Chapter 24: The Role and Function of Financial

Institutions
Definition:
Financial institutions are organizations that provide financial services to individuals,
businesses, and governments, helping them manage money, credit, savings, investments,
and risks.

Types of Financial Institutions and Their Roles

1. Banks
• Accept deposits from customers and provide safekeeping.
• Offer different accounts: current (for daily transactions) and savings (for earning
interest).
• Provide loans and overdrafts for businesses and individuals.
• Facilitate payments through cheques, debit/credit cards, and electronic
transfers.
• Help in currency exchange and provide financial advice.
2. Building Societies
• Similar to banks but mainly owned by members (mutual organisations).
• Specialize in providing mortgages and savings accounts.
• Aim to help people buy homes by lending money.
3. Credit Unions
• Non-profit, cooperative financial institutions owned by members.
• Provide small loans to members at low interest rates.
• Encourage saving and provide safe places for deposits.
4. Insurance Companies
• Offer protection by providing policies against risks like accidents, illness, fire,
theft, or death.
• Collect premiums regularly from customers.
• Pay out claims when insured events occur to reduce financial loss.
5. Investment Companies
• Help people and businesses invest money in shares, bonds, or funds.
 • Offer professional management of investments to grow capital.
• Provide products like unit trusts and pensions.

Main Functions of Financial Institutions

• Accepting Deposits: Provide safe storage for money with interest earnings on
savings.
• Providing Credit: Supply funds to individuals and businesses via loans, mortgages,
overdrafts, and credit cards.
• Facilitating Payments: Enable smooth transactions using cheques, electronic
transfers, debit/credit cards, and online banking.
• Investment Services: Help customers invest money wisely through advice and
managed funds.
• Insurance Services: Protect customers against financial risks through various
insurance policies.
• Currency Exchange: Exchange foreign currencies for trade and travel.
• Financial Advice: Guide customers on savings, investments, insurance, and
borrowing.

Importance of Financial Institutions

• Economic Growth: By providing loans and credit, they help businesses expand and
create jobs.
• Encouraging Savings: They offer safe places to save, helping individuals build
wealth and financial security.
• Reducing Risks: Insurance companies reduce financial uncertainty by covering
losses.
• Facilitating Trade: Banks enable easy payments and foreign currency exchange,
supporting local and international trade.
• Stability: They help maintain a stable economy by managing money supply and
credit
Chapter 25: Sources of Finance
Definition
Sources of finance are the various ways a business can raise money to start, operate, or
expand its activities. These can be internal (from within the business) or external (from
outside the business).

Types of Sources of Finance

1. Internal Sources

• Owner’s Capital: Money invested by the owner from personal savings.

• Retained Profit: Profits kept in the business instead of being paid out as dividends.
• Sale of Assets: Selling old or unused equipment, property, or inventory to raise
funds.

Advantages:

• No need to repay.
• No interest costs.
• Immediate availability.

Disadvantages:

• May not raise enough money for large projects.

• Selling assets can reduce business capacity.

2. External Sources

A. Short-term finance (less than 1 year)

• Bank Overdraft: Allows a business to withdraw more money than it has in its
account up to an agreed limit.
• Trade Credit: Buying goods and paying the supplier later, usually within 30-60 days.
 • Debt Factoring: Selling unpaid invoices to a third party to get immediate cash.

Advantages:

• Quick access to funds.

• Useful for managing cash flow.

Disadvantages:

• Interest or fees may apply.

• Overdrafts can be withdrawn by the bank at any time.

B. Long-term finance (more than 1 year)

• Bank Loan: A fixed amount of money borrowed from a bank to be repaid with
interest over a set period.
• Mortgages: Loans specifically for purchasing property, secured against the
property.
• Issuing Shares (Equity Finance): Selling ownership shares in a limited company to
raise capital.
• Debentures: Long-term loans raised by selling bonds to investors, repaid with
interest.
• Grants: Money given by government or organizations that does not have to be
repaid.
• Venture Capital: Investment from specialized investors in start-ups or risky
businesses in exchange for shares.
• Leasing: Renting equipment or property instead of buying it outright.

