asset - Venture capitalist may get involved in the day to day running of the company in return for the investment = conflict
➔ Very likely it had depreciated
Trade credit - when a business buys a good or service from suppliers but pays later within an agreed time limit
External sources of finance: raising capital from outside the resources of a business
+ Simple to arrange and maintain if credit terms are met
Family and friends - owners of small or new business may ask family and friends to help them out financially + Cheap form of short term finance
+ No control is given up
+ Family and friends may offer the money as a gift or be willing to to agree to a flexible repayment with little or no interest + Helps them avoid cash flow problems
- Amount of money available may be limited + Manufacturers cam ask to extend these periods at times of difficulty in order to help in the short term
- Risk of spoiling relationship with supplier if credit terms are not met - they’ll get a bad credit rating making it harder to get
Bank loan - when a business borrows a fixed amount of money and pays it back with interest over an agreed period of time credit from suppliers and finance providers in the future
- If the business fails to pay on time it will be charged interest on the credit by the supplier until it’s all paid and may also
+ Guaranteed money for a certain time be charged a fine
+ No control is lost - Business can miss out on discounts for paying up front
+ Interest rates may be fixed
+ Repayments are made in instalments Share capital - finance raised by selling shares to the public
- Strict lending criteria
- Increased costs as interest must be paid on the loan amount + Fast way of raising finance
- Loss of control as assets will be taken if you fail to repay + Doesn't need to be repaid
- Increases gearing of business + Easy to raise capital from loyal investors
+ New shareholders can bring additional expertise into the business
Calculating interest on a bank loan (%) = (total repayment - borrowed amount / borrowed amount) x 100 + Public limited companies can issue shares which can easily be bought and sold on the stock exchange
- Ownership of the company is diluted = risk of takeover
- Costly and time consuming process - legal and administrative costs of issuing new shares
, Grants - a fixed sum of capital provided to a business by the government or other organisations to fund specific projects Net cash flow = cash inflows - cash outflows for a given period
+ Non-repayable therefore no interest needs to be paid Opening balance = closing balance of the previous month
+ No share of the business has to be given up - no control given up therefore retains decision making
+ Application process forces a business to think thoroughly about the project and how the money will be spent Closing balance = net cash flow + opening balance
- Application process can be long + time consuming - risk of getting rejected
- Even if a firm is awarded a grant it often doesn't get the money until the of the project SECTION 2.2
- Grant tied to certain conditions - if not met any grant money the business was offered may be retracted
Sales forecasting: process of predicting future sales volume and sales revenue based on past sales data and market research
Leasing - a financial arrangement in which a company pays to use an asset for a particular time
+ Enables firms to make informed decisions + predict short term and long term performance
+ Helps businesses gain valuable insight to predict demand fluctuations
+ Helps spread cash-flow payments
+ Can lower costs - predicting demand will help tweak production process to increase efficiency
+ Asset leased is often up to date + so less likely to become faulty - sometimes maintenance + repair costs are included in
+ Helps to make decisions on marketing
the lease
+ Helps to make decisions on resources such as staff, stock - can identify seasonal peaks in sales
+ Flexible
+ Regular on-going market research can be used to help anticipate changes in customer tastes and preferences
- Can be more costly in the long run than buying an asset outright
- Never 100% accurate as consumer tastes, preferences, trends + economic variables can be volatile
- Limited control over the asset
- Tastes are difficult to predict as society and technology change
- Any improvements made to te asset are lost at the end of lease term
- Unreliable if there are significant fluctuations in historical data
- Time consuming and resource intensive
Limited liability: the amount of a company’s losses that a shareholder is liable for is limited to the amount they have invested in the
- Assumes past trend will continue into the future
company
- Unanticipated economic booms or recessions will affect consumer incomes and therefore affect demand
Unlimited liability: the business and the owner are seen as the same legal entity meaning the owner is responsible for all debts the
Factors affecting sales forecasts:
business incurs
● Consumer trends
Business plan: a document setting out a business’s future objectives and strategies for achieving them
● Actions of competitors
● Economic variables e.g. exchange rates, interest rates, taxation
Business plan consists of:
Circumstances where sales forecast are likely to be inaccurate:
❏ Business’s aims and objectives
❏ Plans to repay debts
● When a business is new so it’s difficult to interpret its sales data
❏ Cash flow forecast
● Demand is highly sensitive to changes in price and income elasticity
❏ Sales forecasts
● Significant changes in market share e.g. new market entrants
● Market subject to significant distribution from technological change.
