Sources Of Finance
Larger firms find it easier to raise finiance than smaller firms. Being bigger and more established means they're less likely to go bust. They are less of a credit risk to banks. established firms can get finanace from various sources.
Sources Of Finance: RETAINED PROFITS
Profits tht owners have decided to plough back into the business fter they've paid themselves a dividend. However larger companies (e.g. PLCs) are under pressure from shareholders to give large dividends, reducing the amount of profit they can retain.
Sources Of Finance: RE-INVESTED SAVINGS
Large, successful firms may have used retained profit from previous years to build up bank savings or buy stocks or shares. They can use these to get cash quickly if they need it but when it's gone, it's gone.
Sources Of Finance: FIXED ASSETS
Firms can raise cash by selling fixed assets (e.g. machinery/buildings) that are no longer in use. There is a limit to how many assets you can sell - sell too many and you can't go on trading.
Sources Of Finance: SHARES
A limited company can issue more shares. The money raised doesn't have to be repaid to shareholders BUT more shares means less control for existing owners.
Sources Of Finance: DEBENTURES
Limited companies can issue debentures to the public. These are long-term loans which the firm commits itself to repay with interest. People who are issued with debentures don't own any part of the business - only lend the business more money.
Sources Of Finance: LOANS/MORTGAGES
Larger businesses may still use bank loans or mortgages which have to be repaid with interest. However, it's much easier for large firms to get loans - banks are more willing to lend them money because there's less risk of them failing. Also, they have more assets to be used as collateral (assets the bank can reposses if the business can't repay the loan).
Different Situations and Different Sources of Fina
Seveal factors influence which sources of finance are available to a particular business and which they should actually use:
1) TYPE OF COMPANY - Not all companies have access to all types of finance:
- Some may not have fixed assets to sell
- Only limited companies can issue shares and debentures
2) AMOUNT OF MONEY NEEDED - Small amounts of money usually come from retained profits or savings. Large amounts of money are more likely to need a loan or mortgage.
3) LENGTH OF TIME - Using savings on an arranged overdraft from a bank should be able to see a business through a short-term lck of finance.
4) COST OF THE FINANCE - Some sources are more expensive than others as they have to be paid back with interest.
5) STATE OF THE ECONOMY - When interest rates are high people are less likely to invest into a business due to the risk involved. Also, when interest rates are high, loans and mortgages are more expensive to take out.
The Trading Account
1)The Trading Account records the firms gross profit or loss.
2)Turnover is another word for revenue - it records the calue of all the products sold during the year. Cost of sales records how much it cost to make the products sold that year - the direct costs.
3) There has to be an adjustment for stock. E.g. how much stock was left over from last year and how much will be left for next year. This figure is used to work out the cost of sales.
4)Gross profit is the difference between the revenue from selling the chocolate and the direct costs of making it...
GROSS PROFIT = REVENUE - DIRECT COSTS
The Profit and Loss Account
1)The Profit and Loss Account records all the indirect costs of running the business. Does not include the costs of buying assets but does include the cost of using and replacing them.
2)Some assets wear out with use and eventually need replacing. Money is usually set aside by the firm each year so there's money for replacements when they're needed. This is treated as a business expence- its called depreciation.
3) The money left after paying the costs of running the business is the operating profit.
4) Finally, any interest paid or recieved is included. What's left is the true profit or the NET PROFIT.
Two ways of doing so:
1) Straight line method. If a machine costs £5000 and will wear out after 5 years, the depreciation is £1000 each year.
2) Reducing balance method. This depreciates the machinery by a percentage of its value each year. A £5000 machine might depreciate by 25% each year...
- Depreciation in year 1 = 25% of £5000 = £1250
The value is now £5000 - £1250 = £3750
- Depreciation in year 2 = 25% of £3750 = £938
The value is now £3750 - £938 = £2812.
And so on...
The Appropriation Account
1) This is only included for limited company accounts.
2) It records where the profit has gone - to the government as tax, to shareholders as dividends, or kept in the business as retained profit.
How are profit and loss accounts useful?
Profit and Loss accounts are useful to people who have an interest in the firm's performance (e.g. stakeholders). Here are some examples of people who might use the accounts:
1) SHAREHOLDERS - Existing shareholders are usually entitled to a share of the profits. Potential shareholders can look at how much profit the business makes to help them decide if they want to invest. Shareholders may also use the accounts to assess the performance of the directors who are running the business.
