BUSINESS FINANCE

START UP CAPITAL

Start-up capital is the money and material resources used to start the business. Material
resources maybe in the form of assets such as buildings, motor vehicles and machinery
brought into the business that may help the business to operate. The money and material
resources used to start the business.

It is essential to have an accurate idea of your financial needs including running expenses
for at least the first six months. Customers may not pay you immediately – but you will
still need to pay all bills and keep trading.

At the same time you need to make sure that you have taken into account how much
money you need to live on. In the early stages, a new business is unlikely to produce
spare cash that you can spend on yourself.

IMPORTANCE OF START UP CAPITAL

Start-up capital is important for any business for four main reasons:-

 To buy initial assets of the business such as Buildings, fittings and fixtures, furniture,
as well as stock.
 To maintain day to day running of the business buying stock, paying salaries, rent and
bills for utilities
 To pay for any new projects once the business has started
 To act as a financial reserve for any unexpected expenses that may arise in future
.
The amount of start - up capital will depend upon the type and size of the business you
are going to set up and it will be used to buy fixed assets and provide working capital.

The owner(s) of the business are likely to allocate a substantial amount of this start-up
capital into the acquisition of:
 Land – on which the business can be erected
 Buildings – money will be spent to buy or erect buildings
 Plant and machinery – money will be needed to install the plant and machinery to
be used by the business
 Fixtures and fittings – money shall be required for shelves, display cases,
counters, lightings etc.
 Office equipment – such as computers, printers, copiers, fax and telephone
equipment shall be needed.
 Vehicles such as vans, delivery trucks, sales person’s cars etc, will have to be
bought.

WORKING CAPITAL

Working capital is that part of start - up capital which has been allocated to cover day to
day expenses of running the business like buying stock, paying salaries, paying rent,
water and phone bills.
IMPORTANCE OF WORKING CAPITAL

Once the fixed assets necessary to establish the business has been acquired, the owners of
the business must then turn their attention to the working capital. This will include:-

 Buying raw materials, semi-finished goods or components – if the business involves

manufacturing;
 Buying stock for resale – if the business is retailing or wholesaling;
 Advertising and sales promotion in order to increase sales;
 Paying wages and salaries to workers for work done for the business;
 Paying for services offered by other people to facilitate the smooth running of the
business such as power, water, telephone, rates, insurance and transport;
 Financing possible expansion of the business.

CALCULATION OF WORKING CAPITAL

Working capital is calculated by subtracting current liabilities from current assets i.e.:

WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES

CURRENT ASSETS

These are assets whose form or nature keeps on changing during the course of the
business’ trading activities e.g. stock, debtors and cash. Stock can change into debtors
when sold on credit, debtors will change into cash when payment is received from
debtors, cash can turn into stock when goods are bought. There is an endless circle of
current assets and because of this, they are also known as circulating capital or floating
capital.

CURRENT LIABILITIES

These are also known as short term liabilities. They are resources or money the firm
owes other people or organization which have to be repaid. Because they are short term
they are usually repaid over a short period of time of less than a year. Examples of
current liabilities are creditors, bank overdraft, services due but not yet paid for
(telephone bills owing, rent owing, water bill owing etc)

The business should never allow itself to run short of working capital. In other words, the
working capital should be positive when you subtract current liabilities from current
assets. A positive working capital means that the firm is solvent. This means the firm is
able to pay its debts when they fall due. If working capital is negative or zero it means
the firm is insolvent. This means the firm will not be able to pay its debts when they are
due and this is a dangerous situation as it might lead to liquidation or the closure of
business.

To determine a safe working capital, the firm will need to work out a working capital
ratio. A reasonable safe working capital should have a ratio of 2:1 of current assets to
current liabilities. It is the ratio that shows the ability of the business to pay its short term
debts.
 The ratio is calculated as follows:-
Working capital ratio = Current Assets
Current Liabilities

If current assets are P100 000 and current liabilities are P50 000
Working capital = 150 000 which is equal to 3:1
50 000
This would be a perfect and satisfactory working capital ratio.

What does lack of working capital mean to the firm?

A firm should never allow itself to run short of working capital because this is a common
reason as to why businesses fail. The common causes of lack of working capital are:-

 Over capitalization - buying too many fixed assets, leaving the firm with no or little
working capital
 Over trading - this is where the firm is buying more on credit than it can sell
 Excessive drawings – taking money by the owner(s) of the business for personal use.

IMPLICATIONS OF LACK OF WORKING CAPITAL

 Creditors will not be paid on time this means loss of valuable cash discounts offered
by suppliers for prompt payments. If legal action is taken, the firm’s assets may be
seized and auctioned – forcing it to close down.
 Some providers of certain services such as telephones, water and power may be
terminated if not paid on time
 The business will not be able to buy stock adequately. This is dangerous because
customers will be disappointed if they cannot get their requirements, this will result
in the loss of customers.
 The firm cannot take advantage of opportunities like discounts from suppliers
 A firm may be forced to borrow money from banks hence paying interest

HOW TO PREVENT LACK OF WORKING CAPITAL

 Avoid over trading – do not buy too many fixed assets at the expense of working
capital. You should budget in such a way that after buying your fixed asset you will
have enough working capital.
 Avoid over capitalization – buying too much stock on credit without corresponding
sales volumes would risk shortage of working capital as the firm will not be able to
pay its creditors in time.
 Avoid excessive drawings (taking money for personal use) – owners of business
should avoid taking too much money or stock from the business for personal or
private use. Excessive drawings will eventually lead to serious shortage of working
capital.

However, if a firm finds itself in a situation where there is a shortage of working capital it can
try to improve working capital by taking one or many of the following actions:-
 Obtain either a loan or an overdraft from the bank
 The firm may sell some of the old fixed assets, whose disposal may not seriously
disrupt the smooth running of the business.
 By factoring – this is the selling of invoices to other businesses at a discount.
 By introducing sales promotions

HOW TO IMPROVE WORKING CAPITAL

 Obtain a loan or overdraft from the bank. X
 Sell some of the old fixed assets
 Introducing sales promotions eg. Happy hours
SHORT TERM CAPITAL

Capital that has been borrowed by a firm for a short period of time, usually up to 2 years.
It may be obtained in the form of :

 Loan from a bank

 An overdraft
 A hire purchase agreement
 A credit from a supplier

LONG TERM CAPITAL

The capital a firm has borrowed which has to repaid over a long period of time, usually
over a period of more than 2 years. It may be in the form of :
 Long term loans from banks
 Renting equipment or machinery
 Mortgage on property

SOURCES OF SHORT TERM CAPITAL

 Current account given for a short term to meet day to day expenses
 For a specific purpose namely supplier purchase of capital items
 The working capital of the retailer
 Factoring sell invoice to finance at a discount
 Company sell goods on cash to customer.

SOURCES OF LONG TERM CAPITAL

 Sales of shares
 Debentures
 Ploughing back/re-investing profits
 Renting equipment
 Government grants and loans
 Long term bank loans

FACTORS TO CONSIDER BEFORE CHOOSING A METHOD OF FINANCING

 Interest rates
 Amount of finance required
 Method of repayment
 Duration of the loan or Time allowed for repayment
 Availability of security.