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Finance and Financial Management

Subject: Business Studies
Topic: 2
Cambridge Code: 0264 / 0450 / 7115

Sources of Finance​

Internal Sources​

Retained Profit - Money kept in business

  • No interest payments
  • No dilution of ownership
  • Limited availability

Sale of Assets - Selling off business assets

  • Quick cash
  • May harm operations
  • One-time source

External Sources (Short-term)​

Bank Overdraft - Negative account balance

  • Quick access
  • High interest rates
  • Repayable on demand

Trade Credit - Payment terms from suppliers

  • Delayed payment (30-90 days)
  • No interest (usually)
  • Builds relationships

External Sources (Long-term)​

Bank Loans - Fixed sum borrowed

  • Fixed interest rate
  • Defined repayment period
  • Security often required

Mortgages - Loans secured on property

  • Lower interest rate
  • Long repayment period (15-30 years)
  • Tied to property value

Share Capital - Selling company shares

  • No repayment required
  • Share ownership diluted
  • Cash injection for growth

Debentures - Bonds, loan certificates

  • Fixed interest rate
  • Secured against assets
  • Long-term finance

Cash vs Profit​

Profit​

Profit=Revenue−Costs\text{Profit} = \text{Revenue} - \text{Costs}

  • Accounting concept
  • Calculated over period
  • Matches income and expense timing

Cash​

Actual money in bank

  • Physical concept
  • Timing differences
  • Can be positive while losses occur

Difference Scenario​

Business sells on credit (invoice):

  • Profit: Recorded immediately
  • Cash: Received later
  • Timing gap: Days to months

Cash Flow Problems​

Cash flow crisis - Cannot pay bills despite profitability

Causes​

  1. Slow customer payments - Credit terms too generous
  2. High inventory - Too much stock tied up
  3. Seasonal demand - Uneven cash throughout year
  4. Large upfront costs - Equipment, premises
  5. Rapid growth - Needs more working capital

Solutions​

  • Improve debt collection
  • Reduce inventory levels
  • Negotiate better payment terms
  • Short-term loans/overdraft
  • Factoring (sell debts at discount)

Working Capital​

Working Capital=Current Assets−Current Liabilities\text{Working Capital} = \text{Current Assets} - \text{Current Liabilities}

Current Assets: Cash, inventory, receivables Current Liabilities: Payables, overdrafts

Management​

Too little working capital: Cannot pay bills, business fails

Too much working capital: Money wasted not earning returns

Optimal balance: Sufficient to operate smoothly

Improving Working Capital​

  • Reduce payment time to suppliers
  • Speed up customer payments
  • Reduce inventory
  • Manage seasonal variations

Budgeting​

Budget - Financial plan for period

Types​

Revenue Budget - Forecast sales

  • Based on historical data
  • Market conditions
  • Price changes

Expenditure Budget - Expected costs

  • Variable costs (material, labor)
  • Fixed costs (rent, salaries)
  • Capital expenditure

Cash Budget - Monthly cash flow forecast

  • Inflows: Sales, loans
  • Outflows: Payments, wages
  • Closing balance

Uses​

  • Planning and control
  • Identifying problems early
  • Motivating staff
  • Resource allocation

Variances​

Budget variance - Actual vs budgeted amount

Variance=Actual−Budgeted\text{Variance} = \text{Actual} - \text{Budgeted}

  • Favorable: Better than budget
  • Unfavorable: Worse than budget

Break-even Analysis​

Break-even point - Output where revenue equals total costs

Break-even=Fixed CostsContribution per unit\text{Break-even} = \frac{\text{Fixed Costs}}{\text{Contribution per unit}}

where Contribution = Selling price - Variable cost per unit

Importance​

  • Minimum production needed
  • Profit determination
  • Pricing decisions
  • Risk assessment

Margin of Safety​

Margin of Safety=Expected sales−Break-even sales\text{Margin of Safety} = \text{Expected sales} - \text{Break-even sales}

  • Higher margin = More secure
  • Lower margin = Risky

Costs and Pricing​

Fixed Costs​

Costs that don't change with output

  • Rent, insurance, salaries
  • Must be paid regardless

Variable Costs​

Costs that change with output

  • Raw materials, packaging
  • Zero if no production

Total Cost​

Total Cost=Fixed Cost+(Variable Cost × Output)\text{Total Cost} = \text{Fixed Cost} + \text{(Variable Cost × Output)}

Pricing Strategies​

Cost-plus: Cost + markup percentage

  • Simple, ensures profit
  • Ignores competition

Competitive: Based on market price

  • Customer-focused
  • Risk if costs too high

Penetration: Low price to gain market share

  • Attract customers
  • Build brand

Premium: High price for quality/brand

  • Higher profit per unit
  • Limited market

Key Points​

  1. Internal vs external finance sources
  2. Cash and profit are different
  3. Working capital = Current assets - liabilities
  4. Budgets plan and control spending
  5. Break-even shows minimum sales needed
  6. Fixed + variable costs = total cost
  7. Pricing strategies depend on objectives

Practice Questions​

  1. List sources of finance and advantages/disadvantages
  2. Calculate break-even point
  3. Prepare cash flow forecast
  4. Analyze variance from budget
  5. Calculate working capital
  6. Recommend pricing strategy

Revision Tips​

  • Know finance sources and uses
  • Understand cash vs profit
  • Learn budgeting process
  • Practice break-even calculations
  • Know pricing strategies
  • Understand working capital importance