Chap22.

Business Finance: Needs,

Sources & Decisions
1. Why Do Businesses Need Finance?
●​ To Start a Business – Buying land, premises, equipment, advertising.
●​ To Expand – Purchasing more land, upgrading machines, opening new shops.
●​ To Run Day-to-Day Operations (Working Capital) – Paying wages, purchasing raw
materials.

2. Short-Term vs. Long-Term Finance

●​ Long-Term Finance (>1 year): Used for expansion, large purchases, and capital
expenditure (e.g., buying land, machinery).
●​ Short-Term Finance (<1 year): Used for day-to-day operations and working capital
management.

3. Capital Expenditure vs. Revenue Expenditure

●​ Capital Expenditure: Money spent on fixed assets (e.g., buildings, machinery) to
increase capacity or efficiency.
●​ Revenue Expenditure: Money spent on operational costs (e.g., rent, wages,
maintenance).

4. Sources of Business Finance

Internal Sources (From Within the Business)

●​ Owner’s Investment: Personal money from the business owner.

●​ Retained Profits: Profits kept aside for future use (does not need to be repaid).
●​ Selling Assets: Selling old machinery, unused buildings.
●​ Selling Inventory: Selling stock to free up cash and reduce storage costs.

External Sources (From Outside the Business)

●​ Selling Shares: Raising capital by selling ownership (no repayment needed but leads to
loss of control).
●​ Bank Loans: Borrowing from banks with interest (quick but must be repaid).
 ●​ Government Grants: Free money from the government (no repayment but strict
eligibility).
●​ Debt Factoring: Selling invoices to a company to get cash quickly (but lose part of the
value).

5. Alternative Sources of Finance

●​ Microfinance: Small loans for individuals or small businesses without bank access.
●​ Crowdfunding: Raising funds from many people via social media or crowdfunding
platforms.

6. Factors Considered in Financial Decisions

●​ Purpose of Finance (e.g., buying land vs. paying wages).
●​ Timeframe Needed (short-term vs. long-term).
●​ Amount of Money Required.
●​ How Quickly Finance is Needed.
●​ Cheapest Available Option.
●​ Legal Considerations.

Chap22. Cash Flow Forecasting and Working Capital –

Key Points
1. Importance of Cash and Cash Flow Forecasting

●​ Cash is a liquid asset immediately available for business operations.

●​ It includes physical currency, bank deposits, undeposited checks, and easily
convertible assets.
●​ Businesses need cash for:
○​ Paying employees
○​ Buying stock/raw materials
○​ Covering rent and operational expenses

2. What Happens if a Business Has No Cash?

●​ Golden Rule: Never run out of cash.

●​ Problems include:
○​ Inability to pay employees and suppliers → production stops.
 ○​ Business may have to liquidate (sell assets to pay debts).
○​ Risk of business closure.

3. Understanding Cash Flow

●​ Definition: The total amount of money moving into and out of a business over a
period of time.
●​ Cash Inflows (Money Coming In):
○​ Revenue from product/services sales
○​ Investments
○​ Bank loans
○​ Sale of assets
○​ Capital raised from selling shares
●​ Cash Outflows (Money Going Out):
○​ Purchasing stock or inventory
○​ Employee wages and salaries
○​ Buying assets (machinery, buildings, equipment)
○​ Loan repayments
○​ Paying dividends

4. Cash Flow Cycle (Cash Conversion Cycle - CCC)

●​ Measures how quickly a business converts its products into cash.

●​ Shorter cycles = More working capital & less borrowing.
●​ Cycle:
○​ Business pays suppliers → Produces goods → Sells goods → Receives
cash from customers.
○​ Repeats in a continuous loop.

5. Cash Flow Forecast

●​ Definition: A plan showing expected cash inflows and outflows over a period.
●​ Formula to Remember:
○​ Net Cash Flow = Cash Inflows – Cash Outflows
●​ Uses of Cash Flow Forecast:
○​ Ensures the business can afford expenses.
○​ Helps secure bank loans.
○​ Aids in managing financial health.

6. Interpreting a Cash Flow Forecast

 ●​ The closing balance of one month becomes the opening balance of the next.
●​ Negative net cash flow (more outflows than inflows) is problematic.
●​ Businesses should aim for positive net cash flow to remain financially stable.

7. Overcoming Short-Term Cash Flow Problems

●​ Delay supplier payments (but not too long to avoid supply disruptions).
●​ Ask debtors to pay faster (request early payments).
●​ Apply for a bank loan (but consider interest costs).
●​ Delay/cancel new equipment purchases (reduces cash outflow).
●​ Buy supplies on credit (but might lose supplier discounts).
●​ Only sell in cash, not credit (ensures immediate income but may lose
customers).

8. Understanding Working Capital

●​ Definition: The money available to cover daily business operations.

●​ Formula:
○​ Working Capital = Current Assets – Current Liabilities
●​ Examples of Current Assets:
○​ Cash, accounts receivable, inventory.
●​ Examples of Current Liabilities:
○​ Payroll, taxes payable, bank overdrafts.
●​ Why is Working Capital Important?
○​ Pays employee wages and day-to-day costs.
○​ Ensures the business runs smoothly without cash shortages.

9. Final Tips

●​ Businesses shouldn’t keep too much cash in the bank – better to reinvest it.
●​ Working capital is essential for stability – without it, a business cannot survive.

