The use of funds

A study of finance of a business is concerned with three areas:

ú the monetary resources of a business;

ú the acquisition of monetary resources by a business;

ú the effective management of monetary resources.

The common denominator of each of the three areas is the word monetary. Money, in whatever form a society uses it, represents the claim of an individual, a business, an organization or the state on the collective wealth of the society. In other words how much money you hold is your slice of the cake of national wealth. Whether or not the cake is shared fairly is a problem for politicians and will be decided by the culture of a society We are concerned with how accumulated wealth, that is wealth that has been saved rather than consumed, is shared amongst the people who want it.

In simple terms money is a resource and it obeys market forces. Unlike other goods money is not bought or sold; it is borrowed and lent. The documents which record the transaction of borrowing and lending (referred to as bills and stocks) are bought and sold. The price of using money is the interest rate. If there is a comparatively large amount of money available compared with the demand for it then the interest rate will tend to be low. Should demand rise or the supply of money be restricted then the interest rate will rise.

However, the situation is not quite so simple. Market power operates in the money market just as it does in other markets. The government, for example, is a major borrower and, as a result, is in a position to influence the interest rate.

In this unit we will look at the sources of funds in more detail and examine some of the techniques a business will use in making decisions about the use and management of the funds available.

In the simplest terms a business spends money on acquiring factories and equipment, on buying in the stock to carry on the business and in paying labour and other necessary expenses. Let’s look at the following example:

A couple own and jointly run a small general store in an inner city area. They live in a flat over the shop. Property prices in the area are not high and they were able to buy the leasehold of the shop and flat for £20 000. Stocking the shop needed another £20 000, with a further £5000 each year to meet expenses. In common with many other small businesses the owners did not pay themselves a set wage. Instead they drew enough money from the business each week to meet their immediate expenses and reserved large items of personal expenditure for times when the cash balance of the business was sufficiently high, in their judgment, to cover foreseeable business outgoings and still leave a surplus. At 31 December 2004 the cash balance of the business stood at £15 000.

At 31 December 2004 business employed a total capital of £55 000. Of this approximately 36 per cent was invested in fixed assets (buildings, fixtures and fittings), a further 36 per cent in stock and approximately 27 per cent in liquid assets (cash). The flat in which the couple lived has been regarded as part of the business because it would be impracticable for it to be let or sold separately from the business. Now look at the next example:

A multinational company decided to sell one of its subsidiaries. Three members of the existing management team decided to buy the business. (This is known as a management buy-out). The price was £10m. For this the new owners got the factory, machinery, existing stock and orders and the right to use the trade name under which the products were already being sold. They also raised an additional £1m.

A breakdown of the asset structure of this business gave fixed assets at 60 per cent of the total, stock at 23 per cent and liquid assets at 17 per cent. Which of the two businesses had made the right decisions in deciding how they would use the money they had available to them? The decision about how a business should use its funds and what proportion it should devote to any particular use depends on a number of factors. Some are quantifiable, others depend upon skill and judgment. The following list must be seen only as an indication of the way in which a business might be influenced in the final decision.

1. The technology used A business which uses advanced technology is likely to employ a larger proportion of its total assets as fixed assets. Advanced technology is usually expensive but it can offer savings on labour and materials. If it is easier to use, itcanreduce training costs and the need to employ expensive skilled labour.

2 The nature of the business An engineering firm will need the premises and machinerytocarry out its work. Stock levels may be kept quite low. A retailer, on the other hand, could have relatively low fixed costs but need to hold a higher level of stock.

3 The size of the business Even within the same industry a small business might show a different asset structure from a large business. It could be that although classified as being in the same industry they are making different products, or that the smaller business cannot afford the technology available to the larger firm. Small firms might have to buy stocks in larger quantities than they need, but a larger business with greater market power can regulate its stocks according to its needs.

4 The stage of development A new or expanding business is likely to have a distorted asset structure compared with a business in the same industry in a more settled phase of its life.

5 The size of the market A business with a large, constant market for its product will be more likely to use production methods that require the use of a lot of capital equipment.

6 Management skill The asset structureof a business may also be affected by the skillofmanagement. Bad management can produce a bad asset structure.

7 The government Tax concessions can affect the asset structure of a business,as can grants. The effect may be marginal but it still exists.

