The management of business finance
In this unit I am going to show my understanding of the management of business finance. I will also investigate the sources of finance available to businesses and how to interpret the use of financial information for decision-making. Sources of Finance The core aim of any business is to survive, additionally, it may have other goals such as to make a profit or improve or expand the products or services it provides to satisfy stakeholders, either way, it will need to control its financial resources to do this.
By collecting all the available financial information and recording it into various accounts, a business can assess how well it is performing. This is important both for a business internally as well as externally. Financial resources are needed throughout a company’s life. The type and amount of finance depends on many factors e. g. type of business, the success of the firm, the economy of the state etc. There are two main types of financial resources that a firm needs. This is:
o Capital Expenditure~ this is used for buying fixed assets where large sums of money are involved and needed but this is not used for buying property or new premises o Working Capital~ this is the money used for the day to day running of the business like petty cash When these means are not enough, or the business is not making a quick enough turnover for the business to expand, other sources of finance may be considered that are essential to fill that cleft. Short Term Sources (0-2 years)
Short-term sources are usually to cover short-term orders or bulk orders that businesses take on that working capital can’t cover and is needed for a brief period of time. These are: o Overdraft~ if a business spends more money then it has in its bank account, we say that it is overdrawn. Businesses usually have an arrangement with the bank whereby the bank will pay the extra money provided the business will pay them back in a fairly short period of time with interest. The advantage of this source is swift availability of the funds.
The disadvantages on the other hand are the expensive costs if this use is miscalculated in interest rates and bank charges. o Factoring~ businesses are often owed money and can find difficultly in collecting its debts from its customers but may need to get its hands on the money very quickly. A special factoring company may offer to handle the debt collection process for a charge. The factoring company pays the business most of the value of the debt first and would then collect the money from the debtor. The advantage of course of this method like above is the prompt availability of cash.
Other benefits to this method are the saving of time, effort, resources and hassle in the debt collecting process. The disadvantages to this method are that factoring organisations would only however, take on client companies with an annual turnover of i?? 50 000 or more and take 5% of the owed balance on your companies’ debt. o Trade Credit~ unlike me for example, a business does not normally pay for things before it takes possession of them. Instead, it will usually place an order for supplies and pay after receiving them.
Usually payment is received within one month of purchases as this is considered good supplier relations. The advantages of this method is supplier relations as mentioned, allows cash to be freed up for a short period of time to cover other costs but with an added benefit of interest free credit like a credit card company gives before a payment is required. Payment days can be negotiated up to 90 days meaning these new terms could allow a business to have up to three months interest free credit to pay off its debts.
In these circumstances good company credit is usually required, a good company profile e. g. strong sales, customer base etc, and good relations with the supplier are a must. The disadvantage are supplier relations can be tarnished if a business starts to have cash flow problems and finds It hard to pay its creditors, causing bad debts to form which could make the company black listed and have to look for other sources to pay off those debts. o Retained Profit~ this is the money left over at the end of the trading year.
If the company has been successful enough to make a profit after taxes and overheads, it may choose to use this revenue to fund future activities. This can be a useful source of finance providing the company makes a profit every year. The advantages are no fees or charges payable and shareholders are likely to be pleased with businesses that put money back into the business for further growth. The disadvantages are that if emergencies or other financial priorities arise where retained profit could have been used, other sources have to be considered.
Also, this option is only available to business trading more then one year. o Savings~ this method is mainly used by sole traders and partnerships. This is when the owners use their own money usually savings to invest as capital into the business. The advantages are the quick access to cash and the idea of knowing the investment will benefit those closest to them and no initial charges. The disadvantages are investors can lose the money the put into the business, a dividend or interest may be payable when the balance is due back to the investor, they can also have no guarantee and feel pressured to give the investment.
Medium Term Sources (2-5 years) Medium term sources are usually used for paying for machinery, vehicles or business assets that the business need now, can’t currently afford to pay for, but can over a long period. These are: o Bank Loan~ this is the large sums of money borrowed from banks or building societies. A loan is useful for a business that is starting up or looking to grow. Loans are often used to buy fixed assets such as machinery or assets. The business will pay back the loan in monthly instalments with interest.
The advantage to this is the large sums of money that can be granted and the quickness of decisions. The disadvantages are the preparation needed with bank meetings such as business plans, time and resources. The interest added to a loan and the fact that this sort of resource is outside of the businesses control that can seriously affect the businesses performance is another disadvantage. o Hire Purchase~ this involves paying for equipment in instalments. The business will not own the items purchased until the full payment has been made.
The advantages to this method are the business can have the items needed straight away and also allows cash to free up for other things, as a large amount is not being paid out all at once. The disadvantages to this method are it can work out very expensive to buy items this way and if loan repayments are not met, the items can be reposed to cover the outstanding balance. o Lease Purchase~ leasing involves business renting equipment that it may use for a few months or many years, but never own. This is used for photocopiers or photographic equipment, particularly in colleges and schools.
The advantage to this method is all breakdowns and services are covered in the leasing cost, and also the deal may include replacing the product or a newer model every so often. The disadvantages to this method are the business never owns the item, but this could be classed as an advantage in terms of repair costs, if the item in hand has a high repair rate, like photocopiers and also it is never an asset to the business, therefore will never show on the balance sheet, so they don’t boost the value of the company. o Sale ; Leaseback~ this is when an asset is sold and rented back from the buyer.
Football stadiums, property, head offices are examples of this. The advantages to this are the substantial amount of cash this provides companies to put into other areas, usually growth and expansion and still have the use of the site. The disadvantages are the loss of the asset and high rents payable. Long Term Sources (5 years +) Long-term sources are usually used by established companies to invest in major company changes, For example, the development of new sites, purchasing property, improvements and changes etc.
o Bank Loan~ a bank loan can be for longer periods of time of up to 20 years or more in some cases. (See medium term sources) a Debenture is the long term equivalent to a bank loan for PLC’s only. It is only borrowed form special bodies and paid over long periods of time usually several years. o Mortgages~ are usually provided by building societies but, nowadays banks are more often offering them and the difference between banks and building societies are narrowing. A mortgage is a special type of loan used to buy property.
Mortgages can be offered at fixed or variable rates and can be up to 25 years long to pay back. The advantages are mortgages are a great way for businesses to get on the property ladder, they allow large sums of money to be used at lower interest rates then short term sources. They’re an asset to the business, so if the value of the building goes up, so does the value of the business. The disadvantages are if variable rate mortgage is taken out, if interest rates are high, so are repayments on the property.
o Shares~ (see fig 1. 1 for share process diagram) are an important source of finance for limited companies. A business selling new shares that entitle the shareholders to share in the control of the business. Each share gives the shareholder a vote on the direction of the company. The advantages to this method are the substantial amounts of cash that can be raised, can make directors and mangers work harder as they can be voted off the company.
The disadvantages are only PLC’s can issue shares to the public, some aspects of control are lost in this process and if the directors have a different idea to the shareholders in the direction the company should go in, it could lead to problems, particularly if shareholders own the bigger share in the organisation. o Venture Capital~ a group of people who join together and provide finance for new business that are just starting up. These individuals look for promising businesses and put investments into them. This is similar to share issuing. (See share for pro’s and con’s of method. )