Advantages:

• Allows large amounts of finance to be raised.

• Can be planned for the long term.
• Equity finance does not need to be repaid.

Disadvantages:

• Interest payments increase costs.

• Loans and mortgages require security.
• Issuing shares dilutes ownership and control.
• Venture capital investors may want a say in business decisions.
Factors Affecting Choice of Source of Finance
• Amount Needed: Large projects may need loans or shares; small needs may use
retained profit.
• Time Period: Short-term needs can be met by overdrafts; long-term by loans or
equity.
• Cost: Interest rates, fees, and other costs influence choice.
• Risk: Borrowing increases risk due to repayment obligations.
• Control: Issuing shares may reduce owner control.
• Purpose: Different purposes require different sources (e.g., fixed assets vs. working
capital).
• Legal Structure: Sole traders cannot issue shares; limited companies can.
• Availability: Some finance options may not be available to small businesses.

Summary
Understanding the different sources of finance helps businesses choose the best option
depending on their needs, size, risk appetite, and legal status. Proper choice ensures
smooth operations, growth, and financial health.

Chapter 26: The Process of Issuing Shares

and Debt
Introduction
When companies need to raise long-term finance, they often issue shares or borrow
money through debt instruments. Understanding the process helps to see how businesses
attract investment and fund growth.
Issuing Shares (Equity Finance)
What are Shares?
Shares represent ownership in a limited company. When a company issues shares, it sells
ownership stakes to investors in exchange for capital.

Types of Shares:

• Ordinary Shares: These give shareholders voting rights at company meetings and a
share of the company’s profits through dividends. However, dividends are not fixed
— if the company makes less profit, dividends might be lower or even not paid.

• Preference Shares: Shareholders get fixed dividends, meaning they receive the
same amount regardless of profits, but usually do not have voting rights. This makes
preference shares less risky than ordinary shares but with less control.

Process of Issuing Shares:

1. Decision to Issue Shares: The company decides how many shares to issue and the
type.
2. Approval by Shareholders: Existing shareholders usually approve new shares to
avoid dilution of control.
3. Valuation and Pricing: The company values itself and sets a price per share.
4. Regulatory Approval: Companies must follow legal rules, register shares with
relevant authorities, and comply with stock exchange regulations if listed.
5. Marketing the Shares: Using prospectuses or investment banks to attract buyers.
6. Allocation and Sale: Shares are sold to investors, and money is raised.
7. Recording Ownership: Shareholders’ details are recorded in the company’s
register.

Advantages of Issuing Shares:

• No repayment obligation.
• Permanent capital for the company.
• Can raise large sums from the public.

Disadvantages:

• Ownership dilution, existing owners lose some control.

• Dividends are expected by shareholders.
 • Process can be expensive and time-consuming.

Issuing Debt (Debentures/Bonds)

What are Debentures?
Debentures are long-term loans taken by a company from the public or institutions. They
are evidence of debt and promise repayment with interest.

Issuing Debt (Borrowing) : Another way companies raise money is by borrowing, which
means taking loans or issuing bonds. Unlike shares, this does not give ownership to the
lender but requires the company to pay back the money with interest.

• Types of Debt:
o Bonds: Bonds are like IOUs issued by the company to investors. The
company promises to pay back the face value on a certain date and to pay
regular interest (called coupons) until then.
o Loans: Companies can borrow money from banks or other lenders with a set
interest rate and repayment schedule.

Process of Issuing Debt:

1. Decision to Raise Debt: Management decides to raise capital through debentures.

2. Set Terms: Interest rate, maturity period, and conditions are fixed.
3. Regulatory Compliance: Legal requirements and disclosures must be met.
4. Marketing and Sale: Debentures are marketed to investors, often with the help of
financial institutions.
5. Money Raised: Investors buy debentures, giving the company the loan.
6. Interest Payments: Company pays interest at regular intervals.
7. Repayment: Principal amount is repaid at the end of the term.

