Revenue and capital expenditure - Essay Example

Nerikar Meghana Nerikar Topic-Editing the document Every business needs money. For starting, expanding and running it on a day to day basis. Money used for short run business is known as Revenue Expenditure while the funds used in long run business is called Capital expenditure. The money to pay for both Revenue and capital expenditure will either be generated by the business or borrowed or owners will have to put into the business itself. These are the three sources among which first one is internal while another two are external. Internal Sources of finance Funds are generated in two ways: - 1. generating profit and retaining them in the business. 2. By selling some of his assets. Only successful business can retain the profit. It is very difficult to decide how much profit should retain and how much should distribute. Retaining a large proportion of profit requires a long term view. Retained profit is the most important source of finance for small as well as large scale business. Sale of Asset: - If the firm has no other way to arrange funds from any source, then reluctantly the firm sells a particular division or a subsidiary business. Sale asset is a quite normal part of business. Sometimes the firm buy another firm with the intension of raising finance by selling of its assets. This is known as asset stripping. External Source of Finance This source is divided into two parts, first is short term funds and second is long term funds. Long term funds are very useful for new business but all types of businesses need capital planning. Long term funds are of two types: - 1. Share Capital 2. Loan Capital Shares are the proof of ownership. Each shareholder has a share in the business. Shares can be sold at a profit. If a company wants to arrange large amount of funds through share, it can offer the shares for sale to outsiders. When the private company issues Loan Capital Long term loans are part of the capital of the business. Long term loans come in forms of mortgages, long term bank loans, venture capital and debenture. Nerikar-2 External Sources of Short term finance There are different sources of short term finance. They are as follows. 1.Short Term Bank Loan. 2.Overdraft 3.Hire Purchase 4.Leasing 5.Working Capital 6.Factoring Section-2 Choosing Finance Some factors affect the choice of finance. Some of them are given below. size of the firm, cost of alternatives, use of funds, financial performance of the firm, strategic objectives of the business and the external threats. Section-3 Role of Finance Finance as a resource- It is very essential to understand the role of the finance in business. We have already seen that there are three types of finance. Now it is necessary to study what happen with the money. There are two things that the funds can be used. One is to purchase fixed assets and another is working capital. Financial Performance Financial Performance is not just measured in terms of profit. But it is about the ability of the business. So it is important to measure the following things. 1.Stability 2. Profitability Every business is managed differently and depends upon the manager. Some managers like to take big risk while some don’t want to take the risk. Profit is usually a reward of risk. It is necessary to study the relationship between short term debts and short term assets. For the measures of performance, we must look at the profit. The financial statement gives us the data of business. In it the balance sheet tells us about the assets and liabilities. The profit and loss account tells about profits. We can analyze profit performance by studying the important section of any firm and that is Profit and Loss Account. This account takes the total of all the sales revenue earned in this year, and deducts the cost to give the profit figure. There is a large difference between Gross Profit and Net Profit. Nerikar-3 Gross Profit Percentage By expressing Gross Profit as a percentage of sale we can see whether the firm is earning money just to pay its cost or to generate profit. Returning on Capital Employed A business is a form of investment. Money is put into it, and after a period of time, the money generates a return. It is just like bank deposit accounts and Government bonds generating interest. There are three different kinds of funds : 1. Owners Funds 2.Long Term Loans 3.Retained Profits If the balance sheet tells us the Capital of the business, the profit and loss accounts tells us the status of Net Profit. We use the Net Profit before the tax figure. Banks quote their interest rates before tax in the same way. Financial Decisions There are three major financial decisions: - 1.Costing and Budget decisions 2.Pricing Decisions 3. Project Appraisal. It is a management task to use financial data to improve the quality of decision making. These decisions affect what the business will do in the future. Cost and Budgeting Management Accounting is about making a detailed study of all of the costs in a business, and predicting budgets to be allocated. Fixed and Variable Cost The cost which do not vary with the level of output or sales. If the business were to expand its capacity then these costs would obviously increase. But in the existing capacity they are always fixed. Variable Cost changes as per the output and sale change. If the firm produce nothing, we assume that variable cost is zero. When the output rises the variable cost also rises. The level of output required before the firm breaks even, and above which the firm is making a profit. Nerikar-4 Budgeting Once we understand the nature of cost, we can predict the future finance needs of the business. If we know in advance how much money will be required, we can make certain plans accordingly. Businesses produce such forecasts like the government. The Board of Directors set the objectives. This is the basis for the timescale of the budget. There are two separate budget forms. First is Sales Budget and the second is Production Budget. Each department has its own budget, so that individual managers are responsible for managing their budget. These are known as Subsidiary Budgets. A master budget contains the details from all the departmental budgets. It is useful in predicting cashflow problems Variance Analysis Once the budgets have been drawn up, the projected profit and loss account will be accurate as long as each budget is an accurate forecast of what really happens. In reality there are differences between the forecasts and actual figures. These are called variances. Some variances are favorable (F) while some are adverse (A) Prices Decisions Cost plus pricing is crudest method of setting prices. Cost plus pricing is on decline because it does not take customer preferences into account. Absorption Cost pricing Instead of working out the average cost of everything produced, each product in a firm’s range is allocated its own share of direct and indirect costs. It tries to allocate a share of every cost to every item. The profit mark is added. Project Appraisal For receiving the funds, it is important to apply a consistent method of investment appraisal. This is important in the large organization. All financial approaches to project appraisal are in requirement of the future cash flow that will result from the investment. Read More