Budgeting

A firm's managers need to be aware of the inflow and outflow of cash to plan future finances. The firm has various costs and different sources of income [Income: Money from sales, or revenue coming into the firm. ]. To keep the business profitable and avoid running into financial difficulties, accountants ensure the firm has enough working capital [Working capital: The difference between current assets less current liabilities - the difference between a firm's cash and its short-term debts - the money it has to play with. ] to pay any short-term debts when they fall due. They plan a budget that:

1. sets performance targets over a certain time period
2. limits expenditure [Expenditure: Costs the firm has to make ie its spending. ] to what the business can afford

The firm's accountants monitor and record the actual financial performance of the firm against the budget, so that its likely financial performance can be forecast. When the two are compared there will usually be a difference. Adjustments will be made for the next budget or forecast.

Now look at both in detail and try to remember three ways of raising finance from each source.

Internal sources of finance

1. The board of a public limited company may retain profits for a year rather than share it amongst the owners. The cash can be invested to earn interest.
2. Assets that are no longer required, like an outdated computer or an obsolete piece of machinery, can be sold.
3. Stock levels can be reduced and funds made available for other uses.

External sources of finance

1. A sole trader or a small business may be able to borrow money from family or friends without paying interest.
2. Loans from a bank or a building society can be expensive. An agreed amount is borrowed and repaid over a fixed period of time with interest.
3. Grants from central or local government will cost the firm nothing.
4. Firms often lease equipment or machinery to avoid a large outlay of cash. This is useful if a firm needs to upgrade within the medium term as technology advances.