Advantages of Issuing Debt:

• No loss of ownership or control.

• Interest payments are tax-deductible.
• Can be cheaper than equity if interest rates are low.

Disadvantages:
 • Regular interest payments create financial pressure.
• Failure to repay may lead to insolvency.
• Debt increases company’s financial risk.

Aspect Shares Debt (Debentures)

Ownership Yes, shareholders own No ownership; company borrows
part of company money
Repayment No repayment of capital Principal repaid at maturity
Cost Dividends paid from profits Fixed interest regardless of profit

Risk Lower risk for company Higher risk due to repayment

obligation
Control Dilution of control No effect on control
Tax benefits Dividends not tax- Interest payments are tax-
deductible deductible

Summary
The process of issuing shares or debt is vital for businesses to raise long-term funds. Each
method has pros and cons, and the choice depends on the company’s financial strategy,
control preferences, and cost considerations.

Chapter 27: Methods of Payment

In business and daily life, paying for goods and services can be done in many different
ways. Choosing the right payment method is important for convenience, security, and
efficiency. This chapter explains various methods of payment used in commerce and their
advantages and disadvantages.

1. Cash Payments
Cash is the most common and simplest form of payment. It involves the direct exchange of
physical money (notes and coins).
 • Advantages:
o Immediate payment with no delay.
o Accepted almost everywhere.
o No extra charges or fees.
• Disadvantages:
o Risk of theft or loss.
o Not suitable for large transactions.
o No record of payment unless a receipt is given.

2. Cheques
A cheque is a written order from a bank account holder instructing the bank to pay a
specific amount of money to another person or organization.

• How it works: The payer writes a cheque and gives it to the payee, who deposits it
into their bank account. The bank then transfers money from the payer’s account to
the payee’s account.
• Advantages:
o Safer than carrying large amounts of cash.
o Creates a written record of payment.
o Useful for large payments.
• Disadvantages:
o Takes time to clear (usually a few days).
o Risk of dishonoured cheques if funds are insufficient.
o Can be forged or altered if not handled carefully.

3. Debit Cards
A debit card allows the cardholder to pay directly from their bank account electronically.

• How it works: When making a payment, the amount is deducted immediately from
the cardholder’s account.
• Advantages:
o Convenient and fast for both buyer and seller.
o Safer than carrying cash.
o Provides an electronic record of transactions.
• Disadvantages:
o Requires electronic equipment for payment.
 o Risk of fraud or theft if the card is lost or details are stolen.
o Some banks may charge fees for certain transactions.

4. Credit Cards
Credit cards allow the cardholder to borrow money from the card issuer up to a certain
limit to pay for goods and services.

• How it works: The cardholder uses the card to make payments but pays the money
back later, usually monthly, with interest if not paid in full.
• Advantages:
o Enables buying on credit, helpful if cash is short.
o Can build credit history.
o Offers protection and sometimes rewards or cashback.
• Disadvantages:
o Interest charges if the balance is not paid on time.
o Can lead to debt if not managed carefully.
o May include fees for late payments or foreign transactions.

5. Electronic Transfers (Bank Transfers)

This method involves transferring money directly from one bank account to another
electronically.

• How it works: The payer instructs their bank to send money to the payee’s account
using online banking, phone banking, or at a branch.
• Advantages:
o Secure and fast, often instant or within one day.
o Suitable for large payments.
o Provides clear transaction records.
• Disadvantages:
o Requires access to a bank account.
o Can have charges for international transfers.
o Errors in account details can delay payment.

