BUSINESS STUDIES –STD 7
Chapter 26- Business finance
Why does a business require finance?
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For working capital- day to day expenses which should be covered to keep the business running
ex: electricity bills)
For start-up capital- money needed by any entrepreneur to start a business ex: to purchase
necessary machinery and other capital equipment.
For expansion
To perform research and development.
EXPENDITURE (spending money)
Capital expenditures are for fixed assets, which are expected to be productive assets for a long
period of time. Ex: building and machinery
Revenue expenditures are for costs that are related to specific revenue transactions or
operating periods, such as the cost of goods sold or repairs and maintenance expense. Ex:
wages, costs of raw materials.
Working capital
The capital of a business which is used in its day-to-day trading operations,
calculated as current assets minus current liabilities.
A company's working capital is a reflection of its operational efficiency and budget
management. If a business has more current liabilities than assets, its working capital is
negative, meaning it may have difficulty meeting its financial obligations. A company with a
very high working capital figure, conversely, is easily able to pay all its expenses with ample
funding left over. Whether a given business requires high working capital is determined by
three key factors: business type, operating cycle and management goals.
Liquidity- A measure of the extent to which a person or organization has cash to meet
immediate and short-term obligations, or assets that can be quickly converted to do this. This
term is a component of working capital. If a business is in a good liquid position, it has good
working capital.
Where does finance come from?
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Internal sources of finance- (from inside the business)
Retained profits
Sale of assets belonging to the business.
Reducing working capital
External sources of finance
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Short-term
A bank overdraft facility, where a bank allows a firm to take out more money than it has in its
bank account.
Trade credits, where suppliers deliver goods now and are willing to wait for a number of days
before payment.
Factoring where firms sell their invoices to a factor such as a bank. They do this for some cash
right away, rather than waiting 28 days to be paid the full amount.
Long-term sources of external finance
A pink piggy bank- Owners who invest money in the business. For sole traders and partners this 
can be their savings. For companies, the funding invested by shareholders is called share
capital.
 Loans from a bank or from family and friends.
 Debentures are loans made to a company.
 Hire purchase or leasing, where monthly payments are made for use of equipment such as a
car. Leased equipment is rented and not owned by the firm. Hired equipment is owned by the
firm after the final payment.
 Issue of shares.
Other sources of finance
Grants from charities or the government to help businesses get started, especially in areas of
high unemployment.
Venture capital- Venture capital (VC) is a type of private equity,[1] a form of financing that is
provided by firms or funds to small, early-stage, emerging firms that are deemed to have high
growth potential, or which have demonstrated high growth.
Main providers of finance (can be known as stakeholders)
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Shareholders
Banks
Creditors
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A business plan is a detailed documented evidence about a business, that aims to convince external
sources of finance to invest more in a business. This is a very necessary document for any business,
to raise finance.
Unit 27- Cash flow
Cash flow is the movement of money in and out of the business.
cash flows into the business as receipts - e.g. from cash received from selling products or from
loans
cash flows out of the business as payments - e.g. to pay wages, supplies and interest on loans
net cash flow is the difference between money in and money out
Profit and cash flow are two very different things. Cash flow is simply about money coming and
going from the business. The challenge for managers is to make sure there is always enough
cash to pay expenses when they are due, as running out of cash threatens the survival of the
business.
Insolvency
If a business runs out of cash and cannot pay its suppliers or workers it is insolvent. The owners
must raise extra finance or cease trading. This is why planning ahead and drawing up a cash
flow forecast is so important, as it identifies when the firm might need an overdraft.
Forecasting cash flows
A cash flow forecast is an estimate of the amount of money you expect to flow in and out of
your business and includes all your projected income and expenses. A forecast usually covers
the next 12 months, however it can also cover a short-term period such as a week or month.
Cash flow forecasting is important because if a business runs out of cash and is not able to
obtain new finance, it will become insolvent. Cash flow is the life-blood of all businesses—
particularly start-ups and small enterprises. As a result, it is essential that management forecast
(predict) what is going to happen to cash flow to make sure the business has sufficient funds to
survive. How often management should forecast cash flow is dependent on the financial
security of the business. If the business is struggling, or is keeping a watchful eye on its finances,
the business owner should be forecasting and revising his or her cash flow on a daily basis.
However, if the finances of the business are more stable and 'safe', then forecasting and revising
cash flow weekly or monthly is enough.[1] Here are the key reasons why a cash flow forecast is
so important:
Make sure that the business can afford to pay suppliers and employees. Suppliers who don't get
paid will soon stop supplying the business; it is even worse if employees are not paid on time.
