Home › Learning Hub › IB DP Business Management › 3.1 Introduction to finance
3.1

Introduction to finance

Unit 3 · Finance and accounts · SL and HL

Finance is the lifeblood of a business: it pays for the equipment that makes production possible and for the day-to-day costs that keep it running. This short introduction sets up the key distinction that runs through Unit 3, between capital expenditure and revenue expenditure, and explains why finance matters to every other function.

🎯What you need to be able to do

  • Explain the role of finance for businesses.
  • Distinguish between capital expenditure and revenue expenditure, with examples.

📚The business management

The role of finance

Businesses need finance to:

  • start up: buy premises, equipment and initial stock before any revenue comes in;
  • run day to day: pay wages, suppliers, rent and bills, bridging the gap between paying costs and receiving revenue (working capital, 3.7);
  • grow: new outlets, new products, acquisitions (1.5);
  • replace and upgrade worn-out or outdated assets;
  • survive shocks: a fall in sales, a pandemic, late-paying customers;
  • fund research and development and marketing campaigns that pay off later.

The finance function also records and reports financial performance (final accounts), analyses it (ratios), and helps managers plan and control (investment appraisal, budgets).

Capital and revenue expenditure

Two boxes. Capital expenditure: spending on non-current assets used for more than a year, such as a new kiln, delivery van, building, computers or website, shown on the balance sheet. Revenue expenditure: spending on day-to-day running costs used up within a year, such as wages, raw materials, rent, electricity, repairs and advertising, shown in the profit and loss account.
The two kinds of spending, and where each appears in the accounts.
Capital expenditure
spending on non-current (fixed) assets that will be used for more than one year: land, buildings, machinery, vehicles, computers, software. Usually large and infrequent; financed by long-term sources; recorded as assets on the balance sheet and spread over time as depreciation.
Revenue expenditure
spending on the day-to-day running of the business, used up within a year: wages, raw materials, rent, utilities, advertising, repairs and maintenance. Regular; financed from revenue or short-term sources; recorded as costs in the profit and loss account.

Why the distinction matters: it determines where spending appears in the accounts and therefore the profit figure; it guides the choice of finance (matching long-term assets with long-term finance); and misclassifying spending (treating a running cost as an asset) would overstate profit, which is why auditors check it.

✏️Worked example

A pottery studio in Ubud spends the following in one year: (a) $12 000 on a new electric kiln; (b) $3000 on clay and glazes; (c) $600 to repair the old kiln; (d) $2500 on a new website; (e) $18 000 on wages. Classify each and explain one case that is easy to get wrong.

Capital expenditure: (a) the kiln and (d) the website, both used for several years. Revenue expenditure: (b) clay and glazes, (c) the repair, and (e) wages.

The repair is the common trap: it keeps an existing asset working rather than creating a new one, so it is revenue expenditure. An upgrade that improves the kiln’s capacity for years would be capital expenditure.

Check it. Ask: will the business still benefit from this spending in more than a year? If yes, it is capital expenditure.
Classifying by size. A large wage bill is still revenue expenditure; a cheap laptop used for three years is capital expenditure.

📝Practise

Work through these on paper, then reveal the answer.

1. [2 marks] Define the term capital expenditure.
Spending on non-current assets such as buildings, machinery and vehicles that will be used by the business for more than one year.
2. [2 marks] Distinguish between capital expenditure and revenue expenditure.
Capital expenditure buys long-term assets used for more than a year (on the balance sheet); revenue expenditure pays day-to-day running costs used up within the year (in the profit and loss account).
3. [2 marks] Classify: a delivery van; fuel for the van; insurance for the van; a new GPS system installed in the van.
Van: capital. Fuel: revenue. Insurance: revenue (a running cost, renewed each year). GPS system: capital (a lasting improvement to the asset).
4. [4 marks] Explain two reasons why a new business needs finance before it starts trading.
(1) To buy non-current assets such as equipment and premises (capital expenditure) needed to produce anything. (2) To pay start-up running costs (initial stock, wages, rent, marketing) before revenue arrives, because customers pay only after goods or services are delivered.
5. [4 marks] Explain why a business should normally finance capital expenditure with long-term sources.
Capital assets generate benefits over many years, so repaying the finance over a similar period matches costs with the returns the asset produces. Using short-term finance (an overdraft) would require repayment before the asset has generated enough cash, creating liquidity problems and higher interest costs.
6. [4 marks] Explain how misclassifying revenue expenditure as capital expenditure would affect a firm’s profit.
Revenue expenditure should be deducted as a cost in the profit and loss account. If it is wrongly treated as an asset, costs this year are understated, so profit is overstated (and assets on the balance sheet are too high). This misleads investors and lenders and may lead to paying more tax or dividends than justified.

🔗Go deeper — other people’s work

These are external resources, not mine. If one stops working, tell me and everything above it on this page still stands.

  • AccountingCoach — free explanations of capital and revenue expenditure.
  • Company annual reports — look for “capital expenditure” (capex) in the cash flow statement.
  • Investopedia — definitions of key finance terms.