5. Finance and accounting

Businesses need finance for start-up assets, working capital, expansion, emergencies and investment. The amount, timing and purpose determine which source is suitable.

A profitable firm can still fail if cash arrives after bills are due. Finance decisions therefore connect investment, liquidity, risk, control and cost.

A retailer may need a loan for equipment but enough working capital to pay wages and suppliers before customers pay.

“Need for finance” is not only about growth; routine operations can create a funding gap.

Working capital is current assets minus current liabilities. It supports day-to-day payment of wages, suppliers and other obligations while inventory and receivables are converted into cash.

Too little can create liquidity pressure; too much can mean cash is tied up inefficiently. Inventory, credit terms and collection speed all affect the cycle.

A wholesaler may show a profit but need extra cash before customers settle invoices; faster collection or better stock control can reduce the gap.

Positive working capital is not automatically healthy, and a single snapshot does not show cash timing or quality of assets.

Owners can finance a business through retained profit or additional capital, while legal form affects access to shares, borrowing, liability and control. Finance is linked to governance as well as cash.

Retained profit avoids interest and new owners but may be limited. Share finance can raise substantial funds but dilute control; debt preserves ownership but creates repayment risk.

A private company might reinvest profit for a small expansion, while a public company can issue shares but face disclosure and shareholder expectations.

A source is not “cheap” without considering control, risk, timing and opportunity cost.

Internal finance comes from within the business, such as retained profit or sale of assets. External finance comes from outside, such as loans, overdrafts, trade credit, leasing or share capital.

Internal funds avoid some interest or dilution but may be insufficient and have opportunity cost. External funds add capacity but bring repayment, security, information or control conditions.

Selling an unused vehicle may fund a modest upgrade; a new factory usually needs a larger external source and a plan for repayment or investor return.

Internal does not mean free, and external does not always mean long-term debt.

Choose a finance source by comparing amount, duration, cost, security, repayment, speed, risk, flexibility and impact on ownership. The need and the business context come first.

Short-term working capital should not usually be funded with an inflexible long-term commitment, while a long-lived asset should not depend on a source that must be repaid immediately.

Trade credit may bridge inventory purchases, whereas a term loan or lease may match equipment life; a start-up with uncertain cash flow needs a different mix from a mature firm.

The lowest interest rate is not necessarily the lowest total cost once fees, security, risk and control are included.

Selecting finance means matching the amount, duration, cost, risk, security and control effects of a source to the business need.

A firm should compare what it can repay, what assets or ownership it can offer, how quickly it needs funds and what uncertainty it faces.

A seasonal retailer may use an overdraft for short timing gaps but a term loan for equipment; choosing the reverse can create avoidable repayment pressure.

The “cheapest” source depends on total cost, flexibility, security and control—not just the headline rate.

A cash-flow forecast estimates cash inflows, outflows and the opening and closing balance over future periods. It tests liquidity, not accounting profit.

Forecasts can reveal a timing gap early enough to delay spending, negotiate credit, raise finance or change operations. Assumptions should be visible and updated when evidence changes.

A profitable firm that pays suppliers in March but collects customer invoices in April may need short-term finance despite positive expected profit.

A forecast is not a promise; its value depends on realistic sales, cost and timing assumptions.

Costs are sacrifices incurred to produce or sell output. Fixed costs do not change directly with output in the short run; variable costs change with activity; total cost combines both.

Classifying costs helps price, budget, outsource, compare options and assess break-even. A cost can behave differently at different scales or time horizons.

Rent may be fixed within current capacity, while packaging rises with units. If a second site is opened, rent may become a step cost.

Fixed does not mean permanent, and variable does not mean every unit costs exactly the same.

Job, batch, unit and process costing assign or average costs in different production contexts. The approach should match the traceability, variety and volume of the output.

A costing method influences pricing and profitability information; it is a model of resource use, not a perfect measure of economic value.

A bespoke consultancy can trace labour and materials to one job, while a continuous chemical process may average costs across a large output stream.

A cost per unit is only meaningful when the cost pool and output basis are clearly defined.

Managers use cost information to set prices, prepare budgets, compare alternatives, control waste and evaluate performance. The useful measure depends on the decision and time horizon.

Relevant costs are future costs that change between options; sunk costs should not drive a new decision, while opportunity costs capture what is forgone.

When deciding whether to accept a one-off order, spare capacity and incremental cost matter more than a historical development cost that will not change.

A full allocated cost can be useful for reporting but misleading for a short-term decision if it does not change.

Break-even is the output where total revenue equals total cost. It depends on fixed costs, selling price and variable cost per unit; contribution per unit is price minus variable cost.

Break-even analysis shows the output needed to avoid an accounting loss and how safety margin changes when assumptions change.

If price is £10, variable cost £6 and fixed cost £2,000, contribution is £4 and break-even is 500 units. A price cut changes the calculation even if demand rises.

Break-even is a model based on assumptions such as constant price and unit cost; real demand and capacity may not behave linearly.

A budget sets expected income, expenditure or resource use for a future period. It translates objectives into numbers that can be monitored and revised.

Budgets coordinate departments and provide a baseline for control, but targets can motivate or distort behaviour depending on how they are set and used.

A marketing budget can reserve money for a launch while linking spend to expected reach and sales; managers can then investigate a shortfall rather than simply cut blindly.

A budget is a plan under assumptions, not a guaranteed outcome or a substitute for judgement.

A variance is the difference between budgeted and actual performance. A favourable variance is not always good and an adverse variance is not always bad; interpretation depends on the cause and objective.

Price, volume, efficiency, timing, one-off events and unrealistic assumptions can all create variance. Managers should focus attention on material, controllable and decision-relevant causes.

Lower labour cost may reflect efficiency—or understaffing that reduces quality. Higher material cost may follow a deliberate quality upgrade.

Blaming a department from the number alone ignores causation, interdependence and the quality of the original budget.