Finance is the money a business raises and the way it uses that money. Where the money comes from depends on the form of the business and on how long the money is needed.
The idea
Owner's capital is money the owner puts in. It is not repaid on a fixed date, and a sole trader does not pay a dividend to anyone else. Retained profit is profit kept in the business instead of being taken out. It has no interest, but it exists only if the business made a profit. Trade credit is time a supplier gives before payment. It is short term. A bank overdraft lets the firm draw more than the balance on its current account. Interest is charged on the amount used, and the bank can ask for repayment. A bank loan is a fixed sum for an agreed period, often with security, and repayment is planned. Do not call an overdraft a loan. The amount, the period and the right to recall them are different.
A company can also raise long term money by issuing shares or debentures. Shareholders own the company. A dividend is not guaranteed. Debenture holders are creditors. Interest on debentures is an obligation, whether or not the company made a profit. Hire purchase and leasing let a firm use equipment while paying over time. Working capital is current assets minus current liabilities. It pays wages, stock and suppliers before cash comes back from customers. Fixed capital is money tied in long lasting assets such as buildings and machines. A firm can own a large building and still fail if it cannot pay this week's wages. That is a shortage of working capital, not of fixed capital. A budget is a plan of income and spending. It is not the final accounts, which record what already happened.
The Business Management tips guide keeps a budget apart from final accounts, and tells you not to invent a figure. WASSCE Business Management tips
What earns the marks
Name the source, say how long it is for, and say one limit. "A loan from the bank" is thin. "A fixed sum for an agreed period, with interest, often secured" is the answer. Overdraft against loan is a favourite distinction. Shares against debentures is another: owners against creditors. Working capital needs both halves of the subtraction. Current assets alone are not working capital. Do not invent a profit figure or an interest rate. None is required.
Practice questions
These are practice questions in the style of the paper, with a model answer and a mark scheme. They are not a promise of what your paper will ask.
1Question 1
4 marks
Distinguish between a bank overdraft and a bank loan. (4 marks)
Model answer
An overdraft allows a firm to draw more than the balance on its current account. It is short term, interest is charged on the amount used, and the bank can ask for it to be repaid. A loan is a fixed sum for an agreed period, repaid by an agreed plan, and it is often secured.
Mark scheme
Overdraft: drawing above the current account balance, or short term1 mark
Interest on the amount used, or the bank may recall it1 mark
Loan: a fixed sum for an agreed period1 mark
Loan is repaid on a plan, or is often secured1 mark
2Question 2
3 marks
(a) Define working capital. (2 marks)
(b) State one reason a firm needs it. (1 mark)
Model answer
(a) Working capital is current assets minus current liabilities.
(b) It pays day to day costs such as wages and stock before customers pay.
Mark scheme
Current assets minus current liabilities2 marks
A reason, such as paying wages, buying stock, or meeting suppliers1 mark
3Question 3
2 marks
State one advantage and one disadvantage of using retained profit as a source of finance. (2 marks)
Model answer
No interest is paid, because the money already belongs to the business. The disadvantage is that the firm can keep only profit it has actually made, so the amount is limited.
Mark scheme
An advantage, such as no interest or no loss of control1 mark
A disadvantage, such as the limit of profit already earned, or less money taken out by the owners1 mark
Practise Business Management with Anna
More questions on this topic are inside glearn, marked as you answer, with the reason written out. The first ones need no account.
What is the difference between a bank loan and an overdraft?+
A loan is a fixed sum for an agreed period. An overdraft is permission to spend more than the current account balance, interest is charged on what you use, and the bank can ask for it back. They are both bank finance. They are not the same facility.
What is working capital?+
Current assets minus current liabilities. It is the money available to run the business from day to day. A firm can have valuable machines and still have too little working capital to pay wages. All WASSCE Business Management past questions