3.1.1
What are the two main types of expenditure that the finance department oversees in a business?
capital expenditure and revenue expenditure
How is revenue expenditure related to a firm’s non-current assets?
Revenue expenditure includes routine spending on maintaining the firm's non-current assets to ensure they continue functioning properly.
What are the two main classifications of sources of finance?
Sources of finance are classified as internal or external.
Why are sole traders considered high risk by lenders?
Sole traders are high risk because they have limited liability, face business uncertainties alone, and may lack the financial stability or security needed to repay external finance.
What are fixed assets? List two characteristics.
Fixed assets are long-term items owned by the business that:
Are used for over 12 months.
Help generate income for the business.
What is loan capital?
Loan capital refers to long-term borrowed funds from lenders such as commercial banks. It is usually used to purchase fixed assets and appears as a non-current liability on the balance sheet.
Identify one key benefit of trade credit.
Improves short-term cash flow as payment is delayed.
Why might a company lease rather than buy equipment?
Leasing conserves capital and avoids maintenance costs, which are handled by the lessor. This is useful for businesses needing assets temporarily or with limited funds.
Sugar Whisk, a boutique cupcake café in Amman, Jordan, has seen a steady rise in customer demand due to social media exposure and partnerships with local influencers. The owner is considering expanding by opening a second location and launching a delivery service.
To finance this expansion, the owner is exploring different funding sources. While she has some retained profit from the last two years, it is not enough to cover all expected costs. She's considering a bank loan, crowdfunding through a local platform, or leasing bakery equipment instead of buying it outright.
a. Define the term retained profit.
Retained profit refers to the net earnings that a business keeps after paying taxes and dividends. It is an internal source of finance used to reinvest in the business for growth or expansion.
Award [1 mark] for a vague or partially accurate definition (e.g., "money kept by the business").
Award [2 marks] for a clear, accurate definition that shows good understanding.
Using an example, explain the difference between variable and fixed costs.
Variable costs change with the level of output. For example, a t-shirt manufacturer pays more for cotton as more shirts are produced.
Fixed costs remain constant regardless of output. For instance, the rent for the factory remains the same whether the company makes 10 or 10,000 shirts.
What is capital expenditure in a business context?
Capital expenditure refers to business spending on non-current assets or capital equipment that offer long-term gains in efficiency, productivity, or earning capacity.
How does revenue expenditure differ from capital expenditure?
Revenue expenditure covers day-to-day operational costs and maintenance, while capital expenditure involves long-term investments in non-current assets that improve productivity or capacity.
What distinguishes internal sources of finance from external sources?
Internal sources of finance come from within the business (its own resources) and do not require repayment or incur interest, whereas external sources involve funds from outside parties and often require repayment with interest.
What is retained profit?
Retained profit is the portion of a firm’s financial surplus that is reinvested in the business rather than distributed to the owners or shareholders.
Give three examples of assets a business might sell to raise finance.
Buildings
Vehicles
Computers or machinery
Outline two advantages of using loan capital.
Structured repayments: Businesses can repay in regular instalments, making it manageable.
Ownership retention: Unlike issuing shares, loan capital doesn’t dilute ownership.
Explain how trade credit can help a company grow.
It allows businesses to obtain and sell goods before paying for them, boosting working capital and enabling sales-driven growth.
Evaluate the use of leasing for a construction company. ( 1 pro, 1 con, conclusion)
Pros:
Access to expensive equipment without large upfront payments.
Maintenance responsibilities lie with the lessor.
Cons:
Long-term costs can exceed purchase price.
No ownership, which can impact asset value.
Conclusion: Leasing offers flexibility and reduces short-term costs, but may be expensive long-term if assets are needed permanently.
(b) Explain one advantage and one disadvantage of using a bank loan for Sugar Whisk’s expansion. [4 marks]
A bank loan allows Sugar Whisk to access a large sum of money quickly, which is ideal for financing the opening of a second location and delivery logistics. The repayment terms can also be spread over a longer period, making budgeting easier.