Spot problems with customer payments—preparing the forecast encourages the business to
look at how quickly customers are paying their debts.
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As an important discipline of financial planning—the cash flow forecast is an important
management process, similar to preparing business budgets.
External stakeholders such as banks may require a regular forecast. Certainly, if the business has
a bank loan, the bank will want to look at the cash flow forecast at regular intervals.
Some components of a business that should be forecasted:
 Bank loan payments
 Customers’ cash payments
 Debtors payments
 Electricity bills
 Labor cost payments
 Annual rent payment
Uses of cash flow forecast
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Business decisions can be made according to the positivity or negativity. If negative, costs can be
cut down, loans can be issued. If positive, a business can expand or take a new step.
To attract more investors, or make new proposals in making large deals.
Limitations in forecasting
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Mistakes can be made in preparations.
Unexpected costs can lead to major changes.
Wrong assumptions can be made in estimations.
Causes of cash flow problems.
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Lack of planning
Poor credit control- if the company has no control over the credit it offers its customers, they
won’t be paid back on time.
Allowing customers too much time to pay back their loans.
Expanding too rapidly.
A business can improve its cash flow by:
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reducing cash outflows - e.g. by delaying the payment of bills, securing better trade credit terms
or factoring
increasing cash inflows - e.g. by chasing debtors (people who owe the business money), selling
assets or securing an overdraft.
Managing working capital
It is managed by concentrating on the four main components:
1. Debtors- (people who owe the business money.)
Managed by collecting money as soon as possible
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2. Creditors- (the people who the business owes money to.)
By increasing goods bought on credit.
Extending the period of time taken to pay.
3. Inventory
By keeping lesser inventory, to save storage expenses, this improves working capital.
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4. Cash
Reducing wastage of stock By forecasting and planning
Chapter 28- Costs
Uses of costs data (data which calculates the amount of money spent on costs)
To calculate profits.
To set a price for a product.
Comparisons can be done with previous time to improve performance
To make decisions and form strategies.
What are the costs of production?
Direct costs- The costs that can be clearly identified with each unit of production. Ex:
ingredients of a hamburger
Indirect costs- Costs that cannot be identified with the unit of production. Ex: Building
Fixed costs- These are the costs that remain fixed no matter what the level of output is.
Variable costs- These costs vary as output changes.
Marginal costs- These are the additional costs of producing one more unit of output.
Note: Fixed costs and indirect costs are similar in meaning, on the other hand, variable costs and
direct costs are similar in meaning.
Break-even analysis
Breakeven analysis is a useful tool for working out the minimum sales needed to avoid losses.
Breakeven point
At low levels of sales, a business is not selling enough units for revenue to cover costs. A loss is
made. As more items are sold, the total revenue increases and covers more of the costs. The
breakeven point is reached when the total revenue(sales) exactly matches the total costs and
the business is not making a profit or a loss. If the firm can sell at production levels above this
point, it will be making a profit.
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Establishing the breakeven point helps a firm to plan the levels of production it needs to be
profitable.
Many organizations add on a margin of safety to the breakeven level of output- a calculation of
how much sales could fall without any loss.
Uses of break-even technique:
A marketing decision of increasing the price and still achieving maximum sales.
To purchase new equipment.
Choosing a location for a new factory.
To make safety margins.
However, it has its limitations. It makes assumptions about various factors - for example that all units
are sold, that forecasts are reliable and the external environment is stable. If new rivals enter the
market or an economic recession starts then it could take longer to reach the breakeven point than
anticipated
Overhead costs
The extra costs in the business, which cannot be calculated by the amount of goods produced. A
company must pay overhead on an ongoing basis, regardless of whether the company is doing a high or
low volume of business
Production overheads- these include factory rent.
Selling and distribution overheads- These include costs warehouse, packing the product and salaries to
sales staff
Administration overheads- These include office rent and other employees salaries.
Finance overheads- These include the interest on loans.
CHAPTER 29: ACCOUNTING FUNDAMENTALS
1-WHY KEEP ACCOUNTS:
It is important that a business maintains accounting records since they provide a record of transactions
that a business has carried out. This means that managers can monitor the activities of the business and
measure its performance over time.
