Introduction to Finance
The role of finance for businesses, and the distinction between capital and revenue expenditure.
- Explain why businesses need finance and identify the role of financial management
- Distinguish between capital expenditure and revenue expenditure with examples
- Identify where CapEx and RevEx appear in the financial statements
Three Big Views of Finance
A useful framework for thinking about everything in this unit. Finance can be viewed through three lenses:
| View | Question it answers | Where it's shown |
|---|---|---|
| Assets & Financial Position | What does the business own and owe? | Balance sheet (Statement of Financial Position) |
| Income & Expenses | What did the business earn and spend? | P&L account (Statement of Profit or Loss) |
| Liquidity & Cash Flow | What cash does the business have right now? | Cash flow forecast / statement |
Each topic in this unit corresponds to one (or more) of these views. Keep this framework in mind — it helps you see how everything connects.
The Role of Finance
Every business needs finance — money to set up, operate, and grow. Finance enables businesses to purchase resources, pay employees, develop products, and expand into new markets. Without adequate financing, even profitable business ideas can fail.
Finance serves four core purposes:
- Start-up costs — purchasing premises, equipment, initial stock, and covering early losses
- Day-to-day running costs — wages, rent, utilities, raw materials
- Growth and expansion — opening new locations, launching products, entering new markets
- Unexpected costs — equipment breakdown, economic downturns, legal disputes
When a question asks about the "role" of finance, go beyond just "buying things." Link it to the business's objectives — a business seeking growth needs finance for expansion; a struggling business needs finance for survival.
Capital Expenditure vs Revenue Expenditure
All business spending can be classified as either capital expenditure (CapEx) or revenue expenditure (RevEx). This distinction matters for financial reporting and taxation.
| Capital Expenditure | Revenue Expenditure | |
|---|---|---|
| Definition | Spending on assets that will be used over multiple years | Day-to-day spending consumed within the current accounting period |
| Appears on | Balance sheet (as a fixed/non-current asset) | Profit & loss account (as an expense) |
| Examples | Buildings, machinery, vehicles, computers | Wages, rent, electricity, raw materials, advertising |
| Time horizon | Long-term benefit (>1 year) | Short-term (consumed within the year) |
Capital expenditure (CapEx): Money spent on purchasing or improving fixed/non-current assets that will be used for more than one year.
Revenue expenditure (RevEx): Money spent on the day-to-day running costs of a business, consumed within the current accounting period.
Buying a delivery van = CapEx (the van lasts several years). Paying for van insurance or fuel = RevEx (consumed during the year). The purchase price of an asset is CapEx; the ongoing costs of using it are RevEx.
Grey Areas
Some expenditure is ambiguous. Context and materiality matter — accountants apply professional judgement:
| Business | Borderline item | Classification | Reasoning |
|---|---|---|---|
| Restaurant | Major kitchen refurbishment | CapEx | Extends the life/value of the premises significantly |
| Restaurant | Repainting walls and small repairs | RevEx | Routine maintenance — restores, not improves |
| Delivery company | Replacing an old truck | CapEx | New asset with multi-year life |
| Delivery company | Replacing the engine in an existing truck | Borderline | Extends asset life → often CapEx, but depends on materiality |
| Clothing retailer | Installing a new POS system | CapEx | New fixed asset |
| Clothing retailer | Upgrading existing software | Borderline | Minor upgrade → RevEx; major new capability → CapEx |
Fortescue, an Australian iron ore mining company, ordered 360 battery-electric haul trucks as part of a $4 billion deal with Liebherr to electrify its mining operations. This is pure capital expenditure — the trucks are fixed assets with multi-year lives. The result? Analysts estimated savings of almost $400 million per year in fuel costs. The capex generates long-term efficiency gains — a classic illustration of why CapEx matters.
Set-Up Costs vs Running Costs
A related but distinct classification (particularly relevant for new businesses):
| Set-Up Costs | Running Costs | |
|---|---|---|
| When incurred | Before trading starts (one-time) | After the business is operating (ongoing) |
| Linked to | Starting the business/project | Day-to-day operations |
| Examples | Legal fees, initial advertising, premises fit-out, first machinery | Rent, wages, utilities, stock replenishment |
Set-up costs and running costs cut across the CapEx/RevEx distinction. A set-up cost like buying machinery is CapEx. A set-up cost like legal fees for incorporation is RevEx. Running costs are almost always RevEx.
Key Terms
- Finance enables businesses to start up, operate, and grow
- Capital expenditure = spending on fixed assets (long-term)
- Revenue expenditure = day-to-day running costs (short-term)
- CapEx appears on the balance sheet; RevEx on the P&L
- The same asset type can generate both CapEx and RevEx costs
(a) A bakery purchases a new commercial oven for $12,000.
(b) The same bakery pays its monthly electricity bill of $400.
(c) A tech startup buys office chairs for its new headquarters.
(d) A restaurant re-stocks its kitchen with ingredients for the week. [8 marks]
Show answer
(a) Capital expenditure. The oven is a fixed asset that will be used over many years, not just one accounting period.
(b) Revenue expenditure. Electricity is a running cost consumed within the current period.
(c) Capital expenditure. Office furniture is a fixed asset (though low-value items are sometimes expensed as RevEx — worth noting).
(d) Revenue expenditure. Ingredients are consumed in the short term as part of daily operations.
Common mistake: Students often classify repairs as CapEx because they involve large sums. The key test is: does it extend or improve the asset beyond its original state (CapEx), or does it maintain it (RevEx)? A roof repair = RevEx. Adding a new floor to a building = CapEx.
Show answer
Accept any two well-explained reasons, e.g.:
- Start-up costs: New businesses need finance to purchase premises, equipment, and initial stock before generating any revenue.
- Expansion: Established businesses need finance to invest in new products, markets or locations to achieve growth objectives.
- Unexpected costs: Businesses need a financial buffer for emergencies such as equipment failure or sudden market downturns.
Award 1 mark for identification + 1 mark for explanation, per point.
Common mistake: Naming a reason without explaining it ("a business needs finance for expansion") scores 0 for the explanation mark. Always link the reason to a consequence: "…so that it can open new branches and increase its market share."
Show answer
The $50,000 renovation is capital expenditure — it improves a fixed asset (the store) and provides long-term benefit. It appears on the balance sheet as a non-current asset (and may be depreciated over time).
The $3,000 wages is revenue expenditure — it is a recurring operating cost for the current period. It appears on the profit & loss account as an expense, reducing profit.
Common mistake: Forgetting to state where each type of expenditure appears. It is not enough to label something CapEx or RevEx — in a full question you must connect it to the correct financial statement.