However, bank loans come with interest payments, which increase the total cost of the finance. Additionally, the café may need to provide collateral or meet strict credit requirements.
Award [1 mark] for each relevant point (1 advantage and 1 disadvantage).
Award [1 mark] for each well-explained point in the context of Sugar Whisk
Discuss the importance of controlling indirect costs for a non-profit organization.[10 marks]
Definition:
Indirect costs (overheads) are expenses not directly tied to a specific product or service, such as utilities, rent, and admin salaries.
Importance for a non-profit:
Non-profits do not aim to generate profits but must ensure financial sustainability. Controlling indirect costs allows them to maximize the portion of revenue used for their core mission (e.g., feeding the homeless, education programs).
Examples:
If a non-profit can reduce electricity costs by switching to solar panels, more funds are available for outreach programs.
Negotiating cheaper rent can free up money for hiring more social workers.
Evaluation:
While cutting indirect costs is beneficial, excessive cuts may harm the organization's efficiency or quality of service. A balance must be struck to ensure operational effectiveness while keeping donor trust and maintaining mission integrity.
List three examples of capital expenditure.
Examples of capital expenditure include spending on buildings, machinery, and research and development. (Other valid examples: tools, computers, printers, photocopiers, vehicles.)
What type of expenditure would the following fall under: payment for electricity, employee salaries, and delivery of goods?
Revenue Expenditure
What are the three main internal sources of finance?
Personal funds (for sole traders)
Retained profit
Sale of assets
Why is retained profit considered an internal source of finance?
Because it comes from within the business (from its profits), does not involve external parties, and does not need to be repaid.
Why might a business use external finance?
Because internal sources are insufficient, especially when larger amounts of funding are needed for expansion or capital investments.
Explain one risk associated with variable interest rate loans.
Variable interest rates can rise over time. This increases the cost of loan repayments, potentially causing liquidity problems for the business.
Evaluate the use of trade credit for a new business.
Pros:
Interest-free if paid on time.
Supports cash flow and liquidity.
Cons:
May harm supplier relationships if not paid on time.
Difficult for new businesses to secure generous terms.
Conclusion: Trade credit is beneficial if managed responsibly and the business builds good supplier trust.
What is microfinance?
Microfinance refers to small-scale financial services, including small loans, provided to individuals or businesses with low income who cannot access traditional banking.
Explain why leasing bakery equipment might be more suitable than purchasing it outright. [2 marks]
Leasing allows Sugar Whisk to use the bakery equipment without a large upfront cost, which is helpful given the limited retained profit. It also enables access to newer equipment and includes maintenance, which can save money long-term.
Award [1 mark] for identifying leasing as a lower-cost alternative.
Award [1 mark] for a justified explanation in context.
Define the term “cost” in a business context and give two examples.
Costs are the financial expenditures a business incurs in its daily operations to produce goods or services.
Example 1: Paying for raw materials to manufacture furniture.
Example 2: Monthly rent for a factory.
Give three examples of revenue expenditure.
Examples of revenue expenditure include utility bills, wages and salaries, and rental payments for premises.
(Other valid examples: raw materials, delivery costs, insurance premiums, monthly loan repayments.)
How does revenue expenditure differ from capital expenditure?
Revenue expenditure covers day-to-day operational costs and maintenance, while capital expenditure involves long-term investments in non-current assets that improve productivity or capacity.
Do internal sources of finance need to be repaid? and why?
No, internal sources of finance do not need to be repaid, as they belong to the owner or the organization.
What is another term for retained profit?
Ploughed-back profit.
List any four external sources of finance from the IB syllabus.
Share capital
Loan capital
Trade credit
Crowdfunding
(Other correct answers: overdrafts, leasing, microfinance, business angels)
Evaluate whether a growing startup should use loan capital (pros and cons, 2 each). Give conclusion too.
Pros:
Access to large sums of finance for expansion.
No loss of ownership or control.