6. Mobile Payments and Digital Wallets

These include apps and services (like Apple Pay, Google Pay, or mobile banking apps) that
allow payments using smartphones.
 • How it works: The payer links their bank account or card to the app and pays by
scanning QR codes or using NFC technology.
• Advantages:
o Very convenient and quick.
o Reduces need for cash or cards.
o Often includes security features like fingerprint or face recognition.
• Disadvantages:
o Requires smartphone and internet access.
o Not accepted everywhere yet.
o Risk of hacking or technical glitches.

7. Postal Orders
A postal order is a certificate purchased at a post office that can be sent by mail and
cashed by the receiver.

• Advantages:
o Useful when the sender or receiver does not have a bank account.
o Safer than sending cash through mail.
• Disadvantages:
o Limited maximum amount.
o Involves fees for purchase.
o Not commonly used today due to electronic payments.

Summary
Choosing the right method of payment depends on the size of the transaction, urgency,
security, and convenience. Cash is simple but risky for large amounts. Cheques provide
safety but are slower. Cards and electronic payments are fast and secure but need
technology. Postal orders can be useful where banking is limited but are less common
today.
Chapter 28: Commercial Calculations
Commercial calculations are essential for businesses to manage finances, set prices, and
understand profits and losses. This chapter explains the key calculations used in
commerce, helping businesses to make informed decisions.

1. Cost Price (CP)

The cost price is the amount a business pays to buy or produce a product. This includes
the price paid to suppliers plus any additional costs like transport, packaging, or taxes.

• Knowing the cost price helps a business determine how much to sell the product for
to cover costs and make a profit.

2. Selling Price (SP)

The selling price is the amount at which a product is sold to customers. This price must be
higher than the cost price if the business wants to earn a profit.

• Setting the right selling price involves understanding the market, competition, and
customer demand.

3. Profit
Profit is the money a business makes when the selling price is higher than the cost price.

• Formula:
Profit = Selling Price – Cost Price
• Profit shows how successful a business is in making money from sales.

4. Loss
Loss occurs when the selling price is less than the cost price, meaning the business is
losing money on the sale.
 • Formula:
Loss = Cost Price – Selling Price
• Consistent losses can cause a business to fail, so businesses try to avoid selling
below cost.

5. Profit Percentage (Profit %)

This shows profit as a percentage of the cost price, making it easier to compare
profitability.

• Formula:
Profit % = (Profit ÷ Cost Price) × 100
• For example, if a business buys an item for $50 and sells it for $60, the profit is $10
and profit % is (10 ÷ 50) × 100 = 20%.

6. Loss Percentage (Loss %)

Loss percentage shows loss as a percentage of the cost price.

• Formula:
Loss % = (Loss ÷ Cost Price) × 100
• This helps identify how much percentage of the investment is lost in sales.

7. Markup
Markup is the amount added to the cost price to get the selling price. It represents the
gross profit margin a business wants.

• Formula:
Markup = Selling Price – Cost Price
• Businesses use markup to cover overheads and earn profit.

8. Discount
Discount is a reduction offered on the selling price, often to encourage sales or clear
stock.

• Formula:
Discount Amount = Original Price – Discounted Price
 • Discounts can be given as a percentage or a fixed amount.

9. Trade Discount
Trade discount is a reduction given by suppliers to buyers (usually retailers) on bulk
purchases or as an incentive.

• It is not recorded in accounts but is deducted from the list price when invoicing.

10. Value Added Tax (VAT)

VAT is a tax added to the price of goods and services by the government.

• Businesses charge VAT on sales and pay VAT on purchases.

• The difference is paid to the government.