2-INTERNAL AND EXTERNAL USERS OF ACCOUNTING INFORMATION:
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-The managers of a business are termed as internal users; they will have to access data more in detail
than other groups
-External users include:
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Business managers: to measure the performance of the business to compare against targets.
Banks: to decide whether to lend money to the business or not
Creditors: to see if the business is secure and liquid enough to pay off its debts
Customers: to access whether the business is secure
Government and tax authorities, investors, workforce, local community.
3-LIMITATIONS OF PUBLISHED ACCOUNTS:
1) Presented in summary form which may not provide relevant information for decision making.
2) Window dressing (presenting the company accounts in a favorable way) may occur meaning
inaccurate decision making.
3) Do not show non financial factors such as customer service.
4) Based on historic information therefore may not represent current levels of performance or
position.
E.G:
- Selling assets at the end of the financial year to give the business more cash and improve
liquidity position.
-giving stocks a higher value than they are.
4-DIFFEERNECE BETWEEN MANAGEMENT AND FINANCIAL ACCOUNTING:
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5- INCOME STATEMENTS:
1) Trading account: shows gross profit and loss.
2) Profit and loss account section: calculates both net profits before and after tax.
3) Appropriation account: the final section; shows how the profits are distributed between the owners
and retained as profits for the company.
6- BALANCE SHEETS: They consist of 5 components:
Assets = Liabilities + Equity
1. Current assets (short-term): items that is convertible into cash within one year
2. Non-current assets (long-term): items of a more permanent nature
3. Current liabilities (short-term): obligations due within one year
4. Non-current liabilities (long-term): obligations due beyond one year
5. Shareholders’ equity (permanent): shareholders’ investment and retained earnings.
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CHAPTER 30: BUDGETS
1-ADVANTAGES OF SETTING BUDGETS: A budget is a detailed plan for the future.
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Planning
Effective allocation of resources
Setting targets to be achieved
Coordination
Monitoring and controlling
Modifying
Assessing performance
2-KEY FEATURES OF BUDGETING: a budget is not a forecast, budgets are plans that
organizations aim to fulfill, it is a prediction of what could occur in the future.
3-STAGES IN PREPARING BUDGETS:
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Most important objectives for the coming year should be established
Key limiting factor to restrict growth should be recognized
Prepare the sales budget
Subsidiary budgets are prepared
These budgets are coordinated to ensure consistency
A master budget is prepared
And then presented to the board
4-SETTING BUDGETS:
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Incremental budget: is a budget prepared using a previous period's budget or actual performance as
a basis with incremental amounts added for the new budget period
Zero budgeting: is a method of budgeting in which all expenses must be justified for each new period
Flexible budgeting: is a budget that adjusts or flexes for changes in the volume of activity.
5- LIMITATIONS OF BUDGETING:
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Lack of flexibility, Budgeting is based on a lot of assumptions in estimating the expenses and
revenues.
Focused on short term
May lead to unnecessary spending, budgeting exercise can be at times a very time-consuming
exercise. It involves extra manpower to get the estimates as accurate as possible.
Training must be met.
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CHAPTER 31 – CONTENTS OF PUBLIHSED ACCOUNTS
1-WHAT ARE PUBLISHED ACCOUNTS:
The accounts of a company which have been prepared and audited and then must be
published by sending to the shareholders and other interested parties.
2-AMENDMENTS IN PUBLISHED ACCOUNTS:
 Goodwill (the established reputation of a business regarded as a quantifiable
asset and calculated as part of its value when it is sold)
 Valuing intangible assets
 Capital expenditure (any money spent by a business or organization on
acquiring or maintaining fixed assets, such as land, buildings, and equipment.)
and revenue expenditure (is an amount that is expensed immediately—thereby
being matched with revenues of the current accounting period)
 Depreciation of assets(decline in the estimated value of a non-current asset)
 Valuation of inventories (An inventory valuation allows a company to provide a
monetary value for items that make up their inventory)
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CHAPTER 32- ANAYLYSIS OF PUBLISHED ACCOUNTS
1-INTERPRETING COMPANY PERFORMANCE:
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PROFITIBILITY RATIOS: these compare gross and operating profits of the
business with sales revenue
LIQUIDITY RATIOS: these give a measure of how easily a business could meet its
short term debts or liabilities.
FINANCIAL EFFECIENCY RATIOS: these give indication of how efficiently is using
its resources and collecting its debts.
SHAREHOLDER RATIOS: these can be used by existing shareholders to assess the
rate of return on shares and prospects for their investment.
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