Finances for starting up

Businesses need financae (money) for various reasons, such as starting up, expanding, or covering day-to-day expenses. There are two main categories of finance sources:

• Internal Finance: Money raised from within the business.
• External Finance: Money raised from outside sources.

Internal Sources of Finance

• Personal Savings: Often the first source of finance for new businesses. This is money the owner has saved up.
• Retained Profit: Profit from previous years that has not been distributed to shareholders.
• Sale of Assets: Businesses can sell assets they no longer need (e.g., old equipment) to raise funds. You can also sell company shares to new or old investors or be publically traded.

External Sources of Finance

• Family and Friends: This can be a loan or an investment in the business.
• Bank Loans: A common way to raise money, especially for established businesses. The bank charges interest on the loan.
• Overdrafts: Allows businesses to spend more money than they have in their bank account, up to an agreed limit. Interest is charged on the overdraft.
• Venture Capital: Investment from individuals or companies specializing in financing new, high-risk businesses with growth potential. Venture capitalists often want a share of the business and a say in its management.
• Business Angels: Wealthy individuals who invest their own money in start-ups and early-stage businesses. They may also offer advice and guidance.
• Share Capital: Selling shares of ownership in the company to investors. This is a way for limited companies (Ltd or PLC) to raise a large amount of capital.
• Crowdfunding: Raising small amounts of money from a large number of people, typically via the internet.

Factors Affecting the Choice of Finance

• Cost: Some sources of finance are cheaper than others. For example, a loan from family or friends might have a lower interest rate than a bank loan.
• Risk: Some sources of finance, like bank loans, can put the business in debt if not managed properly.
• Amount: Some sources are better suited for raising small amounts of money (e.g., crowdfunding), while others are better for larger amounts (e.g., share capital).
• Control: Some investors may want a say in how the business is run, which could be a disadvantage for the owner.

Important Considerations

• Purpose of finance: Different sources are suitable for different purposes. For example, a bank loan might be good for buying equipment, while share capital might be better for expanding the business.
• Financial situation of the business: New businesses with no trading history may find it difficult to get a bank loan.
• Legal structure of the business: Sole traders and partnerships have fewer options than limited companies.

Additional Notes

• Hire Purchase: A way to buy an asset by paying in installments. The business doesn’t own the asset until the final payment is made.
• Leasing: Renting an asset rather than buying it. This can be useful for expensive equipment that the business may not need to own outright.

Finances for growth and operation

Established businesses need finance for various reasons, including managing day-to-day operations, investing in growth opportunities, or dealing with unexpected challenges.

Internal Sources of Finance

• Retained Profit: This remains a crucial source for existing businesses. Accumulated profits can be reinvested for expansion, new product development, or improving existing operations.
• Sale of Assets: Businesses can sell unused or underutilized assets (e.g., surplus land, old equipment) to raise capital for expansion or new ventures.
• Debt Factoring: Selling unpaid customer invoices to a third party (factor) at a discount. This provides immediate cash flow but at a cost.

External Sources of Finance

• Bank Loans: Established businesses with a good credit history can often secure larger loans or favorable terms for expansion or to cover operational expenses.
• Overdrafts: Can be useful for managing short-term cash flow fluctuations or to cover unexpected expenses during expansion.
• Additional Share Capital: Limited companies can issue more shares to existing shareholders or new investors to raise substantial capital for growth projects.
• Corporate Bonds: Companies can issue bonds, which are essentially loans from investors. This is a way to raise large sums, but interest payments are required.
• Venture Capital and Business Angels: While typically associated with start-ups, venture capital and business angel investment can also be available to established businesses with high growth potential or those venturing into new markets.
• Government Grants and Subsidies: Governments sometimes offer financial incentives to businesses for specific purposes, such as research and development, exporting, or creating jobs in certain areas.

Factors Affecting the Choice of Finance

• Cost: Interest rates, fees, and potential dilution of ownership (in the case of share capital) are key considerations.
• Risk: Debt increases a business’s financial obligations and can lead to difficulties if not managed carefully.
• Flexibility: Overdrafts and certain types of loans offer more flexibility than long-term commitments like bonds.
• Speed: Debt factoring or bank loans can provide quick access to cash, while issuing shares or bonds can take longer.
• Purpose: The specific financial need (e.g., working capital, equipment purchase, new product launch) will influence the choice of finance.

Important Considerations

• Financial Health of the Business: A strong track record and good financial performance will make it easier to attract favorable financing options.
• Market Conditions: Economic conditions and investor sentiment can affect the availability and cost of different sources of finance.
• Exit Strategy: If external investors are involved, businesses need to consider how they will eventually repay or provide a return on investment.

