Finance is a critical part of business management and impacts on all other functions of the business, including human resources, marketing, and operations.
Organizations engage in capital expenditure (which is the purpose of fixed assets) and revenue expenditure (which finances working capital and allows those fixed assets to generate productive opportunities).
There are a range of internal and external sources of finance available to an organization.
Smaller organizations (such as sole traders) may be limited to personal funds, retained profits and the , or loans, and overdrafts from friends, family and financial institutions.
As an organization grows, the range of external sources increases. Share capital becomes a potential source of finance. With increasing growth, an organization can borrow from financial institutions at lower interest rates.
The growth of the internet has enabled crowdfunding for businesses that might struggle to secure finance from more traditional sources.
The type of finance that an organization is looking for will depend on several factors, but central to this issue is the idea of matching. Short-term needs should be funded by short-term sources of finance. Longer-term needs should be funded by long-term sources of finance.
There are a number of complex sale and lease-back schemes. They are used mostly for large fixed assets, or, increasingly, ICT systems. In lease schemes, firms may be able to update assets periodically to avoid obsolescence. This has become a feature of new outsourced ICT schemes.
Trade credit needs to be monitored carefully by an organization. The normal trade credit period is 30, 60, or even 90 days. Some organizations allow for discounts for prompt payments before the time limit is up.
Venture capitalists are usually represented by groups and are arguably more aggressive in their dealings with providing finance. Venture capitalists may demand a greater say in decision-making. A business angel is generally more hands-off. Increasingly, we are seeing business angels being attracted to financing more socially responsible or ethical business models.
The work of Muhammad Yunus and the Grameen Bank, who were pioneers in trying to help struggling entrepreneurs in developing countries finance some of their start-up capital, has lead to an increase in microfinance providers .
Fixed or indirect costs must be paid even if the organization produces no output at all. These include insurance and electrical power. These costs are not related to the level of output and are also called "overhead costs".
Variable or direct costs are related to the level of output produced. The higher the level of production, the higher the level of total variable or direct costs. Examples include raw materials used in the production of goods and services, and wages.
Total revenue is defined as the price of a unit sold to a customer multiplied by the number of units. The number of units sold is sometimes referred to as the sales volume.
Ideally, organizations should not rely on just one product and thus one revenue stream. Increasingly, organizations are looking for ways to generate additional revenue streams. The film industry, for example, has had to look for ways to increase revenue other than sales of cinema tickets.
Financial accounts have several purposes for stakeholders and these purposes depend on the level of direct or indirect interest they have in an organization. Key stakeholders such as financial managers, the CEO, and shareholders will be looking at the final accounts to consider the financial performance of the organization.
There are two versions of the profit and loss accounts account depending on whether the organization is a for-profit or not-for-profit entity.
In addition to physical assets, an organization will also have several important intangible assets such as brand value and goodwill.
Organizations must depreciate assets as they are used in the production process and/ or become obsolete. Depreciation is the way in which the cost of a fixed asset is spread over the useful life of the asset is spread over.
There are two methods of depreciation to study as part of this course which are the straight-line method and the units of production method(HL only).
Once an organization has selected a method of depreciating assets, it should continue to use this so that the value of the fixed assets in its balance sheet is true and fair.
Financial Ratios are important for an organization to identify issues with their financial performance and position.
If the financial ratio gives a poor result, strategies should be implemented to improve it.
The interpretation of financial ratios needs to be weighed against external environments where the organization is operating.
They highlight where an organization may need to address issues (i.e. low profitability, weak liquidity).
These ratios need to be viewed in the context of external environments where they are calculated.
Profit Margin identifies the trade profits of a firm.
Efficiency Ratios measure the ability of an organization to use its assets and manage its liabilities effectively in the short term.
Gearing is measured by observing how much of the firm's capital employed in the business is provided by long-term lenders.
A single ratio in isolation without comparison to other firms or the external environment is not a basis for making a considered financial decision.
In short term, the economic sustainability of an organization will depend on how the cash flow is managed.
Another way to view the difference between profit and cash flow is that cash flow allows a business to purchase resources, transfer them into finished products, and deliver them to customers.
A cash flow forecast can highlight a particular month where the organization may face a difficult liquidity position.
Investment appraisal provides a good technique and insight into whether an organization should accept or reject a possible investment opportunity.
There are various methods to help decide whether an investment opportunity should be taken: Payback, Average Rate of Return (ARR), and Net Present Value (NPV).
Payback is a straightforward way of looking at an investment opportunity. It assumes that expected returns are received evenly throughout the year.
The average rate of return sees whether the potential addition return is justified compared to the level of risk taken.
However both payback and average rate of return lack a consideration of the time value of money the time value of money.
The net present value takes the time value of money into consideration, making it a more rigorous method.
Profit Centres are allocated direct costs and revenues to calculate individual profit at that centre.
Profit centres become accountable for their actions, which can lead to greater efficiency and productivity.
A budget is a financial target or prediction of how much a firm is expected to spend or receive in a specific period of time.