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Topic 3

Business banking and budgeting

Learning outcomes

After studying this topic, you will be able to:

� outline the tools that a business uses to manage money;

� identify the key features of a business budget.

Introduction

In Unit 2 Topic 7 we looked at using financial tools to manage money. Abank account helps us to carry out most transactions we need asindividuals, such as checking our balance and keeping track of moneycoming in and going out each month. We can pay bills, move moneybetween accounts, and pay other people using tools like online andtelephone banking.

In this topic we look at money management from a business’s point of view.Some of the financial tools used by individuals are also used by businesses,but there are additional tools designed solely for business use. This topicalso explores business budgeting – how and why businesses need to drawup detailed budgets and cash-flow forecasts, and how they use such toolsto set their business objectives and work out how they can achieve them.

3.1 Business banking

In order to manage their money, businesses need up-to-date and relevantinformation about their accounts, and must be able to carry out a range oftransactions quickly and easily to keep their business running. Somebusinesses are very simple and may largely carry out transactions in cash(a self-employed window cleaner, for example). At the other end of thespectrum, national and international businesses have very complex bankingneeds. Whatever their size, all businesses share a need to be able to:

� receive payments (for example from customers);

� make payments (for example to suppliers); and

� keep a record of all transactions.

1© The London Institute of Banking & Finance 2018

All of the mainstream banks, which have a network of high-street branchoffices around the country, offer a business banking service. They oftenprovide separate banking services for different types of business: new start-ups; small- to medium-sized businesses; large businesses; and internationalbusinesses.

High-street banks also offer services through the same channels they usefor personal banking: in the bank branch, by post, by telephone and online.Some smaller businesses such as shops and cafes, whose customers stillfrequently pay in cash, prefer to use a local bank branch where they canregularly deposit cash. Many also value face-to-face contact with a memberof the bank’s staff (ie a business account manager) when necessary –someone who will know them and deal with their questions in person.

To get the full picture of business banking, we need to look at the types oftransaction that businesses use.

3.1.1 Cash transactions

Some small local businesses may be paid in cash by many of theircustomers. Examples include individuals who are self-employed soletraders, such as window cleaners, charity shops, hairdressers, taxi drivers,and cafe owners like Sue Baker (see Topic 1). They will use this cash to coversome of the costs incurred in running the business, such as the wages ofstaff who are paid weekly. The advantage of customers paying thesebusinesses in cash is that the money is available straight away for use bythe business.

A small number of businesses may keep their cash locked in a safe ratherthan use a bank, but they run the risk of losing the money in the event ofa fire or burglary. Most cash businesses, however, use a bank businessaccount. By making regular visits to a convenient branch of their bank, theycan pay any cash received into their account, where it will be kept safe. Theycan also use account facilities such as standing orders and direct debits topay money to suppliers and pay other running costs.

Discuss

Can you think of localbusiness people in yourarea that deal mainly incash? Why do you think theydeal in cash?

2 © The London Institute of Banking & Finance 2018

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3.1.2 Cheques

In Unit 2 Topic 1 we explained the uses of cheques. In business terms,cheques can be used both to collect money from customers, and to paysuppliers and other people that the business owes money. These days,banks prefer not to deal with cheques, as it involves extra work for them,which adds to their costs. But cheques do have advantages:

� they are safer than handing over large sums of cash (if a cheque is lostor stolen it can usually be cancelled); and

� they can benefit a business if its customers like to have a choice of waysto pay.

However, paying a business by cheque can cause problems. It may be a fewdays before someone has a chance to pay in the cheque on behalf of thebusiness. After the cheque has been paid in, it can take up to six daysbefore the money is ‘cleared’ into the account; and if there is not enoughmoney in the account to ‘cover’ the cheque, it will ‘bounce’ and the businesswill not get the money.

These problems might be solved in future, as some banks have startedoffering customers an app that allows them to scan and send a chequeusing their phone or tablet. New technology may also speed up the processof ‘clearing’ cheques (GOV.uk, 2013), and by late 2018 cheques will becleared within one working day (BBC, 2017).

