Module 6 - Accounts and Finance - Khairul Syahir

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BUSINESS & MANAGEMENT (STANDARD LEVEL) Module 6: Accounting and Finance Content retrieved from Wikirevise ( on 27/10/08 6.1 Source and Application of Funds Forms of finance Internal finance Internal Sources of finance sources that come from the business’s assets or activities. 1. Retained profit o if the business made profit, it could use some of that profit to finance future costs. 2. Sales of Assets o The business can sell of its assets such as property, mac
  BUSINESS & MANAGEMENT (STANDARD LEVEL)Module 6: Accounting and Finance Content retrieved from Wikirevise (     ) on 27/10/08 6.1 Source and Application of FundsForms of financeInternal finance Internal Sources of financesources that come from the business’s assets or activities.1.   Retained profit   o   if the business made profit, it could use some of that profit to finance future costs.2.   Sales of Assets   o   The business can sell of its assets such as property, machinery and such to finance future costs or debts. o   This can be a short term source of finance if the assets sold are like vehicles and machinery, but can be a long term source of finance if the assets are valuable like buildings and lands.3.   Reducing stocks   o   By holding too many stocks, the business is actually holding money in the form of goods. o   The business can sell these stocks and thus, gain money. o   This is a short term source of finance. External finance External sources of financesources that come from outside the business. Short term finance (under 1 year) 1.   Personal savings   o   when the business is facing financial constraints, the owner of the business can use his or her ownmoney to finance the costs or debts. o   This is considered as external because the money is not raised by the business’s activity. o   This source of finance is only applicable for sole traders and partnership, where the owners are under unlimited liability. o   This can be a short term or long term source of finance, depending on the amount of savings investedinto the business.2.   Overdrafts   o   Bank overdrafts are given on current accounts and are usually short term sources of finance. o   It is different from loans as the payments are only based on how much money the business used fromthe overdraft. o   So, lets say the overdraft is $30 000, but the business only used up to $10 000, then the debt is only $10 000 plus interest, which is also based on the amount used. Let’s say the interest rate is 5%, then theinterest is 5% x 10 000 instead of 5% x 30 000.3.   Debt Factoring –  o   Debt factoring is selling the business’s invoices to a factoring company. o   The business customer does not have to collect the debt anymore as the factoring company will payfor it and will then collect the debt from the debtors, however, the factoring company will pay lessthan the actual amount of debt noted in the invoice. o   So, one advantage is that the business customer will obtain cash quickly and does not have to wait for the debtors to pay back their debts. o   However, there will be a loss, as the factoring company will pay less, for example, only 80% of thedebt. That is how these factoring companies make their profits. o   Another disadvantage is, it may so happens that the debtors prefer to deal with the business they aretrading rather than a factoring company. Dissatisfaction might happen. o   Debt factoring is usually a short term source of finance4.   Loans   o   Businesses can apply for loans from commercial banks, and need to pay interests for it. o   There are three types of loans: long term loans, medium term loans and short term loans, dependingon the length of time the business is given to pay off the debts. o   Long term loans are due to be paid between 5 to 7 years and medium term loans   Medium (1-5 years) / Long term (over 5 years) finance 1.   Debentures   o   This is a form of loan obtained by specialist financial institutions. o   It is usually a long term loan.2.   Leasing   o   Leasing involves a business customer renting equipments that it may use for several years, but theequipments are not owned. o   The equipments are rented from a leasing company, and after the contract is finished, the equipmentsare to be returned to the leasing company. o   Since the equipments are not owned, the leasing company is responsible in financing the maintenancesuch as repairs for the equipments. o   Leasing can be either medium or long term source of finance.3.   Hire purchase   o   Hire purchase is a little bit like leasing as the business does not own the equipments at first and has to pay monthly rents or installation, but different as when all the payments have been made, then the business becomes the owner of the equipment. o   Under the agreement, the business customer usually is responsible for the maintenance of theequipment. o   Hire purchasing can be either medium or long term source of finance.4.   Issue shares   o   if an unlimited company converts to a limited company, then sources of finance can now come fromthe shareholders. o   For limited companies, issuing new shares can increase the capital as there are more shareholders. o   This is a long term source of finance.5.   