Cons:
Interest must be paid regardless of profit.
May require collateral, risking assets.
Conclusion: For startups without strong cash flow or collateral, it might be risky. Alternatives like equity finance or crowdfunding may be more suitable initially.
Define crowdfunding.
Crowdfunding is a method of raising finance by collecting small amounts of money from a large number of people, typically online.
Explain how microfinance empowers entrepreneurs.
It provides them with the financial means to start or grow small businesses, increasing self-reliance and reducing poverty.
Discuss two appropriate sources of finance for Sugar Whisk’s expansion. [10 marks]
1. Retained Profit:
Sugar Whisk can use its retained profit to partially fund the expansion. It doesn’t involve repayment or loss of ownership. However, the retained profit is not enough to fund the full expansion, making it unsuitable as the only source.
2. Crowdfunding:
The café’s strong social media following and influencer connections could be leveraged to run a successful crowdfunding campaign. This source does not require repayment or collateral, and it builds community support. On the downside, crowdfunding campaigns are not guaranteed to succeed and require significant marketing effort.
Evaluation:
Combining retained profit and crowdfunding might provide a balanced approach to finance the expansion without incurring interest or diluting ownership. However, if these prove insufficient, leasing or a small bank loan might still be needed.
[2 marks] for clear explanation of each source of finance (retained profit + crowdfunding).
[2 marks] for applying to the case study.
[2 marks] for advantages of each.
[2 marks] for disadvantages of each.
[2 marks] for evaluation and judgment of overall appropriateness.
Explain the difference between fixed and variable costs, using one example for each. [4 marks]
Fixed costs do not change with the level of output; they must be paid regardless of how much is produced.
Example: Rent of $2,000 per month for the business premises.
Variable costs change directly with the level of production.
Example: Cost of raw materials like wood, which increases as more chairs are produced.
What is revenue expenditure in a business?
Revenue expenditure refers to business spending on its everyday and regular operations, necessary to keep the business running.
Which type of expenditure is usually financed from short-term sources: revenue or capital?
Revenue expenditure is typically financed from short-term sources of finance, such as operational revenue or working capital.
Who typically uses personal funds as a source of finance?
Sole traders and partners typically use personal funds from their own savings to finance start-up businesses.
Where is retained profit recorded on a company’s financial statements?
In the balance sheet, as part of the firm’s equity.
What is share capital?
Finance raised by a company through selling shares to investors via a stock exchange.
What is an overdraft?
An overdraft allows a business to withdraw more money than it has in its bank account, up to a pre-agreed limit.
State one difference between donation-based and equity-based crowdfunding.
In donation-based crowdfunding, contributors receive no financial return, while in equity crowdfunding, they receive a share in the business.
Identify one ethical concern about microfinance.
It may exploit low-income individuals by charging them interest and increasing their debt burden.
Define the term total revenue and explain how it is calculated.
Total revenue is the total income earned by a business from selling its goods or services.
It is calculated by multiplying the price per unit by the number of units sold.
Formula: Total Revenue = Price × Quantity
Classify each of the following costs as fixed, variable, direct, or indirect:
a) Salaries of management
b) Insurance premiums
c) Electricity for manufacturing machines
d) Raw materials used in production
a) Fixed cost, Indirect cost
b) Fixed cost, Indirect cost
c) Variable cost, Indirect cost
d) Variable cost, Direct cost
How does capital expenditure affect a business's earning capacity?
Capital expenditure increases a business's earning capacity by improving efficiency and productivity through long-term investments.
In which financial statement is revenue expenditure recorded?
Revenue expenditure is recorded in the profit and loss account.
List three advantages of using personal funds as a source of finance.
Personal funds do not require repayment.
No interest is charged.
Shows commitment, increasing the chance of securing additional external finance.
List three advantages of using retained profit as a source of finance.
No interest is incurred.
It is a permanent source of finance (no repayment).
Offers flexibility—can be used for any purpose within the business.
What is an Initial Public Offering (IPO)?
