Sources of finance and investment appraisal basics - Business Studies IGCSE Study Notes
Overview
Imagine you want to buy a cool new video game console, but you don't have enough money. What do you do? You might ask your parents for some money, save up, or maybe even do some chores to earn it. Businesses face the exact same problem, but on a much bigger scale! They constantly need money to start, grow, and even just keep running. This money is called **finance**. But just getting money isn't enough. Businesses also need to decide *how* to spend that money wisely. If they have a choice between buying a new super-fast delivery van or upgrading their old computers, which one will bring them more success? This is where **investment appraisal** comes in. It's like trying to figure out which choice will give you the biggest bang for your buck, or in business terms, the most profit. Understanding sources of finance and investment appraisal is super important because it helps businesses make smart money decisions. These decisions can be the difference between a business doing really well and one that struggles or even closes down. It's all about making sure a business has enough money and uses it smartly to achieve its goals.
What Is This? (The Simple Version)
Think of a business like a giant hungry monster that needs to be fed money to stay alive and grow. This 'food' is called finance. There are two main ways this monster can get its food:
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Internal Sources of Finance: This is like when you find money in your own piggy bank or under your bed. It's money the business already has or has made itself. It doesn't need to ask anyone else for it.
- Retained profit: This is like when a business makes money (profit) but instead of giving it all to the owners, it keeps some of it to use for itself later. It's saving up for a rainy day or for new projects.
- Sale of assets: Imagine a business has an old, unused delivery van sitting in its garage. If they sell it, the money they get from the sale is an internal source of finance.
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External Sources of Finance: This is like when you ask your parents for money, or borrow from a friend. The business gets money from outside itself.
- Loans: This is like borrowing money from a bank. The business gets a lump sum, but it has to pay it back over time, plus extra money called interest (a fee for borrowing the money).
- Share capital: Imagine a business wants to build a new factory. It can sell tiny pieces of ownership in the company, called shares, to people. These people become part-owners and give the business money in return.
- Grants: Sometimes, the government or other organizations give businesses money for specific projects, and the business doesn't have to pay it back. It's like winning a prize!
Real-World Example
Let's imagine 'Bella's Bakery', a small but popular local bakery. Bella wants to expand and open a second shop in a nearby town.
Sources of Finance:
- Retained Profit (Internal): Bella has been running her bakery for five years and has always saved a portion of her profits instead of spending it all. She has £10,000 saved up in the bakery's bank account. This is her own money, so it's an internal source.
- Bank Loan (External): The new shop will cost £50,000 to set up. Bella's £10,000 isn't enough. So, she goes to the bank and asks for a loan of £40,000. The bank agrees, but Bella will have to pay back the £40,000 over five years, plus some interest (extra money) for borrowing it.
- Grant (External): Bella also finds out that the local council has a scheme to help small businesses grow in the area. She applies for and receives a grant of £5,000 to help with the new shop's initial marketing. This is fantastic because she doesn't have to pay it back!
So, Bella used a mix of her own saved money and money from outside sources to fund her expansion. Smart thinking, Bella!
Investment Appraisal: Choosing Wisely
Now, let's talk about **investment appraisal**. This is like when you have a few options for how to spend your pocket money, and you want to pick the best one. Should you buy that new video game, or save up for a bike? Businesses use investment appraisal methods to decide which big projects or purc...
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Key Concepts
- Finance: The money a business needs to start, operate, and grow.
- Internal Sources of Finance: Money generated from within the business itself.
- Retained Profit: Profit that a business keeps and reinvests back into the company instead of distributing to owners.
- Sale of Assets: Money obtained by selling items that the business owns but no longer needs.
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Exam Tips
- →When asked about sources of finance, always try to give both an internal and an external example to show a broad understanding.
- →For each source of finance, be ready to explain one advantage and one disadvantage (e.g., a loan provides quick cash but has interest).
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