FACS module introduction Page 

1.1

An introduction to Business Finance

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Session objectives

Understand three key facets and related 
accounting terminology
How is the business financed?
How has the money been used?
How has the business performed?
Understand expenditure classification

This session is designed to:

•Provide a framework which will put the financial model into the context of the
business as a whole.
•Provide a lead into the examination of the finance function, with particular reference
to the financial aspects of this module.

•A clear understanding of how a business is financed will provide an introductory

framework in which much of the rest of this module will focus.

•In order to do that, there will be strong emphasis on the structure of two of the key
statements produced by accountants for use both within the business, and for external
presentation. These two facets of accounting statements not necessarily being
identical. This means that the emphasis on particular users of the accounts may vary
from one part of the module to another.

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Business Funding
How is the business financed? 

Key questions here are:

Where has the business got its money from?

What are the consequences of using different 
sources of funding?
Business Finance:
•Is fundamental to the development of any business. Without sufficient funds, a
business cannot expand. Or at a very basic level it may not survive at all.
•Money is the thing which oils the wheels of a business, without it, it will die!
•The different aspects of business finance means that key questions are not only
•will the business have sufficient funds to pay its debts as they fall due, but
also
•what types of additional funds may be needed
•when will they be needed
•why will they be needed (there is always an option to say no!)
•how much will be needed
•how much interest will be payable (and when)
•when will the additional funds have to be repaid (if at all!)

•It is hoped that this module will provide an insight into why some of these issues are
important to a business, and what can be done about finding some of the answers on
which management decisions may be based.

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Use of Business Funds.
How has management used the money?

Key questions here are:
Where has the money been spent?

What assets does the business own?

Could the money have been used more effectively?

•In order to answer some of these questions successfully, it is clear that the first issue
is to understand what is being measured, and how it is measured.
•To do that it is necessary to understand the key financial statements, and how they
have been prepared.

•In addition, an appreciation of the regulatory framework, and the environment within
which accountants have to operate, is necessary before it is possible to apply some
management decision making to the information as it is presented.

•After all, you might not wish to make a decision about crossing a road, until you can
identify
•what is travelling on the road
•what type of vehicle it is
•how fast it is travelling
•which way it is travelling
•etc.
•So this should also apply to accounting information.

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Operational Performance
How has the business performed?

Key questions here are:
Was it worth it?

How much can the business return to its owners, without 
risking damage to the business?

Could the business have performed better?
Operational Performance:
•Requires just the same type of knowledge and understanding to be able to make
informed decisions on operating performance.
•Not only will management need to be informed, but they will also need to understand
the basis of the information on which they are making their decisions.

•Much could be at stake. Look at the questions being asked here

•was it worth it?
•Etc.

•Once again it is necessary to have an understanding of the underlying principles

before an informed decision can be made.

•But this time, the questions move on slightly, to consider

•improvements to performance, and
•alternative options available
•There is always the option to ‘do’ nothing!

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Published Accounts

The Limited company
Has Limited Liability
The owners (or shareholders) are only 
liable for the nominal value of the shares
A legal consequence of limited liability is 
that a company’s financial statements 
must be a matter of public record.
A business which is run by an individual is known as a sole trader. Where two owners 
or more are involved it will be a partnership and subject to the Partnership Act 1895. 
A business can go through a simple legal process to “incorporate” and become a 
“limited company”. The legal advantage of this is that the company can raise capital 
widely, such capital being in the form of shares. The word “limited” refers to the fact 
that under companies legislation, shareholders, once they have paid for their shares, 
are under no obligation to make any further payment to the company. Thus if the 
company fails they need not contribute funds to pay the creditors.

In the UK, shares  have a ‘nominal’, ‘par’ or face value (all meaning the same thing). 
This nominal value will represent the amount of money received for the shares when 
they were first issued to shareholders. 
Quoted company shares also have a market value, which, hopefully, is different from 
(higher than) the nominal value

When shares change hands it is between two individuals, rather than between the 
company and the individual – except at the time the shares are first issued. 

