Sources of Finance - The Basics

Businesses need different types of funding depending on what they're buying and how long they need the money. Short-term finance covers things like extra stock or helping out during quiet trading periods. Medium-term finance is for assets that last a few years, like delivery vans. Long-term finance pays for big purchases like buildings that'll be used for decades.

The key is matching the right type of finance to what you're buying. You wouldn't take out a 20-year mortgage to buy stock that'll sell next month - that would be mad expensive!

Internal sources come from within the business itself. The owner's investment means putting your own money in, which keeps things private and doesn't need paying back. Retained profits are when you reinvest last year's earnings instead of taking them out as personal income.

Remember: Internal finance is often limited by how much money the owner actually has or how profitable the business has been.

More Internal Finance Options

Sometimes businesses can raise money quickly by getting creative with what they already own. A sale of inventory means having a clearance sale at discounted prices - perfect when you need cash fast and want to free up storage space too.

Sale of fixed assets works when businesses sell equipment or property they don't really need anymore. This raises bigger sums but obviously you can't sell everything without affecting how well the business runs.

Debt collection is about chasing up customers who haven't paid their bills yet. It's brilliant for getting money you're already owed, but you need a proper system to track who owes what.

Top tip: These methods work best for established businesses - new companies probably don't have enough assets or unpaid invoices to make much difference.

External Sources of Finance

When internal finance isn't enough, businesses look outside for funding. External sources can provide much larger amounts but they're more expensive and often require security (something valuable the lender can take if you don't pay back).

Hire purchase lets you buy equipment and pay for it in instalments whilst using it straight away. You become the owner once all payments are made, but the total cost ends up much higher than paying cash upfront.

Mortgages work for buying premises over very long periods (up to 35 years). You can use the building whilst paying it off, but the property can be taken away if you miss payments. Share issues involve selling parts of the company to investors - no interest to pay, but shareholders expect dividends when profits are good.

Watch out: External finance always comes with strings attached - make sure you understand exactly what you're signing up for!

Short and Medium-Term External Options

Trade credit is probably the most common form of business finance - suppliers give you 30 days to pay for goods after delivery. This means you can sell the products and collect money before paying your supplier, essentially getting free finance.

Bank overdrafts let your account go negative up to an agreed limit. You only pay interest on what you actually owe each day, making it cheaper than fixed-rate loans for short-term needs.

Leasing means making regular payments to use equipment without buying it outright. The finance company usually covers maintenance costs too, which can be handy. Bank loans provide a set amount for an agreed period with fixed interest rates, whilst additional partners bring in capital in exchange for a share of future profits.

Smart move: Compare the total costs of different options - the cheapest monthly payment isn't always the best deal overall.

Cash Flow Forecasts - Why Bother?

Cash flow forecasts predict how much money will come in and go out over the next year. Think of it as a financial crystal ball that helps businesses avoid nasty surprises.

Forward planning means you can see problems coming before they hit. Performance review lets you compare what actually happened against your predictions, helping you get better at forecasting.

The forecast shows exactly when you'll need to borrow money and when you can afford to pay it back. This stops you paying interest for longer than necessary and gives lenders confidence that you'll repay on time.

Cash flow forecasts also keep you disciplined about spending and form a crucial part of any business plan. They set realistic targets and help secure funding from banks or investors.

Reality check: A good forecast can be the difference between business success and failure - it's not just paperwork!

Understanding Cash Flow Problems

Cash flow describes money moving in and out of a business. Without proper cash flow, even profitable businesses can fail because they can't pay wages or suppliers on time.

Liquidity problems happen when money gets stuck - maybe customers aren't paying quickly enough or you've bought too much stock. This creates a cash shortage even if the business looks profitable on paper.

Getting forecasts wrong leads to serious consequences: shortage of working capital means you can't pay essential expenses. You might be forced to sell important assets like machinery, disrupting production.

Poor forecasting also means wrong inventory levels, badly timed purchases that tie up cash, expensive emergency loans, and missed opportunities to buy profitable stock. In extreme cases, the business might have to close down.

Warning: Cash is the lifeblood of business - run out and even the most successful company can collapse overnight.

Improving Cash Flow and Final Accounts

You can improve cash flow forecasts by increasing receipts (more sales or higher prices) and reducing payments (finding cheaper suppliers). Better promotion builds awareness and sales, whilst arranging overdrafts or loans provides a safety net.

Final accounts show the true financial position of a business. The Income Statement calculates gross profit (sales minus cost of sales) and net profit (gross profit minus expenses).

Cost of sales equals opening inventory plus purchases minus closing inventory. This shows exactly how much the goods you sold actually cost to buy.

Net profit is the real profit after all running expenses are paid - this is what's left to reward the owners for the risks they've taken. Some might be shared with shareholders as dividends.

Key insight: Profit on paper means nothing if you can't pay the bills - cash flow trumps profit every time.

Statement of Financial Position Basics

The Statement of Financial Position lists everything the business owns (assets) and owes (liabilities) on a specific date. It's like a financial snapshot showing the business's worth.

Non-current assets are permanent fixtures lasting over a year - buildings, machinery, vehicles. These generate profits over time and represent capital expenditure. Current assets can quickly become cash - inventory, money owed by customers, actual cash in the bank.

Current liabilities must be paid soon (trade payables, overdrafts) whilst non-current liabilities are long-term debts like mortgages.

Working capital is current assets minus current liabilities - this shows how much money you have for day-to-day operations. Bad debts occur when customers don't pay their bills, reducing your expected income.

Essential fact: A healthy Statement of Financial Position shows more assets than liabilities and enough working capital to cover daily expenses.

Key Financial Terms and Concepts

Working capital measures the difference between current assets and current liabilities - it's the money available for daily operations. Without enough working capital, businesses struggle to pay wages and suppliers.

Capital represents the owner's investment in the business, whilst drawings are money taken out for personal use. Start-up capital is the initial investment needed to get the business running.

Net assets equals all non-current assets plus working capital - this represents everything the business actually owns after paying short-term debts.

The Statement of Financial Position must balance: net assets should equal capital plus long-term loans. This proves the accounting is correct and shows how the business's assets are financed.

Remember: These statements work together - the Income Statement shows performance over time, whilst the Statement of Financial Position shows the position at one moment.

Financial Ratios for Performance Analysis

Financial ratios help you understand how well a business is performing by comparing different figures from the accounts. Always compare with previous years, targets, and competitors to get the full picture.

Gross profit percentage shows trading efficiency - higher percentages mean better control of supply costs. Net profit percentage includes all expenses and shows overall profitability after everything's paid.

Inventory turnover reveals how quickly stock sells - supermarkets turn over inventory much faster than jewellers. Return on capital employed (ROCE) shows whether the owner's investment is worthwhile compared to putting money in a bank.

Working capital ratio measures the business's ability to pay short-term debts. A ratio of 2:1 means £2 of current assets for every £1 of current liabilities, showing good financial health.

Pro tip: One ratio alone doesn't tell the whole story - look at several ratios together to understand what's really happening financially.