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