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Introduction to Business Finance
Sources of Funds
Share  Retained  Loan
capital profits capital

Share Capital
•The investment made by the owners of the business.
•The share capital is broken down into individual units - known as shares
•The funds provided by the share capital remain in the business as the basis of funding
•Although the ‘value’ of the shares may increase on the stock market, shares will
change hands between individuals - at an agreed price, the shares originally issued by
the business remains in the business at the ‘historic’ price at which they were issued
•Each share is entitled to one vote in any company meetings

Retained profits
•Retention, and re-investment of retained profits acts as ‘self financing’

Loan capital
•monies borrowed from outside sources - such as banks
•provide finance for a period of time

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The Consequences of Different Types 
of Funding
Total equity Loan Capital
New share capital Retained profits New loan capital
Ownership Interest free Interest payments
Growth Dividend free Capital repayments
Dividends Collateral security

Share Capital:
•The owners of the business
•They expect a dividend
•Expect their investment to grow - in terms of increased share value, and size of
business
Retained Profits
•Money not paid out to shareholders to finance future growth, new equipment etc
•No external finance is needed
•No dividend is paid on retained profit
Loan capital (external funding)
•Requires payment of interest
•Requires repayment of the loan in the future
•May have power over certain business assets as security

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Introduction to business finance
The Use of Funds
Working Capital Non Current Assets
•Inventory •Land and buildings
•Receivables •Plant and machinery
•Bank and Cash •Vehicles

Non-current Assets:
•Money is used to acquire non-current (fixed) assets which are those assets used by a
business to produce and sell whatever it is the business exists to ‘do’. They are
assets held by the business for longer than a year.
•Usually things are classified as non-current assets if they are used by the business
for more than a year and a day.
•Non-current assets include:
•Land & Buildings
•Plant & Machinery
•Fixtures & Fittings,
•Motor Vehicles
•etc.
•Working Capital relates to the day to day funding used to keep the business ‘ticking
over’.
•It supports the flow of material and services throughout the business
Cash
Receivables Materials

Finished Goods Work in progress

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Introduction to business finance
Measuring Operating Performance

Generation of economic wealth

Value added Profit
Gross value added Accounting profit
Economic value added Taxable profit
Economic profit

One of the prime reasons for a business is the generation of economic wealth. 
Unfortunately there is no universally agreed measure of “economic wealth”.
Attempts at producing such a measure fall, semantically at least, into two categories, 
those that talk about “Value added” and those that talk about “profit”.
Governments use the Gross Value Added measure, defined as “output at market 
prices minus intermediate consumption at purchaser prices” (Source: European 
Commission 
http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Glossary:Value_add
ed)
Economic Value Added is used by some companies as a measure of profit and is 
profit after a charge for the cost of providing capital 
Accounting profit, the main measure that interests us here, is indirectly defined in 
Accounting Standards. A simple definition is that is the profit generated after selling 
goods or services and deducting the associated costs. 
Taxable profit is defined in each country by the relevant Taxation legislation. It will 
not usually be the same as accounting profit.
Economic profit is very similar to Economic Value Added, being the increase in value 
of the company, after having charged the the required return to all providers of 
capital.

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Introduction to Business finance
Operating Performance‐ Accounting profit
£
Sales 1,000
Less Cost of goods sold 200
Gross profit 800
Less operating costs 160
Operating profit 640
Less finance costs 150
Profit before tax 490
Taxation 100
Profit for the year 390

•Profit is achieved by selling goods or services for more than it

costs a business to make them

•Gross Profit: is the amount by which sales revenue exceeds the cost
of production which has been incurred in generating those sales.

•Cost of Sales: includes all costs which are directly attributable to the
cost of production. This could include materials, direct wages, depreciation of
machinery etc.

•Operating Profit: is the figure which is arrived at after deducting all the
other expenses, frequently called overheads

•Finance costs: are interest charges paid to the providers of loan finance,
and similar such payments

•Taxation: Most countries raise some sort of tax based on the

profits achieved by business. It is this profits tax that is deducted here.

