SOURCES OF FINANCE-

Internal sources:
• Personal savings: This is most often an option for small businesses where the owner
has some savings available to use as they wish.
• Retained profit: This is profit already made that has been set aside to reinvest in the
business. It could be used for new machinery, marketing and advertising, vehicles or
a new IT system.
• Working capital: This is short-term money that is reserved for day-to-day expenses
such as stationery, salaries, rent, bills and invoice payments.
• Sales of assets: There may be surplus fixed assets, such as buildings and machinery
that could be sold to generate money for new areas. Decisions to sell items that are
still used should be made carefully as it could affect capacity to deliver existing
products and services.
External sources:
• Shares: Limited companies could look to sell additional shares, to new or existing
shareholders, in exchange for a return on their investment.
• Loans: There are debenture loans, with fixed or variable interest, which are usually
secured against the asset being invested in, so the loan company will have a legal
shared interest in the investment. This means that the company would not be able to
sell the asset without the lender’s prior agreement. In addition the lender will take
priority over the owners and shareholders if the business should fail and the cost
will have to be repaid even if a loss is made.
There are other types of loan for fixed amounts with fixed repayment schedules.
These may be considered a little more flexible than debenture loans.
• Overdraft: A bank overdraft may be a good source of short-term finance to help a
business flatten seasonal dips in cash-flow, which would not justify or need a long-
term solution. The advantage here is that interest is calculated daily and an
overdraft is therefore cheaper than a loan.
• Hire purchase: Hire purchase arrangements enable a firm to acquire an asset
quickly without paying the full-price for it. The company will have exclusive use of
the item for a set period of time and then have the option to either return it or buy it
at a reduced price. This is often used to fund purchases of vehicles, machinery and
printers.
• Credit from suppliers: Many invoices have payment terms of 30 days or longer. A
company can take the maximum amount of time to pay and use the money in the
interim period to finance other things. This method should be treated with caution
to ensure that the invoice is still paid on time or else the firm might risk upsetting
the supplier and jeopardise the future working relationship and terms of business. It
should also be remembered that it’s not ‘found’ money but rather a careful
balancing act of cash-flow.
• Grants: Grants are often available from councils and other Government bodies for
specific issues. For example there may be a council priority to regenerate a
 particular area of a town and who are happy to help fund refurbishment of
buildings. Alternatively there may be an organisation that specialises in helping
young entrepreneurs to launch new businesses. Assessment for grants can be very
competitive, is very individual and not automatic.
• Venture capital: This source is most often used in the early stages of developing a
new business. There may be a huge risk of failure but the potential returns may also
be big. This is a high risk source as the venture capitalist will be looking for a share
in the firm’s equity and a strong return on their investment. However the significant
experience these investors have in running businesses could prove valuable to the
company. This is what the TV programme ‘Dragon’s Den’ is all about!
• Factoring: This involves a company outsourcing its invoicing arrangements to an
external organisation. It immediately allows the company to receive money based on
the value of its outstanding invoices as well as to receive payment of future invoices
more quickly. It works by the firm making a sale, sending the invoice to the
customer, copying the invoice to the factoring company and the factoring company
paying an agreed percentage of that invoice, usually 80% within 24 hours. There are
fees involved to cover credit management, administration charges, interest and
credit protection charges. This must be weighed up against the benefit gained in
maximising cash flow, a reduction in the time spent chasing payments and access to
a more sophisticated credit control system. The downside is that customers may
prefer to deal direct with the company selling the goods or services. In addition
ending the relationship could be tricky as the sales ledger would have to be
repurchased.
Money is a scarce resource and each source has its own advantages and disadvantages.
Lenders will be looking for a return on investment, the size of the risk and the flexibility
with which they can get their money back when they want or need it. For the company
seeking money, the decision as to the best source will ultimately depend on what the money
is for, how long the money is needed for, the cost of borrowing and whether the firm can
afford the repayments.
Accounts are records of financial transactions, where the information about how much has
been spent and how much has come in, is entered onto a sales ledger. The completed ledger
can be manipulated to produce reports and this helps with financial planning.
In preparing accounts there are several accounting principles which must be followed:
Going concern:
This assumes that a business will continue to trade in the future.
Consistency:
The same principles must be used for every set of accounts that is prepared. For example,
depreciation must always be set at the same percentage. This means that different sets of
accounts can easily be compared to see trends and growth rates.
Prudence:
Accountants should always err on the side of caution in their estimates and valuations. For
example if revenue were to be over-estimated dividends may appear to be due to
shareholders that have not actually been earned.
Accruals:
Sales and costs are considered to be incurred at the point that the sale is made and
delivered, rather than when the company is actually paid. This means that sales which have
been secured, perhaps in the form of orders taken but not yet delivered, will not be taken
into account.
Materiality:
This is about the relative importance of individual transactions. Most parties will only be
interested in significant amounts. This means that lots of low value sales for one customer
could be combined together. However if combining transactions could mislead the user of
the accounts the amounts should be split out.
Cost:
When looking at fixed assets, such as fully owned buildings and machinery, only the
original cost of the item is recorded. Its actual value may be quite different, perhaps due to
rising property prices, but to calculate a value would make the accounts subjective.
Entity:
Financial transactions from one person or group of people should be isolated from other
unrelated transactions from the same person or group. For example, a sole trader may be
withdrawing money for their salary but this would be classed as two transactions because
the owner is receiving money and the business is paying out money.
Stable money:
Transactions that happen over a period of time must reflect a single currency and exchange
rate. This will allow one year’s set of accounts to be compared with another regardless of
the rate of inflation.
Duality:
Duality dictates that every transaction has two effects. For example, if a company buys a
new asset such as a new printing machine, then fixed assets must be shown to increase and
either cash or liabilities must also show an increase.
Profit and Loss