+ Increases chances of obtaining external finance as a good plan proves the owners have done their research
+ Allows closer inspection of the various business area and identify any gaps in information
Sales volume = number of units sold in a given time period (sales revenue/selling price)
+ Reduces risk as it forces the entrepreneur to consider all factors that could cause the business idea to succeed or fail
+ Encourages analysis of the competitive position of the business and the market attractiveness
Sales revenue = amount of money coming into a business from the sale of goods or services (quantity sold x selling price)
+ Helps determine the amount and type of finance required
- Only a plan, reality likely to be different
Profit = sales revenue - total costs
- Dangers of becoming stuck on a plan
- Dangers of inflating revenue and deflating costs
Fixed costs: costs that do not vary directly with the level of output e.g. rent
Cashflow forecast: the flow of cash into and out of a business over a set period of time. A business will monitor cash flow to ensure it’s
Variable costs: costs which vary directly with the level of output e.g. raw materials
able to meet day to day expenses or put in place a provision such as an overdraft to allow for this
Total variable costs = quantity x variable cost per unit
+ Identifies potential shortfalls in advance
+ Makes sure that the business can afford to pay suppliers and employees
Total costs = fixed costs + variable costs
+ Heps to spot problems with customer payments
+ Provides reassurance to investors and lenders that the business is being managed properly
Break even point: point at which total revenue equals total costs meaning the business is neither making a profit or loss
- Poor cash flow forecast may lead to a usinees running out of and could become insolvent
- Difficult to create as businesses exist in dynamic markets where circumstances can change suddenly and frequently
Break even point (units) = total fixed costs/contribution per unit (selling price per unit - variable costs per unit)
- Lots of experience and research into the market is required to create an accurate forecast
Break even point (revenue) = break even point in units x price
Poor cash flows happen due to:
Total contribution = contribution per unit x quantity sold
● Sales prove lower than expected/costs prove higher than expected
● Customers don't pay up on time
Break even analysis:
● Over trading means there’s too much stock
● No cash flow forecasting therefore poor business management
+ Useful tool for management - influences decisions on whether new products are launched or not
+ Allows to predict future profit levels and set goals and targets accordingly = provides a target to work towards
Solutions to cash flow problems:
+ Can be used to set prices
+ Data generated can be used in business plan to obtain bank loans
1. Rescheduling payments
+ Simple planning tool which sets a target level of sales which must be reached in order for a firm to be profitable
+ Increase speed of receiving cash inflow = may lose sales
- Based on predicted data not actual data - information may be unreliable
+ Decrease speed of paying cash outflows = may damage relationship
- It’s a static model - it doesn’t take sales trends into account
2. Increase cash inflows: - Has limited use because of the many unrealistic assumptions made
+ Run a marketing campaign to increase sales = increased costs ➔ One same price used
+ Increase selling price = reduced sale ➔ No waste
➔ All units produced are sold
3. Sources of finance
Why do business need finance:
+ Easy to arrange and flexible (tailored to the businesses needs) e.g. seasonal business
● To fund expansion e.g. buy fixed assets + Interest is only paid to the amount used
● To pay day to day costs e.g.wages + No control is given up
● To assist future forecasted cash-flow problems + Short term debt so not included in gearing ratio
● To survive in periods of seasonality - High interest rates = increased costs
● To fulfil demand - Increased risk as it’s payable to the bank at any time, the bank may cancel overdraft at any time
● To pay off debts - Persistent use of overdraft will lower credit rating
Sources of finance depend on: Peer to peer funding (P2P) - an online platform that enables individuals or businesses to obtain loans directly from other individuals
❏ Amount of finance required + Business pays less interest than at the bank
❏ Level of risk involved + Quick and easy to apply
❏ Business’s organisational structure - Application fee
❏ Cost of finance e.g. interest rates, share of the business or profits - Needs to pass a credit score and internal checks to secure the loan
Short term finance: usually repaid within a year Crowdfunding - raising capital via the internet from a large number of people who each contributes a small amount
Long term finance: repaid over a longer period usually 3 years or more
+ Can raise finance from a large group of investors
Internal sources of finance: raising capital from within the company’s resources + No interest rate/doesn’t need to be repaid = lower costs
+ Investors may require a lower level of reward than a bank allowing the business to maximise their returns
Owner's capital - the personal funds of the owner, which may be used to invest in the business e.g. by buying shares + Improves brand image as investors promote the business via word of mouth
+ Business raises awareness of its products or brand to people using the crowd funding website = increased sales
+ No financial cost - no interest, doesn’t need to be paid back, no loss of control + Gain good feedback enabling the business to make improvements
+ Easy and quick to access - Profits will be shared with investors therefore lower profits for founder