Whether payments in and out of a business bank account are by cheque orcash, another advantage of having an account is that the bank will issueregular statements of transactions – what has been paid in, what has beenpaid out, and daily balance of money left in the account. The business canuse these statements to keep track of its income and expenditure.

3.1.3 Debit and credit cards

Instead of using cheques, individual current account holders are now issuedwith debit cards to use to make payments (as described in Unit 2 Topic 7).In the same way, businesses are issued with debit cards to use with theirbusiness accounts. They will also receive payments from customers by debitcard, which most businesses prefer because the money is paid into theiraccount straight away. It also means they do not have to accept largeamounts of cash.

A business can also use a credit card to pay for goods and services in thesame way that individuals can (described in Unit 2 Topic 10). Business creditcards are used to pay bills and business expenditure, such as travelexpenses (ie petrol, train and plane fares) and, where necessary, for mealsand hotel bills. This is more convenient for the employee – it saves themhaving to pay these expenses themselves and then claim the money backlater. There are also advantages for the business, which will have a recordof exactly how much has been spent, what it has been spent on, where andwhen.

A key part of using debit and credit cards is the chip-and-pin terminal at the point of sale, which allowscustomers to use a card to pay the bill. Mostbusinesses happily accept card payments throughthese terminals. However, some small businessesmay not be able to carry around a chip-and-pinterminal, so they have to accept cash or chequepayments.

When businesses accept payment by credit card, theyoften charge the customer a fee (usually a small

percentage of the bill being paid). This is because credit-card companiescharge businesses a fee for processing credit card payments, andbusinesses generally pass on this fee to the customer. Credit-cardcompanies may take a day or two to process a payment, whereas a debit-card payment is usually paid on the same day.

Case study: How Paul handles payments

Paul Chater is a self-employed window cleaner.He works in his local area with his businesspartner John. They charge £8–10 to clean thewindows of each house they visit. Paul has tocollect money from customers when it suits him,and if the homeowner is at home, they usuallypay Paul in cash. Sometimes the homeowner hasno cash in the house, and writes Paul a cheque.When Paul is out cleaning windows, he tries to ensure that he visits thebank on his way home to pay any cash and cheques into his businessbank account.

Cheques used to be time-consuming for Paul to pay in to his bank, butnow that technology is more advanced he can pay them over the countermore easily, just by handing over his business debit card.


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Paul

I sometimes go out after work and collectmoney from customers who are at workduring the day. If they give me cash, I haveto hold on to the money overnight, alongwith any cheques, until the bank opens thenext day. I don’t like keeping moneyovernight but I’m lucky not to be dealingwith large amounts. I am always happieronce I’ve paid money into the bank.

3.1.4 Standing orders and direct debits

Business bank accounts enable a business to set up regular payments inthe same way that individuals can from current accounts (to pay, forexample, monthly insurance premiums, rent and energy bills). Customerscan also use regular payments to pay businesses. The two kinds of regularpayment from a bank account are standing orders and direct debits.

3.1.4.1 Standing orders

Standing orders allow individuals or businesses to set up a regular payment(usually monthly) into someone else’s bank account. It has to be a fixedamount (set by the account holder) and must be paid on the same day eachmonth. You can set up standing orders to keep paying indefinitely, or toend on a certain date or after a set number of payments. The customer isin full control – you can start or stop the payment or change its amountwhenever you want.

If a customer has to make regular payments to a business, they may beallowed to use a standing order from their current account. This benefitsboth parties:

� the customer knows how much money is going out of their account andwhen, which means they don’t have to remember to send off a chequeeach month;

� the business can also be more confident that the payment will be madeeach month, and there are cost savings for the business if it does nothave to process customers’ cheque payments.

3.1.4.2 Direct debits

Direct debits are similar to standing orders, but there are significantdifferences in the way they work. Both may be used to make regularpayments, but a direct debit allows for variable amounts, rather than fixedamounts, to be paid each month. The business that is being paid controlshow much money is paid each time.

Many businesses encourage customers to pay by direct debit because itgives them control over how much they take from the customer’s account.The business can collect however much you owe it, but it must tell you inadvance (normally ten working days) how much it will take, when, and howoften. Direct debits are particularly useful for paying regular bills where theamount changes each time, such as phone, gas or electricity bills. As wellas using them to take payments from customers, businesses use directdebits to pay their own bills when appropriate.

