1.3 - Putting a business idea into practice

Question 1

What are financial objectives? Identify 4 examples of a financial objective.

Answer 1

Targets expressed in monetary terms such as:

• Survival
• Profit
• Financial Security
• Market Share

Question 2

What are non-financial objectives? Identify 5 examples of non-financial objectives.

Answer 2

Targets that are not expressed in monetary terms:

• Personal Satisfaction
• Challenge
• Independence
• Control
• Helping Others, these are also known as social objectives, eg to donate a portion of profits to a charity

Question 3

Why do businesses aims and objectives differ?

Answer 3

• If the business grows its aims will need to evolve
• The industry it operates in will be different and so what is relevant for one industry may not be relevant or possible for another
• The type of business e.g. some businesses may be focussed on social objectives whereas others will be profit driven.

Question 4

Explain the difference between fixed and variable costs.

Answer 4

Fixed costs do not change regardless of the quantity produced, whereas variable costs change with the number of products produced.

Question 5

Identify examples of fixed costs.

Answer 5

Fixed costs :

• Rent
• Insurance
• Salaries
• Interest
• One off payments such as advertising, equipment

Question 6

Identify examples of variable costs.

Answer 6

Variable costs :

• Stock
• Raw materials
• Ingredients
• Wages

Question 7

Define the term interest.

Answer 7

Interest is the reward for saving or the cost of borrowing.

Question 8

Define the term break-even point.

Answer 8

The break-even point is the level of output where total revenues are equal to total costs; this is where neither a profit or loss is being made.

Question 9

What is the margin of safety?

Answer 9

The difference between the actual or projected level of output and the break even level of output.

Question 10

What happens to the break even point if your total costs fall?

Answer 10

The BEP will fall, the business will reach the break-even point sooner and thus is likely to make a profit sooner.

Question 11

What happens to the break even point if your fixed costs increase? How might the business respond?

Answer 11

The BEP will rise, and you may need to try and increase your price to cover the increase in costs or look to reduce your variable costs.

Question 12

What happens to the break even point if you increase the sale price?

Answer 12

The BEP will fall, and you will break-even sooner, provided the number of sales don’t fall drastically as a result.

Question 13

Define the term cash flow.

Answer 13

The movement of cash in and out of the business. Cash is used to pay the day-to-day expenses of a business such as stock, utilities, salaries and wages.

Question 14

Explain the importance of cash flow to a business?

Answer 14

A positive cashflow is needed in order to pay its expenses such as their suppliers, overheads, and employess. If these expenses are not paid the business will not be able to operate or carry out its core activity and may be in danger of business failure.

(alternative answer)

Cash flow is vital in preventing insolvency, which means the business is unable to pay its bills, as a result if the business is insolvent they may be forced to sell assets, use ovedrafts or take out loans in order to cover its costs, which will increase the chances of business failure if debt levels are too high.

Question 15

How can a business improve its cash flow?

Answer 15

• Increase inflows; either by raising prices or trying to sell more
• Reduce outflows; reducing prices paid for stock or cutting down on advertsing or changing suppliers, reducing the number of temporary workers
• Sources of finance, e.g. trade credit, loans, investment can be used to increase inflows, but they must be accounted for in the outflows too.

Question 16

What is the difference between long and short - term sources of finance?

Answer 16

Long-term sources of finance are borrowed or invested typically for more than a year. A source of finance is also considered long term if it does not need to be paid back.

Short term sources of finance have to be repaid either immediately or fairly quickly, such as an overdraft, usually within a year.

Question 17

For each of the following sources of finance- define the term, idenitfy whether they are internal or external and short term or long term:

1. Trade credit
2. Overdraft
3. Share capital
4. Crowdfunding
5. Selling assets
6. Venture capital
7. Retained profit
8. Loans
9. Personal savings

Answer 17

1. Trade credit: external, short-term. where you can buy suplpies/items and pay later. Credit terms are usually 7, 14 or 30 days.
2. Overdraft: external, short-term. Where the business can take out more cash than it has up to an agreed limit.
3. Share capital: external, long-term. Where investors buy a percentage share in the business in return for a share of the profits/control.
4. Crowdfunding: external, long term. Crowdfunding is the use of small amounts of capital from a large number of individuals who choose to help fund a new business venture, which does not need to be repaid.
5. Selling assets: internal, long term. Where the business sells something that it owns, eg land, machinery.
6. Venture capital: external, long term. Where investors/groups of investors agree to purchase a share of a business, they expect high returns quickly. They tend to only invest in businesses with high potential returns.
7. Retained profit: internal, long term. Using profit made historically in a business.
8. Loans: external, long term. Loans are usally obtained from banks and tend to be between 1 and 5 years.
9. Personal savings: external, long term. When sole traders/partnerships start businesses they often use their own funds from their personal bank accounts to start the business.

