5. Finance and accounting

A retailer sells $20,000 on 60-day credit and records a profit, but wages and suppliers require$15,000 this week. Until customers pay or finance fills the gap, the business lacks cash despite profit. Persistent inability to pay debts when due can stop supplies/work and trigger insolvency procedures.

Lack of finance can prevent adequate start-up assets/marketing, interrupt wages and supplies, block maintenance/innovation/growth or remove the reserve needed for a shock. Trace the consequence: unpaid supplier → credit withdrawn/supply stops → output/sales fall → cash shortage deepens → failure risk rises.

The cycle is cash → pay/buy inventory and operating inputs → sell goods/services → create cash sales or trade receivables → collect customer cash → pay trade payables and other current liabilities. Longer inventory holding or customer collection delays lengthen the funding gap; supplier credit can partly bridge it.

Too little liquid working capital can prevent payment of wages, suppliers and bills, damaging supply and causing insolvency even when profitable. Excess working capital may signal idle cash, slow receivables or obsolete inventory, sacrificing return/growth. Judge asset quality and cash timing, not only a positive snapshot.

Legal availability is only the first screen. Lenders/investors still judge amount, credit history, collateral, cash flow, profitability, business plan, existing debt, risk and management. A new limited company is allowed to issue private shares, but that does not guarantee willing investors or affordable debt.

Changing ownership can unlock finance—adding a partner, incorporating or becoming public—but changes liability, governance, disclosure, profit sharing and control. Compare the funds gained with setup cost and the permanent ownership consequences.

These factors operate within availability: ownership form, business age/credit record, collateral, profitability/cash flow, amount/speed needed and grant/investor criteria may remove a source before comparison. A start-up with little cash and no record faces different terms from a mature profitable company.

Turn each factor into a consequence. Example: high existing debt + another large loan → larger fixed interest/repayment outflow → less cash buffer if expansion receipts are late → higher insolvency risk. The same loan may still fit if cash flows are stable, security is available and control is the priority.

Use four steps. (1) Define exact amount, purpose, date needed, duration and repayment/cash pattern. (2) Remove legally or practically unavailable sources. (3) Shortlist at least two realistic sources and compare total cost, flexibility, control, use-fit, existing debt, security, speed and risk. (4) Recommend one source or mix, state its strongest reason, main drawback/mitigation and what the judgement depends on.

Quantify where data permit. Hire purchase at $600 per month for 25 years costs$600 × 12 × 25 = $180,000 before comparing any deposit/other terms. For debt, test repayments/interest against forecast cash and existing debt; for equity, test ownership/voting/profit share given up.

One source need not fund everything. A furniture retailer might mortgage premises, lease display/IT equipment, use retained earnings for promotion and trade credit for inventory. Matching each component can reduce maturity mismatch and avoid concentrating repayment, control or supplier risk.

January opens with $5,000, receives$18,000 and pays $21,000: net cash flow = −$3,000 and closing balance = $2,000. February therefore opens at$2,000. A negative net flow can still leave a positive closing balance; a negative closing balance is the forecast funding shortage.

To amend a forecast: (1) place the changed receipt/payment in the period cash actually moves, (2) recalculate that period's total inflow/outflow and net flow, (3) recalculate its closing balance, (4) carry that revised closing balance through every later opening/closing balance, and (5) interpret the new shortage/surplus and action. Do not change profit entries that are not cash movements.

Behaviour and traceability are separate axes. Flour for one pizza is direct-variable. A designer's annual salary dedicated to one product can be direct-fixed over the period. Factory power may be indirect-variable; shared rent is usually indirect-fixed within current capacity. Classify for the decision, period and activity range.

To reduce variable cost, negotiate/bulk-buy inputs, redesign product/process, reduce waste/defects, improve productivity, logistics or energy use—but test quality, inventory, workforce, cash and supplier risks. Accuracy is an estimate for a new business: state assumptions, update actuals and use ranges/sensitivity where uncertainty is high.

At price $50 and variable cost$30, contribution is $20 per unit. Selling 400 units gives$8,000 total contribution. If fixed costs are $6,500, profit is$1,500. Positive contribution helps cover fixed costs; profit appears only after all fixed costs are covered.

If revenue is $50m, direct costs$10m and indirect costs $20m, total cost =$30m and profit = $20m. If previous profit was$22m, change = $20m −$22m = −$2m. State direction and units; rising revenue can coexist with falling profit if costs rise faster.

For a special order: (1) confirm spare capacity—otherwise include contribution displaced from normal sales, (2) identify future incremental materials/labour/delivery/setup and any fixed cost that changes, (3) calculate incremental revenue minus incremental relevant cost, (4) accept financially only if positive, then test payment risk, lower-price precedent, existing customers, quality, brand and long-run capacity.

A past development cost that cannot change is sunk and should not decide the next action; an opportunity cost such as displaced normal contribution is relevant even without a new invoice. Full allocated overhead is relevant only to the extent it changes or must be covered for the decision horizon.

Price $5, variable cost$2 and fixed cost $12,000: contribution =$3; break-even = 12,000 ÷ 3 = 4,000 units. At sales of 5,500 units, margin of safety = 1,500 units and profit = 1,500 × $3 =$4,500. To earn a target profit, use (fixed cost + target profit) ÷ contribution per unit.

Read a break-even chart: horizontal axis = output/sales volume; vertical axis = cost/revenue. Fixed-cost line starts above zero and is horizontal; total-cost line starts at fixed cost and rises with variable cost; total-revenue line normally starts at zero and rises by selling price. Their intersection is break-even. The vertical gap at a chosen output is profit/loss; the horizontal gap from break-even to current output is margin of safety.

Budgeting forms a control loop: set objectives/assumptions → forecast activity/revenue/cost/resource needs → negotiate and allocate budgets → coordinate action and give authority/accountability → record actuals → calculate/investigate variances → correct operations or revise an unrealistic plan.

Budget results should sit beside relevant non-financial measures. A hotel may meet a cost budget by understaffing while service, reviews and repeat bookings deteriorate. Review assumptions and behaviour as well as totals; use flexible budgets where activity differs materially from plan.

Budget profit $2,000,000; actual$250,000: difference = $1,750,000 adverse. Budget revenue$400m; actual $340m: difference =$60m adverse. Budget labour cost $90,000; actual$84,000: difference = $6,000 favourable—before judging why. Some schemes calculate actual − budget and others budget − actual; the sign convention may flip, but the F/A economic meaning must not.

Investigate in order: (1) check data and original assumptions, (2) separate activity/volume from price/efficiency and one-off timing, using a flexible budget where appropriate, (3) judge materiality and whether the manager could control the cause, (4) trace quality/customer/employee/cash consequences and linked departments, (5) correct operations, reallocate resources or revise an unrealistic future budget, then monitor.

Variance analysis highlights exceptions, improves control/accountability, supports manager/centre comparison, reveals overspend/underperformance, guides corrective resource allocation and improves future budget assumptions. Focus attention on material, recurring and decision-relevant causes rather than every small difference.