MODULE IV: ACCOUNTING AND FINANCE



MODULE 3: ACCOUNTING AND FINANCE

3.1 SOURCES OF FINANCE

Financing is anything that allows the business to run. A business requires financing for two reasons:

1. To purchase or use capital equipment to replace outdated machinery or expand present machinery functions (fixed assets)

2. To run the business on a day-to-day basis: buying materials & paying labor (working capital)

CLASSIFICATION OF SOURCES

1. The length of time that financing is required for.

• Short-term financing: limited up to three years, although company reports refer to a period of one year due to the accounting rules which determine current liabilities.

• Long-term financing: anything over three years. The length of time refers to the period for which the finance is borrowed.

2. Internal or External financing.

• Internal Source: financing comes from within the company.

• External Source: financing is from a financial institution.

INTERNAL SOURCES

1. Retained Profit is the profit that is left after all costs have been deducted.

• Used to increase working assets or to reduce liabilities. Either way, net assets will increase.

Advantage: Cheap source of financing due to lack of interest payments, however, the opportunity cost of using the profit must be taken into account when deciding how to use it.

2. Depreciation is the allocation of the cost of a plant asset over its useful life.

Advantages of depreciation include: (1) The allocation charge never leaves the company in cash. It stays in the business because the asset has already been bought and paid for. (2) Due to the amount of the retained profit the company has, the business can use depreciation as a source of internal financing.

3. Working Capital is the ability to use the current assets of stock and debtors, along with the current liabilities of creditors, can be used as a source of finance. Working capital can be increased by reducing debtors. When accounts receivable are paid early, the money is released into the business.

4. Dividends. Due to the fact that businesses are not legally required to pay dividends, a company may decide that to use the money as a source of internal financing by reducing or postponing dividends.

INTERNAL SOURCES OF FINANCING

Consider the following requirements for finance and state whether they are long-term or short-term:

1. Car

2. Stock

3. A new machine, with a life expectancy of eight years.

4. Moving to a new location

5. Paying wages

A business makes a retained profit of 340 million in a year. It owns assets of 800 million, which depreciate at 15% per year.

A) How much finance is available to the company during the year. Include statements to support your answer.

B) Why might this figure not be available at the end of the year, when the profit is reported?

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