An Introduction To Business Accounts.

Profit and loss accounts and balance sheets are two of the most useful tools to see how well
a company is performing.
The profit and loss (P&L) account is a basic record of an organisation’s annual accounts. It
will show how much the company has earned, how much it has spent to earn that amount
and the difference between the two, which is the profit or loss made.
The P&L is calculated as follows: total sales minus the cost of those sales (also known as
direct or variable costs) will give you the gross profit. Subtract from that the fixed costs (for
example insurance, marketing, administration costs etc) to find the net profit. Tax
payments and shareholder dividends must then be subtracted and an allowance can made
for retained profit to reinvest in the business. This will give you a picture of performance
over a particular period in time, either historical or forecast for the future.
In contrast a balance sheet gives a snapshot at a specific moment in time, as it is constantly
changing with day-to-day activities, sales and expenditure.
The balance sheet shows the relationship between a firm’s assets and liabilities.
Assets are things that the company owns or money it is owed and are used to generate sales.
There will be fixed assets which are kept in the business long-term and include buildings,
computers and machines. There will also be current assets which can be turned into cash in
the short-term. An example of a current asset would be customer invoices that are due for
payment. The two are added together to give a total asset worth.
Liabilities are concerned with money the firm owes to other people, both internally and
externally, such as bank loan repayments and shareholder funds. They are split into
creditors due in less than one year (short-term) such as invoices to be paid and creditors
due in more than one year (long-term) such as bank loans and mortgage repayments. The
sum of the two gives an amount for total liabilities.
Total assets will always be equal to total liabilities as assets are financed by liabilities.
Hence the name ‘balance sheet’.
Only limited companies and partnerships where the partners are limited companies are
legally obliged to complete these financial statements. It’s produced mainly for corporate
purposes to be used by the owners and shareholders and for Revenue and Customs
(HMRC) for tax purposes. However they are beneficial to all companies seeking finance to
grow or expand their business as potential investors will want to see current and projected
performance.
Whilst they make take time to put together there are clear benefits to be gained. If the
company knows its financial position, it can manage it. Compiling a profit and loss account
will ensure that the business knows how much tax it is liable for and can therefore plan and
budget for that in its cash flow.
Cash is crucial to a company’s survival. It’s a key indicator of corporate health as whilst a
company can survive short-term without sales or profit, it will fail without cash to finance
the day-to-day running of the business.
The amounts and timing of money coming in and going out of the business must be
carefully monitored and controlled to ensure that there is always enough money available
to pay bills on time. Ideally there would be more money coming in than going out, although
there will often be a delay between the time money is invested and when a cash return is
seen on that investment.
The most effective way of managing this flow of income and expenditure is with budgeting.
What Is A Budget?
A budget is a statement of the revenue and expenses that a company expects to experience
over a particular period of time. It’s a plan to control expenses and ensure that there is
enough money available to finance current commitments and future projects.
There are four types of budget:
1. Operating budgets are based on the money a business needs for its day-to-day
activities.
2. Flexible budgets allow for changing business conditions.
3. Objectives based budgets are driven by the objectives set by the company in the
business plan, and
4. capital budgets account for the amount of cash available for capital expenditure.
Budgeting is usually done on an annual basis as part of the business planning process.
However there should be some degree of flexibility which allows unplanned expenditure to
enable the company to take advantage of new opportunities which may arise. However this
leads onto the fact that budgets not only need to be created, they also need to be monitored
and managed.
Careful tracking of cash flow is important to highlight any variations against the original
plan. Once problems are identified action can be taken to resolve them. In addition if a
company knows exactly where its cash-flow stands then it knows how much money it has
available at any given time and can confidently refine its business plan to invest in new
activities if the opportunity arises.
Without a budget a company would be working blind with no knowledge of whether they
can afford to pay tomorrow’s invoices or could be taking on new commitments without
knowing whether it can really afford to pay for them.
The Benefits of Budgeting:
The benefits of budgets are far reaching. They allow money to be managed effectively
which in turn improves decision-making, resources can be allocated appropriately to the
projects with the highest priority, and performance can be monitored to identify and
respond to problems before they occur.
Cash flow can be improved if necessary, perhaps by asking customers to pay more quickly,
chasing debts to ensure invoices are paid on time, seeking extended credit from suppliers or
leasing rather than buying new equipment.
Costs, revenue and profit are basic but crucial parts of the financial analysis of a business
and it is on the comparison of these three things that success is judged.
Costs:
Costs are described as fixed or variable.
Fixed costs:
• Fixed costs are incurred and have to be paid regardless of the
volume produced and sold. They are the costs of running a business
such as heating, lighting, rent, insurance, marketing and so on.