Whether a standing order or a direct debit, each payment is recorded onthe bank statement. This allows a business to keep track and keep a recordof its customers’ payments so it can, for example, chase up any missedpayments.


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3.1.5 CHAPS and Bacs

CHAPS (the Clearing House Automated Payment System) is an electronicpayment system used for very high-value payments and for paymentsbetween large companies. Bacs (the Bankers’ Automated Clearing Services)allows electronic payments to be made between bank accounts. Both ofthese systems were described in Unit 2 Topic 7, and businesses use themin a similar way to individuals. Bacs is commonly used by businesses to paystaff salaries directly into their current accounts each month.

3.1.6 PayPal for business

You may be familiar with PayPal as a way of makingpayments on eBay and similar auction websites. Inbusiness terms, PayPal is not a bank, but a way ofmaking electronic payments between PayPalaccounts. A PayPal account can be set up either byan individual or by a business. One of the mostpopular ways for a business to use PayPal is toplace a ‘Buy Now’ button on its website. The

advantage of using PayPal, for both customer and business, is that it is asecure, trusted system that allows payments to be made quickly and easilyvia the internet. The customer can choose whether to pay by card or bytransfer from a registered bank account. Wherever the money comes from,it will arrive almost immediately in the business’s bank account.

3.1.7 Telephone banking

Businesses may also use telephone banking, whereby they ring up a call centreto carry out various transactions. In most cases, a bank will direct a businessto the correct service via options on the telephone keypad. So for a businesslike Paul’s window cleaning, he may be able to check whether money hascleared into his business account without going to his local branch.

Business telephone banking allows you to:

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Some banks make their telephone service available outside normal businesshours – in some cases 24 hours a day, 7 days a week. This can be veryuseful for businesspeople who do not have time to get to a branch duringthe day.

3.1.8 Online banking

Most banks now provide businesses with internet banking facilities, givingthem access to their accounts 24 hours a day. This allows businesses tomake transactions whenever it suits them. A wide range of transactions areavailable, such as checking the account statement or balance on a dailybasis, paying bills by bank transfer, and moving money between accounts.This is useful to a business owner who wants to keep up to date witheverything that is happening with the business’s finances. The businessowner will have more control if they know exactly what is being paid in andpaid out of the business account each day.

Internet banking has security issues just as personal accounts do, butimprovements in internet security mean that bank websites are now muchmore secure than they used to be. Many banks require customers to usecard readers and other devices to generate security numbers, as an extrasecurity measure.

3.1.9 Mobile banking

Most people now use mobile phones, smartphones or tablets for a widerange of purposes. Mobile banking has become increasingly common forindividuals via their bank’s app, which allows them to bank online throughtheir mobile.

For businesses, this means they can transact – buying, selling, making andtaking payments – with customers wherever they happen to be (for examplein a park, on a train, in a cafe). It is therefore easier to stay in touch withcustomers and build good customer relationships. Small businesses mayalso benefit from using mobile technology, as it enables them to maketransactions and manage their business finances while on the move.

However, there are still security concerns with mobile banking – theconsequences of a business mobile being stolen or lost, for example.Therefore, there are limitations to what can be done via mobile banking.Often a business will still need to log in online to see full statementinformation, details of monthly charges, fees and interest, and to send andreceive secure messages. Some people nevertheless predict that mobiletechnology will one day replace cash, thanks to developments likecontactless card payments and Paym and Zapp – apps that allow you totransfer money to a friend, relative or business using your phone.


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Discuss

Some people do not trust theinternet when it comes tobanking. They are worriedthat bank websites are notalways fully protected fromhackers trying to accesscustomers’ personal details.

Do you think they are rightto be worried? On whatevidence do you base youropinions?

3.2 The key features of business budgets

3.2.1 Business records

All businesses keep records of their financial transactions – money coming inand money going out of the business. These records or accounts are necessary:

� for legal reasons (eg they might be used as evidence if a company isaccused of fraud or corruption);

� to calculate tax liabilities; and

� to allow the business’s finances to be monitored.

These records are also used to construct business budgets and cash-flowforecasts, which play an important part in business planning and financialmanagement.