Additional Notes

• Refinancing: Replacing existing debt with new debt under different terms, often to secure lower interest rates or better repayment conditions.
• Initial Public Offering (IPO): Going public by listing shares on a stock exchange can raise significant capital but involves greater scrutiny and regulatory requirements.

Choosing the right sources of finance for continuing trades and expansion requires careful consideration of various factors and aligning the financing strategy with the overall business goals.

Debit and Credit

Credit, debt, and payment terms are fundamental concepts in business finance, impacting cash flow, profitability, and relationships with suppliers and customers.

Credit and Creditors

• Credit: The ability to obtain goods or services before payment, based on the trust that payment will be made in the future.
• Creditor: An individual or business that provides credit (lends money or allows delayed payment) to another party.

Advantages of Using Credit for Businesses

• Improved Cash Flow: Allows businesses to purchase necessary goods or services even when immediate cash is not available.
• Builds Relationships with Suppliers: Regularly paying on credit can establish trust and lead to better deals or more favorable terms.
• Opportunity for Growth: Credit can finance expansion, inventory purchase, or marketing efforts without depleting current funds.

Disadvantages of Using Credit for Businesses

• Interest Charges: Most forms of credit come with interest charges, increasing the overall cost of goods or services.
• Risk of Debt: Mismanagement of credit can lead to accumulating debt, impacting profitability and potentially damaging creditworthiness.
• Potential for Overspending: The availability of credit can tempt businesses to spend beyond their means, leading to financial difficulties.

Debt and Debtors

• Debt: The amount of money owed by one party (the debtor) to another party (the creditor).
• Debtor: An individual or business that owes money to another party.

Types of Debt

• Short-Term Debt: Typically due within one year, often used for working capital needs or short-term financing. Examples include bank overdrafts, trade credit, and short-term loans.
• Long-Term Debt: Due in more than one year, often used for larger investments like property, equipment, or business expansion. Examples include mortgages, bonds, and long-term loans.

Advantages of Debt for Businesses

• Retains Ownership: Unlike equity financing, debt allows businesses to raise capital without giving up ownership or control.
• Tax Deductible Interest: Interest payments on debt can often be deducted from taxable income, reducing the overall tax burden.

Disadvantages of Debt for Businesses

• Financial Risk: Debt carries the obligation to make regular interest payments and repay the principal amount, which can be a burden if cash flow is tight.
• Collateral Requirements: Secured debt may require the business to pledge assets as collateral, risking those assets in case of default.

Payment Terms

• Payment Terms: The conditions under which a buyer agrees to pay a seller for goods or services.

Common Payment Terms

• Cash in Advance: Payment is made before the goods or services are received.
• Cash on Delivery (COD): Payment is made upon delivery of the goods or services.
• Net 30, Net 60, etc.: Payment is due within a certain number of days after the invoice date.
• 2/10 Net 30: A 2% discount is offered if payment is made within 10 days, otherwise the full amount is due within 30 days.

Advantages and Disadvantages of Different Payment Terms

Payment Term	Advantage for Buyer	Disadvantage for Buyer	Advantage for Seller	Disadvantage for Seller
Cash in Advance	May get a discount	High risk, no guarantee of delivery	Eliminates risk of non-payment	May deter potential customers
Cash on Delivery	Ensures delivery before payment	May delay receiving goods/services	Lower risk than offering credit	Requires immediate payment system
Net 30, Net 60, etc.	Time to generate funds before payment	No discount for early payment	Improves cash flow compared to longer terms	Risk of late payment
2/10 Net 30	Incentive for early payment, improves cash flow	Pressure to pay quickly	Encourages prompt payment, improves cash flow	Reduced profit if discount is taken

Important Considerations

• Negotiation: Payment terms are often negotiable between buyers and sellers.
• Industry Standards: Some industries have typical payment terms, but these can vary based on specific agreements.

Understanding credit, debt, and payment terms is crucial for making informed financial decisions in business.

Cash flow

Cash flow is the movement of money in and out of a business. It is a crucial indicator of a business’s financial health and sustainability.

Key Terms

• Cash Inflow: Money coming into a business, such as from sales revenue, investments, or loans.
• Cash Outflow: Money going out of a business, such as payments for expenses like wages, rent, utilities, and inventory purchases.
• Net Cash Flow: The difference between cash inflows and cash outflows over a specific period.
• Cash Surplus: Occurs when cash inflows exceed cash outflows, resulting in a positive net cash flow.
• Cash Deficit: Occurs when cash outflows exceed cash inflows, resulting in a negative net cash flow.