Venture capital   o   Venture capitalists are specialist finance providers and the loan a business money in return for a shareof business ownership or of any eventual profit. Debt and Equity DebtDuty or obligation to pay money, deliver goods, or render service under an express or implied agreement. Onewho owes, is a debtor; one to whom it is owed, is a creditor, or lender.EquityOwnership interest in a corporation in the form of common stock or preferred stock.Both debts and equities are usually required in financing a company, and the best ratio needs to be obtained dependingon different situations the company is experiencing. For new and small companies, they would mostly need equity tofinance their growth, while companies that are already profitable, generate cash and have healthy asset base can befinanced mostly by debts.Debt to equity ratio is one of the examples of gearing ratio.= total debt / total equity   6.2 Investment appraisal Investment appraisalThe process of evaluating an investment opportunity. MethodsPayback period Payback periodThe time it will take for the srcinal investment to pay for itself through savings.Calculating the payback period can be done using the following formula:  For example, take a project costing $200 000 and the annual expected returns is $40 000. The payback period thuswould be 5 years.If the period is say 2 years and x months, The formula to calculate x: Advantages of payback period method:   ã   easy to calculate ã   easy to understand ã   focuses on the short term cash flow Disadvantages of payback method:   ã   does not measure the total incomes as it ignores any benefits that occur after the payback period ã   ignores the time value of money Non-financial factors Apart from the financial factors, a business must also take into account the non-financial qualitative factors:1.   Corporate objectives  Which investment most closely suits corporate objectives? Are profit long-term or short-term? A firm withlong-term profit horizons may consider investments with long payback-periods, while a firm facing cash-flowcrisis may prefer shorter payback period2.   Corporate image  How an investment affect its overall image and brand (e.g. Coke investing in undies??)3.   Human factors  The management may not favour the investment. The opinions of staff, the need for staff training and theeffect on workplace culture may all be considered.4.   Risk   Is the business willing to take risks? Is the benefit worth the risks?5.   Operations  Current production capacity? Will quality standard be maintained? Links and relationship with suppliers?6.   State of economy  the current and forecast state of economy will have a significant effect in investment decisions. Businesses areunlikely to invest heavily during economic recession. 6.3 Cash Flow ForecastsCashflow ForecastsAdvantages and disadvantagesAdvantages:   ã   Identify cash shortages ã   For banks to grant loan (documents for bank’s consideration) ã   Plan expenditure based on future surplus or shortage ã   Provide virtual implications of financial decisions i.e how much trade credit to give Disadvantages:   ã   Only estimates ã   Impossible to forecast every item ã   Reveal a problem, but no indication of underlying cause ã   Must be monitored closely and updated according to changing circumstances Worked example Data for  Double Fresh Business   Item Amount Notes Capital introduced $500 -Electricity $150 due in February, May, August, November Part-time labour $500 in June due to lack of manpower Withdrawal $700 every monthFuel $200 every month  Rent $2000 paid by instalments at every beginning of the quarter Income$1200 from January till May$2200 in June, due to festivities Task: Prepare a cash flow forecast for Double Fresh Business from January till June.Cashflow forecasts for Double Fresh Business from January to June January ($) February ($) March ($) April ($) May ($) June ($)Income 1200 1200 1200 1200 1200 2200 Electricity 0 150 0 0 150 0 Part-time Labour 0 0 0 0 0 500 Withdrawal 700 700 700 700 700 700 Fuel 200 200 200 200 200 200 Rent 500 0 0 500 0 0 Opening Balance 500 300 450 750 550 700 Closing Balance (200) 150 300 (200) 150 800 Net Balance 300 450 750 550 700 1500  Notes: ã   Brackets denote negative values, i.e (200) means -200. Analysis:  1.   The business has fluctuating net flow.2.    Net balance remains positive, meaning the business will not anticipate cashflow problems. 6.5 Breakeven AnalysisTypes of cost 1.   Fixed cost – costs of production that do not vary directly with the level of output in the short term2.   Variable cost – costs of production that vary directly with changes in output3.   Semi-variable cost – costs of production that combines both the aspects of variable and fixed costs4.   Direct cost – the cost of resources that are directly used up in the production of a good or service5.   Indirect cost – the overheads involved in running a business (cost such as management salaries andadministration expenses that are not directly related to production) Breakeven analysis ã   Total revenue  The values of goods or services sold to customers over a period (Selling price per unit x number of unit sold) ã   Total costs  The total costs needed for any level of production (Fixed cost + variable cost) ã   Breakeven  The point at which a business is making neither a profit nor a loss, where total revenue is equal to total costs ã   Contribution  The surplus on each unit sold, which is selling price less variable cost per unit ã   Margin of safety  The number of unit that a business is currently producing above the breakeven level
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