- Amount of finance is likely to be limited - it depends on the personal wealth of the owner - Investors may not be experts in the market so guidance may be limited if they contribute a small sum of money
- If business doesn’t initially make profit using savings it may lead to financial pressures - Failed projects risk damage to the reputation of the business and investors
- Unless the full amount is raised, the business will not receive any finance from the crowd funding
Retained profits - when a business uses historical profits from previous years to invest
Business angels - individuals who invest money into new or innovative businesses that they think have the potential to be successful
+ No financial cost - no interest, doesn’t need to be paid back in return for a share of the business
+ Flexible - management has complete control over how they’re reinvested
+ Doesn’t dilute the ownership of the company + Offer the business owners advice and guidance
- Retaining profit may cause the business to miss out on investment opportunities + A business angel might have lots of business knowledge and useful contacts
- May create conflict between shareholders due to low dividends - Difficult and time consuming to find a business angel willing to invest
- Usually limited therefore slow growth - A share of the business has to be given up, loss of control and decision making power
- No expertise added e.g. bank advisors, shareholders
Venture capitalist - finance offered by a venture capitalist fund to high risk; high reward firms in exchange for a share of the business -
Sale of assets - raising capital via the sale of surplus fixed assets e.g. machinery it can be provided by business angels or by venture capitalists
+ No financial cost - no interest + Does not need to be repaid and involves no payment of interest = lower fixed costs = ability to survive
+ Providing you can find a buyer it’s a quick form of cash + Can raise substantial amounts making expansion possible, due to the high risk involved banks may not be interested
+ No control given up + Reduces personal risk as venture capitalist fund has taken a % of risk
- Likely to be limited - businesses are likely to have few surplus assets + Venture capitalist could be a valuable source of advice due to their expertise and contacts in the industry
- Risk: - Share of the business is given up therefore profits have to be shared
➔ Can’t find buyer - Loss of control and decision making power if more than 50% of share is given up
➔ Don’t receive true value for the fixed asset - Venture capitalist may get involved in the day to day running of the company in return for the investment = conflict
➔ Very likely it had depreciated
Trade credit - when a business buys a good or service from suppliers but pays later within an agreed time limit
External sources of finance: raising capital from outside the resources of a business
+ Simple to arrange and maintain if credit terms are met
Family and friends - owners of small or new business may ask family and friends to help them out financially + Cheap form of short term finance
+ No control is given up
+ Family and friends may offer the money as a gift or be willing to to agree to a flexible repayment with little or no interest + Helps them avoid cash flow problems
- Amount of money available may be limited + Manufacturers cam ask to extend these periods at times of difficulty in order to help in the short term
- Risk of spoiling relationship with supplier if credit terms are not met - they’ll get a bad credit rating making it harder to get
Bank loan - when a business borrows a fixed amount of money and pays it back with interest over an agreed period of time credit from suppliers and finance providers in the future
- If the business fails to pay on time it will be charged interest on the credit by the supplier until it’s all paid and may also
+ Guaranteed money for a certain time be charged a fine
+ No control is lost - Business can miss out on discounts for paying up front
+ Interest rates may be fixed
+ Repayments are made in instalments Share capital - finance raised by selling shares to the public
- Strict lending criteria
- Increased costs as interest must be paid on the loan amount + Fast way of raising finance
- Loss of control as assets will be taken if you fail to repay + Doesn't need to be repaid
- Increases gearing of business + Easy to raise capital from loyal investors
+ New shareholders can bring additional expertise into the business
Calculating interest on a bank loan (%) = (total repayment - borrowed amount / borrowed amount) x 100 + Public limited companies can issue shares which can easily be bought and sold on the stock exchange
- Ownership of the company is diluted = risk of takeover
- Costly and time consuming process - legal and administrative costs of issuing new shares
, Grants - a fixed sum of capital provided to a business by the government or other organisations to fund specific projects Net cash flow = cash inflows - cash outflows for a given period
+ Non-repayable therefore no interest needs to be paid Opening balance = closing balance of the previous month
+ No share of the business has to be given up - no control given up therefore retains decision making
+ Application process forces a business to think thoroughly about the project and how the money will be spent Closing balance = net cash flow + opening balance
- Application process can be long + time consuming - risk of getting rejected
- Even if a firm is awarded a grant it often doesn't get the money until the of the project SECTION 2.2
- Grant tied to certain conditions - if not met any grant money the business was offered may be retracted
Sales forecasting: process of predicting future sales volume and sales revenue based on past sales data and market research
Leasing - a financial arrangement in which a company pays to use an asset for a particular time