11. Calculations Involving VAT

• To add VAT:
Price including VAT = Price excluding VAT + VAT
• To find VAT from price including VAT:
VAT = Price including VAT × VAT rate ÷ (100 + VAT rate)

12. Examples of Commercial Calculations

• If a product costs $80, and a business wants a profit of 25%, the selling price is:
Selling Price = Cost Price + (Profit % × Cost Price)
= 80 + (0.25 × 80) = $100
• If a shop offers 10% discount on a $50 product, the price after discount is:
Price = 50 – (10% of 50) = 50 – 5 = $45

Summary
Commercial calculations help businesses decide prices, discounts, and taxes.
Understanding how to calculate profit, loss, markup, discount, and VAT is crucial for
financial success. These calculations ensure businesses remain profitable and
competitive.
Chapter 29: Measuring Commercial Performance
Measuring commercial performance is important for businesses to understand how well
they are doing financially and operationally. It helps managers make decisions to improve
profits, efficiency, and competitiveness.

1. Importance of Measuring Performance

Businesses measure performance to:

• Check if they are achieving their financial goals.

• Identify strengths and weaknesses.
• Decide where to cut costs or increase investment.
• Satisfy stakeholders like owners, employees, and investors by showing success or
warning signs.

2. Key Performance Indicators (KPIs) *NOT IMPORTANT

KPIs are specific financial and non-financial measures used to evaluate business success.

Examples include:

• Sales Revenue: Total money earned from selling goods or services.

• Gross Profit: Money left after subtracting the cost of goods sold from sales
revenue.
• Net Profit: Profit after all expenses (including overheads, taxes) are deducted.
• Market Share: Percentage of total sales in the market that a business controls.
• Customer Satisfaction: Measured through surveys, repeat sales, or feedback.

3. Financial Ratios
Financial ratios help analyze performance by comparing figures in financial statements.

Some common ratios:

• Gross Profit Margin: Shows how much profit is made from sales before expenses.
Formula: (Gross Profit ÷ Sales Revenue) × 100
 • Net Profit Margin: Shows actual profitability after all costs.
Formula: (Net Profit ÷ Sales Revenue) × 100

• Return on Capital Employed (ROCE): Measures how well capital is used to

generate profit.
Formula: (Net Profit ÷ Capital Employed) × 100

• Current Ratio: Measures a business’s ability to pay short-term debts.

Formula: Current Assets ÷ Current Liabilities
(A ratio of 2:1 is usually considered healthy.)

• Expense as a Percentage of Turnover: Shows how much of the total sales is spent
on a particular expense.
Formula: (Expense ÷ Turnover) × 100

Chapter 30: Improving Commercial Performance

Improving Sales Turnover
Sales turnover is the total value of goods or services sold during a specific time period.
Increasing it helps raise revenue and potentially profit.

1. Launching New Products or Services

Businesses can attract more customers by introducing items that meet new or unmet
customer demands.

2. Enhancing Product Quality or Customer Service

Better quality and service improve customer satisfaction, leading to repeat sales and
strong word-of-mouth.

3. Effective Promotion and Advertising

Using advertising campaigns, social media, and discounts can raise awareness and
attract more buyers.

4. Expanding into New Markets

Selling in new areas — either new locations or online — helps reach more customers and
boost sales.
5. Improving Distribution Channels
Making products more available through multiple platforms (e.g., online stores,
partnerships) can increase turnover.

Note: Boosting sales should not come with too much cost increase — otherwise, profits
might not grow.

Reducing Purchasing Costs

Lower purchasing costs allow businesses to spend less on materials and earn more profit
per sale.

1. Buying in Bulk (Economies of Scale)

Purchasing large quantities often gets suppliers to offer discounts, lowering per-unit
costs.

2. Finding Cheaper Suppliers

Switching to suppliers with lower prices can save money — but quality must still meet
business standards.

3. Negotiating Better Deals

Building strong supplier relationships can lead to better prices, credit terms, or delivery
options.

4. Using Local Suppliers

Choosing local options can reduce transportation expenses and delivery time.

Balance Needed: Cutting costs too much may harm product quality or reliability.

