Business Studies in Action: HSC Course 3rd edition

Chapter summaries
Topic 2: Financial planning and management
Chapter 6 Management of funds

·  A business cannot establish itself and thrive without funds to enable it to pursue its activities.

·  Sources of funds can be either internal or external.

Debt

/ Equity

External lenders



Short-term Other sources Long-term
borrowing borrowing
- overdraft - venture capital - mortgage
- bank bill - grant - debenture
- factoring - leasing
- trade credit / Internal lenders
- owners’ equity
- retained profits

·  Internal sources - equity:

-  Owners’ equity is the funds contributed by the owner or partners to establish and build the business.

Retained profits (profits not distributed) are the most common source of internal finance.

Business Studies in Action: HSC Course 3rd ed. Chapman, Norris, Devenish and Merritt. Chapter summary Page 1 Page 1

·  External sources - debt:

Business Studies in Action: HSC Course 3rd ed. Chapman, Norris, Devenish and Merritt. Chapter summary Page 1 Page 1

Bank overdraft: allows the business to overdraw their account up to an agreed amount.

-  Bank bills: a type of bill of exchange given for large amounts, usually over $50 000.

-  Mortgage: a loan secured by the property of the borrower.

-  Debentures: issued by a company for a fixed rate of interest for a fixed period of time.

-  Leasing: a long-term source of borrowing that involves payment for the use of equipment that is owned by another party.

-  Factoring: the selling of accounts receivable for a discounted price to a finance factoring company.

Venture capital: funds supplied by private investors either to new businesses (seed capital) or to established businesses ready to expand or diversify.

·  Financial considerations: match the terms and source of finance to business purpose and structure.

·  Comparison of debt and equity finance:

Debt / Equity
·  Lenders have prior claim in the event of liquidation.
·  Debt must be repaid by periodic repayments.
·  Interest payments are tax deductible.
·  Lenders usually require lower rate of return.
·  Interest payments are fixed.
·  Debt providers have no voting rights.
/ ·  Shareholders have a residual claim on
assets.
·  No maturity date.
·  Dividends are not tax deductible.
·  Shareholders require higher return due to higher risk.
·  Dividend payments are not fixed and
may be reduced through lack of
funds.
·  Equity holders have voting rights.

·  Debt finance is a liability to a business as it is money owed to external sources.

·  Equity finance is the most important source of funds for companies because it remains in the business for an indefinite time.

·  The capital structure is determined by the mix of debt and equity, and the proportion of each is known as leverage, or gearing.

·  Leverage (gearing) is the proportion of debt (external finance) and the proportion of equity (internal finance) that is used to finance the activities of the business.

Business Studies in Action: HSC Course 3rd ed. Chapman, Norris, Devenish and Merritt. Chapter summary Page 1 Page 1