Examples of Cash Inflows and Outflows

Cash Inflows	Cash Outflows
Cash sales	Purchase of inventory
Payments from debtors (customers who owe money)	Wages and salaries
Bank loans	Rent and utilities
Investments from shareholders	Loan repayments
Sale of assets	Tax payments
Grants and subsidies	Marketing and advertising expenses

Export to Sheets

Significance of Cash Flow Surplus and Deficit

• Cash Flow Surplus:
  • Advantages:
    • Indicates a healthy financial position.
    • Allows for investment in growth opportunities, such as new products, expansion, or marketing.
    • Provides a buffer against unexpected expenses or downturns in the market.
    • Can be used to repay debts or pay dividends to shareholders.
  • Disadvantages:
    • May indicate underinvestment in the business if the surplus is too large.
    • Could attract unwanted attention from competitors or potential takeover targets.
• Cash Flow Deficit:
  • Disadvantages:
    • Indicates a financial strain and potential difficulty meeting short-term obligations.
    • May require borrowing or selling assets to cover expenses, which can be costly and risky.
    • Can lead to insolvency if the situation is not addressed promptly.
  • Advantages:
    • Can be a temporary situation during periods of growth or investment.
    • May highlight areas where cost-cutting measures could be implemented.

Cash Flow Forecasting and Management

• Cash Flow Forecasting: A vital tool for businesses to predict future cash inflows and outflows. It helps businesses to:
  • Plan for future expenses and investments.
  • Identify potential cash shortages and take corrective action.
  • Secure financing if needed.
  • Make informed business decisions.
• Cash Flow Management: Involves monitoring and controlling the movement of cash to ensure sufficient liquidity to meet obligations and fund operations. Strategies for effective cash flow management include:
  • Offering discounts for early payment.
  • Tightening credit terms for customers.
  • Negotiating better payment terms with suppliers.
  • Efficient inventory management to avoid overstocking or stockouts.
  • Reducing unnecessary expenses.

Important Note: Profitability is not the same as cash flow. A business can be profitable on paper but still face cash flow problems if it has a lot of money tied up in accounts receivable (unpaid customer invoices) or inventory.

Understanding cash flow is essential for the success of any business. By carefully monitoring and managing cash flow, businesses can ensure they have enough liquidity to meet their obligations, invest in growth, and navigate challenging times.

Break even

Break-even analysis is a crucial tool for businesses to determine the level of sales needed to cover all costs and start making a profit. It helps in decision-making regarding pricing, production levels, and cost management.

Key Terms

• Break-Even Point (BEP): The level of output (in units or sales value) at which a business’s total revenue equals its total costs. At this point, there is neither profit nor loss.
• Fixed Costs: Costs that remain constant regardless of the level of output. Examples include rent, salaries, insurance, and depreciation.
• Variable Costs: Costs that change in direct proportion to the level of output. Examples include raw materials, direct labor, and packaging.
• Total Costs: The sum of fixed costs and variable costs.
• Contribution: The difference between selling price per unit and variable cost per unit. It represents the amount each unit sold contributes towards covering fixed costs and generating profit.
• Break-Even Chart: A graphical representation of the break-even analysis, showing the relationship between output, costs, and revenue.

Calculating Break-Even Point

• In Units:
  • BEP (units) = Fixed Costs / Contribution per unit
• In Sales Value:
  • BEP (sales value) = Fixed Costs / Contribution Margin Ratio
  • Contribution Margin Ratio = (Contribution per unit / Selling price per unit) x 100

How to Draw a Break-Even Chart

1. Label Axes: The horizontal axis represents output (in units), and the vertical axis represents costs and revenue (in currency).
2. Plot Fixed Costs: Draw a horizontal line representing fixed costs, as they remain constant at all levels of output.
3. Plot Total Costs: Start at the fixed costs line and draw a line that slopes upwards, representing the increasing total costs as output increases (due to variable costs).
4. Plot Revenue: Start at the origin (0,0) and draw a line that slopes upwards, representing the increasing revenue as output increases.
5. Identify Break-Even Point: The break-even point is where the total costs line and the revenue line intersect. This point indicates the level of output at which the business covers all its costs.
6. Margin of Safety: The difference between the actual output and the break-even output represents the margin of safety. It indicates how much sales can decline before the business starts incurring losses.