Variable costs:
• In contrast, variable costs are directly related to the job and so
change with the level of output. The best example of a direct cost is
the raw materials that go into making a product.
Fixed costs plus variable costs are known as total costs:

Figure 1: Illustration of Fixed and Variable Costs.

Revenue:
This is the total amount of money coming in to a business from sales of goods or services. It
is a ‘top-line’ figure that excludes deductions of tax, interest and dividend payments. It also
usually excludes discounts for early payments and customer returns.
Profit:
This is often referred to as the ‘bottom-line’ and is the result of subtracting costs from total
revenue. It can be expressed as gross profit which is revenue minus the variable cost of
goods. It can also be expressed as net profit which also takes off the relevant amount for
fixed costs, tax and so on. Profit is perhaps the most important indicator of how well a
business doing.
Various calculations, or ratios, can be used to analyse the relationship between costs,
revenue and profit. One would be the profit margin. This is found by dividing the profit
figure into the revenue figure and allows you to see how well the company controls its costs
to turn revenue into profit.

Break Even Analysis

The break-even point (BEP) is the point at which the cost of producing a product or
providing a service exactly matches the revenue gained from selling that product or service.
For example, if a firm’s total annual costs are £1m and in the same year it generates £1m of
revenue, then the firm is said to have broken-even, as it hasn’t made any more or less than
it has invested:

Figure 1. Break Even Point

The fixed costs (horizontal line) do not vary with output - they are the costs of running the
business. The variable costs (line starting on top of fixed costs) are directly related to
volume and increase or decrease as production and sales increase or decrease. Together
they add up to give total costs. The revenue line (starting from zero) shows the total sales at
a given price and volume. The BEP is the point at which the revenue and total cost lines
cross.
A working example:
A designer mug costs £10 to buy. The variable costs are £6 per mug which makes the
contribution to fixed costs £4 per unit. The total fixed costs are £12,000. The BEP point is
calculated as follows:
Fixed costs / contribution per unit 12,000 / 4
Fixed costs / price - variable costs = BEP = 300 units
Or in terms of value
BEP in units x price per unit 300 x £10 = £30,000
This is a simple and straight-forward technique that is widely used. It will show the profit
or loss made at different levels of output, the BEP at different prices and the effect on the
BEP and profit if costs change.
The BEP analysis is often used as a tool in price setting. A company can produce several
variations of this chart to compare the revenue, total cost and BEP for different price
scenarios. Whilst it won’t give an absolute answer it will highlight the options that should
be avoided.
The major disadvantage with break-even analysis is that demand is assumed to be inelastic.
It suggests that a higher price will make the revenue curve steeper and therefore lower the
BEP. However in reality there will often be a maximum price that customers will pay. This
will vary by customer and be dependent on many factors including the cost of switching
and the availability of alternatives. The BEP is therefore more about whether a company
can sell enough to break-even rather than about what volume they can expect to sell. It
must be remembered that this is a revenue curve, not a demand curve.
Another downside of break-even analysis is that it focuses on how to break-even rather
than achieve a specific objective, such as percentage market share or a specific return on
investment (ROI).
That said, analysing the BEP can help to determine whether a new product has enough
critical mass to make a profit and is feasible to be launched. It can also be used to support
business cases where funding is needed by demonstrating that a product can be made and
sold profitably.
As a result, we can see that BEP analysis should be used for evaluation purposes