Basic Financial Terms memorandam file report

finance

1. Module 1
Basic Financial Terms
Entrepreneurship Training for CSC Academy

2. What is a business?
•Primary Objective:
•Make money for investors by providing goods or services
•Key Inputs:
•Labour
•Capital
•Land
•Output:
•Good or Service

3. Forms of business organisations
•Sole proprietorship
•Partnership
•Corporations

4. Sole proprietorship
•Single owner who is also usually responsible for the day-to-day running of
the business.
•Simplest example of a sole proprietorship are your telawalaor local kirana
store.
•Advantages:
•A single person owns and runs the business, his/her interests are aligned.
•All profits are taxed as personal income (single taxation).
•Disadvantages
•Uncertainty about business beyond the single owner’s life.
•Given this uncertainty, it is difficult for sole proprietorships to raise capital from
various external sources.
•Personal wealth may be used to cover business losses, leading to unlimited liability
for the owner.

5. Partnership
•Similar to sole proprietorship but has multiple owners or partners,
some of whom are also usually responsible for the day-to-day running
of the business.
•Largely same set of advantages and disadvantages as for sole
proprietorships but since there are multiple persons involved, there
could be misalignment of interests.
•Example would the local kiranastore, which could be a partnership
between siblings or friends.

6. Corporations
•Separate legal entity with a large number of owners (called shareholders).
•Examples of corporations are LIC, SBI, Reliance, Airtel, ICICI Bank.
•Advantages
•Since its life is not dependent on the owners, it can raise capital far more easily,
making it easier for corporations to grow.
•Owners cannot lose more than what they have invested (limited personal liability).
•This is why companies or corporations usually have the word “Limited” at the end of their
name.
•Disadvantages
•Managers and owners are different, which could lead to conflict or misalignment of
interests.
•Profits are taxed as well as dividends (double taxation).

7. What is Accounting?
•Recording and reporting of day-to-day transactions.
•Keeps track of flows of money into and out of the business.
•Examples
•How much value in rupees of goods or services has the business sold?
•What costs has the business incurred?
•What investments in land, facilities, buildings, etc. has the business made?
•It keeps a record of a business’ past transactions.

8. What is Finance?
•Finance is forward-looking
•It is about planning for the uncertain future
•What investments should the business make?
•Where does the capital for these investments come from?

9. Liabilities, equity and assets
•Liabilities
•These represent ways in which a business has raised capital (money) from various entities
and has an obligation to pay that capital.
•These include bank loans and other forms of borrowing.
•They also include cash that the business has yet to pay different entities like suppliers,
government (in the form of taxes), etc.
•Equity
•This is another way for a business to raise capital but, unlike liabilities, there is no obligation
to repay entities that provide capital in the form of equity.
•In return for providing equity capital, these entities are given ownership in the business.
•Assets
•These represent various ways in which a business has used its capital.
•These include cash, buildings, machinery, computers, furniture, land, etc.
•They also include cash that the business is yet to receive from customers or clients.

10. Revenues and costs
•Revenues or sales
•This is the income or inflow that a business generates from providing goods
and/or services to its customers or clients.
•A business cannot exist if it does not have any revenues.
•Costs or expenses
•These are outflows that a business must pay to those who supply goods and
services to the business, which are then used to generate revenue, as well as
any taxes payable to the Government.
•These include employees’ salaries, labourcost, raw material cost, goods and
services taxes (GST), income tax, etc.

11. Money flow through a business
1
•Liabilities + Equity: Raise capital for the business.
2
•Assets: Make investments using the capital.
3
•Costs:Incur outflows to use and operate assets to produce goods/services.
4
•Revenues: Receive inflows for delivering goods/services to customers or clients.
5
•Profit:Revenues minus costs.

12. Sources of capital
•Two major sources of capital for any business:
1.Borrowing or debt
2.Equity (also called shares or stock)

13. Debt
•Borrowing by a business means the following:
•A business borrows a loan or principal amount for a certain period from a lender.
•It promises to make periodic payments to the lender, called interest payments.
•It promises to repay the loan amount, typically, spread over the life of the loan.
•The EMI (Equated Monthly Installment) that you pay the bank every monthforany loan
consists of interest on your outstanding loan amount and repayment of a part of the loan
amount.
•Because each EMI includes repayment of a part of the loan amount and the interest for the next month
depends on the remaining amount owed to the lender, this is called the Reducing Balancemethod.
•If a business misses an EMI, it has defaultedon the loan, which means that the lenders can
takeover the company, sell all its assets and recover the amount due to them.
•The important aspect of borrowing is that the business promises the periodic
(most commonly monthly) payment to the lenders and missing a payment leads
to default.

14. More on debt
•Key sources of debt:
•Banks (examples: SBI, ICICI Bank, Canara Bank, Indian Bank)
•Non-Banking Financial Company; NBFC in short (examples: Bajaj Finance Ltd,
L&T Finance Holdings, HDFC Ltd)
•Debentures
•This is borrowing directly from investors.
•They trade on exchanges like the BSE and NSE after issuance.
•Here, loan amount is paid back entirely only at the end of the life of the bond (called
maturityof the bond).
•Borrower pays only interest periodically, called coupon payment.

15. Equity
•Unlike debt, no promise to pay any money to people who provide
capital in the form of equity (called shareholders).
•However, shareholders are owners of the business.
•If a business makes profits after deducting all costs and taxes, the
business may choose to pay shareholders some or all of the profits.
•This is called dividends.
•No obligation or promise to pay dividends; even in an extremely profitable
year, the business may choose not to pay any dividends to its shareholders.
•All businesses, even start-ups, will have equity but not all businesses
will have debt.

16. Key takeaways
•List the forms of business organisationsand their advantages and
their disadvantages.
•Distinguish between accounting and finance.
•Explain what assets, liabilities, equity, revenues and costs are.
•Explain the money flow through a business.
•What are the common sources of capital?
•Compare and contrast debt and equity.