8. The state of the economy and business confidence A flourishing economy will result in an increase in business confidence and is likely to encourage a business to seek available funds for expansion. An economy in recession could result in investment in labour saving machinery.

Influences on the asset structure of a business are shown in Figure 1.

Figure 1. Influences on the asset structure of a business

2. Comprehension check.

Are the following statements true or false? Correct the false ones.

a) Money is the demand both of natural and legal persons for the common riches of the community.

b) The percentage that a bank charges or pays for utilization of money is the interest rate.

c) Demand fluctuations for available money cause changes in interest rate.

d) Being the principal lender of money the government can affect the interest rate.

e) Up-to-date know-how is costly but economizes on labour and materials.

f) Neither a small company nor a large business can adjust its stocks to its needs.

g) Poor management of a business has a bad effect on the asset structure.

h) The economic regress leads to investments in labour saving machinery.

3. Match each word on the left with a correct definition on the right. Use the grid below.

1. money 2. to save 3. to consume 4. market forces 5. to borrow 6. to lend 7. bill 8. stock 9. interest rate 10. demand of money 11. supply of money 12. market 13. skill 14. management 15. confidence 16. investment

a. a particular ability that involves special training and experience b. commitment of resources to a particular project c. an organizational role which involves planning, organizing, controlling, communicating and co-ordinating in order to achieve set objectives d. represents the claim of an individual, a business, an organization or the state on the collective wealth of the society e. an amount or quantity of money that is available to use f. the price of using money g. to use a good or service not necessarily making the purchase of it h. the economic influences that affect prices, salaries, and the number of jobs available and are not controlled by the government i. the amount of money that people want, or the fact that they want it j. to keep or store something so that you can use it in the future k. the belief that someone or something is good and you can trust them l. to receive or use something that belongs to someone else, and promise to give it back to them later m. a particular place or group of people that a product is sold to n. the total equity capital of a company, held by shareholders in the form of shares o. to give someone something for a short time, expecting that they will give it back to you later p. a written statement showing how much money you owe someone for goods or services you have received

d

Writing

Write the review of the text 15.

Vocabulary

Do you know the meaning of the following words? Try to match up each of them to its Ukrainian equivalent. Use your dictionary if necessary.

a) subsequently b) ploughed back profits c) legal proceeding d) bankruptcy e) involuntary liquidation f) interest on debt g) retained profits h) to tie up i) to convert j) stock exchange council k) stringent l) to be aware of m) Unlisted Securities Market

n) safeguards o) to dispose of p) prevailing q) rights issue r) to underprice s) tender t) preference share u) rate of return v) to declare a dividend w) cumulative preference shares x) arrears y) redeemable preference shares z) articles of association

а) конвертувати, перебудовувати

б) усвідомлювати

в) міри безпеки, захист

г) укладати гроші у що-небудь

д) кумулятивні привілейовані акції

е) згодом, потім, пізніше

є) борг, заборгованість, несплачена по рахунку сума, недоїмка

ж) статут акціонерної компанії

з) нерозподілений прибуток

и) банкрутство

і) привілейовані акції, котрі можуть бути погашені за рахунок резервів компанії

ї) тендер, заявка на торгах, заявка про підписку на цінні папери

й) недобровільна ліквідація

к) рада фондової біржі

л) ринок цінних паперів, котрі не котируються

м) випуск акцій для розподілу серед акціонерів, що надає їм право придбання нових акцій відповідно до кількості акцій, котрі вони вже мають

н) капіталізований прибуток

о) норма прибутку; норма рентабельності

п) процент по заборгованості

р) проголошувати про виплату дивідендів

с) встановлювати надто низьку ціну

т) привілейована акція

у) переважний, поширений

ф) суворий, скрутний (про гроші), напружений

х) розпоряджатися, продавати, збувати

ц) судовий процес

Pre-reading task

Work in small groups.

Can you answer the following questions?

– Do you know anything about sources of finance for any business?

– Owners’ capital has some advantages and disadvantages. Do you have any idea about what they are?

– Can you identify the difference between ordinary and preference shares?

Preface each answer with one the following according to what is true for you:

I can say that … I’d like to point out … It should be noted …

The important thing is … I am not sure … I have no idea

Reading

1. Read text 16. How much of the information did your group already know?

Text 16

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