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    Finance Basics
    Finance Basics
    Finance Basics
    Ebook138 pages1 hour

    Finance Basics

    By Stuart Warner

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    About this ebook

    The finance basics that experts and top professionals understand.

    Get results fast with this quick, easy guide to the fundamentals of Finance.
    Includes how to:
    • Analyse a business from its financial reports
    • Understand a Profit and Loss account
    • Make sense of accounting jargon
    • Build a financially sound business plan
    • Deal with revenue, profit and cashflow

    LanguageEnglish
    PublisherHarperCollins UK
    Release dateApr 29, 2010
    ISBN9780007358922

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      Book preview

      Finance Basics - Stuart Warner

      Introducing business finance

      Owners, managers and employees need to be aware of the financial consequences of running their business. In this chapter I’ll explain the different types of business entities. I will show you where a business gets its money from and what it does with it. You’ll appreciate the need to record, analyse and summarize business transactions. I’ll also explain the essential difference between financial accountants and management accountants.

      1.1

      Know the different business entities

      A useful starting point to understanding business finance is to appreciate the different ways of trading. There are three main categories: sole traders, partnerships and limited companies. Each offers advantages and disadvantages in relation to legal issues, taxation and the personal liability of its owners.

      1 Sole traders. A sole trader or proprietorship is a business with 1 one owner, who has unlimited personal liability. If the business becomes insolvent, the proprietor is personally liable for any unpaid debts. Examples can include shopkeepers, tradesmen (e.g. electricians), hairdressers and florists.

      2 Partnerships. A partnership is a business with multiple owners, who share profits or losses. The partners can share unlimited personal liability or can take limited liability status. Examples tend to include doctors, dentists, lawyers and accountants.

      A friendship founded on business is better than a business founded on friendship John D. Rockefeller, industrialist

      3 Limited companies. A limited company is a business incorporated by law. Its owners are ‘shareholders’ who have the benefit of limited liability. If the business becomes insolvent the shareholders are only liable for the amount they invested in the company. Limited liability is a key advantage of turning a business into a limited company and can help to attract potential investors. In practice, however, banks may require personal guarantees from shareholders of small owner-managed businesses for loans or overdrafts. There is also an increased administrative and financial burden, in comparison to sole traders.

      A limited company can be ‘private’ or ‘public’. Most companies, especially small ones, are private and are owned by a small number of shareholders. In the UK, private limited company names end with the suffix ‘Limited’ or ‘Ltd’. The directors of a private limited company are also likely to be the majority shareholders.

      Public companies are usually much larger than private compa-companies. Their shares can be sold and purchased on a public stock exchange. In the UK public company names end with the suffix ‘Public Limited Company’ – or ‘PLC’.

      This book will be useful to all entities and in particular limited companies which experience the most regulation.

      Limited liability is a key advantage for limited companies.

      1.2

      Find out how a business gets money

      The majority of businesses need money to get started. The ability to raise finance is essential to the initial and ongoing success of a business. A lack of finance is one of the main ways that businesses fail.

      Imagine you about to start a new business that requires $1 million initial investment. Let’s say this money is needed for premises, a motor vehicle, computer equipment and goods to sell. If you don’t have $1 million, where can you get the money from?

      Most entrepreneurs will initially invest their own money when starting a new business. This is known as ‘share capital’ and for limited companies the owners are called ‘shareholders’. ‘Share capital’ is sometimes referred to as ‘equity finance’.

      If more money is needed, there are three main options:

      1 Raise further equity finance. Ask existing shareholders for more money or find investors who wish to become joint owners/shareholders of the business and contribute to the share capital. As these investors will become joint owners of the business, they will have a say in the running of the business. They will also expect returns on their investment in the form of dividends.

      Never spend your money before you have earned it Thomas Jefferson, 19th-century American President

      2 Borrow money. Typically from a bank or family and friends. This is known as ‘loan finance’ or ‘debt finance’. It is a common route for shareholders who don’t want to share ownership of their business. Equity finance does not have to be repaid, and dividends to shareholders are discretionary. Loan finance, on the other hand, needs to be repaid and will incur interest costs.

      3 Use surplus cash generated from operating activities. See Secret 4.5 for more on this. The surplus cash must not have been paid as dividends to shareholders or committed elewhere in the business.

      There are many other alternative sources of finance for a business. Examples include leasing assets (as opposed to purchasing assets outright), government grants and even sponsorship. Reading a company’s financial statements should reveal where they have got their money from (Secret 2.5).

      A successful financing strategy is just as important as a successful business strategy.

      1.3

      Find out how a business uses money

      If the first thing a business does is raise finance, the next thing it does is to spend it, usually on assets. These are resources owned or controlled by a business and are used to generate money. Assets are generally the biggest investments made by businesses. Both long-term and short-term assets are essential for most businesses.

      There are four main categories of assets, as follows:

      1 Fixed assets. The term ‘fixed assets’ refers to assets that are a ‘fixed’ item within a business, usually for more than a year (and hence long-term assets). Fixed assets are also referred to as ‘property, plant and equipment’ and sometimes as ‘non-current assets’. They are for continuous use in the business and are essentially used to make money. There are many different types of fixed assets found in businesses. The most common types are land, buildings, machinery, fixtures and fittings, office equipment, computers and motor vehicles.

      2 Intangible assets. Intangible assets are also long-term assets. They are non-physical resources and rights owned by a business that offer a competitive advantage or add value to the business. Examples of intangible assets include brands, trademarks and patents.

      3 Investments. Many businesses spend their money on investments, which they intend to ‘hold’ for the future and hence are also long-term assets. Investments include assets such as shares held in other companies and rental property.

      4 Current assets. The term ‘current

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