An IPO is when a company sells its shares to the public for the first time on a stock exchange.
State two advantages of an overdraft.
Flexibility: Used only when needed.
Speed: Quick to arrange, useful for emergencies.
Explain one reason crowdfunding has become more popular in recent years.
Low interest rates and inflation have made traditional savings unattractive, prompting people to seek higher returns via crowdfunding.
Who are business angels?
Wealthy individuals who invest their own money in startups with high growth potential in exchange for equity.
Explain two different revenue streams that a gym might have.
Membership Fees: Monthly or annual subscriptions paid by members to access the gym facilities.
Merchandise Sales: Revenue from selling branded products such as protein bars, water bottles, or fitness gear.
Explain how the total fixed cost is shown on a cost diagram and what it represents.
The total fixed cost (TFC) is shown as a horizontal line on a cost diagram because it does not change with output.
It starts at the value of the fixed cost on the y-axis, for example, $100,000, and runs parallel to the x-axis (output level).
This represents that the fixed costs remain constant regardless of the number of units produced.
Give an example of a company that has used significant capital expenditure for growth and explain how.
Tesla is an example. It has spent billions of dollars over the past decade on capital expenditure to increase market share in the electric vehicle industry.
Where is capital expenditure reflected in a company's financial statements?
Capital expenditure is reflected in the balance sheet, as it relates to non-current assets.
Why can using personal funds increase a sole trader’s chances of borrowing money?
It demonstrates greater commitment to the business venture, which makes lenders more likely to trust and support the business financially.
List three disadvantages of retained profit.
Not available to start-ups.
May not be sufficient to fund large projects.
Reduces dividends paid to shareholders, which may cause dissatisfaction.
List three advantages of using share capital as a source of finance.
It is permanent capital and does not need to be repaid.
No interest payments are required.
It doesn’t add debt to the business, unlike loans.
Are overdrafts suitable for long-term financing, and why?
No, because they carry high interest rates and can be called in by the bank at short notice, making them unreliable for long-term investment.
Evaluate crowdfunding as a source of finance for a tech startup (2 pros, 2 cons and conclusion).
Pros:
Can raise significant funds quickly.
Avoids dealing with banks.
No need to give up full control (unless equity-based).
Cons:
IP theft risk.
Regulatory and legal issues.
Public failure can harm reputation.
Conclusion: Crowdfunding suits creative or tech-driven startups with strong online communities, but it requires transparency and a compelling pitch.
Why are business angels important for startups?
They provide capital and mentorship when banks or other investors are unwilling to take the risk.
Define the term fixed costs and give one example.
Fixed costs are costs that do not change with the level of output or sales. They remain constant regardless of the amount of goods or services produced.
Example: Monthly rent for a bakery.
Explain the meaning of direct and indirect (overhead) costs in the context of a manufacturing firm, using examples.
Answer:
Direct costs are expenses directly tied to the production of specific goods or services.
Example: The cost of steel used to make bicycles.
Indirect (overhead) costs are not directly linked to a particular product and are incurred to run the business.
Example: Salaries of office staff or electricity used in the administrative building.
Why is capital expenditure important for business growth?
Capital expenditure is important for business growth because it enables a company to invest in assets that support expansion, increase market share, and improve overall operations over time.
Which type of expenditure improves a firm’s operational efficiency?
Capital expenditure improves a firm’s operational efficiency by investing in productive assets.
List three disadvantages of relying on personal funds.
Personal funds are often not sufficient for most small businesses.
Sole traders carry high risk, making external finance harder to obtain.
Entrepreneurs may risk losing their entire life savings if the business fails.
Why is retained profit considered similar to a business’s savings?
Because it represents accumulated profits that are stored and reinvested over time, just like personal savings.
List three disadvantages of using share capital.
Dividends may be expected by shareholders.
Ownership and control of the business may be diluted.
Only public limited companies can trade shares on the stock market.
Discuss whether a small seasonal business should rely on overdrafts (2 pros, 2 cons and conclusion).