The various financial tools, payment methods and current account featureswe looked at above provide ways for businesses to keep records of theirfinancial transactions. Banks will provide:

� regular printed statements;

� summaries of recent transactions; and

� online, electronic records of money paid in and paid out.

All of this supplies the business with detailed information about its pastand current finances. But it is crucial to the success of every business touse historical information to predict and plan for its financial future. Thisis where budgeting and cash-flow forecasting comes in.

3.2.2 Business budgets

Business budgets are a business’s financial plans for the future. Budgetsset out the business’s expectations and objectives, with focus on the profit(or loss) it expects to make. Drawing up a budget ensures that those


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running a business think carefully about all of the business’s likely costs(ie expenditure – the things it needs to buy, the bills it has to pay, employeesalaries) and all of its likely income or revenue over a future period of time.Deducting the expenditure from the revenue provides an estimate of theprofit the business will make.

Figure 3.1 How profit is calculated

Many businesses write an annual budget at the beginning of their financialyear, estimating their total expenditure, revenue and profit for the next 12months. Some businesses also break down this annual budget into separatemonthly budgets. In medium and large enterprises, there will be an overallbudget for the whole company, but every department in the company will alsohave its own budget – ie a proportion of the overall budget. Businesses faceexpenditure out of their budgets from all directions, as shown in Figure 3.2.

Figure 3.2 Typical business expenditure

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Revenue is mostly money received from customers buying thebusiness’s products or services. If a business takes out a

loan at any point, that money is also recorded asrevenue, as are other one-off receipts, such as a tax

refund.

The process of constructing an annual budget mayinvolve informed guesswork – particularly for newbusinesses, who have no past experience toinform their estimates. The accuracy of predictedrevenue will depend entirely on how realistic thesales forecasts turn out to be. But, howeverdifferent the actual figures are from thosepredicted in the budget, it is businesses whichdo not budget at all that may not stay inbusiness for long. Without a budget, a businessis working ‘in the dark’ and may be basing

decisions on hunches (like Sue Baker in Topic 1).

For some small businesses and sole traders,working without a budget may not cause major

problems; but bigger businesses can easily run out ofcash, build up high levels of unwanted debt, or end up

making a loss rather than a profit if they don’t have aneffective budgeting system.

When a business puts together its budget for the upcoming year,it will start by deciding its business objectives for that year. These

objectives may be:

� to achieve a certain amount of profit; or

� to increase the quantity of products made and sold; or

� to develop new products and services.

Once these objectives are agreed, businesses can start to work out theexpenditure needed to achieve them, and estimate the revenue that theyexpect to be achieved in order to cover the anticipated expenditure.

If the first attempt at a budget suggests that total expenditure will be morethan total revenue, this tells the business that it will end the year making aloss rather than a profit. If making a profit is a key objective, the businessneeds to revise the budget. It must look for ways to cut costs and increaserevenues, to create a better chance of ending the year with a profit ratherthan a loss.

At times, some businesses plan to trade at a loss for a period in order toachieve other objectives – particularly if they want to increase their marketshare (the percentage of customers who buy a product from them ratherthan from one of their competitors). The following case study illustrateshow this works.


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Sue Baker increases her market share

A year after Sue Baker set up her ‘Burgers à la Carte’ cafe, she contactedan online business advice service to see how she could make her businessprofitable. The adviser made a number of suggestions, such as puttingmore tables and chairs in to the room that was being used as a gallery /shop for Sue’s brother Richard’s pottery. This would increase the cafe’sseating capacity. They also suggested introducing discounts and specialoffers to bring more customers into the cafe on weekday lunchtimes andevenings – times when it had not been very busy.

3.2.3 Flexibility and contingency plans

Businesses also need to build flexibility and contingency plans into theirbudgets – partly because their estimates and predictions may turn out tobe inaccurate, but also because they need to allow for unforeseencircumstances and changes that are outside of their control. The worstsituation for any business is to run out of money, making it unable to pay


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Sue

I was wary at first when I was advised to cutsome prices in order to increase my profits – Ithought that it would have the opposite effect!The adviser explained that it’s sometimes betterto offer some items at a price that doesn’t evencover the cost of producing them. When peoplecome in for a ‘buy one burger, get one free’offer, which is only available Monday toThursday, they will typically buy drinks, startersor desserts at full price. In most cases the totalbill will more than cover the costs and I will stillmake a profit, but the special offer is what drawscustomers in.

