Notesale: Turn your study into money

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Chapter 5: Selecting Financial Strategies
Raising finance
Classifying sources of finance
Internal or external
- Internal sources of finance are ways of raising finance from within the business such as retained
profit or the sale of assets
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Short term or long term
- Short term finance describes finance that is normally intended for payments within 12 months
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- Long term finance describes finance that is usually intended for capital expenditure and where
repayment, if necessary, is due after 3 years or more
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Internal sources of finance
Trading (retained) profit
- Good indicator of the success of a firm, and allows the organisation to use the surplus for future
activities
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- If used well, the company will succeed and the shareholders will gain because the share price
will rise
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g
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- Attractive source for managers as there is no interest charged
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In the long-term this will lower the firm’s profitability
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This means the firm uses funds as a long-term or medium-term
source of finance in order to expand other, more profitable parts of the business
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- Sale gives the firm immediate cash, but the leaseback means that the firm pays regular sums to
rent or lease the asset in the future
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- Traditionally issued for 25 years, but the pace of change in the business world means that firms
expect to be able to repay even very large loans much more quickly, so shorter periods are more
common
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Should a business use internal or external sources of finance?
- A business will have to weigh up these factors:
- the legal structure of the business
- the use of finance
- the amount required
- the firm’s profit levels
- the level of risk
- the views of the owners
How long is the finance needed for?
- Finance is used to fund:
- Capital expenditure: spending on items that can be used over and over
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- Revenue expenditure: spending on current day-to-day costs, such as the purchase of raw materials
and payment of wages
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The interrelationship between raising finance and other functions of a business
- Raising finance relates closely to all other functional areas of a business
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FD must take a view on the best method of raising finance required for
expenditure of other departments
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g
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- Sales revenue is easy to calculate and it is possible to calculate the costs of running that branch
or making that product
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Reasons for profit centres
- They allow a more focused study of a firm’s finances
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- Responsibility for a profit centre may help to motivate the individual responsible
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Disadvantages of profit centres
- Allocating costs may be difficult
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- Setting targets – may be too easy or too hard
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- External changes
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g
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- It means each product will yield more profit and this will increase total profit
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- Similar benefits can be obtained by reducing OVERHEADS such as rent and office expenses
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- If the finance department is intending to pursue a strategy of cost minimisation, it must liaise
closely with other functional areas of a company
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- There may also be indirect consequences for a functional area arising from cost cutting in a
different part of a company
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- Any strategy of cost minimisation must be agreed at strategic management level, as
implementation of such a strategy will often have a broader impact than might have been
recognised at the functional (departmental) level
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Allocating capital expenditure
- Decisions on allocating capital expenditure fit into two categories:
- Decisions on whether to introduce capital equipment to replace labour
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- As with any decision involving expenditure of limited financial resources, it is vital that the finance
department liaises with the other functional areas to ensure that they have an impact in these
decisions
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