Business Unit 5

Business Finance
Working capital:
The day-to-day finance needs for the business, also can be calculated as
Current assets less current liabilities.
Can be managed by
Managing inventory, trade payable and receivable.
 Lower inventory levels

 Efficient inventory control
 Delaying payments to increase credit period

 Buying from ones who offer credit
 Selling in cash and no credit

 Reducing credit period
Sources of finance
Internal source and external source
Internal
 Retained Earning
 Sale of unwanted assets
 Reduce working capital
Evaluation:
It does not have risks but it does not support rapid expansion.
Short-term external
 Bank overdraft – to allow payment that the amount is larger than the balance.
With interest rate and need reputation.
 Trade Credit – Delaying the payment to suppliers to maintain finance.

 Debt factoring – Sell the company’s trade receivable to a debt factor, then the company
receives the money but less than the original amount.
Long-term external
 Hire Purchase – Credit for purchasing an asset over time, this avoids making a large
initial cash payment.
 Leasing- A contract to acquire an asset but not actually to purchase it with regular
payment. This will avoid high amount of cash to purchase it and reduce the unconvience
to repair, maintaining it.
 Bank Loans- Fixed interest rate.
 Debentures- Similar to bank loan, Company could sell debentures to investors, and pay
agreed interest rate annually, no collateral security will be required.
 Business Mortgages: Loans that offered to businesses when it is going to purchase
premises, secured by the assets.
Finance for unincorporated businesses:
 Bank loan
 From families, friends
Factors influencing the tools of finance:
 How is it needed and the time period:
Using long term finance to pay short term needs is risky
 Cost
Loans, equity finance, selling shares all have costs.
 Amount required
 Wants in business control
Cash Flow Forecast

Benefits:
 Show negative closing cash flow, indicates where needs additional finance to be
injected.
 Essential for start-up businesses for letting investors to be able to access cash flow
forecast.
Limitations:
 Mistakes can be made

 Incorrect assumptions may bring inaccuracy.
Causes of cash flow problems:
 Poor credit control
The record on which costumer is paying on time and not paying on time Is vital in
recording trade receivables, bad record will make the business’ cash flow inaccurate.
 Expanding too quickly
The business has to pay for the expansion and for increased wages and material costs,
and this will contribute to cash flow shortage until the returns are received.
Improve by managing trade receivables:
 Not giving credit

 Research on creditworthy before trade
 Offer discounts to those who pay on time
Improve by managing trade payables:
 Purchase on credit
 Extend credit
Costs
Type of costs
 Direct costs
They are directly linked to production, common direct costs for manufacture business
are labor and materials.
 Indirect costs/overheads
They are incurred by the business but cannot easily be divided up between cost
centers.
 Fixed costs
They don’t change with the output level changes. E.g., Rent
 Variable costs
They change with the output level changes. E.g., materials
Labor costs are hard to identify because sometimes even when they are unoccupied, business
still choose to pay them in the short run.
 Costs centers:
Those sections that cost the business in order to produce revenue.
e.g., Hotel: restaurant, bar, reception
 Profit centers:
e.g., Branches of a chain of shop.
Benefits of using them:
 Assessing the performance of each center and make decision about the future.
Measurement of cost
1. Full Costing
Add direct cost and overheads / units produced = Average cost per unit
When there is more than one product produced, the overheads cost should be allocated
differently depends on the proportion of direct costs.
 Good for business that only produce one product.

 All costs are allocated
 Can be compared overtime
 Inappropriate methods to calculate overheads can make inaccuracy.
 Must use the same method to calculate overheads if want to compare
 Can be risky to use it to make decisions
2. Contribution Cost
Contribution is how many revenues is generated when there is an extra unit
produced minus the marginal cost. (Indirect cost is not considered!!)
Situations where it is used:
 Decisions on the product is based on its contribution, not profit.

 Special order decisions.
Situations where it is not used:
 During expansion, all the costs have to be considered.

 Where some products may result higher indirect cost than others.
Break even analysis

Break Even Level of Output = Fixed cost/Contribution per unit
Margin of Safety = Current output – Break Even Point

Budget
Benefits:
 The budgeting process let managers to consider future plan carefully and
realistically as there is a spending limit.
 An effective way to let business not to spend unnecessarily money, effective
allocation of resources.
 People will work better if they have a target to aim.
Drawbacks:
 Focus on the short term. E.g., cutting labor in order to stay in the budget won’t
benefit long term.
 Training cost on budgeting.
 Unnecessary spending.
Variance
Variance is the difference between the budget level and the real revenue level.
Causes of Adverse:
 Competition, low demand.

 Raw material cost increased
 Labor cost increased
 Higher rent

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Business Finance

Current assets less current liabilities.

Managing inventory, trade payable and receivable.

 Lower inventory levels

 Delaying payments to increase credit period

 Selling in cash and no credit

Internal source and external source

With interest rate and need reputation.

 Trade Credit – Delaying the payment to suppliers to maintain finance.

Finance for unincorporated businesses:

Factors influencing the tools of finance:

 How is it needed and the time period:

Using long term finance to pay short term needs is risky

Loans, equity finance, selling shares all have costs.

Cash Flow Forecast

 Mistakes can be made

Causes of cash flow problems:

 Poor credit control

 Expanding too quickly

Improve by managing trade receivables:

 Not giving credit

Improve by managing trade payables:

They change with the output level changes. E.g., materials

Those sections that cost the business in order to produce revenue.

e.g., Hotel: restaurant, bar, reception

Benefits of using them:

 Good for business that only produce one product.

Contribution is how many revenues is generated when there is an extra unit

produced minus the marginal cost. (Indirect cost is not considered!!)

Situations where it is used:

 Decisions on the product is based on its contribution, not profit.

Situations where it is not used:

 During expansion, all the costs have to be considered.

Break even analysis

Margin of Safety = Current output – Break Even Point

 Competition, low demand.

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