Interpreting Break-Even Charts

• The area below the break-even point represents the loss zone, where costs exceed revenue.
• The area above the break-even point represents the profit zone, where revenue exceeds costs.
• The steeper the revenue line, the higher the contribution per unit and the faster the business can reach profitability.
• The steeper the total costs line, the higher the variable costs per unit and the more sensitive the business is to changes in output.

Uses of Break-Even Analysis

• Pricing Decisions: Helps determine the optimal selling price to achieve desired profit levels.
• Production Planning: Helps decide the production level required to meet sales targets and avoid overproduction or underproduction.
• Cost Control: Helps identify areas where costs can be reduced to lower the break-even point and improve profitability.
• Risk Assessment: Helps assess the financial risk associated with different levels of output and market conditions.

Limitations of Break-Even Analysis

• Assumes Linearity: It assumes that fixed costs remain constant and variable costs change proportionally with output, which may not always be true in reality.
• Ignores Other Factors: It doesn’t consider other factors that can influence profitability, such as competition, market demand, and external economic conditions.
• Simplified Model: It’s a simplified representation of reality and should be used in conjunction with other financial tools and analysis.

Income Statement

An income statement, also known as a profit and loss (P&L) statement, is a financial document that summarizes a business’s revenues and expenses over a specific period, usually a year. It provides a snapshot of the company’s financial performance.

Key Terms

• Revenue (or Sales): The total income generated by a business from its primary activities, typically through the sale of goods or services.
• Expenditure (or Expenses): The costs incurred by a business in the process of generating revenue. Expenses can be categorized as:
  • Cost of Goods Sold (COGS): The direct costs of producing the goods sold by a business. This includes the cost of raw materials, direct labor, and manufacturing overheads.
  • Operating Expenses: The costs associated with running the business, excluding COGS. This includes expenses like rent, utilities, salaries, marketing, and depreciation.
• Gross Profit: The difference between revenue and the cost of goods sold. It represents the profit a company makes after paying for the direct costs of producing its products or services.
  • Gross Profit = Revenue – COGS
• Net Profit (or Loss): The final profit or loss made by a business after deducting all expenses, including COGS and operating expenses, from revenue.
  • Net Profit = Gross Profit – Operating Expenses
• Profit: Occurs when a business’s revenue exceeds its total expenses, resulting in a positive net profit.
• Loss: Occurs when a business’s total expenses exceed its revenue, resulting in a negative net profit.

Income Statement Structure

1. Revenue (or Sales)
2. Cost of Goods Sold (COGS)
3. Gross Profit
4. Operating Expenses
   • Selling and Distribution Expenses (e.g., advertising, sales commissions)
   • Administrative Expenses (e.g., salaries, office rent, insurance)
   • Finance Expenses (e.g., interest on loans)
5. Net Profit before Tax
6. Taxation
7. Net Profit after Tax (PAT)

Uses of Income Statements

• Assess Profitability: The primary purpose is to determine whether a business is profitable or not and to what extent.
• Compare Performance: Income statements for different periods can be compared to analyze trends and identify areas of improvement or concern.
• Inform Decision-Making: Stakeholders, such as investors, lenders, and managers, use income statements to make informed decisions about the business.
• Taxation: Income statements are used to calculate the tax liability of a business.

Debt in Relation to Income Statements

• Interest Expense: Interest payments on loans are recorded as a finance expense in the income statement, reducing net profit.
• Impact on Profitability: High levels of debt can significantly impact a business’s profitability due to the interest expense burden.
• Debt Repayment: Loan repayments (principal) are not recorded in the income statement, as they are considered a financing activity, not an expense.

Important Considerations

• Accrual Accounting: Income statements are typically prepared using accrual accounting, which recognizes revenue when it is earned and expenses when they are incurred, regardless of when cash changes hands.
• Depreciation: The allocation of the cost of a tangible asset (e.g., building, equipment) over its useful life is a non-cash expense that reduces net profit.

Income statement vs cash flow forecast

Feature	Income Statement	Cash Flow Forecast
Purpose	Measures profitability over a specific period. Shows if a business made a profit or loss.	Predicts future cash inflows and outflows. Shows the timing and availability of cash.
Focus	Revenues earned and expenses incurred, regardless of when cash is received or paid (accrual accounting).	Actual cash receipts and payments.
Time Period	Typically covers a past period, such as a month, quarter, or year (historical data).	Projects future cash flows, usually for a specific period like a month, quarter, or year.
Components	Includes revenue, cost of goods sold (COGS), gross profit, operating expenses, and net profit (or loss).	Includes cash inflows from sales, investments, loans, etc., and cash outflows for expenses, loan repayments, investments, etc.
Non-Cash Items	Includes non-cash items like depreciation and amortization.	Excludes non-cash items, focusing only on actual cash transactions.
Main Users	Investors, lenders, managers, and government agencies to assess profitability and financial performance.	Managers and business owners to manage cash flow, plan for future expenses, and make informed financial decisions.