Pros:
Helps manage cash flow during low revenue periods.
Easy and fast to obtain.
Cons:
High cost due to interest.
Not suitable for capital investment.
Conclusion: Overdrafts are useful for short-term seasonal needs but should be managed carefully to avoid dependency.
What is leasing in business?
Leasing is a contract where a business rents fixed assets from a leasing company instead of purchasing them.
State one disadvantage of using business angels.
They require a share of ownership and decision-making power, which reduces the entrepreneur's control.
Explain the difference between direct and indirect costs, using examples.
Direct costs are those that can be directly linked to the production of a specific good or service.
Example: The cost of flour and eggs used to bake cakes in a bakery.
Indirect costs, also called overheads, cannot be traced directly to a specific product.
Example: Electricity bills for the bakery or salaries of administrative staff.
A business has a total fixed cost of $100,000. What will be its total fixed cost if it produces:
a) 0 units
b) 500 units
c) 1,000 units
a) $100,000
b) $100,000
c) $100,000
What are typical sources of finance for funding capital expenditure?
Capital expenditure is normally funded through long-term sources of finance, such as loans or equity, with repayment periods longer than 12 months from the balance sheet date.
Does revenue expenditure improve a business's operational efficiency?
No, revenue expenditure does not directly improve operational efficiency; it maintains day-to-day operations.
Why might internal sources of finance be preferred over external ones, despite being more limited?
Internal sources are cheaper because they do not incur interest and do not require repayment, making them cost-effective for the business.
What is meant by the "sale of assets" as a source of finance?
It refers to generating finance by selling business-owned items of value, such as vehicles, equipment, or buildings.
What is meant by a “share issue”?
It is the process of a company raising more finance by selling additional shares.
What is trade credit?
Trade credit is when a business buys goods or services but pays the supplier at a later date (usually within 30–90 days).
Give one advantage and one disadvantage of leasing.
Advantage: No large capital outlay is required.
Disadvantage: The lessee never owns the asset.
Evaluate the use of business angels for an innovative startup (2 pros, 2 cons, conclusion)
Pros:
Provide both finance and expertise.
Tolerate more risk than banks.
Ideal for high-growth sectors.
Cons:
Equity dilution.
Not widely available.
May lead to conflicts over business direction.
Conclusion: Business angels are ideal for innovative startups that need both funding and guidance, but entrepreneurs must be willing to share control.
A coffee shop incurs the following monthly costs:
Rent: $2,000
Coffee beans and milk: $1,200
Baristas’ wages (hourly): $2,400
Advertising: $600
Identify and classify each of the above as either a fixed, variable, direct, or indirect cost.
Rent – Fixed cost, Indirect cost
Coffee beans and milk – Variable cost, Direct cost
Baristas’ wages (hourly) – Variable cost, Direct cost
Advertising – Fixed cost, Indirect cost
Discuss the importance for a business of correctly distinguishing between fixed and variable costs.
[10 marks]
Correctly distinguishing between fixed and variable costs is crucial for financial planning, budgeting, and decision-making.
1. Break-even analysis:
It helps determine how many units must be sold to cover all costs. Misclassifying costs can lead to incorrect break-even points.
2. Pricing decisions:
Knowing variable costs allows businesses to set prices that cover costs and ensure profit margins.
3. Cost control:
Understanding cost behavior allows managers to control or reduce costs effectively—for example, negotiating better terms on fixed lease agreements.
4. Investment and expansion decisions:
If a business knows which costs are fixed, it can assess how scalable operations are and whether it can afford new investment.
Example:
A bakery needs to understand that rent ($2,000/month) is fixed, while the cost of flour increases with bread output. Misunderstanding this could lead to underestimating costs during growth.
Evaluation:
While important, some costs may appear fixed in the short term but become variable in the long term (e.g. staff salaries if working hours vary). A firm must also revisit cost classifications regularly due to changes in suppliers, economic conditions, or operations.