IB Business Management SLTopic 3 — Introduction to FinancePaper 1 & 2Core idea~10 min read
Why Businesses Need Finance
Money going out always starts before money comes in. You buy the oven before you sell the first loaf. That gap is the whole reason finance exists — and the reason profitable businesses still run out of cash.
📚 What you need to know
Finance is needed to start up, to run day-to-day, and to grow.
Capital expenditure is spending on non-current assets — things used many times, for more than a year.
Revenue expenditure is spending on day-to-day items that get used up quickly.
Working capital is the money that keeps the business trading: stock, wages, bills, paying suppliers.
Other needs: research and development, marketing, risk management and servicing debt.
Finance is also how performance is measured — profit, cash and assets are the scoreboard.
Being profitable and having cash are not the same thing. This is the single most useful idea in the whole topic.
The six reasons money is needed
Whenever a question asks why a business needs finance, the answer is one of these six. Learn them as a picture, not a list.
Notice that only one of the six is about growth. Finance is mostly about staying open, which students often forget.
Setting up
Before a single sale, an entrepreneur pays for premises, equipment, first stock, market research, staff and some advertising. None of that money has come from customers yet.
Capital spending
Machines, vehicles, buildings, IT systems. These are big one-off payments for things that will be used for years, so they raise productivity and capacity.
Working capital
The money for the everyday: buying stock, paying wages, covering rent and electricity while waiting to be paid by customers. Run out of it and the business stops even if the order book is full.
Growth, R&D and marketing
New branches, new countries, new products, new campaigns. All of it is paid for now in the hope of revenue later.
Risk and debt
Insurance, a cash reserve for emergencies, and the repayments plus interest on money already borrowed. Debt servicing is a cost that never sleeps.
Say this in an exam: a business can be profitable on paper and still fail, because profit is measured over a period while bills have to be paid on a date. That gap is why finance is needed even by successful firms.
Capital expenditure or revenue expenditure?
Every pound a business spends falls into one of two boxes. The test is simple: will it still be useful in a year?
The classic trap: a computer is capital expenditure, but the monthly software subscription that runs on it is revenue expenditure.
Long-term spending should be funded with long-term money and short-term spending with short-term money. Paying for a building on an overdraft is how businesses get into trouble. Say that in an evaluation and you sound like an accountant.
Worked examples
WORKED EXAMPLE 1
Sorting the spending [4 marks]
In its first month a bakery spends: a new oven $18,000; flour and ingredients $2,400; a delivery van $22,000; staff wages $9,600; a shop refit $15,000; electricity $800. Calculate total capital expenditure and total revenue expenditure.
Step 1: apply the one-year test
Oven, van and refit last for years. Flour, wages and electricity are gone this month.
Step 2: add the capital items$18,000 + $22,000 + $15,000 = $55,000Step 3: add the revenue items$2,400 + $9,600 + $800 = $12,800Capital $55,000 | Revenue $12,800worth adding: the $55,000 is a one-off, but the $12,800 comes back every single month — that is the payment the bakery must cover from sales
WORKED EXAMPLE 2
Why a profitable firm still needs finance [6 marks]
A furniture maker has just won a $400,000 contract, its biggest ever. Materials and wages must be paid within 30 days. The customer pays 90 days after delivery. Explain why the business needs finance.
Step 1: identify the gapMoney out at day 30. Money in at day 90 or later. That is a 60-day hole.
Step 2: name what is needed
Working capital — the cash to buy materials and pay staff while waiting.
Step 3: explain the risk
Without it, wages are missed and suppliers stop delivering, even though the contract is profitable.
Profitable, but short of cashthis is called overtrading: growing faster than the cash coming in — a very strong point in any Topic 3 answer
💡 Exam tip
Learn the one-year test. It answers every capital-or-revenue question in seconds.
Use the word working capital whenever the case mentions paying suppliers, wages or stock.
Separate profit from cash in your writing. Examiners reward students who never confuse them.
Say what the money is for before saying where it comes from. Purpose decides the source.
Link finance needs to the stage of the business: start-up, survival or expansion.
Watch for the trap of a growing business: growth usually eats cash before it produces any.
⚠ Common mix-up
Capital expenditure means expensive. No — it means long-lasting. A $200 drill can still be capital.
Revenue expenditure means revenue. It means day-to-day spending, not income.
Working capital called profit. Working capital is the money available to trade with right now.
Thinking only start-ups need finance. Large firms need it constantly for growth and debt.
Treating a loan as revenue. Borrowed money is not income; it has to be paid back.
Listing reasons with no business attached. Always say what this particular firm needs the money for.
Up next: Raising Money From Inside the Business — the cheapest money there is, and why firms still run out of it.
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