Key Differences

• Timing: The income statement focuses on when revenues are earned and expenses are incurred, while the cash flow forecast focuses on when cash is actually received or paid.
• Non-Cash Items: The income statement includes non-cash items like depreciation, while the cash flow forecast excludes them.
• Purpose: The income statement is primarily used to assess profitability, while the cash flow forecast is used for cash flow planning and management.

Example:

A business may show a profit on its income statement but still experience cash flow problems if a large portion of its sales are on credit (accounts receivable) and customers haven’t paid yet. The cash flow forecast would reveal this potential issue by showing a lower cash inflow than the revenue reported on the income statement.

The point of all these documents

1. The Purpose of a Budget (Including Budget Variances)

• Budget: A financial plan outlining a business’s expected income and expenditure for a specific period.
• Key Purposes:
  • Planning and Control: Helps businesses set financial goals, allocate resources efficiently, and track performance against targets.
  • Decision Making: Provides a framework for making informed decisions about pricing, production levels, marketing campaigns, and other operational aspects.
  • Performance Evaluation: Enables businesses to assess their financial performance by comparing actual results with budgeted figures.
  • Communication: Communicates financial plans and expectations to stakeholders, including investors, lenders, and employees.
• Budget Variances:
  • Definition: The difference between budgeted and actual figures. Variances can be favorable (actual results are better than expected) or adverse (actual results are worse than expected).
  • Importance: Analyzing budget variances helps identify areas where the business is over or underperforming, allowing for timely corrective actions and improved financial management.

2. The Purpose of an Income Statement

• Income Statement: Also known as the profit and loss (P&L) statement, it summarizes a business’s revenues and expenses over a specific period, typically a year.
• Key Purposes:
  • Measure Profitability: The primary purpose is to determine whether a business is profitable or not and to what extent.
  • Evaluate Performance: Helps analyze financial performance over time and identify trends, strengths, and weaknesses.
  • Inform Decision Making: Provides valuable information to stakeholders for making informed decisions about investments, lending, and management strategies.
  • Taxation: Used to calculate the taxable income and tax liability of a business.

3. The Purpose of a Cash Flow Forecast (Including True and Fair View, Legal & Taxation Purposes, Forecasting, Decision Making)

Scenario Analysis: Businesses can create multiple cash flow forecasts under different scenarios (e.g., optimistic, pessimistic, most likely) to assess potential risks and rewards.

Cash Flow Forecast: A projection of future cash inflows and outflows, usually for a specific period like a month, quarter, or year.

Key Purposes:

Cash Flow Management: Helps businesses predict and manage cash flow, ensuring sufficient liquidity to meet obligations and fund operations.

Planning and Decision Making: Enables businesses to anticipate potential cash shortages, identify areas for improvement, and make informed financial decisions.

Financial Stability: Ensures businesses have enough cash on hand to pay suppliers, employees, and other creditors, thus avoiding insolvency.

Investment and Financing Decisions: Assists in evaluating potential investments and securing financing by demonstrating the business’s ability to generate cash flow.

True and Fair View:

Definition: A fundamental accounting principle requiring financial statements to accurately represent the financial position and performance of a business.

Relevance to Cash Flow Forecast: The cash flow forecast must present a true and fair view of the business’s expected cash flows, free from bias or manipulation. This can help see the state of the business and how to improve and also this make it easier to make decisions related to the business.

Legal and Taxation Purposes:

Legal Compliance: Businesses may be required by law to prepare and submit cash flow forecasts to regulatory authorities or as part of loan applications. They are also legally sometimes required to keep documents about themselves.

Tax Planning: Cash flow forecasts can help businesses anticipate and manage their tax liabilities effectively.

Forecasting:

Importance: Accurate cash flow forecasting is crucial for anticipating potential financial challenges and opportunities.

Methods: There are various methods for forecasting cash flow, including the direct method (listing all cash transactions) and the indirect method (adjusting net income for non-cash items).

Decision Making:

Impact: Cash flow forecasts are essential for making informed decisions about pricing, production levels, inventory management, and other operational aspects.