Mark-up
Mark-up is the amount added to the cost of a product to set the final selling price. It
represents how much profit a business wants to make on each item sold. For example, if a
product costs $10 and is sold for $15, the mark-up is $5. A higher mark-up means more
profit per unit, but if it becomes too high, customers may stop buying. Businesses must
find the right balance based on customer demand and competitor pricing.
Profit margins
Profit margins show how much profit a business makes compared to its sales revenue.
There are two main types:

• Gross profit margin is the percentage of revenue left after subtracting the cost of
goods sold. It shows how well a business manages its production or purchasing
costs.
• Profit for the year margin (also called net profit margin) is the percentage of
revenue remaining after all expenses have been paid, including wages, rent, and
utilities. It shows the overall profitability of the business. High profit margins usually
mean the business is managing its costs well and pricing its products effectively.

OR
Mark-up
Mark-up is the difference between the cost of producing or buying a product and its selling
price. It is usually expressed as a percentage of the cost price.

• A higher mark-up increases selling price, which can boost revenue.

• However, setting mark-up too high may reduce demand if customers find it too
expensive.
• The right mark-up depends on factors like customer demand, competition, and
costs.

Profit Margins
Gross Profit Margin

Gross profit margin = (Gross profit ÷ Revenue) × 100

It shows how much profit is made after subtracting cost of goods sold from sales.

• A higher gross profit margin means the business is keeping more money from each
sale.
 • Can be improved by increasing prices or reducing the cost of raw materials or goods
bought.

Profit for the Year Margin

Profit for the year margin = (Profit for the year ÷ Revenue) × 100
This shows how much actual profit remains after all expenses (not just cost of goods) are
deducted.

• Helps assess overall financial efficiency.

• A low margin may show high expenses or weak control over costs.

Inventory Turnover
Inventory turnover measures how often stock is sold and replaced over a time period.
A high inventory turnover means stock is sold quickly — helping cash flow and reducing
storage costs.

How to Improve Inventory Turnover (for Retailers):

• Hold popular and trending stock that customers are more likely to buy.
• Increase demand by using better marketing or discounted prices.
• Remove outdated or slow-moving stock through clearance sales.
• Focus on bestselling items instead of holding large amounts of slow sellers.
• Use sales forecasting to plan purchases better and avoid overstocking.

In Manufacturing:

• Use Just-In-Time (JIT) production:

o Don’t hold large amounts of raw materials or finished goods.
o Only produce items when they are ordered.
o Raw materials are delivered regularly in small amounts, reducing storage
needs.

This approach helps save costs and increases efficiency but depends on reliable suppliers.
Expenses
Reducing business expenses can help increase net profit and profit for the year margin.
These are some common ways businesses can lower expenses:

Renegotiate Rents

• Rent is one of the largest fixed costs for many businesses.

• Businesses can try to negotiate lower rent with landlords, especially during tough
economic times.
• Alternatively, they may relocate to cheaper premises, often in less central areas
where rents are lower.

Make More Use of IT in Administration

• Using IT systems helps reduce administrative and communication costs.

• It can eliminate paper use and reduce staff needed for filing and paperwork.
• Digitizing documents saves time, improves efficiency, and lowers long-term costs.

Switch Utility Providers

• Businesses can save money by switching providers for electricity, gas, water,
internet, or phone services.
• Comparison websites can help find cheaper deals.
• Some businesses even use specialist firms that negotiate lower utility bills for
them.

Control Entertainment Expenses

• Entertainment (e.g., client lunches or events) can become costly.

• Limiting unnecessary hospitality can help reduce outgoings without affecting
performance.

Cut Travel Costs

• Reducing business trips and choosing cheaper transport or online meetings can
save money.
• Encouraging virtual communication is both efficient and cost-effective.
Restructure Debt

• Businesses can refinance high-interest loans into lower-interest ones.

• This reduces the total interest paid and helps improve cash flow.

Encourage Homeworking

• Allowing employees to work from home can save money on office space,
electricity, water, and other overheads.
• It also helps attract workers who prefer flexible arrangements.

Share Resources

• Small businesses can share premises, equipment, or staff with others.

• This spreads the cost and helps each business spend less individually.