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Introduction to business finance
Operating performance and risk
Increasing profit is sometimes linked to increasing risk

In an uncertain world, businesses make profits by taking risks

Taking too many risks or failure to manage those risks can lead to 
business failure. A company needs to make sure 

There is enough money to pay the bills / wages
To replace the plant & machinery
To keep the bank manager happy

Key Dilemmas:
•Uncertainty The issues here are perhaps related to levels of uncertainty. For this
module, the issues will tend to relate to within a business rather than choosing
between different opportunities which may be external to the business.
•There are, however uncertainties within a business
•which supplier to choose
•or, choice of which type of machine to purchase
•or, what sort of budgeting focus to adopt

•Each uncertainty will have differing levels of risk, which need to be considered when
making an informed decision

•In order to do this, one of the key areas to focus on will be which measures of
performance will need to be adopted to reach the most effective decision.

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Introduction to Business 
Share 
Finance
Retained  Loan
capital profits capital

Operating  Capital expenditure
expenditure (Non current 
assets)

Sales of goods or 
services

A simple model
The model above is a very simple diagram of the process of funds flowing through an
organisation.
In particular it ignores payments to providers of capital (interest payments and
dividends), and depreciation of capital equipment.

To summarise:
•Funds are raised from various sources (shareholders, loan capital, banks etc) to
support the business.

•Funds are used to achieve the business objectives. In financial terms this will
normally be based on the business plan, which will result in purchasing plant &
equipment and other capital expenditure
•or be spent on operating expenditure which will then be recovered through the sale
of goods or services

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Introduction to Business Finance
Expenditure

NON‐CURRENT ASSETS CURRENT ASSETS
Money spent on assets  Used to buy goods etc. 
to do the job used in the day to day 
Will be used in the  running of the business
business for longer than  Generally ‘consumed’ 
a year within a year
CAPITAL EXPENDITURE REVENUE EXPENDITURE

Any business can only spend money in one of two ways:

Capital Expenditure:
•This is expenditure incurred to buy and install non-current assets into the business so
that they may be used to manufacture products.

Operating or Revenue Expenditure:

•This is expenditure which is used to facilitate the day to day transactions of the
business. This type of expenditure might include payment for raw materials, salaries
and wages, power and other overheads consumed in the normal course of trade, which
should generate sales revenue for the business. There may be a delay between the
buying in of raw materials, through to production and finished goods before the sales
transaction occurs.

•But beware of Inventory!

Frequently a business will spend money on stock which may not necessarily be used
and sold immediately. As a result, money tied up in stock (of all kinds) is treated as
working capital (i.e. it is shown on the balance sheet, rather than as revenue
expenditure). Stock is transferred to revenue expenditure when the finished goods are
sold.

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CAPITAL EXPENDITURE
Includes purchase of :
 Additional            Commits the business to tying up 
NON‐CURRENT ASSETS CASH in non‐current assets for 

 Replacement   several years
NON‐CURRENT ASSETS and results in

 Improvements to
NON‐CURRENT ASSETS  depreciation over several years

Capital Expenditure:
•Can consist of a variety of types of expenditure:
•New machinery and equipment of all types
•Replacement of existing assets
•Improvements to existing assets

•Depending on the scale of the investment, it may be that the same asset in different
businesses is treated as capital expenditure in one business, but revenue expenditure in
another business.

•Reasons for capital expenditure include:

•expansion - new machinery needed
•the advent of new technology, processes or facilities
•replacement or up-grading of existing capital equipment

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REVENUE EXPENDITURE
Includes expenditure on costs incurred in: 

 the direct production of the   Raw materials
product / service being sold by the 
business  Direct labour
 Direct expenses
 winning the business
 Selling and  distribution
 management expenditure
 Human resources, Research,  
Product Improvement etc.

Revenue Expenditure:
•As a general rule, revenue expenditure relates to the day to day trading activities of
the business

•What is considered revenue expenditure again, may vary, depending on each

particular business, size (as in value) may not be a distinguishing criteria

•The main categories of expenditure which fall under the heading of revenue
expenditure are:
•expenditure necessary to provide the products or services sold
•running the day to day activities of the business such as sales, purchasing,
administration, marketing, distribution, finance! etc.
•expenditure which is a matter of management decision making such as
training requirements, health & safety matters,
•and, becoming increasingly important, environmental issues

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CAPITAL or REVENUE
EXPENDITURE?

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SUMMARY

Understanding of the basic business 
finance
Understanding of the difference and 
implications of capital and revenue 
expenditure 

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