Question 18

Identify the advantages and disadvantages of venture capital. (Hint: think Dragons Den!)

Answer 18

Advantages:

• Can raise large amounts
• You do not need to repay the amount invested
• Can provide credibility to your business, depending upon who the venture capitalist is
• The venture capitalists can provide expert advice

Disadvantages:

• The venture capitalists are part owners, so you lose a % of your business, which can affect control and decisions
• Can be difficult to obtain as they tend to target businesses offering high rates of return or with high growth potential
• Negotiation procedures can be lengthy if agreements are not met

Question 19

Identify the advantages and disadvantages of crowdfunding.

Answer 19

Advantages:

• Can raise large amounts and donors can contribute small amounts
• You do not need to repay the amount raised
• Can gain some interest and publicity for your business before it begins

Disadvantages:

• You are reliant upon people willing to donate to your venture, which because they can donate small amounts can take some time to raise the aount needed
• You may need to provide some incentives to donors, such as discounts, free items

Question 20

Identify the advantages and disadvantages of an overdraft.

Answer 20

Advantages:

• Assists cash-flow as you can use it to cover day-day expenses
• Can be easily obtained if you have a current account
• It is only borrowed when needed which cuts down the interest

Disadvantages:

• Interest is charged on the amount you are overdrawn.
• Interest and fees can be quite high, certainly higher than a loan.

Question 21

Identify the advantages and disadvantages of trade credit.

Answer 21

Advantages:

• Assists cash-flow as you can pay later but benefit from the goods immediately
• Goods can be obtained quickly even if you have not got the funds available immediately
• No interest charged

Disadvantages:

• If you breach payment terms then the relationship with your supplier may be strained
• May stop supplying if you do not pay on time

Question 22

Identify the advantages and disadvantages of loans.

Answer 22

Advantages:

• Can raise large amounts and they are relatively straightforward to apply for with quick decisions usually available
• Can be paid back by spreading payments over long periods of time

Disadvantages:

• Interest must be paid, the higher the risk often higher the rate of interest if you do not qualify for low rate loans
• If a business is in difficulty then they may not qualify for a loan, so it can be hard to obtain
• You may need to put up security, such as a fixed asset to use as collateral (ie if you cannot repay, the bank can take the asset)

Question 23

Identify the advantages and disadvantages of share capital.

Answer 23

Advantages:

• No interest to pay; like with a mortgage/loan and it does not have to be paid back
• Can be used to gain large amounts
• Quite low risk, as the investors take on the risk

Disadvantages:

• Possible loss of control, depending on how many shares are issued. A public limited company may be susceptible to takeovers if this type of finance is used.
• Often shareholders aims conflict with the company aims, e.g. dividends v profits
• You will need to pay dividends, though the amount is determined by the company and dependent upon profits

Question 24

Identify the advantages and disadvantages of selling assets.

Answer 24

Advantages:

• Assist cash-flow as depending upon the asset it may sell quickly
• No ongoing cost involved/No interest charged
• Low risk

Disadvantages:

• Could jeopardise production/productivity if the asset is still in use
• May make a loss, as asset may have been purchased at a higher price
• If you have difficulty selling the asset it may delay access to funds
• Less contingency then if something happens

Question 25

Identify the advantages and disadvantages of retained profit.

Answer 25

Advantages:

• No interest to pay; like with a mortgage/loan
• No loss of control
• Can be obtained quickly
• Can be large depending on the level of profit made, for smaller companies this may be more limited though

Disadvantages:

• If there is low profits then access to a large amount will be limited
• May be unpopular with shareholders as they want higher dividends (if a private or public limited company)
• Less contingency then if something happens

Question 26

Identify the advantages and disadvantages of personal savings.

Answer 26

Advantages:

• No interest to pay; like with a loan or mortgage
• No loss of control; you are not having to invite other owners in, therefore you retain control
• Can be achieved quickly as the owner just needs to transfer the funds into the business

Disadvantages:

• Limited to the amount that the owners have, may not be enough
• If the business is a sole trader or a partnership then all the funds could be lost (along with their house) because of unlimited liability
• Takes away from something else, there is an opportunity cost