+ Enables firms to make informed decisions + predict short term and long term performance
+ Helps businesses gain valuable insight to predict demand fluctuations
+ Helps spread cash-flow payments
+ Can lower costs - predicting demand will help tweak production process to increase efficiency
+ Asset leased is often up to date + so less likely to become faulty - sometimes maintenance + repair costs are included in
+ Helps to make decisions on marketing
the lease
+ Helps to make decisions on resources such as staff, stock - can identify seasonal peaks in sales
+ Flexible
+ Regular on-going market research can be used to help anticipate changes in customer tastes and preferences
- Can be more costly in the long run than buying an asset outright
- Never 100% accurate as consumer tastes, preferences, trends + economic variables can be volatile
- Limited control over the asset
- Tastes are difficult to predict as society and technology change
- Any improvements made to te asset are lost at the end of lease term
- Unreliable if there are significant fluctuations in historical data
- Time consuming and resource intensive
Limited liability: the amount of a company’s losses that a shareholder is liable for is limited to the amount they have invested in the
- Assumes past trend will continue into the future
company
- Unanticipated economic booms or recessions will affect consumer incomes and therefore affect demand
Unlimited liability: the business and the owner are seen as the same legal entity meaning the owner is responsible for all debts the
Factors affecting sales forecasts:
business incurs
● Consumer trends
Business plan: a document setting out a business’s future objectives and strategies for achieving them
● Actions of competitors
● Economic variables e.g. exchange rates, interest rates, taxation
Business plan consists of:
Circumstances where sales forecast are likely to be inaccurate:
❏ Business’s aims and objectives
❏ Plans to repay debts
● When a business is new so it’s difficult to interpret its sales data
❏ Cash flow forecast
● Demand is highly sensitive to changes in price and income elasticity
❏ Sales forecasts
● Significant changes in market share e.g. new market entrants
● Market subject to significant distribution from technological change.
+ Increases chances of obtaining external finance as a good plan proves the owners have done their research
+ Allows closer inspection of the various business area and identify any gaps in information
Sales volume = number of units sold in a given time period (sales revenue/selling price)
+ Reduces risk as it forces the entrepreneur to consider all factors that could cause the business idea to succeed or fail
+ Encourages analysis of the competitive position of the business and the market attractiveness
Sales revenue = amount of money coming into a business from the sale of goods or services (quantity sold x selling price)
+ Helps determine the amount and type of finance required
- Only a plan, reality likely to be different
Profit = sales revenue - total costs
- Dangers of becoming stuck on a plan
- Dangers of inflating revenue and deflating costs
Fixed costs: costs that do not vary directly with the level of output e.g. rent
Cashflow forecast: the flow of cash into and out of a business over a set period of time. A business will monitor cash flow to ensure it’s
Variable costs: costs which vary directly with the level of output e.g. raw materials
able to meet day to day expenses or put in place a provision such as an overdraft to allow for this
Total variable costs = quantity x variable cost per unit
+ Identifies potential shortfalls in advance
+ Makes sure that the business can afford to pay suppliers and employees
Total costs = fixed costs + variable costs
+ Heps to spot problems with customer payments
+ Provides reassurance to investors and lenders that the business is being managed properly
Break even point: point at which total revenue equals total costs meaning the business is neither making a profit or loss
- Poor cash flow forecast may lead to a usinees running out of and could become insolvent
- Difficult to create as businesses exist in dynamic markets where circumstances can change suddenly and frequently
Break even point (units) = total fixed costs/contribution per unit (selling price per unit - variable costs per unit)
- Lots of experience and research into the market is required to create an accurate forecast
Break even point (revenue) = break even point in units x price
Poor cash flows happen due to:
Total contribution = contribution per unit x quantity sold
● Sales prove lower than expected/costs prove higher than expected
● Customers don't pay up on time
Break even analysis:
● Over trading means there’s too much stock
● No cash flow forecasting therefore poor business management
+ Useful tool for management - influences decisions on whether new products are launched or not
+ Allows to predict future profit levels and set goals and targets accordingly = provides a target to work towards
Solutions to cash flow problems:
+ Can be used to set prices
+ Data generated can be used in business plan to obtain bank loans
1. Rescheduling payments
+ Simple planning tool which sets a target level of sales which must be reached in order for a firm to be profitable
+ Increase speed of receiving cash inflow = may lose sales
- Based on predicted data not actual data - information may be unreliable
+ Decrease speed of paying cash outflows = may damage relationship
- It’s a static model - it doesn’t take sales trends into account
2. Increase cash inflows: - Has limited use because of the many unrealistic assumptions made
+ Run a marketing campaign to increase sales = increased costs ➔ One same price used
+ Increase selling price = reduced sale ➔ No waste
➔ All units produced are sold
3. Sources of finance