January and February are also quiet months(everyone’s spent too much over Christmas), sothe adviser suggested more price-cutting offers.Even if I don’t make a profit for a few weeks, Iwill be getting more customers coming in – bothnew ones and ‘regulars’ – who will hopefullycome back later in the year, rather than go toone of my competitors. The adviser called it‘expanding my customer base to increasemarket share’.

its bills or pay back its business loans. Many businesses in this situationare forced to close down.

We saw in Unit 2 Topic 1 that individuals should put aside an ‘emergencyfund’ in a savings account, which they can use if their expenditureunexpectedly rises or their income drops. Businesses need to build similarcontingency plans into their forward-planning budgets, to prevent themfrom running out of money.

Business owners need to ask questions like:

Contingency plans to cope with these situations would include:

� keeping a cash reserve (ie ‘working capital’) in the bank;

� identifying areas of expenditure that could be reduced if necessary;

� making sure there is adequate insurance cover in place;

� ensuring the business has sufficient overdraft facilities with its bank; and

� identifying a source of affordable loans, in case the business needs toborrow more money at any point.

A business budget needs to be a ‘working document’ that can be changedand updated when necessary. Used together with cash-flow forecasts(explained below), a budget allows a business to regularly comparepredicted revenues and expenditures with the actual figures, to see ifeverything is ‘going to plan’. If reality is significantly different toexpectations, the business can either amend the budget and cash-flowforecasts to be more realistic, or take steps to bring the revenue orexpenditure in line with the original business plan.

There are many external factors outside of a business’s control that mayaffect its budget. For instance, the price of fuel may rise or fall, and if you

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spend a lot of money on transport then you need to adjust your budgets. Agood example of this on a simple level is a taxi business that budgets forthe cost of fuel used by its drivers. If the price of petrol and diesel suddenlyincreases, then the taxi business’s budget will be wrong. This is outside ofthe business’s control, but will affect its costs, so it may have to put upprices to avoid a fall in profit. Anything the business decides to do will affectits budget and cash-flow forecasts, which will have to be amendedaccordingly.

Some businesses are more vulnerable than others to unpredictable outsideforces. Many businesses are highly dependent on the weather, for example– think of farmers, ice-cream manufacturers and the makers of umbrellas.Their budgets will be based on the kind of weather we typically experienceat different times of the year, but the weather is notoriously difficult topredict with accuracy. Weather-dependent businesses will have good yearsand bad years, and must build flexibility and contingency plans into theirbudgets to ensure their long-term survival.

In business, a contingency plan is a process that prepares anorganisation to respond effectively to an unexpected event.The contingency plan can also be used as an alternativecourse of action if expected results fail to materialise. A contingency plan is sometimes referred to as ‘Plan B’.

3.2.4 Cash flow

A business budget tells a business how much profit (or loss) it will make ifeverything goes to plan and its predictions of revenue and expenditure areaccurate. The limitation of budgets is that they only tell you the likelyoutcome at the end of the budget period. They don’t tell you exactly howmuch money is going to be paid in or paid out of the business’s bankaccount on a weekly basis. Alongside their budget, therefore, businessesneed cash-flow statements and forecasts.

When we talk about ‘cash’ in this context, we don’t just mean physical cash– ie notes and coins. ‘Cash’ in a cash-flow table also includes deposits intoa business’s current accounts and savings accounts, and any positivebalances in those accounts.

‘Cash flow’ is the flow of money into and out of a business. When a businesspays for supplies (such as raw materials), pays a bill (such as for electricity)or pays wages, money flows out of the business (ie expenditure). Whencustomers pay for products or services they are buying from the business,money flows in. Any borrowed money deposited in the business accountsis also counted as ‘cash in’.