CHAP24,25. INCOME STATEMENT

Importance of Profit to Private Sector Businesses

●​ Source of Finance – Needed for growth.
●​ Business Expansion – More profit means scaling opportunities.
 ●​ Repayment of Debts – Helps in managing loans and mortgages.
●​ Innovation & Development – Leads to the creation of new products (e.g., Apple
expanding into watches and tablets).

How is Profit Made?

●​ Selling at a Higher Price than Purchase Price

●​ Reducing Costs (e.g., operational expenses)
●​ Increasing Sales Volume
●​ Raising Product Prices (if market allows)
●​ Avoiding Discounts (which can reduce trust and profits)
●​ Finding Cheaper Suppliers (to cut costs)

Difference Between Profit and Cash

●​ Cash is like air – needed for daily operations.
●​ Profit is like food – not always required daily but essential long-term.
●​ Cash = Money available for immediate use.
●​ Profit = Money left after expenses.
●​ A business can be profitable but have no cash and vice versa.

Income Statement (Profit and Loss Statement)

Reports a company’s financial performance over a specific period (e.g., one year).

Main Features of an Income Statement:

●​ Revenue = Selling price × Quantity sold

●​ Gross Profit = Sales Revenue - Cost of Sales
●​ Cost of Sales = Costs involved in selling and handling products.
●​ Net Profit = Gross Profit - Operating Expenses
●​ Retained Profit = Profit kept for business use.

Statement of Financial Position (Balance Sheet)

A snapshot of a company’s assets, liabilities, and equity at a specific point in time.

Main Elements of a Balance Sheet:

Assets (What the business owns)

●​ Tangible Assets – Buildings, equipment, land, inventory.

●​ Intangible Assets – Brand name, software, patents.
●​ Current Assets – Cash, accounts receivable, inventory.
●​ Fixed Assets – Long-term assets like property and machinery.

Liabilities (What the business owes)

●​ Short-term Liabilities – Bank overdrafts, accounts payable.

●​ Long-term Liabilities – Mortgages, loans, bonds.

Equity (Owners’ Investment & Retained Earnings)

●​ Share Capital – Money invested by shareholders.

●​ Retained Earnings – Profit kept in the business.

Difference Between Balance Sheet and Income

Statement
●​ Balance Sheet = Reports assets, liabilities, and equity at a specific point in time.
●​ Income Statement = Reports revenue and expenses over a period to determine
profit/loss.

26.Analysis of Accounts
Analysis of accounts occurs whenever a financial transaction or statement is
broken into component parts and examined in detail to gather information or gain
a better understanding of a business’s financial health.

Most financial analysis focuses on:

 ●​ Identifying trends
●​ Evaluating business performance
●​ Pinpointing unusual or suspicious transactions

Being able to conduct in-depth account analysis is a fundamental skill that every
small business owner should develop.

What is Ratio Analysis?

Ratio analysis is a quantitative analysis of information found in a company’s
financial statements. It is used to evaluate various aspects of a company’s
operational and financial performance, such as efficiency, liquidity, and
profitability.

In this lesson, we will focus on two types of ratios:

●​ Profitability Ratios
●​ Liquidity Ratios

Profitability Ratios
Profitability ratios measure a company’s ability to generate profit relative to its
revenue, assets, or capital. These are crucial for investors and business owners.

Key Profitability Ratios:

1.​ Return on Capital Employed (ROCE)
○​ Definition: Measures how efficiently a company generates profit
from its capital employed.
○​ Formula:
○​ If capital employed is not given, calculate it as:
2.​ Gross Profit Margin
○​ Definition: Measures how much profit remains after deducting the
cost of goods sold (COGS).
○​ Formula:
 3.​ Net Profit Margin
○​ Definition: Measures the percentage of revenue left after all
operating expenses, interest, taxes, and preferred stock dividends.
○​ Formula:

Liquidity Ratios
Liquidity ratios assess a company’s ability to pay off its short-term liabilities using
its assets.

Key Liquidity Ratios:

1.​ Current Ratio
○​ Definition: Measures the number of current assets available for
every current liability.
○​ Formula:
○​ A ratio above 1 is necessary for financial stability.
2.​ Acid Test Ratio (Quick Ratio)
○​ Definition: Similar to the current ratio but excludes inventory as it
may not be quickly converted into cash.
○​ Formula:

Users of Accounts
Users of accounts can be categorized as internal or external.

Internal Users:
1.​ Managers - Use accounts to analyze company performance and take
strategic actions.
2.​ Employees - Assess financial stability for job security and wages.
3.​ Owners/Shareholders - Evaluate the profitability and viability of their
investment.
External Users:
1.​ Creditors - Assess creditworthiness before offering loans or credit.
2.​ Tax Authorities - Verify tax credibility and compliance.
3.​ Investors - Evaluate financial health before investing.
4.​ Customers - Ensure supplier stability for long-term business relationships.

Limitations of Ratio Analysis

1.​ Based on Past Data - Does not indicate future performance.
2.​ Limited Data for External Users - External users only access published
accounts, missing internal details.
3.​ Inflation Effects - Changing prices can make comparisons misleading.
4.​ Different Accounting Practices - Companies use different accounting
methods, making comparisons unreliable.