2) EMPLOYEES - They'll want to know is the business is making a profit or loss and therefore if they maybe entitled to a pay rise or if there is a loss if there jobs are in jeopardy.
3) GOVERNMENT - The gov recieve corporation tax from the business. Profit and loss accounts are used to calculate how much tax needs to be paid.
Profitability Ratios: GROSS PROFIT MARGIN
- Ignores indirect costs
- basically, show what happens to every pound spent by a customer.
- the fraction of every pound that doesn't go directly to the making of the product.
GROSS PROFIT MARGIN = GROSS PROFIT ÷ SALES(TURNOVER)
Profitability Ratios: NET PROFIT MARGIN
- includes all costs
- this is the fraction of every pound spent by customers that the company gets to keep (after all the costs have been paid)
NET PROFIT MARGIN = NET PROFIT ÷ SALES(TURNOVER)
BALANCE SHEET: Fixed Assets/Current Assets/Current
"The liquidity of an asset tells you how easy it is to convert into money"
Fixed Assets: This is the figure that the fixed assets (premises, machinery, vehicles) are worth on the day of the balance sheet. They'll have depreciated since they were bought.
Current Assets: These are listed in order of liquidity:
- 1) Stock is least liquid. Includes new materials and products that haven't been sold yet.
- 2) Debtors refers to value of products sold which are on credit (not been paid for by customer). Here, firm is lending money to customers so they'll buy their products.
- 3) Cash is most liquid. Money the firm hasn't spent yet, it's just in the bank.
Current Liabilities: Payments which the firm have to make within one year of the date on the balance sheet. Its the opposite of debtors. The firm owes money to it's suppliers. Unpaid corporation tax and unpaid dividends is also included as the money doesn't belong to the firm.
BALANCE SHEET: Net Current Assets
CURRENT ASSETS - CURRENT LIABILITIES = NET CURRENT ASSETS
- Also called working capital.
- NET CURRENT ASSETS + FIXED ASSETS = NET ASSETS (net worth) of the business. This is the amount (in theory) the firm would make if it sold all of its assets in other words, what the firm is worth.
BALANCE SHEET: Shareholders' Funds Sources
SHARE CAPITAL: Money put into the business when shares were originally issued. NOT the same as what shares are currently worth as the shares could've been issued a long time ago. Firms can raise new capital by issuing new shares. Usual way is through a 'rights issue'. This is where existing shareholders are offered new shares at a reduced price.
RETAINED PROFIT AND RESERVES: shows all profit firm has made over the years and decided to retain instead of paying in dividends. They retain profit to finance future investment or protect again future problems. This comes under shareholders funds because profits are really shareholders money. They've just decided to leave it in the firm instead of pay it out as dividends.
BALANCE SHEET: Long-term Liabilities/Capital Emplo
Long-term Liabilities: Money firms borrow from other people. Included here are any debts that take over a year to repay (bank loans/debentures)
Current Liabilities: Debts repayable in less than a year.
Capital Employed: What you get when you add sharholders funds to long term liabilities. Is equal to net assets because it shows where money to fund them came from. a.k.a all the money the business has got (from shareholders and borrowing from other people) is accounted for by capital employed. And everything it's done with the money it got (bought premesis/assets, kept it as cash etc.) is listed under net assets.
BALANCE SHEET: Shareholders
Stakeholders use balance sheet to assess the financial health of the business.
-Also called Working Capital Ratio.
-Compares a firm's current liabilities with its current assets. shows whether the firm has enough money in (or coming into) the business to pay this year's debts.
CURRENT RATIO = CURRENT ASSETS / CURRENT LIABILITIES
- figure should be around 1.5. If below 1, the firm owes more than it has. If over 2 the firm has too much money and should invest more in the business.
Acid Test Ratio
Similar to current ratio but it assumes the company won't be able to turn stock into cash.
ACID TEST RATIO = (CURRENT ASSETS-STOCK) / CURRENT LIABILITIES
If acid test ratio is much above 1 the firm has too much cash and should invest in the business. If much below 1 the business may be in trouble.
1) if you compare ratios from different years you can spot trends.
2) If you compare ratios from different businesses ou can make sure the ratios have been worked out in the same way.