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Figure 3.3 Simple cash flow

The key to a business’s survival is for money to flow in quickly enough tocover the money flowing out. If you have enough money flowing in, you canpay your bills, but poor cash flow means you may not have enough cash inthe business to meet your day-to-day expenses. The difference between theinflow and outflow of money is the net cash flow. If net cash flow is positive(inflow greater than outflow) this surplus adds to the business’s workingcapital.

If a business relies entirely on a budget that predicts a healthy profit by theend of the year, without also using a cash-flow forecast, it runs the

risk of going out of business partway through the year becauseit has run out of cash. One reason for this is that there is

often a delay between when someone buys somethingand when they actually pay for it. Solicitors and

accountants, for example, may do a lot of work fora client but not bill them until all the work is

done; some clients may then take their timepaying the bill. Similarly, self-employedelectricians and plumbers often have to waitto be paid for jobs they have done, whichcan cause a serious problem if they havebills due before the money comes in.

Another reason for cash-flow problems canbe that the business needs to buy – and payfor – bulk amounts of raw materials, or buyin large amounts of stock. In these cases,the business may have to pay out large

amounts of cash at the beginning of itsfinancial year, but the revenue needed to pay

for these supplies comes in slowly month bymonth as products or services are sold (and

paid for).

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Take a look at the following example.

The cash flow of Tom’s Toy Shop

Tom’s Toy Shop is a newbusiness set to open in July.Tom and the other ownershave carefully drawn up abudget for the shop’s firstsix months’ trading, andthey are confident they willsell £80,000 worth of toys. After deducting expectedexpenditure of £65,000, they predict that they will make a£15,000 after-tax profit by the end of the year. However,after putting together a cash-flow forecast for the shop’s firsthalf-year, they are worried that the shop could be forced toclose within the first few months.

Table 3.1 Tom’s Toy Shop: six-month cash-flow forecast

Jul Aug Sep Oct Nov Dec Total£ £ £ £ £ £ £

Cash in:

Sales receipts 2,000 2,000 4,000 8,000 14,000 50,000 80,000

Bank loan 10,000 – – – – – 10,000

Total cash in 12,000 2,000 4,000 8,000 14,000 50,000 90,000

Cash out:

Pay for stock – 20,000 – 5,000 – 25,000 50,000

Rent 2,000 – – 2,000 – – 4,000

Wages 1,000 1,000 1,000 1,000 1,500 2,000 7,500

Utilities* – – 500 – – 500 1,000

Loan repayments 300 300 300 300 300 300 1,800

Other 200 100 300 100 200 300 1,200

Total cash out 3,500 21,400 2,100 8,400 2,000 28,100 65,500

Opening balance 0.00 8,500 (10,900) (9,000) (9,400) 2,600

Add all cash in 12,000 2,000 4,000 8,000 14,000 50,000

Deduct all cash out 3,500 21,400 2,100 8,400 2,000 28,100

Closing balance 8,500 **(10,900) (9,000) (9,400) 2,600 24,500

*Electricity, gas, water and phone bills **Negative (minus) balances shown in brackets


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Discuss

Look at the cash-flow forecast for Tom’s Toy Shop.

Why do you think Tom is worried that his business might notsurvive until December?

3.2.4.1 Tom’s cash flow explained

The cash-flow forecast for Tom’s Toy Shop shows the amount of money thebusiness expects to be able to pay into its bank account each month (ie‘cash in’). This is mostly money taken from customers buying toys, butthere is also a single £10,000 receipt in July. This is money that the businesshas borrowed from a bank, and it shows up as ‘cash in’ because it is moneyin the business account that can be used to pay for expenditure.

The ‘cash out’ rows are predictions of the money that will be paid out ofthe business account each month to cover business costs.

At the bottom of the cash-flow forecast, the monthly cash out is deductedfrom total cash in for the month. If cash in has been greater than the cashout, the result is a cash surplus, which is added to the ‘opening balance’that was in the account at the beginning of the month. If cash out has beengreater than cash in, the result is a cash deficit, which is deducted fromthe month’s opening balance.

As Tom’s Toy Shop doesn’t open until July, the opening balance (ie cash inthe account) is shown as zero. By adding the total cash in (£12,000) anddeducting the total cash out (£3,500) we arrive at the end-of-month balance(£8,500), which automatically becomes the opening balance for the nextmonth.

3.2.4.2 Tom’s cash-flow problem

What is worrying the owners of Tom’s Toy Shop is that they will have to buyin toys from manufacturers to stock their shelves, so that there are productsfor customers to buy. The suppliers will allow them up to 30 days to payfor them, but that still means the toy-shop owners will have to pay £20,000in August for this stock. They have also predicted that sales will start atfairly low levels, as the summer months are not normally busy for toy salesand it may take time for the new shop to attract customers. Even with the£10,000 the owners have borrowed and the £2,000 they expect as salesreceipts, the closing balance at the end of August is still a deficit of £10,900– ie their expenditure will be £10,900 more than their revenue.

The cash-flow forecast predicts that the situation will not get much betteruntil November, when people start doing their Christmas shopping. Toysare always in great demand as presents, so the run up to Christmas isalways the busiest time of the year for toy shops. Tom’s Toy Shop hopes to


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sell £50,000 of toys in December, and even though it will have another bigbill in December for the extra stock bought in November, it still expects toend the year with a £24,500 cash surplus.

Conscious of the need to be able to cover the three months when the shopexpects to have a cash deficit, the owners contact their bank and apply fora £12,000 overdraft facility on their business bank account. After lookingat their budget and cash-flow forecast, the bank agrees to the overdraft –which means Tom’s Toy Shop will be able to pay all its bills without runningout of money.

The owners did consider other ways to resolve their cash-flow problem.

� One option was to ask their suppliers for better credit terms – forexample, to give them 60 or even 90 days to pay their bill. The supplierswould have been reluctant to agree to this, as Tom’s is a brand newbusiness, so there would be a risk that the suppliers might not get paid.

� The other option was to carry less stock and only buy what the shopcould probably sell each month. But this would mean their shelves couldbe half empty, so customers might not feel there was enough choice.Another danger with this approach would be running out of stock andhaving nothing to sell until new stock arrived.

Discuss

Why is Tom’s Toy Shop’s closing balance at the end ofDecember (£24,500) different from the predicted profit(£15,000)?

Check your answer against the answer at the end of the topic.

3.2.5 Funding start-ups and expansion plans

Businesses often need to raise funds from outside sources. New businessstart-ups invariably need money to pay for supplies, stock, raw materials,equipment, fitting out premises, advertising and promotion. Some moneywill come from the entrepreneurs’ own savings, but additional funds willbe raised either:

� from private investors, who put money into the business in return forowning a share of it; or

� by borrowing money from a bank or other lender.

However additional funds are raised, the business will need to present abusiness plan that includes its detailed budget and cash-flow forecasts,which it can use to explain why additional funds are needed, and how thosefunds will be used. This shows that the business is planning ahead. Thebank or investor will take the business owners much more seriously if they


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have prepared a business budget and cash-flow forecast in detail, toconvince the investors or lender that the new business is going to be asuccess and that their money will not be lost.

Established businesses may also need to raise funds from time to time,either to solve short-term cash-flow problems or to allow the business toexpand and grow. Again, most businesses will look for either a bank loanor private investors. They need to be able to:

� present a clear business budget and cash-flow forecast to show how themoney will be used; and

� convince the bank or investors that any risks they will be taking arejustified by the potential rewards.

Did you know?

When larger privately ownedbusinesses want a big cashinjection to fund ambitiousexpansion plans, they maychoose to raise money by‘floating’ the business onthe stock exchange.

This lets individual invest orsand investment funds buyshares (part ownership) inthe company. The com panycan use the money paid forthe shares to invest in new factories, shops and offices.

In addition to helping to attract investment and secure loans, good businessbudgets and cash-flow forecasts can help a business understand how muchmoney it has available to increase spending in different areas of thebusiness. For example, a business can estimate how much is available toinvest in marketing, or to hire an extra member of staff, or to pay foradditional staff training.

Business owners can also draw up amended budgets and cash-flowforecasts to predict whether these new expenditures and investments willachieve the desired outcome (for example higher profits, greater marketshare, higher volume of sales, or a more productive workforce).


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SummaryFinally, we can recap what we have learned in this topic.

We have learned that:

� businesses have a choice between various methods of paying money inand out of their accounts and transferring money between accounts;

� businesses and individuals have a similar range of financial toolsavailable to them;

� these tools can help a business to make forecasts about cash flow andbudgets, and can assist in its financial planning;

� businesses need to have flexible business budgets and cash-flowforecasts with contingency plans for unforeseen events;

� budgets and cash-flow forecasts can help businesses stay on track toachieve their objectives, and can be used to secure additional loans orinvestment for business start-ups and expansions.

Answer to discussion point on page 17

Tom’s Toy Shop expected to make a profit of £15,000 by theend of the year, but the cash-flow forecast predicted a cashsurplus of £24,500.

Here is why these two figures are different. Firstly, theestimated profit figure is for net profit – what is left over afterthe business pays its tax bill. The second reason is that thebusiness pays some of its bills a month ‘in arrears’. Forexample, when it purchased £25,000 worth of extra stock inNovember, to meet the extra demand during the run up toChristmas, it didn’t have to pay for the stock until December.The shop planned to buy another £30,000 worth of stock inDecember, but would not have had to pay for it until January.

To calculate profit, rather than cash surplus, you have to takeaccount of the cost of all the products you have sold, even ifyou won’t actually be paying for them until later.


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Key terms

Bacs – a payment clearing scheme that allows electronic payments to bemade between bank accounts.

Budget deficit – when the flow of cash out is greater than the flow ofcash in.

Budget surplus – when the flow of cash in is greater than the flow ofcash out.

Business budget – a plan that estimates future spending and profit in abusiness.

Capital – the economic term for money, property, equipment, vehiclesand other assets that a business owns and can use to run the business.

Cash-flow forecast – a document that shows the predicted inflows andoutflows of cash over a given period of time, for example 12 months.

CHAPS – the electronic Clearing House Automated Payment System,which is used for very high-value payments and payments between largecompanies.

Cheque – a written order from a bank customer to pay someone else (thepayee).

Contingency plan – a plan that prepares an organisation to respond toan unexpected event.

Credit card – a form of borrowing offered by banks, building societiesand some specialist firms. It allows the cardholder to borrow money bypaying for things using the credit card, but is generally the mostexpensive way to borrow, unless the balance is paid in full every month.

Debit card – a card used by the account holder to make payments orwithdraw money from their current account.

Direct debit – an electronic payment out of an account, for example topay a bill. The amount of a direct debit and how often it is taken can vary.

Expenditure – all of the money a business spends (the outflow of moneyfrom the business).

External factors – factors outside of the control of the business whenmaking decisions.

Financial planning – a process to forecast future financial results anddetermine how best to use your financial resources in pursuit of yourorganisation’s short- and long-term objectives.

Investment – an injection of capital into a business to enable it to begintrading or to expand.

Overdraft – when the money taken out of a bank account exceeds theamount of money in the bank account.


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Profit – the amount of money left over after a business has deducted itsexpenditure from its revenue (profit = revenue – expenditure).

Receipts – money coming into a business from sales.

Revenue – all of the money a business receives from the sale of itsproducts or services.

Standing order – an electronic payment out of an account. In contrast toa direct debit, a standing order is used to make regular payments of thesame amount.

Unforeseen events – events that are either difficult or impossible to planfor in a business.

Bibliography and further reading

BBC News (2017) Bank cheques to be cleared within one day – availableat: http://www.bbc.co.uk/news/business-39351793

GOV.uk (2013) New proposals to make cheque depositing easier andquicker to be unveiled [online]. Available at:https://www.gov.uk/government/news/new-proposals-to-make-cheque-depositing-easier-and-quicker-to-be-unveiled

Further information on budgets, cash flow and business loans:

An introduction to budgets –www.tutor2u.net/business/accounts/introduction-to-budgets.htm

Business finance explained – www.gov.uk/business-finance-explained

Calculating cash flow –www.bbc.co.uk/schools/gcsebitesize/business/finance/cashflowrev2.shtml

Forecasting business finances – www.gov.uk/forecast-business-finances

Golden rules of cash-flow forecasting – www.startups.co.uk/6-golden-rules-of-accurate-cashflow-forecasting

Start-up loans and advice – www.startuploans.co.uk/

All images © iStock.com


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Documents

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